London and Toronto listed Xcite Energy is sitting on a likely 160 million-barrel recoverable oilfield in the North Sea and, although it has the drilling and offtake agreements in place to begin extracting oil by the middle of next year, has a share price that values the company at under a dollar per barrel for its resource.
Among the possible reasons why the market is viewing the shares with an unsympathetic eye, is the fact that the oil in its reservoir is viscous – referred to as ‘heavy oil’ in the industry - which has historically made the extraction process more problematic and means it is sold at a 8-12% discount to more free-flowing Brent Crude. Furthermore the company is small and is unwilling to farm out the extraction process to a larger player, an unusual approach from a small cap resources player – but an innovative one that should reap significantly larger rewards in the long run. The key here is the securing of the business partners earlier this year; BP, AMEC and Transocean/ADTI, who will provide the credibility and services to enable the field to be developed. Small cap doesn’t look so small cap after all.
The oilfield – named Bentley and situated 160 kilometres east of the Shetland islands - was previously owned by Conoco, the world’s fifth largest refiner, who drilled three times in the 1980s but failed to bring oil to surface. ‘They had a bad day,’ confirms Xcite’s chief financial officer Rupert Cole. ‘They had the wrong pump set-up, the wrong sand screens and the oil price and the level of technology was much lower then.’ Indeed, heavy oil is now much less of a technological problem and is being extracted commercially in several continents around the globe, with Statoil’s Grane heavy oil field producing 200,000 bopd (barrels of oil per day) only a few miles away from Bentley and a number of others in the region targeted for 40-60% recovery rates.
BVI-domiciled Xcite acquired 100% of Bentley in 2003 and, with a team that includes a number of former Conoco men, proved oil does flow with an appraisal well in early 2008. This, along with two subsequent Competent Person’s Reports and recent reprocessing of 3D seismic data has shown the oil field could be one of the largest in the North Sea, with an upside of 886 million barrels (mmbbls) of petroleum initially in place (PIIP). However, the company is understandably being cautious and says the most likely level of PIIP for the Bentley field is 689 million barrels (this excludes upside from some lower, Jurassic oil that has been encountered and logged).
The likely amount of viscous oil that can be extracted, according to Competent Person RPS Energy, is between 72 and 166 mmbbls, with a most likely case of 122.5 mmbbls. The recent seismic reprocessing by the company lifts the recoverability estimates to between 109 and 220 mmbbls, with a base case of 160 mmbls. With the project’s current chance of commercial success calculated at 70%, the base risked case is 112 mmbbls. Successful completion of a planned drilling project this July and August will take the chance of commercial success up to 90%, will upgrade a portion of the contingent resources to a proven and probable reserve level, and will cement Xcite’s place as the third biggest independent producer company active in the UK North Sea in terms of reserves. Cole adds that recent 3D analysis means that ‘applying upside reservoir parameters we now think that the 160 mmbbls base case could be 235 mmbbls.’
The oil is contained in large, homogeneous body of high porosity, highly permeable sand and, heavy as it is, the oil has been found to be saturated with methane gas, which makes it ‘behave like lighter oil in situ’, according to the company. So this is a very good reservoir.
Now, can Xcite extract it and then sell it for a reasonable price?
An oilfield of this size is generally only found in the hands of an Exxon, a BP, a Shell or a Statoil. These giants of the industry would simply employ the very best drilling and engineering contractors and most likely succeed without much of a hitch. ‘So we have secured exactly the same team as a major oil company would,’ explains Cole. Xcite has created the ‘Bentley Alliance’, a group of industry partners that will provide the services as well as potentially contributing to the equity/cash flow to take the oil field into an ‘early production system’ next year and to the full production that is expected in 2014.
Top engineers AMEC will take care of the ‘top side’ engineering and consultancy, backed up by Schlumberger behind them, and with Transocean doing the drilling (and taking a 4% quasi-equity stake in the field in return for its $4m contribution to well costs). Another major coup has been to get BP to sign up as the offtake partner, incentivised to maximise the sales value of the oil and with the offtake fee directly related to the realised price achieved by BP in relation to the prevailing Brent crude price. Bentley oil has a very high diesel cut (ie it is good to refine for diesel fuel), among several other uses, and Cole is confident that BP ‘will be able to minimize the discount to Brent’.
It’s quite an agreement that Xcite has rigged for itself and a testament to the experience of the management team, says Cole, himself a former Halliburton man. The board has a wide range of industry experience both upstream and down, and is led by CEO Richard Smith, who worked with Cole at Halliburton, and chairman Roger Ramshaw, former chairman and managing director of ConocoPhillips in the UK and in Venezuela (heavy oil), with local expertise bolstered by exploration and development director Stephen Kew’s 25 years with Conoco and specific experience in respect of the Bentley field.
Cole explains that the result of this brains trust is an excellent deal for all concerned: ‘The Alliance is unusual for a small company like this, but we have done it before. As Xcite is unlikely to fund a conventional full field development, we are going to do it in bite-sized chunks and engage the Alliance partners to provide an extraction service. For our partners this is potentially a very important contract, due to the way we are able to structure it. They would have the potential to earn significant bonus revenues as they are incentivized to deliver much more than the minimum amount extracted.’
With a £24.9 million placing (at 40p a share) completed on 18 March, Xcite has the financing to complete the drilling and flow testing of a pre-development well this summer. By around the end of June, Transocean should have one of its jack-up rigs standing on the sea bed to drill a horizontal well of around 500m with the aim of achieving a representative flow rate and moving the contingent resources to reserve status.
The next stage will be the early production system (NYSEARCA:EPS), which is an extension of this summer’s drilling, with 5 wells planned to be drilled. ‘If we had the money we’d probably do it now,’ says Cole, who says that this is planned for ‘the middle of next year and should be in production for around two years’ and produce ‘around 10 mmbbls; our first oil and cash flow’. He says the EPS funding should be around $100m and will probably be made up of ‘half debt and half equity’.
At £80 million market cap, the 60p shares mean the market is only ascribing 75cents per barrel to Xcite’s base case oil reserves, compared to a Brent crude price of around $80. This assumes a huge amount of uncertainty in the project – much more than seems justifiable based on the big industry names which have signed up to the Alliance after full due diligence on the field. Broker Arbuthnot, based on the Competent Person’s Report, calculates a ‘low’ net present value of 79p, a base of 340p and a high of 669p.
Disclosure: The author holds no positions in the company