As regular readers will be aware, one of the few areas where we see real value at the moment is the resources sector. One company in particular that has caught our eye of late is North Sea oiler Xcite Energy (XEL), shares in which are currently trading at just 65.5p – a far cry from their 2011 high of 400p. So aside from the fact that nobody will touch resource stocks with a barge pole these days (which is all the more reason to be interested, in our view!), what has gone wrong?
Well, the key issue facing Xcite is that it seems to be a hostage to fortune. Essentially Xcite is looking for a farmout partner to help it develop its Bentley oil field, but the looming Scottish Referendum seems to have put off any potential suitors thus far. In addition to this, the North Sea is widely viewed to have an uncompetitive tax regime, albeit one that both Westminster and Holyrood appear keen to address, whatever the outcome of the referendum vote, illustrated by both governments’ support for the Wood Report. Commissioned to ascertain the best way to extend the North Sea’s life and increase the UK’s oil production, the Report contains many recommendations intended to make the region more attractive to investors.
However, not content to simply sit it out until a partner comes along, Xcite has been busy getting its ducks in a row.
In June 2013 it signed a Memorandum of Understanding with construction giant AMEC, laying out commercial principles for future co-operation on the development of Bentley. This was followed up by another memorandum of understanding with Teekay Shipping for the provision of shipping services for Bentley field infrastructure; and, more importantly, a collaboration agreement with Statoil and Shell, with whom Xcite will share technical and operational information to evaluate potential synergies between Bentley and the Bressay oilfield.
This agreement has opened up the possibility of a joint venture between Statoil, Shell and Xcite, while the more excitable market participants believe a takeover of the latter might even be on the cards. However, as a word of caution, readers should be aware that such speculation is not new: in 2013 Statoil paid $15 million for a package of technical data from an extended well test on Bentley, raising hopes that the Norwegian oil giant was lining up a bid either for the asset or the whole company.
At the end of June Xcite took steps to shore up its finances in a move which should set it in good stead to negotiate with potential partners from a position of strength. A $140 million financing package, the majority in the form of two-year senior secured bonds, gives Xcite the flexibility and additional resources to work with its development partners towards submission of a field development plan. This is crucial for presenting a development-ready proposition to the oil majors, who are clearly interested in Bentley, judging from recent activity.
And no wonder! Bentley is undoubtedly a material asset, with 2P reserves of 250 million barrels with a further 46 million barrels of contingent resources, making it one of the biggest proven undeveloped fields in the North Sea.
To put this into context, the average UKCS (United Kingdom Continental Shelf) discovery size over the past ten years has been 25 million barrels of oil equivalent (BOE) and 90% of current fields in production on the UKCS are producing less than 15,000 barrels of oil equivalent per day (boepd). Bentley is expected to have an economic field life of 50 years and modelled to produce 15,000 boepd after 17 years of production and approximately 8,500 boepd after 35 years of production.
So what could the shares be worth? The short answer is quite a lot more than they are now.
Research house Edison has a core NAV of 146p for the company, but notes that “working with partners, either service companies or through a farm-out, would likely enhance this valuation substantially.” Xcite is clearly an undervalued asset, but it is also one where the investment horizon is protracted with numerous hurdles to overcome in the meantime. It seems a no-brainer that Bentley, a large asset with proven commerciality, will get developed at some point down the line; in the meantime holders must be comfortable with bearing risks and playing the waiting game.
While Xcite is certainly an interesting story, the old adage that such shares are not for widows and orphans rings as true as ever. Therefore, our favoured strategy for playing undervalued stocks in the resources sector is through a basket approach, which should mitigate against any nasty surprises that E&P stocks can throw up from time to time.