Despite climbing 465% in one year, shares of North Sea oil explorer Hurricane Energy (LSE: HUR) are only worth 59% more than when they floated in early 2014.
Based on what we’ve learned about the firm’s assets since then, I think there’s a good chance that Hurricane stock is still too cheap.
Look at the assets
Guidance from Hurricane’s experienced management team has been very reliable so far. So I take seriously their estimate that the Lancaster field could contain 593m barrels of recoverable oil.
The current market cap of £670m values this oil at about $1.40 per barrel. That’s fairly cheap, given that the break-even cost of producing this oil seems likely to be below $40 per barrel.
It’s also worth noting that drilling results from the recent Halifax well suggest that Halifax and Lancaster may turn out to be a single, much larger field. If this is the case, the recoverable amount of oil might prove to be much higher than 593m barrels.
Cash could flow in two years
Hurricane hopes to develop an early production system (EPS) to generate cash from Lancaster and build a more detailed picture of the reservoir.
The information available so far indicates that the EPS could produce 62m barrels of oil at a breakeven cost of $37 per barrel. According to the latest projections by the firm, this would generate annual operating cash flow of $192m at a Brent Crude price $60 per barrel.
If the EPS goes ahead as planned, production could start in 2019.
One big risk
Hurricane estimates that a total investment of $467m would be required to bring the EPS into production. This may be funded through an issue of new shares or debt, or by Hurricane selling a share of Lancaster to another oil company.
All three methods would result in some kind of dilution for existing shareholders. However, the firm’s fundraising needs have been well managed so far. I’d stay invested at current levels.
Not such a bargain
Tullow Oil (LSE: TLW) recently completed a $750m rights issue, in which 25 new shares were issued for every 49 already in circulation. This dilution means that the share price alone isn’t a guide to the company’s changing valuation over the last year.
Although Tullow’s share price is almost unchanged from one year ago, the firm’s market capitalisation has risen from about £1.8bn to £3bn over the same period. That fresh cash was needed to reduce the firm’s debt levels, which had ballooned to $4.7bn by the end of last year.
The net proceeds of $724m received will help reduce this total towards the group’s target of 2.5 times cash earnings (EBITDAX). But to reach this target, I estimate Tullow may still need to contribute at least $1,000m from its operating cash flow. Given that the 2017 revenue is expected to be $1,650m, the demands of debt repayment are unlikely to leave much for shareholders.
However, if oil prices rise more quickly than expected, Tullow’s earnings will rise and its net debt target — which is measured as a multiple of earnings — will become much easier to hit.
In my view, investing in Tullow is effectively a bet on a rising oil price. Personally, I’d rate the stock as a hold.