Rockhopper Exploration — Sea Lion funding outlook strengthened

The entry of an additional partner into the JV brings further industry validation and improves the likelihood of securing project financing for Phase 1 of the Sea Lion development. Rockhopper is now fully funded from the start of 2020 through to completion of Phase 1 of the project, which will develop 250mmbbls of gross resources. In addition, a contingent consideration of up to $48m is payable to Rockhopper by Premier Oil and Navitas for future phases of development in the North Falkland Basin.

Under the terms of the transaction, Navitas will acquire a 30% interest in the PL032, PL004b and PL004c Sea Lion licences, leaving Rockhopper with 30% and Premier with 40% (and operatorship) across all three licences. This alignment will simplify and streamline commercial arrangements across the JV and avoid a potentially intricate unitisation among licences. Rockhopper will also receive contingent payments of up to $36m from Premier’s and Navitas’s share of Phase 2 cash flows, linked to production performance. Phase 2 will commercialise a further c 300mmbbls gross resources focused in the southern part of Sea Lion straddling PL032 and PL004, and including the Zebedee discovery, and is expected onstream five years after Phase 1 start-up.

The deal does not cover licence PL004a, in which Rockhopper currently holds a 64% working interest. However, it does include an option for Navitas and Premier to acquire working interests in PL004a (of 30% and 4% respectively) and further align working interests across PL032 and PL004. Navitas and Premier would pay a consideration of $12m from their shares of Phase 3 cash flows. The licence area holds the oil-bearing Isobel-Elaine complex.

Finalisation of the sale and purchase agreement is expected during Q120. The farm-down completion, targeted for Q220, is conditional on the approval of the Falkland Islands Government. Following completion, but prior to 1 April 2021, Navitas can exercise a withdrawal right, subject to certain conditions, including a Phase 1 final investment decision (FID) not having been taken.

The progress of the PIM, a key milestone towards FID for Sea Lion, was held up as a result of the general election, but is now expected to move forward as new ministerial appointments are made.

Navitas Petroleum is an oil and gas E&P partnership mainly focused on North America. The company’s production assets include the conventional onshore Neches field, and the offshore Buckskin field, while the offshore Shenandoah project is at the development stage. Shenandoah is expected to take the company’s production to more than 40,000bopd by 2023. Navitas also holds high-impact exploration prospects offshore Canada, in Block 7. The company is publicly traded on the Tel Aviv Stock Exchange and its chairman, Gideon Tadmor, was CEO and Chairman of Delek Group’s upstream companies, where he was instrumental in the discoveries of the multi-tcf Tamar and Leviathan fields.

Rockhopper’s JV partner Premier has also announced the proposed UK North Sea acquisitions of the Andrew and Shearwater fields from BP for $625m and an additional 25% interest in the Premier-operated Tolmount Area from Dana for $191m plus contingent payments of up to $55m. The additional free cash flow that will be generated by these assets will accelerate debt reduction and the company estimates that it will significantly reduce its forward covenant leverage ratio towards 1x by 2021. However, Asia Research and Capital Management (ARCM), which has had a growing short position in Premier shares since 2017, and describes itself as Premier’s largest creditor, said it would ‘take all steps’ to oppose the North Sea deals. Premier expects to confirm details of the issue in Q120. Assuming the deal is completed, strengthening the company’s financial position should further support the Sea Lion project finance discussions.

In March 2017, Rockhopper started international arbitration proceedings against the Republic of Italy in relation to the Ombrina Mare field it acquired from Mediterranean Oil & Gas. Rockhopper believes it has strong prospects of recovering ‘significant monetary damages’ based on lost profits as a result of the Republic of Italy’s breaches of the Energy Charter Treaty. We estimate this will be recoverable at c $20m on a risked basis in our valuation using a simplified approach, which assumes a 50% chance of recovering the associated acquisition costs. We have not carried out a loss of profits calculation but press reports suggest it could be materially higher, with the claim running up to €275m plus interest. Clearly, there is material upside to our valuation in the event of a damages award to Rockhopper. Indicatively, a $50m award to Rockhopper net of costs would be worth up to 8.5p/share to equity holders. On 26 June 2019, the tribunal rejected Italy’s request for the suspension of the arbitration and Italy’s intra-EU jurisdictional objections. Rockhopper expects a final outcome and potential damages award in the next three to six months.

We value Rockhopper’s asset base using a conventional risked net asset value (NAV) approach, based on a risked valuation for proven reserves, and contingent and prospective resources. Key assumptions in our valuation include estimates of production profiles, asset development costs and operational costs in addition to realised commodity prices and costs of capital. We use publicly available sources for key assumptions, including company guidance.

We have updated our forecasts and NAV to reflect the Heads of Terms agreed between Rockhopper, Premier Oil and Navitas, in which RKH’s participating interest in Sea Lion licences was settled at 30%, the same as Navitas, while Premier retains 40% and remains the operator of the licences. As per the agreement, RKH will be funded by Premier and Navitas from 1 January 2020 to Phase 1 project completion (estimated to occur 9–12 months after first oil from Phase 1). The company was granted an interest-free loan by its partners to fund project development, which will be repaid from 85% of Rockhopper’s working interest share of free cash flow. We assume FID will be taken in H220 and first oil for Sea Lion Phase 1 in mid-2024. We continue to base our valuation on a long-term oil price expectation of $70/bbl Brent from 2022 inflated at 2.5% onwards. The NAV table below, in Exhibit 2, provides a breakdown of our valuation by asset.

Rockhopper currently trades at 20.2p/share relative to our risked valuation of 53.7p/share. Even though an increase in the share price was observed following the deal announcement, the equity market still appears to be taking a more pessimistic view of Sea Lion Phase 1 and/or lower oil price expectations compared with our base case. The current share price suggests an implied chance of success of c 30% for Phase 1 at $70/bbl or c 55% at $60/bbl, similar to current oil prices. We believe the project is more likely to proceed than not, now reinforced by the Navitas deal, hence our 55% commercial chance of success for Phase 1.

Our estimated production profile is in line with company guidance for c 250mmbbls in Sea Lion Phase 1 and c 300mmbbls in Sea Lion Phase 2. Sea Lion Phase 2 is estimated to come online approximately five years from first oil at Phase 1. However, there is no development plan in place for the project. As per the agreed deal with Navitas, the existing funding arrangements between Rockhopper and Premier will be replaced for Phase 2. Rockhopper will receive contingent payments of up to $36m from Premier’s and Navitas’s share of Phase 2 cash flows, linked to the achievement of certain production and oil price milestones.

Rockhopper ended H119 with c $27m of cash on the balance sheet and no debt, in line with our estimates. With the disposal of Abu Sennan, our forecast Italian asset capex and SG&A are covered for the coming years at c $5.4m pa. As a consequence of the Navitas farm-in, Rockhopper is fully funded through to Sea Lion Phase 1 project completion given the newly agreed interest-free loan from Navitas and Premier. We are accounting for this partnership loan in the company’s balance sheet; however, we do not believe Rockhopper will need to access any additional funding for Sea Lion Phase 1 development. Funding for the project to the joint venture is expected to be split into vendor financing, export credit/bank finance and upstream partner equity.