Var Energi AS Has High Potential In A Harsh Environment

Var Energi AS (OTCPK:VARRY) is currently ramping up production with 8 projects in progress that are anticipated to be completed by 2025. The firm anticipates increasing production from 299Mboe/d to 350-400Mboe/d in eFY25 as the firm is set to bring their Balder and Castberg projects online. Management also anticipates significant upside potential as they integrate their recently acquired assets from Neptune Energy and anticipate $500mm in synergies paired with a low-average cost of production. I provide VARRY shares with a BUY recommendation with a price target of $7.75/share at 2.96x eFY25 EV/EBITDA.

Var Energi Operations

Var Energi is a Norway-based, O&G E&P firm that is in the process of bolstering their production through a portfolio of 8 projects that are anticipated to come online by FY25. 7 of the 8 projects are 50% completed with their major Jotun FPSI now 95% complete as of q1’24. Gross production from the Jotun FPSO will result in an additional 80Mboe/d with low operation costs of around $5/bbl. As of q1’24, the drilling and subsea facilities are the last factors in play for the project to become operational and is anticipated to come online in late eFY24 or early eFY25. Management discerned that production and operational benefits won’t be affected as a result of the later start date of the project. The primary risks involved as it pertains to the startup date revolve around weather conditions, which may affect the autumn start date and can result in delays into q2’25. The firm does have flexibility in the FPSO installation arrangement, allowing the firm to work within the harsh environment as weather permits.

Var Energi is also pushing forward with their Johan Castberg project, which is anticipated to begin FPSO installation in the summer months of 2024. As reported in q1’24, all subsea installations are completed and 12 of the 15 development wells planned for startup are already completed. Management anticipates that the firm can grow production by 70Mbbl/d between the Balder project and Castberg, which should commence initial peak production by eq4’24. This project is anticipated to be a major growth catalyst for Var Energi as the project is anticipated to produce 190Mboe/d gross with net barrels to Var being around 55Mboe/d. OPEX for the project is expected to be $4/bbl with a breakeven price of $35/bbl.

Management anticipates drilling 16 exploration wells in 2024, 3 of which have been drilled in q1’24. These exploratory wells should increase Var Energi’s proved and probable resource base by around 150MMbbl. Capital investment for these wells is anticipated to come in at around $300mm. All but two of the exploration wells are step-out opportunities that can utilize existing infrastructure from other projects. 1 of the 3 exploration wells drilled in q1’24 was successful and is expected to add 23MMbbl of inventory. This well is located at Ringhorne North in the Balder area as an extension of the Ringhorne North discovery and should add synergies with nearby discoveries at their King-Prince and Evra-Iving locations. Management anticipates an additional 6 exploration wells to be drilled within this region during q2’24 and should provide results by the end of the quarter.

Neptune Energy M&A

Var Energi and Eni announced the close of the acquisition of Neptune Energy’s assets on January 31, 2024, through a carve-out asset sale. The deal closed at $21b and was financed through $2.1b in cash and the remainder through credit facilities. Neptune Energy owned assets across Europe, North Africa, and Asia Pacific. Neptune Energy’s assets were heavily weighted in dry gas with a 61/39% split between gas and liquids. The firm produced 16.1Mboe/d in 1h23. Total proved and probable reserves summed to 552MMboe, 75% of which are located across Europe. 76% of the firm’s reserves are oil with the remaining 24% liquids. Var Energi received $4.8b of assets and recognized $1.5b in net goodwill as a result of the acquisition.

Var Energi AS Financial Outlook

In aggregate, the firm is targeting production costs in the range of $13.5-14.5/bbl in eFY24 and anticipates reducing costs to $10/bbl by the end of eFY25. Capital investments are expected to fall within the range of $2.7-2.9b in eFY24 and drop off to $1.5-2.5b in the following years. The high level of capex is anticipated to run up in eFY24 as the firm bolsters their long-cycled offshore production. The following year’s is expected to drop off as a result of replacement and enhancement wells in order to maintain an average production rate in the range of 350-400Mbbl/d.

Through fixed contract agreements for gas supply, Var Energi realized significant upside in gas sales, with average prices $14/Mcf above spot for a total sale price of $67/Mcf.

Forecasting production, I anticipate the major upswing to occur in eFY25 as the firm brings projects online. Given that the firm anticipates delays due to harsh weather, I forecast more on the conservative side of management’s 350-400Mbbl/d at 350Mbbl/d for eFY25.

Translating this to the firm’s financials, I anticipate scaling effects to take place as Var Energi increases production while pushing to reduce redundant back-office costs as it pertains to their acquisition of Neptune Energy. Forecasting revenue, I anticipate softening of Brent oil prices from low-to-mid-$80/bbl for the duration of eFY24 and high-$70s for eFY25. Management noted that 16% of gas sold in q1’24 were sold at a fixed realized price of $134/bbl. Management anticipates the fixed-rate sales to increase to 16-18% of total gas sold with an average fixed price of $130/bbl. Fixed price exposure is expected to increase by 4% in q4’24, offering significant upside to the current spot price.

Var Energi Valuation & Shareholder Value

VARRY shares currently trade at 3.87x EV/EBITDA, a small premium over the weighted average of its peers. Var Energi offers significant upside potential with a relatively low level of debt at 0.72x net debt/EBITDA. If the new exploration wells prove successful, the firm may have the ability to scale production at a relatively low operational cost and debt levels.

Building out VARRY’s valuation, I anticipate significant upside potential as the firm scales its production on relatively flat-to-down oil and gas prices. Given that nearly 20% of the firm’s eFY25 gas sales will be at a fixed rate, the firm may have the opportunity to realize further upside potential, as valued in the blue-sky scenario. The gray-sky scenario would imply that the firm runs into weather- or operational-related challenges as it pertains to the harsh environment offshore production sites. VARRY does pay a quarterly dividend annualized at $0.88/share. I provide VARRY with a BUY recommendation with a price target of $7.75/share based on 2.96x eFY25 EV/EBITDA.

There may be some negative risks involved when considering VARRY as an investment. As management at Transocean (RIG) has voiced in their recent quarterly earnings calls, the political environment in Norway has made it challenging to do business in the region and OFS companies have been pulling rigs from the region. This may squeeze the market in Norway and drive up dayrates, which may result in a higher cost to produce for VARRY. These effects are expected to take place throughout 2024-2025. Other than this risk factor, I believe that VARRY offers a strong business case for operational excellence in the tight European gas market and I believe the firm has the ability to realize significant upside as a result.

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