Professional Documents
Culture Documents
24 October 2014
MULTIPLE RECS
Unconnected research
The Falkland Islands Explorers Multiple recommendations
Stocks reviewed
2015 will see the first Falklands exploration drilling in three years. Ahead of
BORDERS & SOUTHERN PETROLEUM PLC
the campaign, we initiate coverage on the regions three key small-cap stocks.
Initiated: Recommendation
Falkland Oil & Gas is fully funded and has material upside, making it our top
Price
pick. Peers face more obstacles but stand to benefit from drilling success.
Target price
HOLD
8.63
18.00
BUY
Price
28.00
Target price
41.00
BUY
Price
268.10
Two of FOGLs 2015 wells will target very significant exploration prospects in the South
Basin, in partnership with US independent Noble Energy (not rated). Furthermore,
FOGL has greater leverage than peers to attractive exploration in the North Basin. As
such, the company is our preferred way to play the upcoming drilling campaign.
Initiated: Recommendation
Price
HOLD
72.00
Target price
212.00
All data as of close 23 October 2014
$IsPrinted$
Contributing analysts
Sales
Robin Haworth
Dragan Trajkov
UK Sales desk
robin.haworth@orielsecurities.com
dragan.trajkov@orielsecurities.com
THIS DOCUMENT INCLUDES RESEARCH WHICH IS A MARKETING COMMUNICATION. It is not investment research and has not been prepared in accordance with legal requirements designed
to promote investment research independence and is also not subject to any prohibition on dealing ahead of the dissemination of investment research. Where a stock is indicated with *, Oriel
Securities has designated research as Connected. Please refer to the back of this document for important disclosures and our research disclaimer.
Table of contents
Investment case: once more unto the breach ...................................................................... 3
The 2015 campaign .................................................................................................................................. 3
Net
Net prospective
Risked ENAV*,
Unrisked ENAV*,
Com pany
w ells, #
w ells, #
resource, m m bbls
% of current s.p.
% of current s.p.
US$m
Premier Oil
1.7
221
9%
57%
(1526)
(156)
Rockhopper Exploration
1.1
147
48%
174%
213
(53)
2.3
586
390%
1871%
106
(100)
20
Order
Operator (interest)
Licence
Type
Partners
resource (m m bbls)
Zebedee
PL04b
Exploration
165
50
Seal
Isobel
PL04a
Exploration
243
50
Reservoir
PL032
Appraisal / exploration
RKH (40%)
79
50
Reservoir
Jayne E
PL04c
Exploration
73
50
Seal
SFB South
Exploration
510
110
Seal
Well 2*
SFB South*
Exploration
240*
110
tbc
Source: Oriel Securities estimates, company data. *The second SFB target is yet to be confirmed. Resource estimate for SFB well 2 is an average of the remaining prospects.
The rig contractor is Ocean Rig, whose Eirik Raude semi-submersible is a dynamically positioned harsh
environment setup capable of drilling in the deep waters south of the Falklands. Despite the fact that the
same rig will be used throughout, differences in complexity and expected duration of the wells means
that those in the North Basin are expected to be significantly cheaper, at c.US$50m, than those in the
South Basin (c.US$110m). Operations are expected to commence in late Q1 or early Q2 2015 and the
firm campaign is expected to take around 240 days. The sixteen contingent drilling slots comprise eight
options that can be exercised prior to rig mobilisation and up to eight further options that can be elected
during the drilling campaign.
Valuation
In line with our valuation methodology for exploration companies, our pre-drill target price for Falkland
Oil & Gas is based on the read-through value of the companys farm-in transactions (farm-in value), the
remaining value of exploration expenditure carried by partners and FOGLs cash position. This sums to
41p/shr and, accordingly, we set our target price at this level. From this we conclude that the equity
market valuation of FOGL is less than the industry valuation of the same assets, which we do not think
is sustainable. That the upside to our valuation, expressed in terms of the risked value of exploration
drilling, as shown in Figure 4, below, is significantly higher. Importantly, FOGLs net cost exposure to the
entire firm drilling campaign is funded from anticipated YE cash resources of US$106m and outstanding
cost carries from partners. The firm drilling programme is anticipated to cost c.US$100m (net) and
additional wells (or, potentially, significant cost overruns) may therefore require further funding.
