A bargain way to exploit a rising oil price

According to International Energy Agency (IEA), the main demand drivers include better-than-anticipated economic growth in OECD countries, the ongoing recovery in global air travel, and oil consumption gushing higher in China. The Asian powerhouse accounts for 70 per cent of IEA’s forecast 2.2mn barrels per day increase in annual global consumption this year.

At the same time, the organisation highlights tighter supply as both Russia and Saudi Arabia have cut output to support prices, the latter being the de facto leader of the Organization of the Petroleum Exporting Countries (Opec). Production from Opec+ countries has fallen to the lowest level since October 2021 and is forecast by the IEA to hit a two-year low in the current quarter.

The resilience of the US economy is also playing its part. The country recorded the biggest ever drawdown in crude inventories in the last week of July, says the Energy Information Administration driven by refinery runs and strong crude exports.

Don’t expect the tightness in the market to ease anytime soon. Saudi Arabia intends to extend its 1mn barrel per day voluntary crude oil output cut into September, the third month of such declines, a positive for both the oil price and one of my small-cap sector picks.

UK North Sea-focused upstream oil and gas company Jersey Oil & Gas (JOG:178p) is wasting no time progressing its flagship GBA project.

In late June 2023, the group completed its farm-out transaction with NEO Energy, a UK North Sea producer of 90,000 barrels of oil per day and a company backed by HitecVision, a private equity investor focused on Europe's offshore energy industry (‘Jersey Oil & Gas deal is being overlooked by investors’, 6 April 2023). As part of the complex transaction, NEO has taken a 50 per cent working interest and operatorship of the Buchan licenses.

It means that Jersey is fully carried on 12.5 per cent of gross project development capital expenditure to Buchan first oil (this element is worth $125mn, or £98mn), and has a full carry on its share of Front End Engineering and Design (FEED) expenditure to Final Investment Decision (worth up to $12.5mn). There are multiple other financial milestones which I outlined in my last article, too. Analyst Daniel Slater at brokerage Zeus Capital values the 12.5 per cent interest on which Jersey is fully carried to first oil at 374p per share on a risked basis, or 468p on an unrisked basis.

Bearing this in mind, the joint venture partners plan to redeploy an existing Floating, Production, Storage and Offloading (FPSO) vessel as their preferred GBA development solution and have already agreed commercial terms for its acquisition. Once a sale and purchase agreement for the FPSO is signed, Jersey will receive the next $9.4mn (£7.4mn) milestone payment from NEO, notes analyst Jonathan Wright at broking house FinnCap.

The development option not only has the lowest full-cycle carbon footprint, having potential for the FPSO to connect to nearby offshore floating wind power projects, but it will allow production infrastructure to be located at the Buchan field. Importantly, it should reduce planned capital expenditure from £1.4bn to £900mn, massively enhancing the financial returns to be earned by the partners. Expect further details of the FPSO development plan to be released later this year.

The North Sea Transition Authority (NTSA), is supportive of the plans, which will be assessed and refined by the partners as part of the FEED and contract tendering activities that precede the formal submission of the field development Plan (likely in the first half of 2024). First production is planned for 2026. The NTSA has also approved an extension to the nearby Verbier license to August 2029 to allow the partners to prepare a FDP for the Verbier discovery, as part of the phased GBA development.

In addition, Jersey is planning a new Competent Person’s Report later this year once detailed development planning is further advanced. Zeus is currently allowing for a development of 110mn barrels of oil in its model, of which the Buchan filed accounts for 90 per cent and 40,000 barrels of oil per day production.

Exploit deep share price discount to NAV

The financial significance of these developments to Jersey’s shareholders should not be underestimated, even if other investors are overlooking them. Furthermore, the group’s chronic undervaluation could be brought into sharp focus far sooner than many investors realise. That’s because the directors are pursuing a second farm-out, targeting a fully carried interest in Buchan in the range of 20 to 25 per cent to completely de-risk its investment.

Clearly, the strong oil price environment and the UK Government’s recent change in stance towards North Sea oil and gas production are positives for Jersey. At least 100 new licences are expected to be awarded in the next North Sea licensing round in the autumn and junior energy minister, Andrew Bowie, highlights the need to max out our existing reserves given that tapping domestic supplies is significantly more cost-effective than shipping gas and oil from other countries.

Slater believes a second farm-out could be announced before the year-end, a major catalyst to drive a re-rating of the £58mn (178p) market capitalisation company and narrow the 75 per cent share price discount to analysts’ 713p per share consensus total risked NAV valuations. Wright at FinnCap has a risked NAV valuation of 755p, Slater at Zeus valued the company at 702p and analyst Brendan Long at WH Ireland has a fair valuation at 684p based on a long-term Brent Crude price of $85 a barrel, slightly below the one month forward price.

So, having advised buying the shares at 205p in my 2019 Bargain Shares portfolio, I feel that the pull-back from the 277p level when Jersey first announced the NEO farm-out is massively overdone. There is a compelling investment opportunity to exploit at the current price. Buy.

■ Simon Thompson's latest book Successful Stock Picking Strategies and his previous book Stock Picking for Profit can be purchased online at www.ypdbooks.com. They are priced at £16.95 each plus P&P of £3.75, or £25 plus P&P of £5.75 for both books.