IOG breathes new life into SNS
Gas-focused producer sees growth opportunities in unloved discoveries
There is many a good tune played on an old fiddle, as the proverb goes. Prospective UK gas producer IOG would certainly agree. Not only is the firm focusing on the Southern North Sea (SNS) gas basin, the UK’s most mature hydrocarbons province, but the firm’s USP is its Thames pipeline—infrastructure decommissioned in 2015 that it plans to refurbish and return to service.
IOG CEO Andrew Hockey and head of corporate finance James Chance sat down with Petroleum Economist to discuss an eventful last 12 months, investor appetite for gas assets and the future of the UK North Sea in general and the SNS in particular.
2019 was quite the year for IOG, was it not?
Hockey: We started 2019 as a bunch of guys with a good idea and ended up with it fully funded. Having a fully funded net asset value is a critical step forward for our business.
There were a number of key pieces to getting there; to begin with, we had to restructure certain loans to get ourselves on a good footing. This gave us the scope to raise equity, which we did in April—raising £19mn through a placing, management subscription and open offer. That allowed us to do two things: firstly, to move forward with farming down our core project so we are funded to actually do the development and deliver cash from the project when it comes onstream in mid-2021. Secondly, it enabled us to drill the Harvey appraisal well. It also had some other benefits too. We changed the shape of the investor base, as we brought 12 new institutional investors onto the register, whereas previously we only had one.
We started 2019 with a good idea and ended up with it fully funded
Another issue was defending ourselves from the hostile approach from [fellow UK independent] Rockrose, which we successfully did. It was an opportunistic approach, but we were in a position where you might have expected someone might try.
Chance: Early last year, we were in a very tight corner financially. But we managed to fight off the hostile takeover. Let us be clear, this is not a ‘lifestyle’ project, we are committed to delivering for investors, and the hostile approach would have led to a very poor outcome for our existing shareholders.
Instead, we managed to get the equity raise done and that gave us the platform to deliver what was, in the context of IOG, an absolutely transformational funding. Market expectation, if we are honest, was sceptical about our ability to deliver a farm-out to a partner of the calibre of [the Berkshire Hathaway-owned] CalEnergy. It is clearly a big endorsement of our strategy, team and assets.
The hostile approach would have led to a very poor outcome for our existing shareholders
The farm-out allowed us to finally deliver the €100mn bond issue that we had been working up to for the previous 12-18 months, completing a very sizable issue relative to the size of the company.
Hockey: The CalEnergy deal was great, not just because we got £40mn upfront and £125mn in carries, but because we got buy-in. They took 50pc of the core project and the pipeline, but we also signed a Harvey option agreement and an area of mutual interest agreement, where they can farm-in to Harvey and we can approach new opportunities within a specified geographic area around the Thames Pipeline on a joint basis.
They are very keen to use this deal to build a platform for growth in the SNS. As part of this, we made applications with CalEnergy in the 32nd licencing round, which is another source of potential upside, again through using our Thames pipeline infrastructure.
Is it fair to say the Harvey well was slightly below expectations?
Hockey: The results were different from our expectations, but we have been able to feed these results back into our geological mapping, and we think that, in the Greater Harvey Area, e.g. the Redwell discovery, there is a lot of potential for another development that can easily be tied into the Thames Pipeline.
Chance: IOG’s strategy focuses specifically on low-cost infrastructure-led gas hubs in the SNS. How can we take things that would otherwise be sub-economic or marginal or stranded and make them attractive commercial developments? Something of the size of Harvey’s 40bn ft³ mid case–which is what the well data initially indicates it should be–could be a very attractive development off the back of the infrastructure that we are already funded to put in place nearby. That is our strategy in action.
Given the growing prominence of ESG concerns among E&P investors, do you think there were advantages for IOG in approaching the equity and debt markets as solely a future gas producer?
