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Deltic rides out the storm

The UKCS explorer’s strong balance sheet allows it to brush off many of the challenges posed by the oil price collapse, but it is still not immune to bearish investor sentiment

It has been a busy 12 months for Deltic Energy, not least with the introduction of a new name for the UK Aim-listed firm formerly known as Cluff Natural Resources.  

In August last year, it secured approval from the country’s Oil and Gas Authority (OGA) to complete the farm-out of a 50pc stake in its UK continental shelf (UKCS) P2437 licence, containing the Selene prospect, to Shell. This marked the second sale of a stake to the major in less than three months, after it sold 70pc in the Pensacola prospect to Shell at the end of May 2019.

But this year’s oil and gas price plunges and Covid-19 pandemic have made life harder—both commercially and operationally—even for a firm at the pre-production stage. Deltic’s share price has taken a hit, but the firm’s CEO Graham Swindells remains optimistic for the future.

How have the equity markets been of late for an exploration-focused oil and gas firm?

Swindells: Our whole industry is facing challenges in the current environment. As a company, we are relatively fortunate in that, being exploration-focused and not currently having operations in the field, we do not have any direct financial exposure to the worst effects of Covid-19 and the reduced commodity prices.

We have been able to continue working effectively and to progress all of our key projects. Naturally, those projects are taking slightly longer, because everything in our industry is done by way of partnership and I do not think any operator has been totally immune to this.

And what we are also not immune to, of course, is investor sentiment, which has obviously been affected. We are no exception to that. Our share price is down by around 50pc over the course of the year on the back of this.

“We have been able to continue working effectively and to progress all of our key projects”

From our perspective, we are currently trading at a significant discount to our cash. We raised a substantial amount of money in the summer of last year—after we completed our two farm-outs with Shell—which means we have a relatively strong balance sheet in the context of the size of our company and remain fully funded by our share of the next two wells that will be going ahead next year and the year after.

Am I happy with the share price? As a shareholder myself, absolutely not. But I have absolute confidence in the quality of the licences that we hold. And success on any one of these would be to be truly transformational for our company.

Clearly, we all want to see an uplift in commodity prices, from which we will all benefit. But they do at least seem to be moving in the right direction and, if that trend continues, I remain very optimistic on the outlook not just for our company but for the North Sea as a whole.

You have five gas licences in the Southern North Sea and two oil licences in the Central North Sea. Do the two commodities feel very different?

Swindells: While the Southern North Sea (SNS) and gas remain the focus, in our applications in the UK[‘s] 30th [licensing] round, we decided to diversify the portfolio. We picked up the two additional licences in the Central North Sea (CNS) covering the Dewar and Manhattan complexes. While they are predominately an oil play, we think those complexes could hold a combination of oil, gas and condensate.

The CNS is clearly different to the SNS, which is purely a gas play. But, having said that, we have seen recently, in a Zechstein play not dissimilar to Pensacola, [the Netherlands’] One Dyas and [UK producer] Spirit Energy drilled the Ossian-Darach well in the SNS which, as well as gas, flowed 3,500bl/d of oil on test. And we have also seen the West Newton Zechstein discovery onshore hitting oil too. So, there is oil potential, albeit our working assumption on Pensacola—and indeed on all our SNS licences—is that it will be purely gas.

Longer-term, do you think that gas reserves will have an advantage over oil as the carbon footprint of production becomes an ever more important issue?

Swindells: Everyone is obviously aware that gas prices are currently very low and clearly that is a challenge for anyone producing gas at the moment. That said, I also think most people are bought into the idea that gas is a transition fuel. And if you look at the fundamentals for UK gas, we have a combination of domestic production anticipated to decline by as much as 80pc by 2050, but UK demand only reducing by c.30pc over the same period.

50pc – Fall in share price in 2020

So, as a country, we face a situation where demand is going to massively outstrip domestic supply, which basically means that we are going to be importing more and more pipeline gas and LNG. And while some of this can come from Norway, the LNG will have to travel long distances from places such as Qatar and North America. The environmental footprint of imported LNG is double that of domestically produced gas.

Domestic production is also good for security of supply, for balance of trade and UK taxable revenue, and for employment. And it will also be necessary if we are to come close to meeting our net zero targets.

There are very strong fundamental reasons why we would seek to position ourselves primarily as a gas company—I think that is a strong proposition for most investors.

Does the current environment potentially offer acquisition opportunities, particularly around producing assets that could provide cashflow to help fund your exploration and development activities?

Swindells: Our core strategy is and will remain very much focused on exploration and appraisal, primarily in the SNS and CNS. That is where our main area of experience and expertise is and where we believe we can potentially add most value in terms of working up assets [and] getting farm-outs—we demonstrated that with Shell—and anticipate moving on to successful drilling.

