Hurricane Energy share price: from first oil to sustainable production?

It could be a big year for the UK oil industry as one AIM-listed company, Hurricane Energy, strives to produce oil from potentially large and previously untapped resources lying in the UK North Sea.

The UK North Sea is one of the oldest producing regions in the world and its maturity means making new major discoveries is getting harder. Most of the big reservoirs have already been found and exploration has suffered as a result as firms opt to search more underexplored areas around the world. Just eight exploration wells were drilled last year – the lowest on record since the 1970s.

However, the world-class infrastructure spanning the North Sea and the fact that new technological developments are allowing companies to drill for resources in new areas means there is still plenty of potential, and Hurricane is a big believer. The company has discovered over 2.6 billion barrels of potential oil in West of Shetland and has now started producing its first oil from its flagship Lancaster field.

We have a look at Hurricane and evaluate what the next 12 months could mean for the stock.

Hurricane targets first oil from Lancaster before the end of June 2019

Hurricane Energy is currently developing the Lancaster field and on 5 June the company announced it had produced ‘first oil’ – defined as three days of continuous production – nearly one month ahead of schedule. The company has funded the project and the five wells drilled to date using $530 million it raised in 2016 and the firm has done incredibly well to keep the project on schedule and on budget.

The company is using a ‘early production system’ that aims to produce enough oil to generate the cashflow needed to fund a larger-scale development later on. The latest independent estimate suggests Lancaster holds up to 523 million barrels of recoverable oil and Hurricane is aiming for initial output to peak at around 17,000 barrels per day over the next 12 months, which will see the firm produce around 37 million barrels in total over the first six years of production. If it can hit its production targets, then Hurricane expects annual cashflow of around $200 million during initial production based on a Brent oil price of $60 per barrel.

Why is it so significant?

This is not a normal oil discovery. Hurricane’s USP is drilling what are known as fractured basement reservoirs that have been abandoned by others in the past. Their existence has been known for decades, but oil companies have traditionally ceased drilling once they have hit basement rock, partly because targeting oil in small natural fractures can be difficult and risky. Royal Dutch Shell originally drilled the Lancaster structure back in 1974 but never regarded the basement as a worthwhile opportunity, leaving it untapped until Hurricane drilled a deviated well in 2009 to discover oil in the basement.

No company has ever managed to deliver sustainable production from a fractured basin in the UK before, but successful operations have been seen in the likes of Vietnam, Yemen, Venezuela and, closer to home, the Norwegian North Sea. Success means Hurricane could be responsible for unleashing a new frontier for oil exploration in the UK North Sea and further afield by demonstrating these fractured basement reservoirs are worth drilling. Finding new sources of oil is becoming increasingly important as finding larger, more conventional oil discoveries becomes more difficult.

However, these basins are far less understood than conventional ones and there are sceptics that believe it is far too risky. Hurricane has itself admitted that it has faced several technical hurdles with Lancaster, especially with evaluating the porosity (how open or wide) and permeability (how easy fluid moves through) of the fractures it must to drill to access the oil.

The difficulty in understanding the prospect means Hurricane must deliver a period of sustainable production to silence the critics and prove its point. And it isn’t just the Lancaster field on the line but its entire portfolio as the results will have a read-across with its other nearby projects. Hurricane has said it will need to see steady production from Lancaster for 12 months before it has the data it needs to validate its other projects and the 'ultimate potential' of the Lancaster reservoir. That means output over the first three months will average around 9000 barrels per day before ramping up to 13,000 barrels daily in the following three months before moving toward its 17,000-barrel-per-day target.

Hurricane Energy’s projects: what you need to know

Hurricane Energy has interests in six licences, including the wholly-owned Lancaster field. It owns 100% of the nearby Halifax field which, together with Lancaster, is known as the ‘Greater Lancaster Area’. It also owns the Whirlwind licence to the north. Hurricane owns 50% of the Lincoln and Warwick licences – together known as the ‘Greater Warwick Area’ – and 100% of the Strathmore licence to the south.

The Aoka Mizu Floating Production, Storage and Offloading (FPSO) is at the heart of its plans. Oil is pumped and stored in the FPSO and then offloaded when it is full. This will not only be used for initial production from Lancaster but also from its secondary core development within the Greater Warwick Area, which it is developing with partner Spirit Energy.

The fact Hurricane has built a portfolio of contiguous licences is not a coincidence. The company believes the Lancaster and Halifax fields could be one 'single supergiant field' and thinks the licenses within the Greater Warwick Area will also be one field rather than multiple accumulations.

Hurricane Energy teams up with Centrica-backed Spirit Energy on Greater Warwick Area

Spirit Energy bought half of the Greater Warwick Area from Hurricane in September 2018, giving each company a 50% interest in the Lincoln and Warwick licenses. In return, Spirit Energy is funding a five-phase work programme up to the value of $387 million.