Figure 3: Target price derivation
US$m
p/sh
56
97
11
106
12
Remaining promote
98
11
358
41
1.65
217
534
Source: Oriel Securities estimates
A methodological note: our farm-in value, above, is calculated based on two transactions: firstly, the
companys August 2012 farm out of its two South Basin licences to Noble Energy, which saw the latter
pay an estimated US$70m in aggregate exploration carries for a 35% stake. This implies a gross value
for the blocks of c.US$200m, or US$97m net to FOGLs 40-52.5% stake (FOGLs June 2012 farm-out
transaction with Edison SpA implies a slightly higher value of US$213m). Secondly, in December 2013,
FOGL completed a transaction with Rockhopper Exploration and Premier Oil in which it agreed to
receive a full carry on two wells in the North Basin, valuing the blocks at US$47m each, or an aggregate
US$56m net to FOGLs 40% stake.
At this stage we have included no value in our target price for a potential unitisation of the Sea Lion
oilfield, which from 3D seismic and well data is known to extend into FOGLs North Falkland Basin PL04
licence. This is because there can be no certainty on whether unitisation will proceed and on what terms
since, although hydrocarbon regulation in the Falklands has largely followed UK precedent to date, the
Falkland Islands Government is an independent body and is under no obligation to continue to do so.
However, it is worth noting that Rockhopper Exploration sees Sea Lions Phase II development as
accessing c.90 mmbbls of gross PL04 resources, which net to FOGLs 40% stake would be worth
c.15p/shr on a fully un-risked basis. Should there be material progress in on-going unitisation
negotiations between the parties, or if the existing JV were to succeed in farming out Sea Lion, this
would bring the issue into sharper focus and could provide material upside.
In Figure 4, below, we calculate the risked and un-risked value of next years exploration drilling
campaign. This table shows the very substantial potential upside (111p risked / 533p unrisked)
associated with exploration south of the Falkland Islands in particular. We do not use this calculation as
the basis for our pre-drill target price. At US$80 oil, the risked value of exploration diminishes by 30%.
Figure 4: Exploration NAV summary (US$100 oil)
Country
Asset
Interest
%
Falklands
Zebedee
Falklands
Jayne E
Falklands
Isobel
Falklands
Humpback
Falklands
South Falklands well 2
Exploration assets
40%
40%
40%
52.5%
52.5%
66
29
97
268
126
586
NPV
US$/boe
3
3
3
10
10
8
NPV
US$m
80
25
67
548
258
978
26
11
38
311
147
533
There is, of course, a caveat that the deep-water Darwin discovery is a gas condensate rather than oil
field, and therefore something of an unknown development proposition in this remote area. The valuable
condensate would have to be stripped from the gas upon extraction, and while this might well be
technically feasible, there are few analogue developments worldwide and, to our knowledge, none that
operate standalone in equally deep water. There are encouraging indications for an oil charge in the
basin, and an upside case exists in which a down-dip oil leg is present at Darwin. However, this cannot
be proven from existing data and would require further appraisal to test. As such, we are cautious over
whether a potential farm in partner would take the risk ahead of third party drilling in the region, which
might allow for some of the uncertainties to be resolved at others expense.
Valuation
We base our target price for Borders and Southern on the implied value of near geographical neighbour
FOGLs southern licences in the SFB, US$120m. We calculate this value via a read-through from the
latters farm-out transaction with Noble Energy in 2012, which we estimate provided FOGL with carried
exploration costs of c.US$42m (relating to its southern SFB licences alone) for a 35% stake. This plus
cash sums to 18p/shr. In contrast to our FOGL target price, it is of course worth noting that Borders has
not executed such a transaction as yet. As such, while we would expect the shares to re-rate to the level
of our target price in the event that a deal is executed, there can be no certainty that this will occur.
Indeed, given Borders current balance sheet position, a farm-out on these terms would likely allow the
company to drill just one appraisal or exploration well without recourse to additional, potentially highly
dilutive equity financing. Since this would not represent the kind of comprehensive, 3+ well drilling
programme that would be needed to fully evaluate the potential resource in Darwin and nearby
structures, we question whether management would approve such a transaction (although there is of
course an opportunity cost to missing next years campaign, which we have not attempted to quantify).