That said, because we are in a relatively strong cash and balance sheet position—and particularly given that a majority of those funds are not going to be required for some time—we believe that there may be a window of opportunity here. With lower valuations on the back of the lower commodity prices, there is the potential to introduce an element of cashflow into our business through, for example, a non-operated position in a single field, or a portfolio of working interests in producing fields.

Our primary focus would very much continue to be the UK North Sea, but we are conscious that the geology does not stop at the border and we may look at the Dutch sector as well. The main driver would be, as well as covering our costs, to access free cashflow to make a significant contribution to our drilling and exploration plans and investments going forward.

Of course, there is no guarantee that we will be able to execute any such transaction. But we believe the current environment presents an opportunity to consider that, and we will be identifying and assessing options as they arise. Our absolute priority, however, is to ensure we remain funded for our share of the Pensacola and Selene wells we will be drilling with Shell.

And is there appetite for further farm-outs among your licences, particularly Cupertino?

Swindells: We picked up Cupertino and Cortez along with a couple of other SNS licences, in the [UK’s] 30th [licensing] round in 2018. Since then we have undertaken a seismic reprocessing exercise on Cupertino to enhance our understanding of that area, and it is looking really encouraging. Everything points to multi-trillion cubic feet scalable prospectivity on that block. It is still early days, but it has certainly attracted some early interest. We have also recently commenced reprocessing of 2D seismic on Cortez which also has trillion cubic feet-scale potential.

We may not necessarily be ready to embark on a formal farm-out process until later this year. But that is certainly what we are working towards. We are very encouraged and excited by what the work we have done is showing and by the early levels of interest we have had.

“There are very strong fundamental reasons why we would seek to position ourselves primarily as a gas company”

You are confident that, even with constraints imposed by the pandemic, you will be able to meet your commitments to the OGA on the Pensacola licence?

Swindells: The key difference with Pensacola is that, under the terms of our licence, both Shell and we have made a formal commitment to drill. So, come the end of November this year, that well commitment will automatically become firm, unless there is some overwhelming technical issue that would prevent drilling. The well would only not be drilled if the OGA agreed that it should not proceed.

So, there is very strong commitment to drilling. The well is scheduled to be spudded in the second half of next year.  

Should you succeed in making a discovery there, you have mentioned a number of existing options to bringing the gas to shore. But you also raise the possibility of a new pipeline into Teesside—what could be the driver of that?

Swindells: It is really just a reflection of us being pre-drill. There are multiple options here, perhaps the most obvious one being a tie-back into Breagh. But the alternative is a pipeline straight into Teesside.

What we have not done yet is fully assessed the commercial implications of both of those solutions. Clearly, if there is an option of using existing infrastructure, there is a strong likelihood that we would do that.

Have you moved the drilling schedule back slightly for the Selene prospect?

Swindells: We would certainly have hoped to have been in a position to drill a well next year. We believe it is drill ready. We are really just in the final stages of the technical milestones to move onto the next phase of making the well commitment. But it is a fair reflection of the current investment environment that only one of these wells can be drilled next year, and that is going to be Pensacola. So, what that has meant is that Selene is now going to be drilled in 2022.

“Our core strategy is and will remain very much focused on exploration and appraisal, primarily in the SNS and CNS”

And have you also postponed the farm-out process for Dewar?

Swindells: Not quite. We commenced a formal farm-out process on Dewar in the second half of last year, and we were talking to a number of parties. But this is probably the one area where we have been affected by Covid-19 and the dramatic drop in oil prices that we saw from March.

We fairly quickly came to the conclusion that, in that oil price environment, it would be very difficult to complete what we would consider to be a commercially acceptable and attractive farm-out deal. So, we have not fully put it on hold—we continue to talk to parties that have expressed interest. But what we are flagging is that it may take some time before we are in a position to complete a deal.

It remains a prospect about which we are very confident. It is a relatively simple Forties sandstone structure with just under 40mn bl of oil on a P-50 basis. At 90m, it is in shallow enough water that it can be drilled effectively and cheaply with a jack-up rig. And it is less than 5km away from BP’s Etap infrastructure, so the economics on this are very attractive.

Before the drop in prices, we carried an independent economic assessment of the prospect and it was coming in at an NPV of £500mn and an IRR of 123pc. Admittedly, that was run at $60/bl oil, as opposed to where we are. But our feeling is that, if oil prices continue to improve, we will be back in a position where we can achieve a farm-out. In our opinion, this prospect is drill-ready and there is high quality data over the block. Subject to getting a farm-out done, we feel we could be drilling this week within 9-12 months of completing a deal.  

What else is on the Deltic agenda?

Swindells: We have made an extensive suite of applications for new licences in the CNS and SNS in the UK’s latest 32nd licensing round and, according to the OGA, those licences are due to be awarded in the summer of this year. If we are successful within those awards it would certainly significantly further enhance and diversify our portfolio. Again, the SNS is the main focus, but also the CNS as well.

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