Massive Johan Sverdrup Oil Field: Worth An Extra 30% For Lundin Petroleum

| About: Lundin Petroleum (LNDNF)
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(Editor's Note: Investors should note that trading of LNDNF is very illiquid. Improved liquidity is available on the Stockholm Exchange under LUPE.ST)

Last Friday, StatOil (NYSE:STO) Executive VP Margareth Øvrum, turned some heads when she commented on the massive Johan Sverdrup discovery:

This is very, very good oil and the reservoir is good. If we work with that over the lifetime, we can manage to get almost a 70 % recovery rate.

While this is certainly great news for StatOil, it is even more important for one of STO's partners: Lundin Petroleum (OTCPK:LNDNF). Lundin Petroleum is an independent Swedish oil and gas exploration and production company with core assets in Norway and South-East Asia. Lundin Petroleum has existing proven and probable reserves of 202 million boe. In contrast, StatOil estimates the Johan Sverdrup fields hold as much as 2.9 billion boe. As a result of STO's 70% recovery estimate, LNDNF was up 9.9% on Friday. However, there is still significant upside potential for Lundin's stock because the company's working interest in the field, at current estimates, equate to roughly 640 million boe. That works out to 50+ years of the company's current production rate. If the 70% recovery factor turns out to be realistic, there is additional and significant upside to that metric. Lundin could easily double over the next 3-4 years and should rise 30% over the next 12 months.

The Johan Sverdrup Reservoir

The Johan Sverdrup field actually consists of two discoveries, Avaldsnes and Aldous, located in the Norwegian North Sea. The discoveries are relatively shallow - only 110 meters of water. It is one of the largest discoveries ever made in the Norwegian Continental Shelf.

Avaldsnes lies in Production License ("PL") 501, while Aldous is part of PL265. When exploration activities revealed that the two discoveries actually constituted one giant connected field, the field was renamed Johan Sverdrup in early 2012.

PL501 is estimated 0.8 to 1.8 billion barrels of gross recoverable oil. Lundin Norway is the operator and holds a 40% stake. STO also owns a 40% interest.

The PL265 field is estimated to contain 0.9 to 1.5 billion barrels of gross recoverable oil. Lundin Norway owns a 10% interest in PL265, while Statoil is the operator with a 40% stake.

A Massive High-Quality Reservoir

According to this Lundin webpage, the Johan Sverdrup field covers approximately 180 square kilometers and is one of the largest discoveries ever made on the Norwegian shelf. Not only is it a massive reservoir, but it is very high-quality. reports the oil present in the field is highly mobile with low viscosity. It has an API of 28° and has a low gas/oil ratio.

Is A 70% Recovery Factor Realistic?

When questioned in the conference call (see Seeking Alpha transcript here) about the 70% recovery factor, Øvrum said:

I have disclosed the figure for what we are putting into the concept selection, and it's obviously not 70%. I just said from our experience, from increasing the recovery rates from 30% to 50% on average, we -- and I know that if you work with that, this is a very, very good oil, and the reservoir is good, and I believe that we can see growth with that over the lifetime. We can manage to get almost a 70% recovery rate.

So what that means, at least to me, is that STO's original resource recovery estimates were in the 30-50% range. So, a 70% recovery rate factor would be a 20% increase to the existing recovery estimate: i.e. over 100+ million barrels for the entire field.

I am sure the 70% recovery factor comment turned some industry heads. As a StatOil shareholder, it certainly turned mine. However, it may not be far-fetched. Here are some factors to consider:

  • StatOil's extensive multi-decade experience on the NCS.
  • The highly mobile nature of the high-quality reservoir.
  • The reservoir is relatively shallow (110 meters of water), and the two discoveries have showed a relatively consistent and shallow depth (2,100 m) and fairly consistent oil columns (30-65 m).
  • StatOil's extensive use of recovery techniques on the NCS.
  • StatOil's use of reservoir monitoring technology.

On this last point, please read my article on Geospace Technologies (NASDAQ:GEOS) and StatOil's use of the company's technology to locate, characterize, and monitor large oil reservoirs. I have no doubt STO and its partners will invest in GEOS equipment to help maximize the value of this huge reservoir. One should also consider that StatOil has a history of very slow, methodical, and conservative estimates when it comes to reservoirs. I have heard it said that this is a common characteristic of the conservative Norwegian culture as a whole.

Lundin's Take

Taking the mid-point of the two recovery estimates (1.3 billion for PL501; 1.2 billion for PL265) puts Lundin's take at ~640 million boe. And remember, these recovery estimates were made before the recent 70% recovery factor was announced. StatOil is tight-lipped on its current recovery estimates using the new factor, but suffice it to say there is significant upside to an already monster of an oil field.

To put the impact this one reservoir will have on Lundin into perspective, let's take a look at some key data from the company's Q4 and full-year 2013 earnings report:

Existing production from assets in Norway, France, Netherlands, Russia, and Indonesia is 32,700 boe/day. This means the 640 million boe I estimate as Lundin's take of the Johan Sverdrup field equates to 50+ years of the company's current production. And this estimate will likely go higher when the new recovery rate factor is included.