Hockey: We have certainly had a different experience, not least because—having purchased the Thames Pipeline and reception facilities at Bacton to get our product to market—we have already significantly reduced our carbon footprint per molecule of gas produced compared to a lot of our competitors as we are reusing infrastructure rather than building new. From a wider ESG point of view, we are using again something that otherwise would have just laid on the seabed, which is another plus.
And, as you say, it is gas, which we see as a transition fuel to a more renewable future. Also, in the way we are going about the development—we will use limited impact, unmanned facilities, offshore but operated from onshore, so less impact from helicopters regularly flying back and forth, and ultimately re-usable—we are trying to make things as automated and as low carbon footprint as we possibly can.
Chance: Yes, we are working on ensuring that we will be among the very lowest carbon footprint operators in the North Sea. We are not doing it for the sake of it, this is something that we think will give us a genuine competitive advantage as carbon footprint has undoubtedly become a key metric.
Gas is very much part of the energy solution. In the UK, the future generation mix will see gas firmly embedded alongside renewables and nuclear. We will also be producing domestic gas—pipeline and LNG gas imports obviously have a much higher carbon footprint.
We are a gas company and the gas market is the lowest it has been for many years
CO2/bl oe measures are already and will become ever more relevant for both equity and debt investors. We saw it when we raised bond last year, in the Nordic markets in particular, every single investor we talked to need us to have a credible ESG answer and not just be box ticking.
This week, a major lender to another North Sea player has been raising questions about falling UK gas prices. Is that a concern as a future UK gas producer?
Chance: We are a pure gas company and there is no denying the gas market is currently the lowest it has been for many years. But it is also worth bearing in mind that it is cyclical. With the supply glut we have seen in the last 12-15 months, it is easy to forget that average 2018 NBP prices were actually 20pc higher than the long-term average. Last year, conversely, they were 20pc lower than that average. So, despite the volatility, you still see variations around a long-term average of 50p/therm. The question now, really, is how quickly the supply glut works off and we revert back to this mean.
There are actually even some benefits for us of the price being currently low. If oil and gas prices were very high at this point, this could have presented challenges for us as we go through the development stage.
£125mn; IOG carries from CalEnergy
A lot of our gas from the core project assets is produced in the first half of the 2020s, and our business development aim to keep production at similar levels thereafter. Wood Mackenzie’s view, at least from a few months ago, is for gas prices recovering in ’21 and peaking in ’23 or ’24, which would suit us pretty well. But these are all just forecasts. What we do know is that the UK is dependent on gas imports and has become a lot more so over the last 15-20 years, now importing well over half the gas we consume.
As domestic production, we do stand at a cost advantage. Once we get on stream, our opex is very low—in a range of $5-6/bl oe, or 7-8p/therm. So, we think we can generate cash even at a relatively low gas price.
Is it harsh to describe the SNS as not the most exciting basin in the whole world?
Hockey: It is not glamorous, but it is a great place to be. Why is that? Well, there are some good fundamentals to start with. It has been producing since 1967—since the Beatles were number one, as I like to say. And the geology, therefore, is pretty well understood. If it has challenges, we understand those challenges.
The infrastructure is there, and we own a piece of it now. So, we control our own destiny, in terms of pace of development, of the capacity for and speed of getting gas to market. And we are very well set to take advantage of what is around us.
In any basin, you make the vast majority of the big discoveries early on, but there is always still a lot to play for with smaller and medium-sized discoveries that are slower to be developed. The core area portfolio looks to take advantage of that—we have been able to fully fund a series of small and medium-sized developments that are now on the way to delivering us cash flow.
1967; Start of SNS production
But around us, there is lots that we can incrementally add on and fund that with the cashflow from our core project once it is up and running. We have the Greater Harvey Area and also add-on opportunities around the Goddard asset. We see discoveries within our own acreage that, as yet, we have said very little to the market about, that we can add on and bring in through the pipeline.
And, when you can do that, then you see huge uplift in returns. IRRs from the core project are very good, but they can rise a lot further when you can start to bring in incremental gas from acquiring and developing what is around you and put it through already functioning infrastructure.
