Serica Energy’s profitable gas-centric business promises lower-risk growth in North Sea

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It is unlikely that at the back-end of 2020 there are many oil and gas investments that will tick as many reassuring checkboxes for AIM investors as Serica Energy Plc (LON:SQZ).


It has been a challenging time for all in the sector as the coronavirus pandemic and global petropolitics saw the price of crude collapse.


Nonetheless, Serica – a North Sea oil and gas producer that remains debt free – was able to ride out much of the macro storm with profitability intact.


“Our costs are very low, we have no debt repayments to make, and we were still profitable in the first half of this year,” chief executive Mitch Flegg told Proactive.


The company is focused on natural gas rather than oil producing assets, with gas making up 80% of production. Gas is seen as an important transition fuel and prices have recovered significantly from the historically low prices seen earlier in the year.


Interim results, released in September, showed GBP46mln of revenue based on 21,000 boepd (barrels) of total sales volumes (as the Bruce caisson was shut-in) leading to GBP20.4mln of gross profit with GBP19.3mln of cash flow.


At asset level, it is a story of a largely predictable producer with sensible incremental growth opportunities across its existing portfolio.


Decisions made by the board several years ago prioritised production and cash-flow over the pursuit of big-bang exploration – a strategy which in 2017 was sealed by a transaction with BP, Total, BHP and Marubeni that saw Serica take control of the Bruce, Keith and Rhum (BKR) fields. The deal, which was completed two years ago on 30 November 2018, also meant that Serica took over from BP as operator of the Bruce platform.


Flegg commented: “Our team has grown from seven people before the BKR deal to now over 150. We’ve built a fantastic operating capability with a firm focus on HSE and establishing strong ESG credentials.”


The BKR assets were added to the 18% interest in the Erskine field, acquired previously in 2015.


Altogether, the asset base yields around 30,000 boepd net to Serica (FY 2019 figures).


At corporate level, Serica is counting down to a step-change in profitability.


As a by-product of the deal structure, Serica will soon see a substantial jump in revenues and cash generation. At the time of the deal, the AIM-quoted firm did not have to pay BP any upfront cash.


Instead, it agreed to pay BP an earn-out from the fields’ sales – in the first year of the deal it was 60% of sales, before reducing to 50% in year two and 40% in years three and four.


“We didn’t have to go into debt to acquire those assets and that has served us really well this year,” Flegg explained.


“The structure of that deal and the fact that we didn’t have to go into debt was absolutely crucial to our current position, and our current success.”


In a year’s time, Serica will retain 100% of the cash generated by the assets. “This means that we will have a boost in cashflow from 60% to 100%. Looking at it another way that’s a 66% increase from current levels.”


Also in the ledger will be the start of production at the Columbus field in 2021, with the 50% owned project slated to yield production rates net to Serica of around 3,500 – 4,000 boe/d at its peak.


Meanwhile, there are project opportunities within the BKR footprint which could provide further production growth. One example is already underway – an intervention project at the Rhum field’s third well (R3; previously drilled and connected for production) kicked off in October with the potential to add significant production volumes.


As a debt-free, profitable producer the company evidently ticks some key boxes for investors and a progressive dividend policy further bolsters the appeal.


In July, the company paid its maiden dividend, which at 3p per share amounted to around GBP8mln.


Increasing the portfolio through further M&A deals remains part of Serica’s strategy. Further deals could be forthcoming in the coming months as corporate activity across the sector picks up following 2020’s turbulence.


“We want to grow the portfolio and we want to do more deals,” Flegg said.


“We’re all hearing lots of stories of companies refocussing away from the North Sea, and wanting to sell assets, but it isn’t happening as quickly as I expected.


“I think part of that is oil prices in particular have been so poor this year and I think a lot of sellers are a bit nervous about selling, or being seen to sell, too quickly.


“There are ways around that. We’re always open to the sort of innovative deal structures that we’ve utilised in the past.


“We’ll buy at a low price and are willing to compensate as things get better. If there’s an upside, I’m happy to share the upside.”


Commenting on timing, Flegg added: “We can afford to wait as well. Hopefully, investors can see we’re not in a position where we’re desperate to do a deal.


“We want to do another deal soon, but if we don’t we’ve got enough to be getting on with in the meantime to get more value out of our existing portfolio.


“What’s important is that we do the right deal. We’ve all seen many companies that have overextended themselves. Have done deals at the wrong time because they’ve wanted or needed to do a deal.


“It is not just a case of acquiring assets or corporate activity just to ‘get bigger’. That doesn’t necessarily add value. It might look good and it might be good for your ego but at the end of the day, nobody really cares how many barrels we produce. They care how many dollars we make.”


“If there’s a deal that brings fewer barrels but gives us more value, then that’s what we want to do.”

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