Time for a punt on Southern North Sea operator IOG ?
“…It’s important to put things in perspective. A2 is producing gas – not just water. The company seems to have the funds necessary to give it a good opportunity to tide it through its present difficulties. And Saturn Banks doesn’t need to a thumping success to allow IOG to explore at least some of its other assets…”
This time last year gas operator IOG (AIM: IOG) was lighting up the small cap energy sector, recording solid progress in developing the seemingly highly prospective offshore and onshore Saturn Banks Project in the UK Southern North Sea.
Phase 1 of the Project, primed to make a meaningful contribution to a domestic market much in need of native gas, commenced production last March, aiming to commercialise the Blythe (1P 25.4, 2P 42.5 and 3P 55.8 Bcfe), Elgood (1P 9.7, 2P 14.1 and 3P 18.3 Bcfe) and Southwark (1P 46.3, 2P 71.2 and 3P 104.7 Bcfe) gas fields. Subject to the outcome of Phase 1, Phase 2 will target the Nailsworth (1P 32, 2P 53 and 3P 78 Bcfe), Goddard (1P 52, 2P 115 and 3P 169 Bcfe) and Elland (1P 20, 2P 28 and 3P 37 Bcfe) gas prospects, which would be piped through the same export infrastructure. The company has other North Sea licences, including the Abbeydale, Panther and Grafton gas discoveries, the Kelham North, Kelham Central, Thornbridge and Thornbridge Deep prospects, and part of the Orrell gas discovery. IOG is the operator across all of the licences, which it holds 50:50 with joint venture partner CalEnergy Resources.
IOG’s most recent half year report, published in August, set out an ambitious strategy for the year ahead. In addition to ongoing development at Saturn Banks, appraisal campaigns are planned at Goddard and Kelham North and Central, which if successful would be connected with the existing Abbeydale discovery to form a three-field gas hub. If Southwark – the Saturn Bank field with the largest production profile – comes onstream, thereby allowing Phase 2 to progress, and the Goddard and Kelhem appraisals prove positive, the company says it will ‘be in a position to review the refinancing strategy’ for a €100m bond maturing in September 2024.
Progress through 2022
Investor interest in IOG peaked last March, when Blythe and Elgood came onstream, achieving gross aggregate production of 34.0 mmscf/d from first gas to 30 June 2022, allowing IOG to secure a maiden H1 revenue of £30.2m, EBITDAX of £25.9m (1H 2021: £0.1m), and a post-tax profit of £11.4m (H1 2021: £0.2m), and to accumulate cash of £12.3m. A Gas Sales Agreement was signed with off takers BP covering the Blythe, Elgood, Southwark, Nailsworth and Elland fields up to at least September 2023.
But IOG’s momentum was spiked during the summer by operating issues that forced restricted production at Saturn Banks. Onshore liquids handling issues at a terminal connected to the Project’s infrastructure necessitated a week of downtime in late May, and unexpectedly high and saline produced water obliged the company to alternate production at the Blythe and Elgood wells, and to reduce H2 gross production guidance from 45-60 mmscf/d to 30-50 mmscf/d.
A November operations update reported that production had been restarted as planned into the Saturn Banks Pipeline System from both Blythe and Elgood after completion of shutdown works, and that gas sales were expected to recommence following full re-pressurisation of the line. Work had been completed at the Bacton terminal to de-risk potential for future shutdowns. The company sought to ensure investors regarding its capacity to cope with the revenue hit, declaring a cash position as at 20 October of £36m, and that its modelling of a range of risk scenarios indicated that ‘no short-term incremental funding need is anticipated.’
Another relatively positive update just before the end of the year, reporting progress at Southwark and Blythe. A well test and clean-up at Southwark’s first well, A2, was underway, with final hook-up and commissioning and safety reviews in anticipation of first gas by mid-January, allowing a second well, A1, to go ahead ‘from early Q2’. Southwark A1 would be followed by the drilling of a new Blyth H2 well, to come onstream ‘by early Q3’. Last year’s drilling would allow H2’s positioning at the field’s optimal location, encouraging the company to promise ‘rapid payback’ on a £26m investment in the well. The two-well appraisal campaign at Goddard and Kelham would follow ‘directly after’. The update confirmed the resumption of production at Saturn Banks, which was projected to average approximately 22 mmscf/d over H2 2022, and to produce a total 27 mmscf/d from first gas in March through to year end. The company was continuing to benefit from exceptionally high gas prices: average realised gas price had been 295.7 p/therm since operations restarted in November, 262.6 p/therm over 2H 2022 to date and 203.2 p/therm since first gas. 30,000 therms/day had been hedged with off taker BP at 303 p/therm for December and 319 p/therm for January.
A troubled start to 2023
Concluding the update, CEO Rupert Newall commented: ‘Operationally, the new leadership is making progress, but we still see room for improvement over coming months. We are proactively engaged in improving not only our own team’s performance but also that of our duty holders.’ Those cautious words proved rather prophetic when a further operations update last week reported that although Southwark’s A2 well had progressed through the hydraulic stimulation phase, the clean-up phase was taking ‘longer than planned’ due to suspected water formation.
Following stimulation of six reservoir zones, gas rates observed from A2 to date had ‘been lower than expected’, with a maximum stabilised rate of 4.2 mmscf/d via coiled tubing, at a flowing wellhead pressure of 456 psi. Associated water rates of up to 1,632 bbl/d indicated a connection to the active aquifer from at least one of the zones. The company acknowledged that having ‘stimulated six discrete reservoir zones, a low gas rate and apparent formation water production at this stage of the A2 well clean-up is unexpected and disappointing.’ A production logging tool was being run to acquire downhole data to help interpret the status of each zone and inform next steps. Equipment had been mobilised in anticipation of the need to isolate water producing zones to enable gas flow elsewhere. If isolation operations are successful, updated well test results are expected ‘within the coming weeks’ allowing a clearer assessment of the scope for the A2 well to produce gas at commercial rates.
Outlook
The disappointing update removed whatever shine had not yet come off IOG’s share price in the wake of last year’s operations difficulties. Since peaking at 43.5p in March the company’s stock had drifted down to 17p going into the New Year. It fell all the way down to 7.7p in the space of a day after last week’s announcement, and is just under 7p at the time of writing, taking the company’s market cap to £36m. In brief, IOG is down by more than 80pc over the past six months.
It’s a tough place to be in for a new company that the market not so long ago believed had bright prospects for contributing to the UK’s pressing need for gas. Perhaps, though, it is not a staging post rather than a hole. True, the current issues at Southwark seem more profound than last year’s operations mishaps, raising questions about the true viability of the Saturn Banks Project, and the company’s prospects for tapping its wider portfolio. Much depends on whether the company can wrest some kind of performance out of the A2 well.
It’s important to put things in perspective. A2 is producing gas – not just water. The company seems to have the funds necessary to give it a good opportunity to tide it through its present difficulties. And Saturn Banks doesn’t need to a thumping success to allow IOG to explore at least some of its other assets. If the company can weather this storm, existing investors prepared to keep the faith – or those prepared to take a speculative stake now – may reap rich rewards. It now seems a long time ago, but it’s less than a year since IOG’s stock was riding above 40p. The price may never hit those heights again. But with adroit operations – and a bit of luck – over the next few weeks, 2023 could still be the ‘high-impact year’ IOG was looking forward to not so long ago.
