Thursday, 17 August 2017

Made a discovery? What are the odds of another?

By Will Forbes

Companies exploring in frontier basins frequently include maps and tables with all the prospects and leads in the acreage in marketing information, often adding the prospects sizes to give an unrisked block resources estimate. There is a risk that these representations are misunderstood by investors.

We agree that managements are right to give investors an idea of the depth of prospectivity in their assets/acreage - more, larger and lower risk prospects give exploration teams the luxury to choose the best chance of drilling a valuable well especially in the case where exploration is mandated by licence commitments. You can therefore understand that a company would want to demonstrate it is drilling from a position of strength.

However, we continue to see dangers in this approach for investors who do not appreciate the complexities in oil exploration. The modern reality is that investors should not use this apparently large resource base as a metric to value the block/company. Companies rarely drill a second wildcat well if the first is a failure. Using Norwegian Petroleum Directorate data, companies have only drilled a licence/block a second time 10% of the time if the first was dry in the last five years or so (see chart below). Frontier exploration failures with no follow-ups are common (just looking at West Africa in the last five years throws up many wells in Morocco, Namibia and elsewhere). 

But is this data indicative of other, more frontier, areas? We think so; from 2011-2015, West African dry wells had a follow up in the same block only 7% of the time.

We have therefore long been advocates of only valuing the first well in a block (unless a campaign is already committed to and more wells are definitely going to be drilled). Managements should be more clear to reduce the possibility that (less informed) investors will attribute value to the cumulative gross block resource estimates.

What about the play opening argument?
Investors and managements have made the argument that if a discovery is made, it significantly de-risks further prospects. This would mean that we should include some value for this de-risking before the first well.

We again look at the NPD for some quantification, but with many caveats. The North Sea was de-risked by UK drilling before widespread exploration/development occurred in Norway and explorers in the basin had higher levels of confidence in the various elements (source, migration etc) before drilling. Commercial quantities of oil are typically much lower in Norway that they may be for more frontier areas offshore (perhaps 50mmbboe for Norway vs 200mmboe for offshore Africa). Every basin is different, so we give this analysis with a pinch or more of salt.

However, looking at blocks in Norway, the chances of a block containing two or more fields given that it already has one is around 40% (where a block is of type 1/3 or 10/11) - see chart below. These blocks are much smaller than those typically seen in Africa. Scaling up to a collection of blocks which are roughly equivalent to Cairn's Deep Offshore block (containing the SNE field) in area, this chance increases to over 55%.

This is for Norwegian blocks, that are substantially smaller than typically frontier offshore blocks

Resulting probability tree
And assuming a 30% CoS (roughly the commercial chance of success for a wildcat in Norway), we can produce a rough interpretation routes to success/failure. Here we also use the observation that if the first well is unsuccessful, the chance of success for the second well falls to 15-20%. For information, if two are unsuccessful, the chance of a third being a success has been 13% (and 6% for a fourth well). Given only 10% of initial unsuccessful wells are followed up, the impact of these CoS on subsequent wells is vanishing small.

Note: We use a 50% chance after a first success here as a simplification of the 40-55% chance of finding more than one field given one has already been discovered (where 40% is over a block in Norway and 55% is for a collection of Norwegian blocks roughly the size of the SNE block in Senegal)

Overall, going from NPD data, the chance of two (or more) successes is 15%, the chance of a first well being successful with no further successes is 15%. The chances of a failed campaign (either because a second well is not drilled or a second is unsuccessful) is 69%. The chance of a first failure is followed up by a success is 1%.

Going from this data, there is therefore a case for including value for play-opening discoveries. For every discovery, further discoveries are have a c.50% chance of occurring, though many more wells may need to be drilled to make another discovery - the implied individual CoS rises by perhaps 15%. 

However, we remain cautious. Investors have to take account of the time to appraise and develop discoveries. When are subsequent wells going to be drilled to enable possible discoveries, are all going to be co-developed or will others be tied-back after first oil or have a longer term phased development?  

In the case of small oil companies, the effect of financing (dealt with in many previous blogs) and possible farm-downs/delays should also be accounted for. Given a failure is far more likely than a success, we are happy to continue to examine only the value of a drill until a result is known. This analysis then gives a possible framework for how an investor (and shares) may then react after a result.

Tuesday, 8 August 2017

Kosmos searching for more investors

by Will Forbes

On 2 August, Kosmos announced that it will be seeking a main-market listing in London during the third quarter in order to access European investors. According to Reuters, the company indicates "There are a number of European investment funds and specialist international oil and gas investors that are currently unable to hold Kosmos' shares due to their listing outside of a European regulated market"

We also believe it is a function of the differing attitudes the investor bases have towards exploration. Given the multitude of onshore producers, US investors typically place more emphasis on near-term cashflows and production. Especially since the advent of shale fracking, exploration risk is smaller and a greater attention is given to cashflows and financial leverage. 

European exchanges tend to see more international explorers focussing on frontier areas, leading to a greater understanding of international exploration and willingness to value it.  European exchanges are more used to taking a risked approach to longer term value ideas such as 2P/3P reserves and exploration. 
This may explain why European analysts have higher target prices given Kosmos' mix of production/ development/exploration assets.

Given these differences it makes sense for Kosmos to list in London. Of the companies operating (or those that had recent drilling) in the West African coast, many of them are European listed. The majors are joined by Tullow, Cairn, Ophir , GALP, Genel, Seplat and many small and micro-cap peers. While recent years have seen the London market paying less attention to exploration, we believe it is a more natural home for Kosmos, which will be exploring for more resource in 2017-2018 than any other E&P (according to the company). 

For European investors interested in exploration, Kosmos may be an attractive prospect.

In 2017-2018 it is targeting six material wells. In Africa four targets represent large opportunities (pre-drill estimates of gross unrisked resources are Yakaar 833mmboe, Requin 833mmboe, Lamarin 833mmboe, Requin Tigre 2.5bn boe). Of these, Yakaar has been a successful discovery which, added to Teranga, opens up 20tcf of pMean gas resource and a large LNG development in Senegal. With partner BP, Kosmos is targeting a 2018 FID and 2023 first LNG. Given the LNG environment at the moment, we would not be surprised to see dates slip slightly, but Kosmos is well placed to monetise these resources.

In South America, Kosmos holds interests in two blocks close to the existing Liza and Payara discoveries made by Exxon. Anapai and Aurora could each hold 300mmboe according to the company.

Additionally, it has production cashflows from Jubilee and TEN, which will be well known to Tullow's base. In May 2017, its presentation indicated around $260m of FCF could be generated at $50/bbl oil (including farm-out proceeds).

Other observations US vs Euro listed E&Ps

If the analysts are a guide to investors' attitudes, it's possible that greater European investor shareholdings could contribute to an increase in the share price, as existing European-focussed analysts for the company have markedly higher average target prices than their US-focussed counterparts.

Source: Bloomberg. Black dot is Kosmos, green dots are European E&Ps

In fact, if we apply only the target prices for European analysts and assume that Kosmos moves towards the trend line in EV vs discount to target price seen in the chart above, it could lead to more than a 20% increase in share price.

Given the relative paucity of European E&Ps (vs US), it is very possible the listing of a $3.5bn EV company on London exchange will attract more investors and interest - only Tullow will be bigger. More analysts are likely to cover the company (Kosmos has 15 at the moment, Ophir 18 and Tullow 27).