We are not an exploration company, but even through licencing rounds, there is still plenty of discovered gas out there to be had. With the Thames Pipeline, we can fast-track the development of those accumulations if and when we are awarded them.
As an example, Goddard, which we were awarded in 2018—we could fast-track that and bring it into the core project relatively quickly.
Chance: We have never set ourselves up to be an exploration-focused company, we have always been development and production-focused and with two layers of strategy. The fully funded core project will deliver good returns and you can then build the extra value layers on top of it—driving higher returns by adding selected further assets into the system while spending incrementally less capital.
We are not afraid of step-out appraisal, as we saw with Harvey, and that is one route to create incremental value. But others can be just as valid: for example, we aim to pick up further discovered gas resources in licence rounds, a route that has worked well for us already.
The SNS being a mature basin has provided very fundamental advantages to IOG: after all, it enabled us to buy the Thames pipeline for a pound. That has saved us up to £100mn in gross project capex and should save more than that in opex over the life of the project, transforming the economics.
It is something that we were able to do coming in at a certain stage of the SNS lifecycle and it contributes to our capital discipline, so that we can focus on returns for investors, rather than just thinking about production or volume. We are confident that focus will allows us to deliver strong cash flows and, eventually, aim to have a distribution policy and actually pay a dividend, while remaining growth oriented.
Hockey: There is also quite a lot of gas out there in potential redevelopments which have perhaps been shut-in prematurely or not optimally developed in the first place. A lot of new technologies are available, particularly 3D seismic and improved recovery methods, so there are a number of relinquished fields that we are looking at as possible opportunities to re-licence and bring back on.
And there is always the possibility for us to add through acquisition. Because of Thames, we can look at buying from our competitors around us who perhaps do not have the same commercial opportunity that we have. Also, though, we can have parties come to us—we have already received requests for tariffing third-party gas through our pipeline, which can deliver us revenue in another way.
Do fields that were shut-in when the Theddlethorpe pipeline infrastructure was decommissioned feature in your thinking?
Hockey: Yes, we do see some opportunities there. Obviously, a lot of these fields have been produced very well by our predecessors in the basin, but some were developed back in the ’70s or ’80s using the then available technologies. So, we can see definite opportunities within that type of that class of assets where we could bring something to the table.
With a number of those fields, they were not shut-in because of being exhausted, there were other reasons, not least the closing of the pipeline system. So, there is remaining potential. You have got to look at each one individually, look at what is the ownership structure, what is the licencing status and what can be done.
What about the gas commercialisation strategy?
Hockey: We will do it as simply as possible, via an offtake agreement. Some of our Blythe gas is already contracted to BP. We will put the gas marketing agreements in place over the course of the next 12-15 months and we will be talking to all the obvious players—we will run a competitive process.
Finally, does the UK North Sea enter the new decade in in rude health?
Hockey: I would not say rude health. I would say as a recovering patient, after the toughest downturn I have seen in my career, and I saw ’85-86 and the mid-’90s. The basin required a complete rethink—previously Northern North Sea average opex/bl in some cases got up to around $80. That is being dealt with in quite a spectacular way. The North Sea is in a far better position than it was six years ago, and it is primed to do well. The fundamentals have been worked on to the point where there are opportunities there. Once that is all worked through, then hopefully it will be in rude health.
Chance: Clearly, there were major economic challenges over the last five years, and a lot of good work has been done to overcome those and get back to a position where the North Sea can be globally competitive again. Of course, the focus has to remain firmly on maximising efficiencies and keeping operating costs down—we believe our particular business model is well placed in that respect but we keep trying to aggregate any marginal cost gains that we can as we go through our development and into production.
While cost bases have been reset in the North Sea, the industry cannot afford to get complacent, there are new and different challenges emerging—not least the social licence to operate which is a big issue already and the industry needs to do more to address it.