Figure 6: Target price derivation
US$m
p/sh
120
15
20
140
18
Other assumptions
Long-term FX assumption, US$/
1.65
85
484
Source: Oriel Securities estimates
We do not ascribe any value for the Darwin discovery itself in our target price, given that the field
requires at least two appraisal wells before commerciality can be established, for which, as noted
above, Borders does not currently have sufficient funding. This is in contrast with the Sea Lion
discovery, for instance, which thanks to its largely appraised status we do include in our Rockhopper
target price despite the development being far from assured. Nevertheless, we do regard a Darwin area
condensate development as being potentially highly attractive if sufficient volumes can be aggregated,
for instance in the case that discovery is made at the nearby FOGL/Noble prospects Scharnhorst
(188mmbbls) or Nurnburg (where the partners technical evaluation is still on-going). Figure 7 illustrates
the potential net asset value of the Darwin discovery alone, which is theoretically very significant.
Figure 7: Darwin NAV summary (US$100 oil)
Country
Asset
Falklands
Darwin
Contingent assets
Interest
%
100%
263
263
258
258
32
32
323
323
Recommendation
We initiate coverage with an HOLD recommendation. This is based on the fact that Borders fate is not
in its own hands until it farms out. While in the continuing absence of a transaction it may offer passive
exposure to attractive South Falkland Basin exploration drilling by third parties, the read-through may be
limited in the case that third parties decide not to target Darwin-lookalike prospects (i.e. if the two firm
wells are both located in the Diomedia area). Either a farm-out or third party drilling success in the
Darwin area would offer upside, while we think the downside is limited to the 3p/shr of cash.
net capital expenditure. Our highly idealised scenario, below, suggests that retention of c.20-25%
equity in the project would represent a reasonable outcome to this second farm-out process. This
conclusion is illustrated graphically in Figure 8, below. Meanwhile, the problematic structure of the
existing arrangement can be illustrated by comparing this idealised transaction with the original deal
between Premier and Rockhopper, in which the latter effectively received a full carry (via access to a
standby financing facility from Premiers balance sheet), yet was able to retain 40% of the asset.
In modelling an idealised transaction, our starting point is to assume that the Sea Lion project NPV of
c.US$2.1bn (at US$100 oil) is fungible with cash, and can therefore be transferred between parties in
exchange for the acquirer paying an equivalent amount in project capex on behalf of the seller. To
calculate the degree of equity transfer needed for a sellers retained capex to be zero (i.e. for it to
receive a full carry), it is necessary to equate the NPV sold with the level of capex retained.
Expressed mathematically, this is found by solving the equation {(1-r)NPV = rcapex} for r, where r is
the equity retained by the present owner and both NPV and capex are gross (i.e. whole project). Given
our estimate of Sea Lion capex (US$5.8bn) and NPV, we conclude that Rockhopper should have had
to sell down c.70-75% of the asset to pay for the remaining 25-30% of capex (i.e. r = 25-30%), while a
greater proportion of equity would have to be sold at lower oil prices (we estimate c.85% at $80 oil).
Figure 8: Carry modelling at Sea Lion [see text for explanation]
3,000
2,000
1,000
-
Full carry
US$m
(1,000)
(2,000)
(3,000)
(4,000)
(5,000)
(6,000)
(7,000)
100 95
90
85
80
75
70
65
60
55
50
45
40
35
30
25
20
15
10
Valuation
Sea Lion sensitivity to oil prices
It is worth noting that Sea Lion exhibits a relatively high degree of cost sensitivity to oil prices, due
principally to the Falklands tax and royalty regime and the front-loaded capex structure. Our estimate of
gross project NPV/bbl under differing oil price scenarios is presented in Figure 9, below. These figures
exclude the US$722m cost carry that Rockhopper is set to receive from Premier Oil, which would
significantly enhance Rockhoppers economics (and diminish Premiers) compared to the numbers
presented. Our Sea Lion asset model is discussed in more detail in Appendix 1. As an illustration, at the
current level Rockhopper is trading at an EV/2C barrel of c.US$2.4.
