Date: 7th August 2022
|272 MM||nº shares|
|2.5MM||3mth avg vol|
|144-423p||52 Week Range|
Serica Energy is a zero debt small cap in the oil & gas sector. It operates in the North Sea and produces 85% natural gas. Its expected production for 2022 will average between 26000 and 30000 boepd. So far, it has averaged 26800boepd YTD in 2022 (19th July). An important point to highlight is the fact that Serica has no debt and nearly £400MM in cash as of 31-May-22
Serica was founded in 2004, and at the beginning, it was not focused on the North Sea as it had a presence in Indonesia, Namibia, Morocco and West Ireland. Serica’s transformation started in 2015 with the Erskine acquisition and was accelerated by the transformational acquisition of BKR to BP in 2018. Serica represents around 5% of the UK gas production
Currently, it produces around 27000 boepd in its 5 fields (Rhum, Bruce, Keith (BKR), Columbus and Erskine. Besides, It is exploring the North Eigg, a field very close to Rhum that is supposed to have 2P of 60Mboe. If in October, Serica releases a positive result of the exploration (20-33% estimated probabilities by the management), it would mean a transformational discovery for the company. We believe that it is not priced in the share price right now, so it means having very good optionality for free.
The main driver for this investment is the natural gas situation in Europe, which is making the sector become cash machines. As we have explained several times, our thought is that the problems that have caused the situation are not easy to solve and will remain for several years. Consequently, an almost unhedged producer, with cash in hand, a good track record and trading at a low valuation was an attractive option to look into.
We invested in Serica before receiving the merger proposal from Kistos. This proposal, although we do not expect to materialise, increases the pressure on Serica’s management to start the buybacks or give a special dividend (we believe that is much more probable the former than the latter). These buybacks, along with the convergence of NBP to TTF and the potential positive result from North Eigg should catalyze the share price.
Rhum: Blocks 3/29a, Serica has a 50% ownership and it is the operator
It is the most important asset of Serica, its production was increased last August (R3 – after being suspended 16 years by the previous operator -added over 6,000 boe/d) resulting in a total net production to Serica close to 20000 boepd. The field produces predominantely gas but it also has oil. It has a small decline
It consists of Blocks 9/8a, 9/9b and 9/9c. where Serica owns 98% of the field. It produces oil and gas. Gas is exported through the Frigg pipeline to the St Fergus terminal, where it is separated into sales gas and NGL’s. Oil is exported through the Forties Pipeline System to Grangemouth. Bruce field production in 2021 averaged approx. 6,700 boe/d of exported oil and gas net to Serica. It has around 60MM decommissioning cost which Serica has to endow before finishing its operative life (it is estimated to be around 5 years)
Keith is an oil field produced by one subsea well tied back to the Bruce facilities and requires very little maintenance. It is placed in Block 9/8a and Serica owns 100% of this field. The well has been shut in since early 2021. Serica did a topsides- based investigation which has been used to define the scope of planning a return the field to production
Columbus: Started production in November 2021 and Serica owns 50% of the field. It produces predominantely gas, but it is producing less than they expected initially
Erskine: It was its first acquisition in the North Sea in 2014. It has exceeded its initial production expectations, but they estimate that there are around 2mmboe in place. Serica only has 18% ownership of this asset.
At the moment, it is an exploration asset. They are doing the exploration well and we will have the results in October. It is placed very close to Rhum and it is assumed to have very similar characteristics. The Serica’s management team gives NE a 20-33% chance of commercial success. In the event of a discovery, Serica will investigate options for a subsea tie-back to the nearby Bruce facilities. Consequently, the costs would be lower (which increases the options of commercial success) and would allow an early development (2025). The unrisked P50 prospective (recoverable) resources, based on seismic mapping and Rhum analogue data, to be around 60 million boe.
Because of the new windfall tax introduced last 26th May, the commercial development of North Eigg would allow Serica to reduce significantly the taxes to pay in the coming 2 years with the Capex invested in this project. Otherwise, Serica would need to look for other assets to invest in the UK or pay a huge amount of taxes. Indifferently of the result of the exploration, Serica is also looking for investment outside of the North Sea, and not only related to natural gas assets.
Serica fields are very mature (they were drilled in 1977 and are with working overs, they dont have infill drilling – Rhum is different). The declines rates are around 10-15%. Although Serica invest yearly to maintain and increase production levels. Recently, it has also finished its well intervention campaign in Bruce, adding 3000 bbls/d
Other licences: Apart from North Eigg, Serica owns several licences to explore in that area
We have used a DCF model to value Serica Energy, with the following assumptions:
WACC: 11.71% (Risk free = 2.5%, Risk Premium = 6.85%, Extra risk premium (AIM market) = 1%, Beta = 0.89. It does not have any debt at the moment, neither preferent shares)
We assume the production to be: 85% natural gas, 11% Brent and 4% LPG (27000boepd in 2022 and 28000 onwards). Hedged as of today, but without considering any new hedges
We assume 60MM maintenance Capex from 2023 onwards, 6MM SG&A, 40MM D&A, Unit Opex: $16 per barrel
We calculate taxes until 2025 following the 26th May new regulation (considering the Capex detailed)
NBP prices are way more conservative than the forward curve that we have at the moment: We used 250p in 2022 (taking actuals so far + forwards in 2H22), $220p in 2023, 160p in 2024, 100p 2025, 80p in 2026 and 50p onwards.
The valuation does not include North Eigg (it only takes into account the Capex needed fot North Eigg in 2022)
Taking into account the listed considerations, we reach a target price of 517p
Natural gas price (NBP) – In the end, commodities are cycles and despite seeing the tightness in the European gas sector last for a few years, things could change dramatically. Apart from that, the storage capacity in the UK only represents <2% of annual consumption, making the NBP price very volatile.
Cash management – Serica has half of its EV in cash which is not the optimal capital allocation. This entails risk related to how they are going to deploy the cash. When we talked with Mitch (Serica’s CEO), he insist that their main option remain M&A activity (probably outside the UK – because of the new tax – and may be related to oil, not natural gas)
Taxes – political uncertainty in the UK can lead the new PM to increase taxes on oil & gas companies if the energy crunch continues for a while. However, we believe that the two final tory candidates are not very kind to this approach (especially Liz Truss)
We see Serica as a good way to play the high prices of natural gas in Europe and the expected convergence between NBP and TTF (as it started to happen in June). We also see this investment as a way to diversify our exposition to E&P natural gas companies a bit from Kistos in a more liquid stock (Although Serica received a merger proposal from Kistos last month – probably it will not be accepted). We opened in May a small position and we will wait until there is a clear plan to spend its cash before increasing (if proceeds) our exposure. Moreover, although we are assuming that the North Eigg will not be commercially viable, we love the optionality that we have on it by owning Serica shares at the current price