Could a Hurricane Energy plc-Premier Oil plc merger be on the cards?

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Premier Oil

The North Sea can be a tough place to operate, as Premier Oil(LSE: PMO) knows all too well.

Premier is one of the North Sea's most experienced operators, but the company is currently saddled with debt, which is constraining the business. To help reduce leverage, management announced today that the firm has decided to sell its relatively small Pakistan oil business for $65m. While the sale proceeds are a drop in the ocean compared to the company's $2.8bn debt mountain, it's a step in the right direction. 

Premier has been hit hard by the oil price crash. The North Sea is one of the most expensive regions in the world to extract oil. Even though costs have fallen dramatically since 2014, operators are still struggling to break even. 

In such a harsh environment, North Sea operators are increasingly looking to collaborate on projects to help lower costs and improve recovery rates from the mature oil basin. This drive may end up bringing mid-sized oil producers such as Premier and Hurricane Energy(LSE: HUR) together. 

A force to be reckoned with 

Last week shares in Hurricane rose by more than 20% after the firm announced that it could be sitting on one of the largest undeveloped oil fields in UK waters. After initial drilling, the company believes its Halifax prospect and nearby Lancaster field are one and the same, which could mean the firm has discovered very substantial hydrocarbon accumulation with over one billion barrels of oil. 

Hurricane may be sitting on a vast oil field, but the company faces an uphill struggle to develop the prospect. Its next step will be to procure funding to help it pay for an early production system, which is expected to require several hundred million dollars. The oil-bearing column, including the gas cap, exceeds 1km, which is huge and not cheap or easy to drill. For some comparison, BP's second stage of the development of the Clair field, which is believed to be of a similar size to the Lancaster/Halifax prospect, has a price tag of £4.5bn. 

At the end of June last year, Hurricane had around £50m in cash, before raising approximately £75m via way of a placing and open offer, and before exploration costs. No matter how you look at these figures, it's clear the firm does not have enough cash to finance further development right now, despite the size of the opportunity. 

This is where a merger with Premier looks appealing. By combining, the two companies could lower field development costs and Premier's existing production can provide cash to help finance field development. 

Standalone performance 

A merger might make sense for Premier and Hurricane, but even if no deal emerges, Hurricane remains an attractive buy. The company is planning to start production from Halifax as fast as possible using an early production system, and at current prices, the shares look severely undervalued. Indeed, as a comparison, in 2014 ConocoPhilips sold its 25% stake in the Clair field for $2bn to $3bn, at the mid-point, and assuming Halifax/Lancaster is the same size, Hurricane's field could be worth in the region of $10bn. 

Make money, not mistakes

Hurricane could be sitting on one of the North Sea's largest oil finds in recent years but the company still has a huge amount of work to do before it can make it into the big league. With this being the case it's best to own the shares as part of a well-diversified portfolio. 

Many investors fail to follow this key piece of advice. According to financial research firm DALBAR the average investor underperforms the wider market by around 5.3% annually thanks to a lack of diversification. 

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.