Figure 9: Sea Lion gross project NPV, US$/bbl
Discount rate, % Brent oil price, US$/bbl:
6.9
10%
12%
14%
80
4.9
3.3
2.1
100
9.2
6.9
5.1
120
13.5
10.5
8.1
Source: Oriel Securities estimates
Asset
Interest
%
40%
24%
24%
24%
Falklands Chatham
Falklands Zebedee
Falklands Jayne E
Falklands Isobel
Exploration assets
NPV
US$/boe
7
3
3
3
5
Risked NPV
US$m
109
48
15
40
212
Recommendation
Target price derivation
Given our view that the Sea Lion commercial arrangement is likely to be reset in a second farm-out,
we value Rockhoppers 40% stake in the project using the un-carried NPV/bbl value of US$6.9, rather
than a carried per-barrel value which would be significantly higher. This yields a value of US$809m at
US$100 oil. We value its 24% stake in NFB exploration licences at US$34m based on the implied
value of its farm-in to PL04, in which it, alongside Premier Oil, agreed to carry FOGL for two
exploration wells. We value the Mediterranean Oil & Gas assets at cost. Net of corporate items, this
sums to 212p/shr and we set our target price at this level. Although this does offer significant upside,
we believe the key price driver will be a commercial resolution at Sea Lion, which may have to wait for
the completion of exploration drilling. Furthermore, Sea Lions sensitivity to oil prices is such that, at
US$80 oil, our target price would fall to 124p/shr, c.40% below our US$100 oil target price. Both of
these facts suggest that a re-rating could be some way off, and as such we initiate at HOLD.
Figure 11: Target price derivation
NPV12 of 40% of Sea Lion development
US$m
p/sh
809
168
34
48
10
213
44
Cash at Mar-15
Net exploration promote
26
-107
-22
1023
212
Other assumptions
Long-term FX assumption, US$/
1.65
620
292
Source: Oriel Securities estimates
10
the
the
the
the
Scotia (FOGL)
Gas shows in tight L.
Cretaceous reservoir
1,000m
water depth
Falkland Islands
Loligo (FOGL)
Tertiary target
2,000m
water depth
Toroa (FOGL)
Good L. Cretaceous
reservoir but dry hole
Figure *
Discovery
Figure *
Likely location of
firm 2015 well
200 km
11
Figure 13: Drilling history of the South and East Falkland Basins
Well
Date
Operator
Target
Prospect type
Result
Reservoir quality
Toroa
Jul-10
L. Cretaceous
Stratigraphic
Dry
Minor
Good
Good
Darw in East
Apr-12
L. Cretaceous
Structural
Gas condensate
n/a
Stebbing
Jul-12
Tertiary
Structural
Dry
Yes
Fine grained
Loligo
Sep-12
Tertiary
Stratigraphic
Dry
Yes
Fine grained
Scotia
Nov-12
L. Cretaceous
Stratigraphic
Dry
Yes
Fine grained
Source: Company data
How far North does good L. Cretaceous reservoir extend? [Not proven by Scotia / Loligo]
Is the Darwin shallow water sandstone widespread and of good quality across the South?
Is the slope fan play viable, either in B&S or FOGL acreage?
(Is there any reservoir potential in the Tertiary section?)
1,000m
water depth
Scotia (FOGL)
Gas shows in tight L.
Cretaceous reservoir
Falkland Islands
Loligo (FOGL)
Tertiary target
Deep water
Volunteer Basin
??
L. Cretaceous shelf
reservoir (Oriel
estimate)
Toroa (FOGL)
Good L. Cretaceous
reservoir but dry hole
500m water
depth
2,000m
water depth
Deep water Fitzroy Basin
Likely location of
firm 2015 well
Shelf sand
Slope sand
Stebbing (B&S):
Gas shows in Tertiary reservoir
200 km
Source: Oriel Securities estimates; Falkland Oil & Gas; Borders and Southern Petroleum
12
As shown in Figure 13, the basins two Tertiary tests, Loligo and Stebbing, found hydrocarbon-bearing
but fine-grained sand intervals of limited thickness and did not flow on test. These results cast doubt on
the Tertiary prospectivity and we do not think it will be an important target of the upcoming campaign.
