Tuesday, 26 November 2013

#XEL Xcite the suspense is killing me!

The following is my opinion only and based on nothing more than conjecture. I'm just laying out my thought process. So please make your own decisions on whether to buy, hold or sell. Thanks.

Image courtesy Stuart Miles FreeDigitalPhotos.net

Last week we heard that Statoil were indeed the mystery $15m buyer of data from Xcite Energy’s extended well test last May. The story is here and has since been carried by Reuters and elsewhere, so I’m certain we would have had a denial by now if it had turned out to be just an inaccurate Norwegian translation!

As a holder of Xcite Energy (previous comment here) I was delighted to hear this news and thought it was very significant. Why? Well imagine the following story being suggested a year ago.... A super major, and a specialist in heavy oil are developing a field development plan for their large heavy oil field called Bressay. They have operated this field since 2007 and have spent many years considering the best way to extract the oil. In March 2013 their concept selection plans are approved. They’ve spent millions of pounds developing these plans which are ready to take forwards. However, they hear about a small independent company called Xcite Energy who are making a lot of noise about their “revolutionary” approach to extracting oil from their nearby Bentley heavy oil field which was discovered in 1977 but abandoned because no-one had the ability to get the oil out.

Incredibly Xcite prove they can flow the oil from this field. They are in fact so successful with their drilling, testing, flowing, and technical approach that the super major decides to investigate further. They like what they see, and agree to cough up $15m to have a proper look at the well data. They decide it is so significant to them that it is worth shelving months of work, costs, and man-hours on their Bressay plans and instead decide to go back to the drawing board to incorporate the new knowledge they have acquired. This will save them hundreds of millions of pounds. They agreed as part of the purchase that the intellectual property remains the ownership of Xcite so they start to discuss with the board of Xcite about a deal which will see them able to copy Xcite’s IP directly into their Bressay field development plan. Without this they would be compromising the IP but they hope to come to a sensible agreement with Xcite, especially as there are several other majors such as BP and AMEC involved in the arrangements.

Sometimes I find we can’t see the wood for the trees and I think we’re all staring an obvious fact right in the face. Maybe we’re too tired with the waiting and the games to realise what we have in front of us. Now of course I don’t know how the IP issue will play out but checking back on Cole’s comments at the time of the data sale he said:
We are very pleased to have completed this agreement, which is complementary to the recently commenced farm-out process, and further validates the quality of the information collected from our two well programmes. This has been done without compromising the company’s intellectual property and is a good commercial outcome that provides additional working capital."
Now the free dictionary defines intellectual property as: “A product of the intellect that has commercial value, including copyrighted property such as literary or artistic works, and ideational property, such as patents, appellations of origin, business methods, and industrial processes.”

That’s why I’m delighted with the news last week. Not that they sold the data, we knew that, but that a super major has confirmed it is worth millions to them and have changed their plans on the back of this insight. And if we believe the above, Xcite have retained the intellectual property rights to this knowledge. Won’t Statoil therefore have to come to an arrangement with Xcite to use their IP at Bressay? A royalty arrangement? Licence arrangement? Joint venture? I might be well off the mark but what does “without compromising our IP” really mean?

Since this news broke, there has been speculation that Statoil might buy Xcite outright. I personally am not so sure. A takeover by Statoil is not what I am expecting as I believe this would release the Xcite team to pursue other opportunities and it’s this knowledge that Statoil need to help with the Bressay plans.

I am still of the opinion that Xcite will do what they have said they plan to do all along. Which is, and which has been repeated many times, continue to production with an increase in their reserves based lending (RBL) facility and a farm in to raise the remaining funds needed for development. Then explore and appraise their other licenses and prospects. And so they go on....

With regards to the RBL they announced in 2012 that they had secured a $155m facility with Royal Bank of Scotland, Societe Generale, GE Energy Financial Services, Nedbank Limited, and Britannic Strategies Limited (a subsidiary of BP). The $155m was secured against only 22m 1P reserves at the time. The increased 1P of 198m should see them able to arrange a much increased RBL facility, especially as the mix of institutions is quite wide. But I’m sure it won’t increase in the same proportion as reserves have increased. So let’s speculate that they secure $400m RBL on their 198m 1P reserves. Now let’s assume that they farm out 25% of Bentley, and for this example let’s base that on an ultra conservative $5 barrel for 2P reserves in the ground. 25% farm out would be 63m 2P, and at $5/barrel that would give Xcite $315 from the farminee plus hopefully some back costs which may conveniently cover the West Face loan.

That would give them the $700m they need to get to first phase production. If we then value their remaining 187m barrels at just $5/barrel fully funded oil in ground then that would come to $935m. At an exchange rate of US$1 to £0.66 that would equate to £623m. That’s nearly twice our current market cap of £323m (in reality it should be far more than $5/barrel. Edison suggests $8/barrel as fair if funding and farm in is in place). That ascribes no value for enhanced oil recovery. No value for the conversion of our prospective resources to reserves. Nothing for the $800m tax loss allowances. Zero for Intellectual Property. Zilch for other licenses. Nada for looming production potential now fully funded. Just a $5 per barrel valuation for oil in the ground, proved and development ready, in a politically safe region, with proven technology. And now fully funded to first production. Once the production starts the valuation for oil in ground and being produced should easily rise to $12 per barrel if not more. That’s another doubling of the market cap (assuming all else equal)

So I’m very happy with the news last week. I’m happy with the validation of all the hard work that Xcite have done to date. And I’m happy to sit on my hands for as long as it takes. I know that things may still come “left field” and that the above could be a rose tinted view of how things will play out. We could see some dilution added to the farm out and RBL, potential for further delays, changes to plans etc, but that’s the reality of oil and gas. It’s a risky market to invest in and there will be ups and downs along the journey. But the last year has seen Xcite prove they have the knowhow to extract their oil, confirm they have 250m barrels of P2 oil, describe it as “of significant strategic importance” and now a super major has validated their technical ability without compromising their IP.

I believe that the final jigsaw pieces are being put in place and that we will see the bigger picture emerge in the very short term. But I see value here and am happy to wait for the picture to come clear, as long as that takes. But I have to admit the very well orchestrated news blackout with just the occasional emergence of significant pieces of the jigsaw is killing me! I’ll leave you with a closing line from Edison’s April 2013 report talking about the negotiations that Xcite management will be undertaking in 2013:

We do not expect much public visibility of these discussions given their confidential nature

Now that is definitely the most accurate prediction an investment analyst has ever made in my opinion! Here’s hoping we get the rest of the pieces soon......

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