Hurricane Energy — Resource downgrade warning

Hurricane Energy (LN: HUR)

Last close As at 21/11/2024

3.05

0.03 (0.99%)

Market capitalisation

61m

More on this equity

Research: Energy & Resources

Hurricane Energy — Resource downgrade warning

Hurricane’s technical committee has concluded that there is a reasonable probability that the oil water contact (OWC) in the Lancaster field is shallower than the range of OWCs estimated in the 2017 competent person’s report (CPR) by RPS Energy. As a result, the company believes there is a risk that the estimated reserves for the Lancaster early production system (EPS) and the contingent resources across the West of Shetland portfolio will be materially downgraded. Given the range of outcomes which could emerge from the technical review, and less than a month to the interim results on 11 September 2020, we believe suspending our valuation is a prudent move until there is further clarity on reserves, resources and remedial actions being considered to mitigate potential reserve downgrades.

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Written by

Energy & Resources

Hurricane Energy

Resource downgrade warning

Technical and
operational update

Oil & gas

18 August 2020

Price

5.1p

Market cap

£102m

US$1.28/£

Net debt ($m) at 31 December 2019

38.2

Shares in issue

1,991.9m

Free float

81%

Code

HUR

Primary exchange

AIM

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(10.1)

(53.1)

(86.9)

Rel (local)

(8.6)

(56.2)

(85.1)

52-week high/low

47.6p

4.9p

Business description

Hurricane Energy is an E&P focused on fractured basement exploration and development in the West of Shetland region. The company’s 100%-owned Lancaster oil discovery achieved first oil on target in H119.

Next events

Interim results and updated reserves and resource estimates

11 September 2020

Analysts

Carlos Gomes

+44 (0)20 3077 5700

Elaine Reynolds

+44 (0)20 3077 5713

Hurricane Energy is a research client of Edison Investment Research Limited

Hurricane’s technical committee has concluded that there is a reasonable probability that the oil water contact (OWC) in the Lancaster field is shallower than the range of OWCs estimated in the 2017 competent person’s report (CPR) by RPS Energy. As a result, the company believes there is a risk that the estimated reserves for the Lancaster early production system (EPS) and the contingent resources across the West of Shetland portfolio will be materially downgraded. Given the range of outcomes which could emerge from the technical review, and less than a month to the interim results on 11 September 2020, we believe suspending our valuation is a prudent move until there is further clarity on reserves, resources and remedial actions being considered to mitigate potential reserve downgrades.

Year end

Revenue
($m)

EBITDA
($m)

Operating cash flow($m)

Capex*
($m)

Net debt/(cash) ($m)

12/18

0.0

(12.6)

(4.4)

(209.9)

99.5

12/19

170.3

(11.7)

112.2

(55.4)

38.2

Note: *Capex is net of carried investment by Spirit Energy

Shallower OWCs driving lower volumes

In June 2020, Hurricane established a technical committee to carry out a root-and-branch review of its geological and reservoir models, including consideration of a shallower OWC given the higher than expected water production seen in the EPS. The work carried out by the committee to date indicates a reasonable probability that the Lancaster OWC is shallower than the range of OWCs previously estimated, and as such there is a risk of a material downgrade to the Lancaster EPS reserves and to the portfolio contingent resources. Given Hurricane is indicating the OWC is potentially shallower than the range of OWCs previously estimated, Edison anticipates that recoverable volumes from the EPS, on a ‘do-nothing basis’ could be lower than original 1P reserves of 28mmbbl.

Production decline without intervention

The potential reserves downgrade indicates that Lancaster EPS production will likely decline from the current level of c 17,000bod without technical intervention. However, Hurricane is looking at production enhancement options to mitigate potential declines. Prior to the most recent shutdown, both wells were producing since the electrical submersible pumps (ESPs) were commissioned in July 2020.

Valuation and forecasts suspended until interims

Our valuation has been suspended until we can review our forecasts and valuation after the company provides its updated reserves and resources and/or conclusions from the ongoing technical review. We expect that our core NAV could be significantly reduced from our previous estimate of 13.6p/share. Our previous RENAV of 37.1p/share could also potentially be downgraded, especially if the shallower OWC leads to downgrades of contingent resources across the wider West of Shetland portfolio. We note that Hurricane may be able to mitigate some of the impact of this downgrade through remedial actions currently being considered.

