High-impact exploration offshore Philippines

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1 Otto Energy All clear for Hawkeye well spud in Q3 Farm-out deal Oil & gas Otto Energy (OEL) has announced a farm-out deal with independent E&P Red Emperor Resources (RMP) for a 15% working interest in the offshore Philippine block SC55. Otto is now fully funded to drill the Hawkeye-1 exploration well, has retained operator control and significantly reduced its financial exposure to the well. Otto has now contracted a deepwater rig at attractive day rates, and is on track to spud Hawkeye-1 in early Q3. The next catalysts after Hawkeye should be two frontier exploration wells onshore Tanzania in Otto is in the enviable and unusual position of an E&P that is fully funded for three near-term exploration wells, targeting 161mmboe of net unrisked resource. The stock trades below our core NAV of A$0.11/share, while our revised RENAV is A$0.21/share. Year end Revenue PBT* EPS* (c) Operating cash flow Net cash Net capex 06/ (38.3) 06/ (49.6) 06/15e 0.0 (12.0) (1.04) (14.6) 06/16e 0.0 (9.6) (0.83) (7.3) 17.2 (13.4) Note: *PBT and EPS are normalised, excluding intangible amortisation, exceptional items and share-based payments. Hawkeye-1 well fully funded; on track to spud Q315 On 2 March, Otto announced a farm-out deal with RMP, an ASX- and AIM-listed E&P, for a 15% non-operated WI in the offshore Philippine SC55 block. This comes on the heels of the proposed 15% farm-out to PNOC announced in January. While the deal does not include a cost carry, it still reduces Otto s financial exposure to the Hawkeye-1 well. The well is now fully funded, as BHP Billiton s US$24.5m contribution and funding from its two JV partners entirely cover Otto s net 63.18% share of well costs. Importantly, Otto has now contracted the high-spec Maersk Venturer deepwater rig to drill the well, and is on track to spud in early Q315. Given the drop in rig rates, we assume US$35m of well costs vs US$48m previously. High-impact exploration well, with running room Hawkeye is a turbidite clastic oil prospect with best estimate gross unrisked prospective resources of 95mmbbl and a 27-32% GCoS. The prospect lies at a water depth of 1,700m in a proven oil and gas province in the Palawan basin, and 3D seismic data show multiple flat spots. There is significant prospectivity in the SC55 block after Hawkeye, notably the 1.6tcfe Cinco gas/condensate prospect plus >8tcf in follow-on prospects. For more detail, please see our recent initiation note. Valuation: RENAV of A$0.21/share offers upside We trim our RENAV to A$0.21/share to reflect Otto s lower WI in SC55, which is not offset by upfront cash or a cost carry. The stock trades below our unchanged core NAV of A$0.11/share, based on Galoc sale proceeds minus G&A. Within this, the capital return represents A$0.064/share. After Hawkeye-1, the next catalyst should be an exploration well in the Kito block in Tanzania, where a recently completed 2D seismic survey is expected to lead to target selection for 2015 or early Price Market cap 5 March 2015 A$0.10 A$116m A$1.29/US$ Net cash at 31 December Shares in issue 1,156m Free float 47% Code Primary exchange Secondary exchange Share price performance OEL ASX N/A % 1m 3m 12m Abs Rel (local) (0.4) week high/low A$0.11 A$0.08 Business description Otto Energy is an Australia-listed E&P with exploration licences in the Philippines and Tanzania. It has fully divested its producing Galoc field in the Philippines. It is looking to farm out its blocks to reduce risk and fund drilling. The Hawkeye-1 well should be drilled in Q315. Next events PNOC farm-out approved Hawkeye-1 spud Q215 Q315 Tanzania (Kito) drill Analysts Kim Fustier +44 (0) Will Forbes +44 (0) Ian McLelland +44 (0) Elaine Reynolds +44 (0) oilandgas@edisongroup.com Edison profile page Otto Energy is a research client of Edison Investment Research Limited

