Malcy’s Blog – Oil price, Diversified Energy, Zephyr Energy, Rockhopper Exploration & finally

WTI $72.05 +$2.56, Brent $75.44 +$2.36, Diff -$3.39 -20c, NG $3.71 +5c, UKNG 249.24p +19.16p

By Malcolm Graham-Wood

Oil price

Yesterday’s rally was worthwhile following the Chinese data I mentioned and of course the path of Omicron. It seems that whilst it is faster spreading it may not be as virile as previous variants. One by one the drug companies are announcing how much their vaccines combat it, so far a mixed bag but third boosters are now beginning to become de rigeur. Indeed as former UK PM Teresa May said in the House of Commons, it is not possible to change policy with regard to every new variant appears and for the first time in history she appears to be right about something.

Post the close the API stats showed a 3.1m draw in crude which was fine but the build in products of 3.7m b’s in gasoline and 1.2m in distillates was a bit more than expected particularly in the latter. Natural gas prices in the US fell after a report forecast a much milder winter in the USA, we shall see…

Diversified Energy Company

Diversified Energy announced the closing of its acquisition of Oklahoma-based Tapstone Energy Holdings, LLC  and Tapstone’s interest in its related party KL CHK SPV, LLC. The transaction, previously announced on 7 October, 2021, consists of certain upstream assets, field infrastructure, equipment and facilities. Oaktree Capital Management, L.P. completed its co-investment in the Acquisition.

 Acquisition Highlights (Diversified’s Interest)

•     Acquisition net purchase price of ~$181 million

•     Highly accretive 1.9x multiple, based on the net purchase price and ~$95 million of estimated next twelve months’ (“NTM”) Adjusted EBITDA(a), before expected synergies

•     Current production of ~12 Mboepd (~72 MMcfepd) from ~660 net operated wells

◦     Production comprised of primarily natural gas and NGLs (~62% and 21%, respectively)

•     Net purchase price approximates a PV27 valuation at the effective date of 1 August 2021 with PDP reserves of ~35 MMBoe (~208 Bcfe) with pre-tax PV10 of ~$324 million(b)

•     Producing asset’s lower emissions intensity complements Diversified’s emissions reduction strategy and positively impacts the Company’s corporate emissions profile

•     Retained experienced Tapstone personnel to complement the continuity and consistency of operations and to facilitate the implementation of Smarter Asset Management opportunities

Diversified funded its portion of the Acquisition with a draw on the Company’s enlarged $825 million Credit Facility, following its semi-annual redetermination completed on December 7, 2021. Post-transaction leverage, as measured by pro forma Net Debt to Hedged Adjusted EBITDA(c), is  ~2.2x.

 Commenting on the Acquisition and the enlarged borrowing base, CEO Rusty Hutson, Jr. said:

“Having closed our fourth acquisition within the Central Region this year, we begin the efficient integration process of these high-quality  assets. Alongside former Tapstone personnel who today join the Diversified family, we look forward to implementing our proven Smarter Asset Management programme and to leveraging our enlarged regional footprint to capture operational synergies. At less than two times Adjusted EBITDA, this highly accretive and attractively priced acquisition further solidifies our position as a leading consolidator of producing assets in the Central Region and enhances our cash flow to support our ESG initiatives, dividend distributions, debt reductions and further accretive reinvestment.”

Diversified also announced that the Company’s bank lending group, led by KeyBank National Association, completed its semi-annual redetermination of the Company’s senior secured credit facility. The Bank Group approved an $825 million borrowing base, representing a $200 million or 32% increase related to higher commodity prices and the added collateral from the Company’s previously announced acquisition of Tapstone Energy Holdings LLC.

Rusty Hutson, Jr., CEO of the Company commented,

“I would like to thank our bank group for their continued support of Diversified as an integral and responsible part of the energy transition solution. The more than 30% increase in the Credit Facility borrowing base affirms our banks’ trust in Diversified’s stewardship and confidence in our assets to generate strong free cash flow to support our business, repay our borrowings, fund our ESG initiatives for our stakeholders and sustain our dividends for investors.”

The completion of the Tapstone asset is excellent, if expected news and continues the building process by DEC. On very attractive economics this deal is unsurprisingly ‘highly accretive’ and adds significant reserves and also demonstrates the continuing corporate emissions policy. The Central region keeps on giving and I would expect now that this is completed there will be other opportunities on the radar screen. 

The redetermination of the debt shows long term confidence in the company and its management from its banking sponsors and in current hydrocarbon markets make the DEC model highly attractive to investors and bankers alike. The recent CMD in Houston was a good opportunity to meet with the company and its depth of management strength was clearly something its backers appreciate, at 103.5p investors should too. 

Zephyr Energy

Zephyr has provided an update on the production testing of the State 16-2LN-CC well at its Paradox Basin project in Utah. The Company is delighted to announce the completion of a safe and highly successful well test. After 23 days of production testing, the well has demonstrated the potential to drain a larger hydrocarbon resource and with stronger economics than initially forecast.   Zephyr is now proceeding with plans to equip the well and facilitate the export and/or sale of hydrocarbons.