Technical review highlights shallower OWC

Hurricane’s technical committee was set up in June 2020 to review the full range of possible geological and reservoir models for the Lancaster field, including to investigate the possibility of a shallower OWC given that water production from the Lancaster wells had been higher than expected from existing production forecasts.

The review is ongoing and has yet to be completed, but at this stage it has become reasonably probable to the committee that the OWC is likely to be shallower than the range of OWCs outlined in the 2017 CPR. The company is now indicating that there is a risk of a material downgrade to the Lancaster EPS reserves and to the contingent resources across the entire West of Shetland portfolio. This assessment does not include any production enhancement options currently under evaluation to mitigate the potential production decline. Hurricane expects to complete the technical review by its interim results, which are due on 11 September 2020.

The Aoka Mizu also underwent a controlled shutdown on 2 August 2020 to undergo inspection, which highlighted the need for repairs.

Lancaster EPS: Volume lower than 1P

A shallower OWC could result in substantially lower volumes than outlined in the 1P case for the Lancaster EPS (the 2017 CPR estimated 2P reserves of 37.3mmbbl and 1P reserves of 28.1mmbbl). In the absence of further technical details from the company at this stage, it is not possible for us to estimate what this volume will be.

We have previously noted that the most recently reported flowing bottomhole pressure seen in the Lancaster EPS (at the 2020 capital markets day) is around 50psi lower than modelled pre start-up for the low case, giving an indication that the reservoir was not responding as originally forecast.

Exhibit 1: Lancaster flowing bottomhole pressure

Exhibit 2: Pre Lancaster start-up bottomhole pressure model

Source: Hurricane Energy

Source: Hurricane Energy

Exhibit 1: Lancaster flowing bottomhole pressure

Source: Hurricane Energy

Exhibit 2: Pre Lancaster start-up bottomhole pressure model

Source: Hurricane Energy

Without any further interventions, the EPS production will, in our view, likely not remain at the current rate of 17,000bod, and will decline as water influx increases. We note that this drop off in production rate is likely to reduce cash flow from our previous estimates and potentially limit the capital available to carry out any technical interventions that the company identifies to enhance production.

In our previous note we outlined a number of remedial options to bring the 205/21a-7z well back into production. Hurricane has since commissioned the ESPs in both wells and, prior to the recent shutdown, the 7z well was producing using an ESP at a rate of c 5,000bod and a water-cut of 53%, while the 205/21a-6 well was flowing naturally at c 12,000bod and a water cut of c 12%. We note that the six well sits around 20m higher than the 7z well, so that water influx here can be expected to lag behind that seen in 7z (assuming that water production could be coming from the aquifer rather than being ‘perched water’ as had initially been assumed).

Valuation

Given the uncertainty surrounding the exact extent of the material downgrade to the Lancaster EPS reserves and to the portfolio contingent resources, we are suspending our valuations (both core NAV and RENAV) until we learn more from the technical review. This will include both assessing production declines and reduced reserves and resources, and also the potential impact of any production enhancement options currently under evaluation.

We expect our Lancaster EPS core NAV could be substantially lower than our last published estimate of 13.6p/share, as we expect EPS total recoverable volumes (absent any production enhancement options) could be below the original 1P case. Furthermore, costs on a per barrel basis will likely increase from our previous estimates as a substantial portion of the Lancaster costs were fixed in nature. Given that the EPS was delivering 18.6p/share within our core NAV of 13.6/share, the downgrade to our core NAV is likely to be substantial.

The impact on our wider RENAV, which also includes both the Lancaster full field development and a portion of the Greater Warwick Area development, is equally uncertain. If Hurricane concludes that a shallower OWC will materially reduce the contingent resources across its wider West of Shetland portfolio then this would also have a significant impact on our RENAV, which we previously estimated at 37.1p/share.

Investors should note that while we expect material reserves and resources downgrades, this does not take into account the potential production enhancement options currently being evaluated. We anticipate learning more about these options along with the conclusions from the review carried out by the technical committee by the company’s interim results on 11 September 2020.

