Serica Energy - plenty to make me think that it will continue to do very well says Gary Newman

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Oil has been on a bit of a charge recently and there aren’t any real signs of that strength coming to an end anytime soon, but quite a few of the producers haven’t responded as well as you would expect, in terms of share price movement. That can definitely create opportunities though, and amongst those which I view as being too cheap, especially in light of recent news and further developments to come, is an old favourite of mine, Serica Energy (SQZ).

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For months the share price was stuck trading in the 110-120p range, despite oil prices strengthening and I had assumed that was largely due to the ongoing re-entry of its Rhum asset, in the North Sea, via the R3 well, and the fact that it was taking far longer to try and get it flowing again than many anticipated. This well had been abandoned by the previous operator with debris stuck in it and an obstruction across the completion, but was always viewed as having the potential to have a major impact on current production. Last week the company announced that it had successfully installed the new completion equipment and that the well had been flowed at a rate of 58.4mmscf/d along with 135bbls/d of condensate, and that this had been constrained by the limits of the testing equipment onboard, which was as expected. These volumes equate to over 10,000boepd and R3 should actually be capable of producing at higher rates when it is brought online, with flows being towards the higher end of previous expectations. To put that into context, the company averaged 23,800boepd during 2020, although that was impacted by work that was carried out during H1 of that year, and should have been closer to 30,000boepd without that.

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That shows just how much of an impact R3 could have once it is producing, as even last year with typically low oil and gas prices, the company still managed to generate a post-tax profit of £7.8 million, as well as over £44 million of operating cash flow. That also resulted in it paying a maiden dividend of 3p/share. Another factor to bear in mind when it comes to the potential to generate free cash flow, and net profit, particularly with strengthening oil and gas prices, and predictions that those are here to stay for at least the next few years, is that currently Serica is entitled to 60% of net cash flow from the BKR (Bruce, Keith and Rhum) assets, but next year that increases to 100% and will make a significant difference, especially as it will coincide with the increased production from Rhum. In addition to the impressive flow data, bringing R3 online also has the potential to significantly increase the current 2P reserves for that field, which stood at around 28.7mmbbls. The R3 well will be hooked up to the facilities on the Bruce platform, and will utilise the spare capacity that had – with the current focus on carbon emissions, it is also worth noting that doing this won’t significantly increase that.

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It hasn’t all been plane sailing though for Serica of late, as whilst the R3 intervention was seen as carrying risk, the development well at its Columbus field, to bring that into production, was seen as much more straightforward, but turned out to be the drill that caused issues, as the screens needed to filter out fine particles, weren’t able to be installed. The good news though is that the horizontal section through the Upper Forties sands and shales was in line with pre-drill expectations, and the reservoir section of the well will now be side-tracked and re-drilled, which, all being well, will avoid a repeat of the problems encountered. The additional cost of this work was around £3 million, but luckily it isn’t expected to delay first oil from Columbus, which is still on track for Q4 of this year – that should see around 3,500boepd net to Serica from this 50% owned project, and with around 70% of that being gas.

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When news on R3 dropped the shares briefly spiked up to around 135p, but have pulled back since then to 125p, giving a market cap of circa £335 million. I suspect we saw some traders taking profit on the R3 news along with a degree of caution over Columbus not quite going as planned, and that may be preventing the share price taking off to the extent I would have expected after that news. I believe that this offers a very good buying opportunity though, as whilst there is still some Columbus risk if anything was to go wrong again with that, in my view the real risk was that R3 would fail, and that has now gone. Currently I don’t own any shares here myself but am planning to buy back in – especially if there are any further dips, possibly driven by any temporary dip in oil and gas prices (although that may not happen) – and can see plenty of upside potential from the current share price, especially towards the end of this year and into 2022. There is still fantastic longer term potential here, and although it has already done better than I could ever have imagined when I first tipped it as a buy at around 5p, I still think there is plenty more to unfold here in the coming years – including the potential for further acquisitions as more large companies look to exit, and picking up these producing assets at a favourable price is something that Serica has proven that it is very good at. Like any company in this sector, there are some risks and largely relate to something happening that significantly impacted production for a prolonged period of time, as has happened to some of the Serica fields before, but with its output spread between a number of wells, R3 should actually have helped reduce that – although of course the Bruce facility is essential to production rates. There is also the risk that oil, and particularly gas, prices could drop, but then that is the same for any company in this sector, and if you are looking to invest in these commodities, then I would assume that your outlook on them is bullish anyway. Overall though there is nothing here to put me off, and plenty to make me think that the company will continue to do very well. Buy.

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