Shares in Ophir Energy (LSE: OPHR) fell by as much as 24% this morning, after the group said a deal with US oil services giant Schlumberger to develop its Fortuna FLNG project in Equatorial Guinea had fallen through.
I think it’s fair to say that the market believed this was a done deal. In January, Ophir and Schlumberger signed a Heads of Terms agreement for the field. The deal would have given Schlumberger a 40% stake in the Fortuna field in return for funding development costs equal to 50% of Ophir’s historic costs on the field.
The deal was expected to fund the development through to production start-up without requiring any new investment by Ophir. It looked good — so what went wrong?
Ophir said today that Schlumberger had successfully completed its technical due diligence on the field, but that the two firms “been unable to complete the transaction on the terms agreed in the Heads of Terms.” This suggests to me that there was a dispute over the commercial terms of the deal.
A potential problem?
The Fortuna FLNG project has the potential to deliver production of 720m cubic feet of gas per day, according to Ophir’s figures. An investment of $600m is required to reach production start-up, with a further $476m of operational expenditure spread across the life of the field.
According to Ophir, these figures equate to a breakeven price of $5.30 per million British thermal units (MMBtu) for delivery into Asia, or $4.40 per MMBtu for Europe.
This could be a problem. Natural gas prices have fallen by about 50% over the last year, as a substantial amount of new gas supply has entered the market. Here are the current natural gas prices in key global markets:
- US: <$2.50/MMBtu
- EU: $4.20/MMBtu
- Japan: $8.27/MMBtu
It’s clear that at current prices, Fortuna would have to sell all of its gas into Asia to avoid losing money. Although the Fortuna project wasn’t expected to being production until 2019, there’s a risk that prices will stay low. Was this why the deal with Schlumberger fell through?
What happens now?
Ophir says that it remains “in active discussions with a number of other parties” about the Fortuna FLNG projects. According to today’s statement, possibilities include selling a stake in the Fortuna field, getting the field development work done on credit, or selling some of the gas now to fund the field development.
These three options are all quite different, which suggests to me that Ophir’s discussions with other firms aren’t very advanced.
Is Ophir a buy?
The problem with Ophir is that while the firm has been a successful explorer, its shares have fallen steadily since 2012. The main reason for this, in my view, is that none of its big African gas discoveries have been converted into commercial reserves.
Ophir remains well funded and had net cash of $315m at the end of 2015. Production revenue from the Asian assets acquired with Salamander Energy should help keep Ophir afloat without having to spend much of this cash.
At about 75p, I suspect Ophir shares are good value. The problem is that unless an opportunistic bidder comes along, shareholders may have to wait a long time to realise this value.