Financials

In our previous note in June 2020 we assessed the ability for Hurricane to cover the Lancaster EPS residual capex, its exploration & appraisal (E&A) commitment wells and repay its $230m convertible bond principal repayment in 24 July 2022 out of cash reserves and EPS cash flows of $183m. We concluded that the company had a modest $43m of headroom to achieve this based on base case EPS assumptions.

Consistent with our approach on valuation, we are suspending forecasts until we learn more about the conclusions of the technical review. However, if EPS cash flows are potentially substantially lower than previously thought through to the end of 2022, it is possible we will conclude that the company may not have sufficient cash reserves to pay the bond principal as previously thought.

This would necessitate the company to either refinance this bond or secure additional sources of finance, which could well be a reasonable approach (many oil and gas companies operate in this manner). Ultimately Hurricane’s financing options will be predicated on the technical options available to the company following the technical committee review and any potential production enhancement measures being considered.


Exhibit 3: Financial summary

 

$m

 

2017

2018

2019

Year end 31 December

 

 

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

0.0

0.0

170.3

Operating Expenses

(14.6)

(12.7)

(118.9)

EBITDA

 

 

(14.6)

(12.6)

(11.7)

Operating Profit (before amort. and except.)

 

(14.6)

(12.7)

51.4

Exploration expenses

(10.4)

0.0

(66.5)

Exceptionals

10.4

(42.4)

34.7

Other

0.0

0.0

0.0

Operating Profit

(14.6)

(55.0)

19.7

Net Interest

7.6

(5.9)

(21.5)

Profit Before Tax (norm)

 

 

(7.0)

(18.5)

30.0

Profit Before Tax (FRS 3)

 

 

(7.0)

(60.9)

(1.8)

Tax

0.0

0.0

60.5

Profit After Tax (norm)

(7.0)

(18.5)

90.5

Profit After Tax (FRS 3)

(7.0)

(60.9)

58.7

Average Number of Shares Outstanding (m)

1,583.8

1,959.6

1,978.5

EPS - normalised (c)

 

 

(0.4)

(2.2)

(2.5)

EPS - normalised and fully diluted (c)

 

(0.4)

(2.2)

0.3

EPS - (IFRS) (c)

 

 

(0.4)

(3.1)

3.0

Dividend per share (p)

0.0

0.0

0.0

Gross Margin (%)

NA

NA

30.2

EBITDA Margin (%)

NA

NA

-6.9

Operating Margin (before GW and except.) (%)

NA

NA

30.2

BALANCE SHEET

Fixed Assets

 

 

587.9

884.2

932.5

Intangible Assets

126.4

131.5

75.9

Tangible Assets

445.3

728.2

796.2

Investments

16.3

24.5

60.5

Current Assets

 

 

350.1

106.0

228.7

Stocks

1.4

4.6

9.9

Debtors

4.7

2.6

50.4

Cash

343.9

98.9

168.4

Other

0.0

0.0

0.0

Current Liabilities

 

 

(28.8)

(55.1)

(94.4)

Creditors

(28.8)

(55.1)

(94.4)

Short term borrowings

0.0

0.0

0.0

Long Term Liabilities

 

 

(226.7)

(307.0)

(375.8)

Long term borrowings

(191.1)

(198.4)

(206.6)

Other long term liabilities

(35.6)

(108.7)

(169.2)

Net Assets

 

 

682.5

628.1

691.1

CASH FLOW

Operating Cash Flow

 

 

(8.1)

(4.4)

112.2

Cash tax paid

0.0

0.0

0.0

Capex

(265.7)

(209.9)

(55.4)

Acquisitions/disposals

0.0

0.0

0.0

Financing

322.3

163.4

13.1

Dividends

0.0

0.0

0.0

Net Cash Flow

48.5

(50.9)

69.8

Opening net debt/(cash)

 

 

(98.6)

(152.8)

99.5

HP finance leases initiated

0.0

0.0

0.0

Other

5.7

(201.4)

(8.6)

Closing net debt/(cash)

 

 

(152.8)

99.5

38.2

Source: Hurricane Energy accounts


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This report has been commissioned by Hurricane Energy and prepared and issued by Edison, in consideration of a fee payable by Hurricane Energy. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

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United Kingdom

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Hurricane Energy and prepared and issued by Edison, in consideration of a fee payable by Hurricane Energy. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2020 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1,185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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