Description

Norwegian Energy Company ASA (“Noreco” or “NOR”)

In case "closely held illiquid small-cap North Sea E&P" doesn't say it all, this is a highly speculative investment. Average daily trading volume has been 7,100 shares (US$161,000) over the last three months, likely leaving this unsuitable for larger accounts. In the summary table above, market cap, net debt and TEV are in USD and the remaining figures are in Norwegian kroner ("NOK"). This write-up assumes USDNOK = 9.18 and USDDKK = 6.8.

Company Overview and Recent History

Noreco is an oil and gas producer established in Norway in 2005 and listed on the Oslo Stock Exchange under the ticker “NOR”. The company was initially involved in E&P activity on the UK and Norwegian continental shelves, as well as in Denmark. Noreco divested most of its legacy hydrocarbon assets (operated and non-operated) from 2014-2017. 

In April, Noreco completed its acquisition of Shell Olieog Gasudvinding Danmark B.V. (“SOGU”), a subsidiary of Shell set up to hold a 36.8% working interest in the Danish Underground Consortium (“DUC”), a joint venture set up to explore for oil and gas in the sole concession area of the Danish North Sea. Noreco paid US$1.9bn for SOGU with an economic effective date of January 1, 2017. Noreco has assumed cash flow from the producing assets as of that date, yielding an adjusted purchase price as of year-end 2018 of ~$1.2bn, representing ~$6.20 per boe of 2P reserves. 

The DUC comprises 15 producing fields and accounts for 88% of all oil and gas production in the Danish continental shelf (see "DUC Fields & Production Hubs" below). The DUC has been operated by French supermajor Total SA since Total’s 2017 acquisition of Maersk Oil (purchase price represented ~$13.40 per boe of reserves). Total increased its ownership in the DUC to 43.2% in connection with the Noreco-Shell deal by buying a 12% stake held by Chevron. The remaining 20% is held by Nordsøfonden, the Danish state-owned oil and gas company. 

Noreco is 73% owned by four hedge funds: Taconic Capital (30%), Kite Lake Capital Management (22%), CQS LLP (18%), and York Capital Europe (3%). These funds led a USD-denominated convertible bond and equity offering to fund the SOGU acquisition.

Current Setup

At today's close of NOK 207 per share, Noreco's market cap is US$554mm. Net debt is $839mm, and the company's TEV is $1.4bn. On recent historicals, Noreco is extremely cheap. Pro forma for the acquisition of SOGU, 2017 and 2018 EBITDA - capex was $757mm and $726mm, respectively.

So why is Noreco trading below 2x trailing unlevered FCF? In short, because over the next three years Noreco plans to spend 80%+ of its current enterprise value on a project that will take one of its major fields offline and—along with organic production declines—will take net production down 50% by 2021. 

Total is redeveloping the DUC’s Tyra field after subsidence of Tyra’s field chalk reservoir caused production platforms to sink by five meters over the last 30 years. The Tyra and Tyra SE fields accounted for ~13k boe/d net to Noreco in 2018 (23% of total net production of 57k boe/d), and they will be offline until the redevelopment is complete. DUC expects the redevelopment will add ~200mm boe of gross reserves (74mm boe net to Noreco), and 60k boe/d of additional gross peak production (~23k boe/d net to Noreco). Noreco’s share of capex and abandonment expenditures will be $1.1bn, which implies $15.44 per boe of new reserves.

With Tyra offline through 2022 and accounting for Noreco’s share of redevelopment capex, Noreco could burn $400-450mm in FCF (assuming $55 Brent and $5/Mcf realized gas pricing). To mitigate cash burn, Noreco secured from Shell a monthly production guarantee for 98% of a pre-agreed liquid production level from the SOGU sale’s effective date through December 2020. Under the guarantee, Shell will make monthly payments based on the price achieved by Noreco in that month on production of ~36k boe/d in 2019 and ~28k boe/d in 2020. 

Noreco has further near-term cash flow support via ~$130mm worth of remaining oil price hedges (at current spot Brent). Based on the SOGU filings and auditor’s report included in Noreco’s August 2019 convertible bond prospectus, I estimate Noreco had hedges on 16mm barrels of oil at an average price of $75/bbl as of 12/31/18. Noreco separately reported its hedges cover the period from October 2018 until September 2020. Based on Danish Energy Agency data, I estimate net production to Noreco of 8.4mm barrels YTD through August 2019.

Noreco’s new RBL facility prohibits the company from paying dividends until the Tyra redevelopment is complete. Thus, the long case largely rests on two pillars: (1) stable commodity prices and (2) on-time and on-budget Total-led Tyra redevelopment. Assuming we come in within a reasonable margin of error on these two, what can we expect?