Is there black oil (as opposed to gas and condensate) in the Darwin area?
Is the undrilled deep water Fitzroy Basin mature for oil or gas?
Is there any potential for an oil charge in the Volunteer Basin?
Scotia (FOGL)
Gas shows in tight L.
Cretaceous reservoir
1,000m
water depth
Falkland Islands
Loligo (FOGL)
Tertiary target
2,000m
water depth
Toroa (FOGL)
Good L. Cretaceous
reservoir but dry hole
500m water
depth
Deep water
Volunteer Basin
(gas mature)
Likely location of
firm 2015 well
Oil-mature area
Thrust front
Gas-mature area
200 km
Stebbing (B&S):
Gas shows in Tertiary reservoir
13
14
15
16
17
18
120
100
3,000
60
40
1,000
20
-
Production, kbbls/d
2,000
-20
(1,000)
-40
(2,000)
-60
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
2028
2029
2030
2031
2032
2033
2034
2035
2036
2037
2038
2039
2040
2041
2042
2043
80
Contractor cashflow
19
20
21
Rockhopper Exploration
Dr Pierre Jungels CBE, Non-Exec Chair: Dr Jungels, a certified engineer with a PhD from CALTECH,
was CEO of Enterprise Oil Plc from 1996 to 2001, MD of Exploration and Production for BG Plc in 1995
and has worked for 23 years with Petrofina SA including eight years on the main board. He is a nonexecutive Director of Baker Hughes Inc. and is Chairman of AIM-quoted Velocys plc. He was twice
President of the Institute of Petroleum, from 1987 to 1989 and 2002 to 2003.
Sam Moody, CEO: a co-founder of Rockhopper and responsible for building and managing the group
from its formation in early 2004. He previously worked in several roles within the financial sector,
including positions at AXA Equity & Law Investment Management and St Pauls Investment
Management.
Fiona MacAulay, COO: Fiona MacAuley is a geologist with over 25 years of experience in the oil and
gas industry including time at Mobil, Amerada Hess and BG. She joined Rockhopper in 2010
immediately following the Sea Lion discovery and was an integral member of the team which managed
the appraisal of the Sea Lion field and discovered the Casper, Casper South and Beverley fields. Ms
MacAuley was appointed to the Board in March 2013.
Stewart MacDonald, CFO: Prior to joining Rockhopper, Mr MacDonald was a Director in Rothschild's
global oil and gas group and spent twelve years advising clients in the sector on a range of M&A
transactions as well as debt and equity financings. He was appointed to the Board in March 2014.
22
Recommendation history
Premier Oil plc
Date
As at 23-Oct-2013
BUY
Date
Initiated today:
Date
Initiated today:
Recommendation
HOLD
Recommendation
Initiated today:
HOLD
Disclosures on interests
A contributing analyst, or a relevant employee who had or could reasonably be expected to have access to the substance of the research recommendation prior to its
dissemination, has a personal shareholding or other significant financial interest in the securities of the following issuer(s): Premier Oil plc and Rockhopper Exploration
plc.
Oriel Securities is a market maker or liquidity provider in the securities of the following issuer(s): Borders & Southern Petroleum plc, Falkland Oil and Gas Limited and
Premier Oil plc
Oriel Securities has been lead manager or co-lead manager over the previous 12 months of a publicly disclosed offer of securities of the following issuer(s): Falkland Oil
and Gas Limited
Oriel Securities is party to an agreement with the following issuer(s) relating to the provision of investment banking services (including, for example, broking and financial
advisory roles) and the agreement has been in effect over the previous 12 months or has given rise during the same period to a payment or to the promise of payment:
Falkland Oil and Gas Limited
Oriel Securities is party to an agreement with the following issuer(s) relating to the production of research, although the timing and content of the research is exclusively
the preserve of the analyst: Falkland Oil and Gas Limited
Certifications
I, Robin Haworth, certify that the views expressed in this research report accurately reflect my personal views about the subject securities or issuers, and I, Robin Haworth,
certify that no part of my compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in this research report.
23
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24
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