South Energy Corp. (SOUC LN/SOU CN): Hitting the pause button until gas price recovers

• In the context of the HH gas price rapid collapse from US$7.90/mcf in 3Q22 to ~US$2/mcf currently, Southern has decided to reduce its capex programme from US$101 mm to US$55 mm. This has already been deployed to drill a total of seven wells (out of 13 initially expected). It also includes long lead items and preparation work that would have been applied to the entire programme. 3 of the 7 wells have been completed, with the 4 remaining wells to be completed when HH is >US$3.5/mcf.
• The 18-10 #2 Upper Selma Chalk well had an IP rate of 3.3 mmcf/d with only 50% in the zone. We note that if 80-100% of the well had been in zone (as it was the case for the 2 other wells), the well could likely have delivered an IP30 rate >6 mmcf/d, which would have been a very good result. The geo-steering system was optimized on subsequent wells in this programme to address this issue.
• The 18-10 #3 Upper Selma Chalk well was 80% in zone. However, during one of the last staged fracks, a joint of casing collapsed and remediation is required. It is anticipated to be remediated in May and put on production.
• The 18-10 #1 City Bank well was 100% in zone and flow back has started. The well should reach peak rate in ~45 days. The results are very encouraging. On success, this well would add reserves (none booked so far in the City Bank). Our unrisked NAV for the City Bank is ~£0.50/sh.
• With faster drilling than expected (9 days per well versus 21 days per well initially), lower rig rates and monobore drilling for future wells, individual well drilling costs could be reduced by 35-40%.
• We have reduced our HH gas prices assumptions and assumed a slower production ramp-up that can be funded through cashflow. We have reduced our target price to £1.50/sh. Southern continues to be a reserves and production growth story.

2P Reserves up ~30%
The YE22 2P reserves were estimated at 25.5 mmboe (+31% vs YE21) which reflects the 2022 drilling programme. This assumes only 7 new drilling locations (to 21 – in the Selma Chalk only) and looks conservative. The NPV10 of the PDP is ~US$52 mm, ~60% > the current market cap. with the 2P NPV 10 ~US$142 mm, 3.5 times the current mkt cap.

Balance sheet and Valuation
Our new Core NAV of £0.74/sh reflects a slower production ramp-up to ~4 mboe/d in 2023, 5.7 mboe/d in 2024 and ~8 mboe/d in 2026. We now assume ~US$3/mcf for HH in 2023, US$4.4/mcf in 2024 and US$5.5/mcf thereafter (US$6.5/mcf previously). Higher HH would allow a faster production increase. We estimate that Southern will hold ~US$2 mm in cash as at the end of March with ~US$23 mm undrawn on its debt facility. The cashflow breaks even at ~US$1.8-1.9/mcf (HH). Our new RENAV is £1.48/sh.