Parallel work programmes underway across Hurricane Energy PLC’s (LON:HUR) offshore UK projects present a question that may often roll around the heads of oil executives - what does the market actually want?
More specifically, what do London’s oil and gas ‘investors’ really want – a big bang explorer, or, the slower growth that comes with building a tangible oil production business?
Hurricane is right now in the enviable position of running two very significant programmes, both with major value catalysts.
In the coming weeks and months, Hurricane will deliver ‘first oil’ from the Lancaster field’s Early Production System (EPS).
Instantly, it will cement Hurricane’s position as a meaningful ‘producer’ in the North Sea and UK continental shelf sector, creating some US$200mln of annual cash flow and, importantly, starting a vital phase of data capture.
Over the same period, a Transocean drilling rig will be putting down three potentially high impact wells in the neighbouring Greater Warwick Area (GWA) – the aim is to bulk up the project’s resources, to confirm over a billion barrels of crude, before moving that project into a development scenario.
Hurricane won’t need to spend anything on the GWA wells, thanks to a 2018 farm-out deal with Spirit Energy (69% owned by Centrica PLC) – which is covering up to US$387mln of Hurricane’s total project costs in return for 50% of the assets.
With two very different field programmes underway, plainly this is a busy time for Hurricane.
The Lancaster and GWA programmes will mean quite different things to the different types of ‘investors’ that commit funds to this kind of company.
Punters love a hole in the ground
Delivering an oil or gas field (and then delivering the product to the marketplace) is an intensely technical and complicated business.
Often such projects involve large scale engineering and infrastructure development.
There’s a reason such projects tend to cost hundreds of millions, if not billions, of dollars to executive them.
Expense and expertise aside, such projects also take a long time – and a lot of that time passes with little or no corporate commentary.
Perhaps it is understandable that for some investors, such ventures tend to be a little bit out of sight, out of mind.
Exploration is, in a sense, comparatively quite simple for the lay investor to understand and, once drilling is committed to, the results are more immediate.
Put in perhaps overly simple terms, once drilling is scheduled, investors know the company is going to drill a hole in the ground and at some point shortly thereafter, the company will find out whether there are any hydrocarbons in the hole and whether that discovery has any commercial value.
It is a (comparatively) quick, binary outcome that is usually conclusively good or conclusively bad news for the company and its share price.
There can be little wonder that the shares of such companies are popular among the ‘get-rich-quick’ brigade of speculators and spread bet punters.
For the companies themselves, what this means is that having a regular schedule of new drilling opportunities is a sure fire way to maintain interest from the investment community and keep sufficient capital in the coffers (so long as they keep a decent track record).
Well successes elevated Hurricane
In certain cases, a successful well campaign can pay off big time.
Looking back to Hurricane, it is plain to see that the series of successful discovery and appraisal wells in 2016 and 2017 marked a very significant threshold for the company.
Since then, it has banked over US$0.5bn of funding from private equity backers, it landed a US$387mln partnership with Centrica’s Spirit Energy, and its shares are now valued at around £900mln.
Importantly, the Lancaster field is now on the cusp of production. Producing at a rate of 17,000 barrels daily, Hurricane expects the Lancaster EPS to generate some US$200mln of cash flow per year, assuming a Brent oil price of US$60 (presently cUS$72).
Achieving this will elevate the company into an exploration and production peer group that includes the likes of Premier Oil, EnQuest and Tullow Oil (albeit, in production terms, it remains smaller than those).
Hurricane is no longer comparable to the pre-revenue explorers and frontier drillers, though that has possibly already been the case for some time.
Patience is a virtue, for long-term holders
Companies, and significantly their valuations, can endure a malaise as they transition from big bang exploration driller to field developer and eventually a fully-fledged producer.
Design studies, project financing, and engineering work programmes seemingly don’t attach the same excitement as the roulette wheel experience of frontier exploration.
This is, however, a vitally significant period in the maturation of successful exploration companies.
Moreover, the graduation period into production opens up to a different kind of investor.
No longer is a company the focus of the get-rich-quick brigade. Instead, the shareholder register is increasingly filled with more long-term minded investors.
Concurrently, however, the valuation becomes less about theoretical or future barrels of oil, instead, the company starts being judged by the number of barrels it is actually getting out of the ground.
Financial reporting stops being an almost irrelevant regulatory obligation, and the numbers are scrutinised increasingly.
Suddenly, the economics of the global crude market and the prevailing price of a barrel matters much more.
That debt-financing - which was lauded years ago because it avoided shareholder dilution - now, increasingly, weighs like a burden.
How quickly is it being repaid? Will an equity conversation create an overhang of surplus shares in the market?
As creditors want repayment, the shareholders also now want income.
So, how much is the dividend and is it sustainable?
Then arrives the issue of sustaining an oil business over the longer term.
How long is the field’s life span? Is the company replacing its reserves? Is there any room in the budget to invest in the next growth project?
Obviously, these are good problems for oil executives to have – after all, it means they’re a success, they’ve delivered the ‘transformational’ growth as they’ve always promised.
But, these are much more nuanced questions compared to the earlier binary question of whether the well has oil or not.
The comparative simplicity is part of the reason why many speculative investors prefer to bet on companies searching for assets, over companies trying to turn discovered resources into a profitable business.
Potential for takeover or partial sale lurks in the background
Evidently, Hurricane is a rare dual-thread opportunity for investors.
With the Spirit-funded drill programme and the pending delivery of the Lancaster EPS, the company perhaps offers a ‘best of both’ proposition.
The remainder of 2019 represents a busy period with huge value creation possibilities – whichever way you like your oil investments.
If neither narrative suits, there’s still the ever-lurking prospect of a big money takeover.
The chances of a company like Hurricane being snapped up by a much larger oil company is rarely at the forefront of discussion, but it is probably more than simply a vague possibility.
On paper, Hurricane’s portfolio holds an already very significant endowment of resources - the combined figure for reserves and resources is pitched at around 3.3bn barrels of crude.
These barrels may be ‘upgraded’ and additional resource barrels may be added through continuing drilling.
Whilst oil majors have been selling off their smaller or older assets in UK offshore, there has notably been an uptick in mergers and acquisition activity – in the industry generally, and, to some extent in the UK specifically.
Earlier this year, Faroe Petroleum was taken out by DNO in a £641.7mln deal while, back in 2017, Israel’s Dekel Group acquired Ithaca Energy for US$1.24bn.
Both companies, at the time of the bids, could boast material production volumes and visibility into larger developments for future production.
The same could be said for Hurricane, though frankly on a potentially much larger scale.
At the same time, Hurricane will at some point in the future need to secure a much more substantial project financing if it is to take its assets to development - for context, the Lancaster EPS addresses only 37mln barrels of the 1.7bn seen across the whole GLA.
Full-scale project financing, possibly in the form of a partnership deal, and/or takeover talks are likely issues for the future.
In the meantime, investors of all persuasions can look forward to a busy summer for Hurricane Energy.