The State 16-2LN-CC well was the first in the Northern Paradox Basin to flow hydrocarbons from a horizontal well with a modern hydraulically stimulated completion design, and the Company’s Board of Directors (the “Board”) believes the results of the production test provide substantial justification for wider development of Zephyr’s Paradox project.

During the test, the well averaged rate-constrained daily rates of 716 barrels of oil equivalent per day (“boepd”), with rate-constrained highs of 1,083 boepd achieved with limited pressure drawdown. Initial simulation modelling suggests possible plateau rates of 2,100 boepd are possible when the well is fully equipped and no longer rate-constrained.

The test was rate-constrained to minimise flow assurance issues from salt deposition in the well bore.  Future flow assurance issues are expected to be mitigated when the well’s final completion equipment is installed. Gas rates are substantially higher than expected, with modelling suggesting the well is capable of production plateau rates of     10 million square cubic feet of gas per day and 500 boepd of liquids.

Initial data from the production test suggests the State 16-2LN-CC has a single well potential Estimated Ultimate Recovery of 2.65 million barrels of oil equivalent, significantly higher than the Company’s   pre-drill estimates of up to 0.85 mmboe.

The test indicates a highly successful appraisal of a substantial new gas condensate resource and one which the Company forecasts will deliver strong single well economics. Using updated production forecasts and realised prices of US$3.00 per thousand cubic feet (“mcf”) of gas and US$65 per barrel of oil, the Company estimates that the well will pay out in under seven months and have a net present value at a ten per cent. discount rate (NPV-10) of US$12.5 million.

Zephyr is currently evaluating well equip and export options in order to put the well on full production as soon as practicable. The Company is also appraising a number of potential profitable solutions for selling the substantial volumes of natural gas expected to be produced from the well.  These solutions, detailed below, include the sale of gas into nearby existing infrastructure, as well as the potential to co-locate a cryptocurrency mining facility onsite in a similar manner to other nearby operators in the Paradox and Williston Basins.

The Board remains highly encouraged by the implications of the test results as related to the wider development of the Paradox project. Following the completion of the production testing, Zephyr has commissioned the independent reserve consulting firm Sproule Incorporated (“Sproule”) to complete a Competent Persons Report (“CPR”) to assess the Company’s reserves across both the Cane Creek reservoir and the eight overlying reservoirs. The CPR is expected to be finalised over the next 60 days.

Colin Harrington, Zephyr’s Chief Executive, said: “I am incredibly excited about the production test results announced today, and even more so about the significant implications for further drilling and potential full field development of our Paradox project. “The well test data, modelled production volumes and potential EURs exceed our pre-drill estimates and all indications point to the State 16-2LN-CC as a well which can generate significant Shareholder returns.

“Not only does this successful production test indicate the potential for a highly profitable single well, but we also believe the test will lead to a substantial reduction in development risk across our acreage while allowing for a future systematic development of the project – one with relatively predictable well distribution within both the Cane Creek reservoir as well as across the multiple overlying reservoirs.

“We are also excited to have several options to monetise the significant gas potential of the well. Given the potential scale of gas volumes, we have already entered into detailed conversations regarding selling produced gas into the nearby pre-existing gas infrastructure.  Alternatively, we’ve also been impressed with the return potential related to the co-location of a cryptocurrency mining facility on site with shared economics – and we’ve seen other forward-looking operators in the Paradox and Williston Basins benefit from such arrangements. We have therefore formed a first-class advisory board to help guide our deliberations in this area of considerable growth, and foresee a future in which both alternatives are weighed from a value perspective, potentially even in tandem.  We aim to have a path forward by the end of the first quarter 2022 and look forward to providing updates as progress is made and the well is equipped.

“In conclusion, we are delighted to be able to report that we appear to have a large and profitable first well on our Paradox asset – one which has far exceeded our expectations and which has validated the Board’s decision to utilise hydraulic stimulation.  The Board believes that the results add considerable weight to the view that the Paradox asset has the potential to be a project of substantial scale and profitability, one which can be developed to maximise resource efficiency while minimising surface disruptions and offsetting Scope 1 emissions.  Our mission, as always, is to be responsible stewards of investors’ capital while also being responsible stewards of the environment and I’m delighted that the results to date are a strong confirmation of that focus.”

This is a spectacularly good result from Zephyr and makes a complete nonsense of the current market cap especially if you take into account the pay-out rate from this  well alone and I can’t wait until the Sproule CPR comes along. There is so much behind this at the Paradox that I am sure that if this valuation doesn’t change pretty soon there will be suitors for Zephyr all down the street. 