Noreco estimates its share of production will return to 45k to 50k boe/d when the Tyra redevelopment is complete in 2022. With $55 Brent and $5/Mcf, as above, Noreco could generate $319mm (NOK 119 per share) in FCF to the equity in 2022, equivalent to a 58% FCF yield on today’s share price.

Capital Structure

As part of the SOGU acquisition, Noreco secured a seven year US$900mm RBL facility. The facility has a 3.0x net debt / EBITDAX maintenance covenant and contains a covenant prohibiting dividend payments until the Tyra redevelopment is completed. 

Also in connection with the deal, Noreco issued an eight year US$158mm convertible bond to the four hedge funds mentioned above. The conversion price is NOK 240 (a 30% premium to the NOK 185 share price in a coincident equity offering). Noreco can pay 6% cash or 8% PIK interest on the convert. After five years, the conversion period expires and the bond stops accruing interest. 

Valuation

I don’t think it’s a stretch to say that Noreco’s FCF discount to peers is due to uncertainty around the Tyra redevelopment. The analysis below shows that for NOR longs to lose money over the next two years, some combination of the following needs to happen:

• Severe and sustained commodity price downturn ($40/bbl Brent and $3.50/Mcf gas in northern Europe)
• Noreco misses its production guide post-Tyra by 10k boe/d or more
• Noreco equity continues to trade at punitive equity FCF yields (30%+)

Assuming at least one of the above doesn’t hold, Noreco longs should at least break even, and if things are a bit better, Noreco equity could more than triple. 

In the table below, I adjusted 2021 estimated net debt for 2020 hedge runoff and for Noreco’s abandonment liabilities rolled forward two years.

DUC Fields & Production Hubs

The DUC comprises 15 fields on the Danish continental shelf. Production started in 1972 and peaked in 2005 at ~500k boe/d. In 2018 the DUC produced 162k boe/d (60% liquids and 40% gas) with production routed via the four hubs Halfdan, Tyra, Dan, and Gorm. Four pipelines secure exports from the hubs to the Danish mainland and the international market. The DUC expects production to increase over the next decade following completion of the Tyra redevelopment in 2022 (see “Tyra Redevelopment” below).

Source: Noreco October 2018 investor presentation

The Danish Energy Agency publishes oil and gas production data on all 15 fields owned by the DUC going back to 1972. DUC fields are mature and have reached slow exponential decline rates. YTD August 2019, barrel equivalent production (using 5.8mm btu = 1 boe) is down just 2% over YTD August 2018, and decline rates have averaged 6% annually since 2015. Below are historical production figures by field going back to peak production in 2005.

Source: Danish Energy Agency

Below are longer-running production totals (thousands of barrels equivalent per day) at Noreco’s current 36.8% interest. Production net to Noreco was 57k boe/d in 2018. 

Source: Danish Energy Agency

Finally, see the chart below for a closer look at recent DUC production net to Noreco. Net production YTD August 2019 was 58k boe/d. 

Source: Danish Energy Agency

Source: August 2019 Noreco convertible bond prospectus

Tyra Redevelopment

Total, as operator, is pursuing a full redevelopment of the DUC's Tyra field. DUC began redevelopment in 2017 after subsidence of the Tyra field chalk reservoir had caused production platforms to sink by five meters over the prior 30 years, creating a gap between the sea and the platform decks. The project scope includes replacing two existing accommodation and one processing platform with one single accommodation and one processing platform. DUC expects the redevelopment to extend Tyra’s useful life by 24 years. Tyra is the center of Denmark’s national energy infrastructure and processes ~90% of the country’s gas production.

DUC will invest DKK 17bn of capex and DKK 4bn of abandonment expenditures (Noreco share of a total of US$1.1bn) and expects it will add an estimated 200mm boe of gross reserves (74mm boe net to Noreco), leading to 60k boe/d of additional gross peak production (~23k boe/d net to Noreco, of which ~68% is gas). The Tyra fields accounted for ~13k boe/d net to Noreco in 2018, and they will be offline until the redevelopment is complete.

Comparable Company Valuation

Historical and Projected Financials

Below are historical audited SOGU financials and my projections incorporating SOGU guidance. I assume cash opex per boe decline from $18/boe to $15/boe by 2022 and that capex per boe (excluding Tyra redevelopment and abandonment capex) is $8/boe. SOGU expects to be joint taxable with Noreco’s other Danish subsidiaries and per the convert prospectus, the group expects to be able to utilize its tax loss carryforwards of NOK 6.3bn, which should shield the company from paying meaningful cash taxes until the late 2020s. 

Catalyst

• Tyra redevelopment progress reports from Total
• Commodity price upside