On February 13th, Lundin Petroleum AB (Ticker: LUPE SS, Share Price: SEK 198.40, Market Capitalization: SEK 67,533 million), an independent oil and gas company, announced its decision to demerge its non-Norwegian assets into a new publicly-traded company that will be listed on the Toronto Stock Exchange and maintain a secondary listing on the NASDAQ Stockholm stock exchange. According to the company’s plan, existing shareholders will receive one share in newly-created International Petroleum Corporation for each Lundin Petroleum share held. The spin-off will be tax-free, pursuant to the Lex ASEA regulation, and is subject to shareholder approval. To that end, the firm plans to call an Extraordinary General Meeting in March 2017. The transaction is expected to be completed soon thereafter.
Lundin Petroleum is controlled by the Lundin family, which has a 28.7 percent stake. The Lundin family has created numerous natural resource companies, engaged in base and precious metals mining and oil and gas exploration and production. Lucas Lundin, son of Adolf Lundin, the founder of the Lundin Group network, serves as the oil and gas company’s Chairman. Statoil, Norway’s state-controlled oil and gas major, is its second largest owner, with a 20.1 percent stake. The firm was created shortly after Lundin Oil—a predecessor company—was acquired by Talisman Energy in 2001, as an exploration company without any producing assets.
Historically, the Lundin family’s oil and gas investments have been in developing markets, and in offshore fields. Their first investment in Norway took place in 2003. Since then, Lundin Petroleum spun off its UK assets into EnQuest Plc. The family divested its stake within a few years of the latter company’s listing. Currently, Norway is dominating Lundin Petroleum’s portfolio. Assets in the country comprise 88 percent of its expected 2017 production and 96 percent of its proven and probable reserves.
The purpose of the spin-off is to create two more focused companies—with management teams better able to optimize each company’s performance. More specifically, Lundin Petroleum’s Norwegian operations are poised to grow organically, primarily as a result of the development of the giant Johan Sverdrup field. At the same time, the company will have to incur several billion dollars in capital expenditures to bring the field online. International Petroleum, on the other hand, will control assets in France, the Netherlands and
Malaysia with significantly more limited reserves; it will also be debt-free. Therefore, the new entity will strive to maximize the value of its existing assets while at the same time using leverage to expand.
It is noteworthy that in this transaction, it is post-spin Lundin Petroleum with its Norwegian assets that is considered the growth entity. That is at odds with most Norwegian oil and gas producers: Energy production in the country has been declining for years, while offshore projects in harsh environments have very high break-even costs. Consequently, over the past couple of years we have witnessed a flurry of activity, with firms such as BP Plc and Det Norske Oljeselskap ASA merging their operations—creating Aker BP ASA—in order to reduce costs, while others such as Exxon Mobil Corp and Royal Dutch Shell Plc looking to divest their local subsidiaries in order to focus on more profitable and promising areas.
International Petroleum Company will comprise Lundin Petroleum’s assets in France, the Netherlands and Malaysia. The company has proven and probable reserves of 29.4 million boe and an expected 2017 production of nine to 11 thousand boe per day. At the current rate of production, these reserves should last for eight years. While Malaysia is responsible for two-thirds of production, it only holds 9.5 million boe in reserves— just one-third of the company’s total. France, on the other hand, produces approximately two thousand boe per day, yet it holds 18 million boe in reserves, primarily in the Paris Basin.
These assets have moderate operating expenses; for 2017 the company expects to incur US$19 per boe in opex. Capital expenditures are limited, and primarily focused on development. The 2017 capital expenditure guidance stands at US$10 million, half of which is reserved for the French operations. Given that International Petroleum will have no debt, it is expected that it will pursue an acquisitive strategy, with a focus on low-risk jurisdictions such as those it currently operates. As an indicative valuation for the firm, we can estimate the free cash flow generated over the next eight years1, and discount it at a 10 percent rate. The resulting net asset value for International Petroleum Corporation is US$ 608 million, or SEK 47.9 per share (SEK 16 per share on a pre-spin basis).
Post-spin Lundin Petroleum will focus on its Norwegian operations. Its assets are fundamentally different. Rather than a portfolio of smaller, diverse producing assets, Lundin Petroleum’s operations will focus on three major projects and several exploration prospects. As a result, the firm’s capital expenditure requirements for the near term will be very high—almost US$1.3 billion for 2017 and approximately US$1 billion for 2018—while operating expenses are very low.
The company will have proven and probable reserves of 714.1 million, and expected 2017 production of 70 to 80 thousand boe per day. At that rate, its reserve life is 26 years. Lundin Petroleum’s major asset, with more than 550 million boe in reserves, is its 22 percent stake in the giant Johan Sverdrup offshore field. The project is managed by Statoil—which holds a 40 percent stake. During Phase 1, Lundin Petroleum’s share of capital expenditures should amount to US$3 billion. The project is 40 percent complete. In 2017, it should absorb three-quarters of the company’s US$1.1 billion development capital expenditures. The field is expected to commence production in the fourth quarter of 2019. Phase 2 of the project should require another US$1 to US$1.5 billion from Lundin Petroleum, and, if approved, will yield results in 2022.
With new production from the Johan Sverdrup field, Lundin Petroleum’s production should increase to 120 thousand boe per day, while the completion of Phase 2 should increase that figure to 150 thousand boe per day. Clearly, the firm’s oil and gas production is on track to grow substantially over the next decade. At the same time, the firm will have to incur billions in cash outflows to develop this field. In order to do that, the company intends to utilize the remaining US$1 billion from its revolving credit facility. Lundin Petroleum already has drawn US$4.1 billion, and does not intend to transfer any debt to the spin entity.
With operating costs estimated at just US$5.65 per boe, the company is generating substantial operating cash flow that will cover the majority of its 2017 capital expenditures. In fact, it will likely have to draw only a few hundred million from its credit facility, providing leeway to make further withdrawals, if required, in 2018. Thereafter, capital expenditures should decline materially to approximately half a billion per year. The new oil and gas production will also push Lundin Petroleum’s operating costs to below US$5 per boe.
Given the increasing production, the firm’s current reserves should be depleted within 15 years. Using a discounted cash flow model to estimate post-spin Lundin Petroleum’s net asset value based on its existing proven and probable reserves2, we arrive at a US$10.9 billion value. Including net debt of US$4.075 billion, the firm’s equity is valued at US$6.9 billion, or SEK 180 per share. Consequently, Lundin Petroleum’s sum-of-the-parts value is SEK 196 per share.