2 High-impact exploration offshore Philippines After the divestment of its Galoc field in Q115, Otto Energy retains interests in two operated offshore licences in the Philippines: Service Contract (SC) 55 and Service Contract 73. Following its two 15% farm-out deals with PNOC and Red Emperor, Otto holds a 63.18% WI in block SC55, located in the south-west Palawan basin offshore the Philippines and covering an area of 9,880km 2. The deepwater (1,400-1,700m water depth) block sits in a proven oil and gas fairway that extends from Borneo in the south-west to the producing Philippine fields north-west of Palawan. Two drillable targets have been defined on 3D seismic: Hawkeye with 95mmbbl of gross unrisked prospective resource and Cinco with 1.4tcf and 48mmbbl condensate of prospective resources. There are eight follow-on gassy targets totalling 8-9tcf of gross prospective resources. A deepwater well must be drilled on SC55 by 23 December All long-lead items have been procured. Importantly, Otto has secured the Maersk Venturer deepwater drillship, commissioned in 2014, for drilling in early Q315. The rig is over-specced to drill the Hawkeye-1 well, notably as it has the ability to operate in up to 3,600m of water. Target depth should be reached in around 25 days. Exhibit 1: Philippine SC55 licence Exhibit 2: Hawkeye prospect cross-section Source: Otto Energy, as of September 2014 Source: Red Emperor Resources, as of March 2015 The more recent development wells on the shallow-water Galoc field cost around US$55m each (including completion) and Otto previously expected Hawkeye deepwater exploration wells to be around US$48m gross. However, there is scope to reduce costs as deepwater rig rates have come down by 25-35% in the last year. In our model, we now assume US$35m for the first Hawkeye exploration well, US$41m for a follow-up well and US$48m for development wells. Otto is now fully funded for Hawkeye-1 well, as BHP Billiton's (BHPB) $24.5m contribution should entirely cover Otto s reduced net share of drilling costs. Following BHPB s change of strategic focus and withdrawal from a previously agreed SC55 farm-in agreement in November 2013, BHPB has committed to paying Otto US$24.5m towards the costs of the first exploration well. If we assume US$35m of gross well costs, then BHPB s contribution should in fact more than cover Otto s net c US$22m share of well costs at its 63.18% working interest, with no need for cost carries from partners. Even assuming a conservative well cost of $48m, Otto would have to disburse only c US$5.8m for the well. Otto Energy 5 March

3 On 9 January 2015 Otto announced it had agreed to farm out a 15% WI to PNOC Exploration Company, the E&P arm of the Philippine National Oil Company. The deal probably includes a cost carry, but the commercial terms have not yet been finalised and disclosed. The deal is subject to approval by the Philippine authorities, expected to come in the next month or so. The farm-out deal to Red Emperor Resources announced on 2 March does not include a carry or back costs reimbursement. However, the well is now fully funded without the need for a carry from RMP, while back costs of c US$30m were already paid by BHPB. Valuation Our updated RENAV for Otto Energy, including a lower working interest in block SC55, is A$0.21/share vs A$0.22/share previously. Offsetting this small dilution, we now have greater confidence in the timing (early Q315) and funding of the Hawkeye-1 well, and are factoring in lower well costs. We have also slightly increased the GCoS for Hawkeye to 29.5%, the midpoint between Otto s 27% and Red Emperor s 32% estimate as per independent consultants Jordan and Pay. Our RENAV includes Hawkeye plus two committed wells in Tanzania, which can be funded at Otto s current WI. Exhibit 3: Otto Energy valuation summary Recoverable reserves Net risked Value per share Number of shares: 1,156m Diluted WI CoS Gross Net NPV/boe value Risked Unrisked Asset Country % % mmboe mmboe US$/boe US$m A$/share A$/share Net (debt) cash December % 100% SG&A (2yrs NPV10) 100% 100% (7) (0.01) (0.01) Remaining cash in from Galoc sale 100% 100% Core NAV Exploration SC55 Hawkeye Philippines 63.2% 14.75% Kilosa-Kilombero (Kito) Tanzania 40% 4.25% Pangani Tanzania 40% 4.25% RENAV Source: Edison Investment Research. Note: Value of capital return is A$0.064/share. Tanzania is shown at 40% WI post-government back-in rights. Tanzania CoS includes 8.5% GCoS and 50% CCoS. A$1.29/US$. The Cinco well is deemed as long-term exploration potential given its unfunded nature. We do not model the gas/condensate leads in licence SC55 at this early stage. Exhibit 4: Otto Energy long-term exploration valuation summary Recoverable reserves Net risked Value per share Number of shares: 1,156m Diluted WI CoS Gross Net NPV/boe value Risked Unrisked Asset Country % % mmboe mmboe US$/boe US$m A$/share A$/share SC55 Cinco Philippines 63.2% 7.5% Source: Edison Investment Research. Note: Cinco CoS includes 20% GCoS and 37.5% CCoS. A$1.29/US$. Financials With cash of over US$52m after the capital return distribution and before capex, Otto Energy is well funded for initial exploration activities in Tanzania and the Philippines well into H216. We model capex of US$15m for the fiscal year ending June 2015, including Hawkeye-1 well preparation and G&G costs and geological studies and pre-drilling preparation in Tanzania. We see capex of US$13m in FY16, comprised of net drilling costs for two wells in Tanzania, and assuming that Otto is fully funded for its net share of Hawkeye-1 drilling costs by BHPB and its JV partners. Otto Energy 5 March

