Cairn Energy’s interim report revealed higher contingent resources at SNE of 563mmbbl, but a phased development plan targeting the lower reservoirs initially. Lower capex to first oil is balanced by a lower (and longer) plateau period of 75-125mb/d. Other offshore projects indicate that phase one will have low production rates (of perhaps 80mb/d), while we expect further phases to increase over time. As a result of these changes, and a number of other adjustments throughout our modelling (not least for the commissioning issues seen at Kraken), our contingent valuation remains broadly flat at 195p, but our RENAV increases to 205p (from 200p).
Cairn’s estimate of SNE contingent resources has increased from 473mmbbl to 563mmbbl on a 2C basis, with 900mmbbl on a 3C basis (a 19% increase). Positive results in the appraisal drilling programme and the interference testing this year has given more confidence. However, with the phased development, the company will be concentrating on the lower reservoirs initially, aiming to extract 240mmbbl before moving onto future phases developing the thinner and less productive upper reservoirs. This will necessitate lower production rates for the FPSO than a combined development, leading to a lower and longer plateau.
Kraken has been experiencing more material issues with commissioning of the production systems. We model substantially lower production volumes from Kraken in 2017 and expect plateau production to be reached in mid-2018. The company is also looking to drill 10 wells in the UK and Norway by 2019, potentially unlocking 1.2bnboe, which could help to build upon the Skarfjell development.
Our valuation falls slightly to 195p/share after adjustments to the development concept at SNE and elsewhere in the portfolio. Despite the lower initial capital investment driven by the phased development, we believe there is good evidence to suggest that phase one production rates will be at the lower end of the 75- 125mb/d range given by Cairn, reducing our valuations for SNE. Delaying the development of the upper reservoirs gives the consortium more time to study the best way to exploit the remaining resources and the up to 1tcf of non-associated gas that Cairn estimates is also present. The major catalyst for the stock is now the resolution of the tax arbitration in India, where Cairn is now claiming over $1.3bn. We expect a decision in H118. Exploration at Drombeg (Q317) and Norway (Q417) could add incrementally and help the company’s exploration and appraisal pipeline.