Lundin released its 2013 reserves update, and proved and probable working reserves dropped from 201.5 million boe at year-end 2012 to 194.1 million boe at year-end 2013. The 2012 Annual Report gives a good look at the company's reserves composition (minus of course Johan Sverdrup):

If my estimate for Lundin's take of Johan Sverdrup is in the ballpark, the field should (over time) triple the company's proved and probable reserves. And the reserves added would be mostly oil, not gas. With STO's announcement Friday, there is significant upside if the 70% recovery factor the company quoted turns out to be realistic. It should be pointed out that Lundin's "contingent resource" estimate for Johan Sverdrup is 923 million boe: 30% higher than my estimate of the company's take based on existing recovery estimates and Lundin's percentage working interest

Lundin's Fundamentals

According to the Q4 earnings report, Lundin forecasts average production will reach approximately 50,000 boe/day in 2015 and will increase to over 75,000 boe/day by the end of 2015 when the Edvard Grieg field comes online. The company generated operating cash flow of close to USD $1 billion in 2013 and expects to exceed $1 billion of OCF in 2014. Although StatOil has not yet reached a final investment decision ("FID") on Johan Sverdrup development, you know it is at the top of its list, as it is for Lundin. Lundin is already getting excellent support from 25 international banks, which have provided a USD $2.5 billion revolving credit facility to fund ongoing development and exploration activities. The company recently increased its credit facility to $4 billion with an eye toward Johan Sverdrup development. The credit facility increase was met with the full support of all Lundin's existing lenders.

While production is still years away (StatOil predicts late 2019), there is no doubt the oil is there, the oil is high quality and mobile, and the reservoir is massive. A total of 20 wells have now been drilled on the Johan Sverdrup field and the appraisal campaign is now substantially complete. Reserves should start being booked as soon as appraisal audits are completed. Once these are made official, I would expect the stock to rise.

Lundin is in a great position as operator and 40% owner of PL501. The company is taking steps to fund the exploitation of the resource. It can go it alone or has the flexibility of reducing its stakes in PL501 or PL265 in order to very easily raise capital. What international oil company would not want a piece of such a massive high-quality reservoir that will be relatively easily lifted?

Summary & Conclusion

Lundin Petroleum is a mid-cap company that is sitting on a gold mine - the massive Johan Sverdrup oil field. The stock has sold off since the post-discovery euphoria and over investor frustration that the Johan Sverdrup discovery has not yet been booked into proved and probable reserve figures. The company represents a solid value despite last Friday's move. Johan Sverdrup could triple Lundin's proven reserves and represents an inventory of 50+ years at the current production run rate. STO's recent announcement of a potential 70% recovery rate should provide a significant upside catalyst to existing reserve estimates even if it is off by 20%.

My 640 million boe estimate of Lundin's Johan Sverdrup percentage take is conservative and will likely be upgraded. For a rough estimate of the value of Lundin's Johan Sverdrup assets, I will simply scale a recent EXXI reserves valuation report (Slide 8) that was based on before-tax SEC pricing of $107/barrel oil and $3.84/Mcf gas that came up with a value of $10.9 billion on 310 million boe. That would put 640 million boe at $20+ billion. To be conservative, let's reduce that estimate by 20% and call it $16 billion. On this quite conservative PV10 basis, Lundin's working interest in the Johan Sverdrup field alone is worth more than 2.5x the company's present market cap of $5.8 billion.

Yet, this valuation doesn't even take into account the company's current reserves and producing assets. And it doesn't take into account STO's updated recovery factor, which will likely result in significant upgrades in recoverable reserves. In addition, Lundin expects production to more than double over the next two years. These are powerful long-term catalysts for the stock. Clearly, Lundin is severely undervalued even after Friday's pop on STO's comments.

Bottom line: Lundin could easily double over the next 2-3 years, and should at least reach its previous high ($26/share) over the next 12 months: 30% higher from today's value. Even at $26, Lundin's market cap would only be $6.63 billion - a bargain considering the company's stake in the Johan Sverdrup field and the significant upside potential of that field.

Lundin Petroleum is a STRONG BUY.

Mkt Cap: $5.8 billion

EPS ((ttm)) = $0.25

PE ((ttm)) = 76.5

Div (Yield) = nil

(Source: Yahoo Finance)

NOTE: Lundin Petroleum trades on its home market (Stockholm) under the ticker LUPE and also on the London and Toronto exchanges. The LNDNF symbol is traded on the OTC.

Disclosure: I am long STO. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am an engineer, not a CFA. The information and data presented in this article was obtained from company documents and/or sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Please do your own research and contact a qualified investment advisor. I am not responsible for investment decisions you make. Thanks for reading and good luck! NOTE: I am considering buying shares in Lundin Petroleum over the next 48 hours.