4 Any discoveries will require material funding to appraise and develop, well beyond Otto s financial capabilities. We would thus expect a reduction in asset ownership and/or equity dilution before first production. Exhibit 5: Financial summary US$'000s e 2016e June IFRS IFRS IFRS IFRS IFRS IFRS PROFIT & LOSS Revenue 0 30,589 60,181 73, Cost of Sales 0 (13,611) (17,736) (19,326) 0 0 Gross Profit 0 16,978 42,445 54, EBITDA 13,359 10,056 31,537 49,092 (6,995) (6,983) Operating Profit (before amort. and except.) 13,124 (4,366) 24,438 32,578 (11,965) (9,625) Intangible Amortisation Exceptionals (35) 322 (3,108) (24,743) 36,441 0 Other 0 (345) (366) (272) (1,700) (300) Operating Profit 13,089 (4,389) 20,964 7,563 22,776 (9,925) Net Interest 34 19,832 (708) (7,735) 0 0 Profit Before Tax (norm) 13,158 15,466 23,730 24,843 (11,965) (9,625) Profit Before Tax (FRS 3) 13,123 15,443 20,256 (172) 22,776 (9,925) Tax 0 (656) (10,814) Profit After Tax (norm) 13,158 14,810 12,916 24,922 (11,965) (9,625) Profit After Tax (FRS 3) 13,123 14,787 9,442 (93) 22,776 (9,925) Average Number of Shares Outstanding (m) 1, , , , , ,155.8 EPS - normalised (cents) (1.0) (0.8) EPS - normalised and fully diluted (cents) (1.0) (0.8) EPS - (IFRS) (cents) (0.0) 2.0 (0.9) Dividend per share (c) Gross Margin (%) n/a n/a n/a EBITDA Margin (%) n/a n/a n/a Operating Margin (before GW and except.) (%) n/a n/a n/a BALANCE SHEET Fixed Assets 34,992 61, , ,960 44,065 54,820 Intangible Assets 19,880 51,907 91, ,509 34,648 45,667 Tangible Assets ,462 1,198 Investments 14,410 8,658 8,823 7,955 7,955 7,955 Current Assets 35,875 46,041 38,111 12,452 42,598 21,918 Stocks 0 5,321 2,133 2,941 2,941 2,941 Debtors 267 2,044 2, Cash 35,584 28,325 31,854 7,735 37,881 17,201 Other 24 10,351 1,377 1,758 1,758 1,758 Current Liabilities (4,751) (6,949) (14,776) (7,393) (7,393) (7,393) Creditors (4,751) (6,949) (9,818) (7,393) (7,393) (7,393) Short term borrowings 0 0 (4,958) Long Term Liabilities (60) (17,963) (33,899) (22,845) (22,845) (22,845) Long term borrowings 0 0 (9,177) Other long term liabilities (60) (17,963) (24,722) (22,845) (22,845) (22,845) Net Assets 66,056 82,512 90,995 91,174 56,426 46,500 CASH FLOW Operating Cash Flow (5,299) 2,989 29,103 42,153 27,746 (7,283) Net Interest Tax Capex (13,240) (12,741) (38,293) (49,644) (14,635) (13,398) Acquisitions/disposals 21,751 2,493 (1,315) ,559 0 Financing 2, Dividends & FX 0 0 (12) (52) (57,524) 0 Net Cash Flow 5,991 (7,259) (10,517) (7,280) 30,146 (20,680) Opening net debt/(cash) (29,593) (35,584) (28,325) (17,719) (7,735) (37,881) HP finance leases initiated Other 0 0 (89) (2,704) 0 0 Closing net debt/(cash) (35,584) (28,325) (17,719) (7,735) (37,881) (17,201) Source: Edison Investment Research, company reports. Note: For 2015e and onwards, we show the pro forma balance sheet after the Galoc sale, which completed in February The Galoc sale is effective 1 July e EBITDA includes accounting gain on disposal of Galoc. Assumes two wells drilled in Tanzania at 50% WI and Hawkeye-1 drilling cost fully carried by PNOC in H215. Otto Energy 5 March

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