Spirit Energy was formed in 2017 following the combination of Centrica’s Exploration & Production business and Bayerngas Norge AS. Centrica owns 69% of the business with the other 31% owned by Bayerngas Norge’s former shareholders, led by Stadtwerke München and Bayerngas GmbH.

This has provided the necessary funding that Hurricane would not have otherwise had and has ultimately accelerated the development of the project. It means three wells will be drilled on the Greater Warwick Area before the end of 2019, with one being tied back to the FPSO, at a minimal cost to Hurricane. The first well, Warwick Deep, was spudded in April.

Hurricane said the deal means these assets will be developed years before they otherwise would have been and says first oil from the Greater Warwick Area is expected in the final quarter of 2020, when a final investment decision will be made. If it pushes ahead then Hurricane will also expand the capacity on the FPSO from 30,000 barrels per day to 40,000 barrels by the end of 2020.

This also frees up Hurricane’s own money to fund other ambitions, primarily within the Greater Lancaster Area but also Whirlwind.

Will Hurricane Energy’s ambitions make it a partner or a target?

Hurricane’s portfolio is centred on the Rona Ridge in the West of Shetland region, which the company says is 'at a very different stage in its life cycle' compared to the more mature areas of the North Sea. Several major companies have moved into the area recently, with Shell, BP and Equinor all making acquisitions in the area.

Hurricane Energy has said the stability of the UK tax regime and the 'relative stability' in oil prices has spurred on this mergers and acquisitions (M&A) activity. The company said 'a number of participants believe there is a lot more [M&A] to come', which should make it easier for the firm to find a partner to help fund the wider development of the Greater Lancaster Area – if it strikes first oil, of course.

However, if Hurricane does deliver sustainable production at Lancaster then there is every chance that other companies will look at the firm as a takeover target rather than a potential partner. Hurricane has become a £1 billion-plus company but it is still tiny in the grand scheme of things and ultimately unable to develop such large and ambitious projects in the same manner as a major. For example, even if it finds a partner for Lancaster a full-field development plan won’t be submitted until 2024.

Plus, Hurricane has also been criticised for its approach to corporate governance, with its former chairman having resigned over concerns about shares awarded to non-execs (which were later rescinded) and wider corporate governance matters. In addition, Hurricane has yet to move to a premium listing on the London Stock Exchange from AIM, partly because it still doesn’t meet the higher standards that come with it. Hurricane has said 'although the company is now well placed to meet the requirements of a premium listing', it is still evaluating the benefits while it continues work on the Lancaster field and Greater Warwick Area this year. However, this is another area where a formidable partner or buyer could provide the leg-up that Hurricane needs.

How to trade Hurricane Energy

A Reuters poll of 10 brokers is extremely bullish on Hurricane Energy. There is a long-term Buy rating on the stock and signals point to huge upside potential. Only one broker has issued a Hold recommendation, and none have assigned a Sell or Strong Sell rating on the stock.

Read more about top oil trading strategies

In May, Berenberg set Hurricane a price target of 100.00 pence while Morgan Stanley said shares could increase by as much as fivefold before the end of 2020, although the latter didn’t set a price target because of the wide range of potential valuation outcomes. Although Morgan Stanley said lifting of the first cargo or strong results from Greater Warwick Area could act as triggers for the share price this year, it added there could still be 'significant uncertainty' about the Lancaster field even though it has delivered first oil – again demonstrating the need to deliver sustainable output over a protracted period if it wants to truly convince the market of its potential. Morgan Stanley also said Hurricane’s Capital Markets Day, currently pencilled in for late July, could also be a catalyst for the share price.

Hurricane Energy: broker recommendations

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Hurricane Energy: bullish short-term optimism but long-term concerns remain

The development of Lancaster has been two years in the making and Hurricane has delivered on its promises so far. The outcome at the field has huge implications not just for Lancaster but Hurricane’s entire portfolio, and even the UK North Sea as a whole. Larger oil companies, keen to find new sources as conventional ones dry up, are taking the potential of fractured basin reservoirs seriously. BP, Shell and Equinox all participated and/or sponsored a London event held by The Geological Society on the geology of fractured reservoirs last year and the Lancaster field was cited as an example.

The market’s confidence behind Hurricane will be bolstered after the company delivered first oil ahead of schedule. Hurricane shares have rallied by over 36% over the past six months but still trade significantly below most target prices set by brokers, which see plenty of upside.

However, Hurricane must prove these untapped resources can deliver sustainable output. Some fear production could decline quickly and have concerns about the potential of each well. Delivering first oil represents a major hurdle cleared, but the long-term investment case for Hurricane will pan out over the next 12 months.