The management has been exemplary in the way it has with speed and confidence fulfilled its early commitments and brought in the Paradox whilst continuing to add production to fund its drilling programme. That this programme has come in so spectacularly and perhaps more importantly, so quickly, is further tribute to the team. Finally that this company has discovered a significant gas profile is an added bonus and might even provide another revenue channel for the company. The upside for Zephyr with the shares up a measly 3.3% is still colossal and I can easily recommend buying from here  even if today is seeing some inevitable profit taking, the risk in Zephyr is not being invested. 

Rockhopper Exploration

Rockhopper has announced that Rockhopper, Harbour Energy plc and Navitas Petroleum LP  have signed detailed heads of terms for Harbour to exit the Falklands and for Navitas to farm-in. The proposed transaction remains subject to definitive documentation and completion subject to, inter alia, regulatory approval.

Harbour will divest its licence interests in the Falkland Islands, and Rockhopper and Navitas will seek to align working interests across all their Falkland Islands petroleum licences – Rockhopper 35%, Navitas 65%, subject to necessary consents

Rockhopper and Navitas to jointly develop and agree a technical and financing plan to enable the development of the project to achieve first oil on a lower cost and expedited basis

Navitas to provide loan funding to Rockhopper:

Rockhopper’s share of Sea Lion costs from transaction completion up to Final Investment Decision (“FID”) will be funded through a loan from Navitas with interest charged at 8% per annum (the “Pre-FID Loan”)

 In the event of a positive FID, Navitas will provide an interest free loan to Rockhopper to fund two-thirds of Rockhopper’s share of development costs (for any costs not met by third party debt financing)

 Funds drawn under the loans will be repaid from 85% of Rockhopper’s working interest share of free cash flow

 In the event that FID has not occurred within five years of completion of the proposed transaction, Rockhopper can elect to remove Navitas from the Falkland Islands petroleum licences (should the licences still be in effect at that time) by repaying the Pre-FID Loan

 Benefits of the proposed transaction include greater alignment and simplified commercial arrangements across the joint venture and Rockhopper retains a higher working interest in the Sea Lion project than under the previous Premier-Navitas transaction announced in January 2020.

The proposals continue to materially satisfy Rockhopper’s proportion of both pre-FID and post-FID costs for Sea Lion with access to Navitas’ expertise in executing and financing large scale oil field developments and provides a clean exit for Harbour. Optionality for Temporary Dock Facility – scope to upgrade for Sea Lion development or future decommissioning

Forward plan for Sea Lion includes;

Technical work to commence by Rockhopper and Navitas jointly in relation to a lower-cost, alternative development for Sea Lion utilising the existing extensive design and engineering work undertaken for the project in recent years

Finalisation of definitive documentation expected in Q1 2022 with completion subject to satisfaction of certain conditions including regulatory approval

Navitas to become Operator at completion

Potential for an additional project partner dependent upon funding requirements – to be defined through ongoing development and financing processes

Should an additional partner be required, Rockhopper does not intend to reduce its working interest

Navitas intends to strengthen its offshore operating capability with a focus on safe and efficient developments

Samuel Moody, CEO, commented:

“We are delighted to be able to announce what we believe is the start of a new chapter in the potential development of Sea Lion. The new Rockhopper-Navitas joint venture will be fully aligned and committed to bringing Sea Lion to production.

We at Rockhopper have huge historic and detailed technical knowledge of the asset and experience of operating in the Islands, while Navitas brings significant proven capital raising expertise and ability as well as development experience. This transaction will ensure we have material funding while increasing our retained working interest compared to the previously announced partnership structure with Premier and Navitas. The importance of Sea Lion in the Navitas portfolio is, in my mind, without question a further positive as we both seek to unlock its underlying value.

We look forward to entering into fully binding documentation in the first quarter of next year.”

This is a new start for Sea Lion and the partnership between Rockhopper and Navitas to whom the development is equally important, RKH are the history and knowledge in The Falklands and Navitas has proved that they can deliver over $1bn for Shenandoah.

At $75 the project is highly profitable and sees the return of Rockhopper to investor lists as Sea Lion is firmly back on the front burner. Navitas has been patient and now owns a meaningful amount of the project with the intent to deliver after such a long time of waiting for investors. The upside for RKH from here is substantial and those patient investors who have waited for this day should be significantly rewarded even at 6.4p.

And finally…

England were rolled out for 147 in the first test at The Gabba, it must of looked like a pitch to bowl on if winning the toss but Nasser put paid to that forever…

Liverpool won again, 6 in a row in Europe is mighty impressive and the Noisy Neighbours also go through after losing in Leipzig. Tonight Chelski and the Red Devils

The opinions expressed here are those of the author

Malcolm Graham-Wood

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Disclaimer: Malcy’s Blog is provided for general information about the international oil and gas industry and the companies that operate within it. It does not constitute investment advice and Malcy does not buy or sell shares, warrants or bonds in any company written about within the blog. Information is taken from publicly available sources and any comment is that of the author who does not take any third party comment in the blog


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