Sterling Energy... after the FOG clears

Here is a copy and paste of the PDF broker note.

It's a bit messy as I ca not find it on the web to put a link in for you.

Some of the financial figures are out of place making difficult reading, but the message is there..............

Starts:-

Evolution Securities
100 Wood Street,
London,
EC2V 7AN
020 7071 4300

Evolution

SECURITIES
www.evosecurities.com 20 December 2004

Sterling Energy (SEY) Buy (unchanged)
Mkt cap: £219m Net cash: £74m Update Price/Target: 16p/29p
Update on Mauritania acquisition
Rebound in oil prices and strong rally in US gas prices gives Sterling the
ability to boost cash flow in 2005 and 2006. We take this opportunity to
outline the details of the Chinguetti deal announced in November
Sterling is one of the few UK E&P companies with exposure to the US natural gas
market. Indeed, almost all of its cash flow currently comes from this source. The
US gas price has shown a strong rally in recent days and is now up 32%
compared to levels at the time of the Chinguetti fund raising. Sterling now has
the ability to hedge 2005 gas production at more than $7/mcf, compared to a
2004 average of $5.50/mcf.
In November, when Sterling won the exclusive right to participate with the
Government of Mauritania in the development of the Chinguetti oil field, the
company talked about protecting its cash flow from the field in 2006 by hedging
at more than $40/bbl. The recent rebound in the oil price means that this option
is once again available.
Details of the deal
Sterling is to fund GPC (a new company 100% owned by the state) allowing it to
back-in to the Chinguetti field development in Mauritania for a 12% stake.
As part of funding agreement we understand that Sterling, will gain access to an
estimated 70% of the profit oil from GPC’s 12% interest in the Chinguetti Field,
as well as full cost oil recovery.
The independent expert’s report gives 2P (proven plus probable) reserves for the
Chinguetti field of 139m.
What is in it for Sterling?
The deal allows Sterling to double its booked 2P reserves at end 2004. Although
the government retains 100% ownership of GPC, Sterling’s funding agreement
entitles it to an equivalent of an 8.4% direct stake in the project or around 11.7m
bbls of 2P reserves.
These reserves are low risk (more than half of reserves are proven) and under
development, for a signature bonus of $15.5m or an equivalent price of
$1.32/bbl. The equivalent cost per barrel to Sterling at the time of project
development approval (May 2004) is estimated at $3.20/bbl. This is based on
Rally in US gas prices should boost
Sterling’s cash flow in 2005
Oil price rebound has given Sterling
the option to hedge 2006 oil
production from Chinguetti at more
than $40/bbl
Sterling will fund government back in
to Chinguetti field development
Deal will double Sterling’s booked
reserves

20 December 2004
Evolution Securities 100 Wood Street, London, EC2V 7AN 020 7071 4300
11.7m barrels attributable, and costs of $15.5m (signature bonus) and $21.6m
(12% of past exploration back-costs – estimated at $120m total, uplifted by 50%).
When the field comes on stream at the end of 1Q2006, Sterling’s cash flow from
operations will be significantly enhanced. The company estimates that 2006 cash
flow will treble and even after the dilutive effect of the increase in the number of
shares in issue resulting from the proposed equity funding, we forecast CFPS in
2006 to almost double to 4p/share.
Costs and Economics
Total cost to Sterling of the deal is $145.5m – broken down as follows
Signature bonus ($15.5m),
Back costs $50m (being a 150% uplift of the proportion of past
exploration costs, plus 100% of the proportion of development costs
incurred to date.)
Development costs for the field going forward ($50m – being the
outstanding share of the $72m proportion of the $600m total
development costs as set out by operator Woodside)
Other costs and contingency ($30m)
Independent experts report (Risc), using a base case oil price of $38/bbl in 2006,
$36/bbl in 2007 and $27/bbl thereafter gives an NPV (10) value of $58.9m
Base on 11.0m bbls of attributable reserves this gives an NPV/bbl of $4.90/bbl –
a good number considering minimal risk and typical of this type of development.
A long term oil price of $30/bbl or more increases the NPV (10) by almost 50%.
Fully developed costs before cost recovery are estimated at $9.87/bbl net to
Sterling. Operating costs (estimated at around $6/bbl) and abandonment costs
(estimated at around $0.5/bbl) are the same for all participants.
Medium term upside to Sterling
If Chinguetti proves to be larger (3P reserves are 50% larger than 2P).
If production >75,000 b/d, GPC’s share in project rises from 12% to 16%
- this would be considered a separate project in which Sterling could
participate.
Potential to add value to the Chinguetti project if production from the
Tevet discovery goes through Chingeutti system, through tariff income
and possible field life extension.
Sterling could be government’s strategic partner for all future field
developments in offshore Mauritania (not just ones where Sterling has
royalty interest). This project could be replicated several times.
And significantly boost cash flow

20 December 2004
Evolution Securities
100 Wood Street,
London,
EC2V 7AN
020 7071 4300

Summary NAV of Sterling Energy
Attributable reserves Value £m p/share
Core NAV
Gulf of Mexico 60 bcf @ $4/mcf 133 9.6
Existing Chinguetti royalty (6%) 8.6 0.6
Existing Tiof royalty (6%) 14.5 1.0
Pipeline infrastructure (GoM) 5.5 0.4
GPC – Chinguetti 11.7m boe @ $5/boe 32.5 2.3
Balance sheet (end 2004e), including net new funding 74 5.3
Core Company 268.6 19.3
Risked developments
Gulf of Mexico 3P reserves 178bcf net Risked at 1 in 3 valued at $2/mcf 65.3 4.7
Mauritania royalty - Banda 12.9 0.9
Mauritania royalty - Tevet 8.6 0.6
Risked Exploration (2005)
Gabon (Iris/Themis – 20.57%) 6.2m bbls net risked at 1 in 5 valued at $2/boe 1.4 0.1
Guinea Bissau (Esperanca – 5% option) 12.5m bbls net risked at 1 in 5 valued at $2/boe 2.8 0.2
AGC (Cheval Marin- 10%) 100m bbls net risked at 1 in 5 valued at $2/boe 22.2 1.6
Cameroon (Ntem – 100%, assume 50% farmout) 125m bbls net risked at 1 in 5 valued at $2/boe 27.8 2.0
Risked exploration and development 140.9 10.1
Total Company 409.6 29.4
Source: EVO estimates: Based on 1393m shares.
We estimate Sterling’s core value at 19.3p/share. Sterling still offers strong
upside potential to its core value together with risked exploration potential
outside Mauritania, which we estimate at around 29p/share.
Deal will boost cash flow 3x in 2006 as the Chinguetti field comes on stream, but
is dilutive to earnings and cash flow in 2005 due to the increase in the number of
shares.
Based on our forecasts for 2006 cash flow from operations should increase from
£20.6.m to more than £60m and cash flow per share from 2.4p to 3.9p. At the
current share price this would put the stock on a 2006 forward cash flow multiple
of around 4x.
Keith Morris +44 (0)20 7071 4408 keith.morris@evosecurities.com EVO Securities is broker to Sterling Energy