FAROE PETROLEUM High quality, with a big discount. BUY TP: GBp142

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1 EQUITY RESEARCH Research report prepared by DNB Markets, a division of DNB Bank ASA Energy Initiating coverage FAROE PETROLEUM High quality, with a big discount Faroe Petroleum is trading at only 61% of our risked NAV, with an implied oil price of USD41/bbl, and looks attractive to us in both absolute and relative terms. Since 2012, the company has reported strong reserve and production/share growth versus peers, second only to Aker BP. Its assets and developments are attractive in our view, with Brasse discovery economics in the top 5% on the NCS. We see good visibility on these growth metrics through the coming development cycle, including funding, with limited downside risk. We initiate coverage with a BUY recommendation and GBp142 target price. 64% upside potential, attractive relative to peers. The stock is trading at 61% of our risked NAV or, conversely, there is 64% upside potential from the closing price on 1 September. We find the valuation appealing on an absolute basis as the shares discount an implied oil price in the low USD40s. Peers Aker BP and Lundin Petroleum are trading at 103% and 102% of NAV, respectively, making Faroe Petroleum a quality alternative growth company in our view. Has delivered historically; we believe it will continue to do so. Faroe Petroleum has generated strong per share metrics since 2012, with a 29% and 13% CAGR for reserves and production, respectively (debt-adjusted figures). This is impressive because the company has outperformed all peers except Aker BP an investor favourite. Following a strong exploration campaign, a shift towards delivering on developments, along with tactical M&A activity, should ensure continued peer outperformance. Appealing risk/reward. Cash and production account for GBp31/share and GBp70/ share, respectively, and on this basis alone the stock looks attractive to us, trading 13% below these combined figures. On our numbers the company is well-funded to bring forward its most important developments, with flexibility in a downside scenario. Significant upside to our numbers unrisked NAV at GBp173/share. Upside potential beyond our risked NAV could result from more accretive acquisitions, achieving unrisked value, synergies as developments are added to the portfolio, appraisal activity, or a potential acquisition of the company. Initiating coverage with a BUY recommendation and GBp142 target price, based on our risked NAV estimate of USD702m or GBp142/share, but contingent on our long-term oil price forecast (USD60 65/bbl). Year-end Dec e 2018e Revenue (GBPm) EBITDA adj (GBPm) EBIT adj (GBPm) PTP (GBPm) EPS rep (GBp) EPS adj (GBp) Revenue growth (%) nm EBITDA growth adj (%) nm nm nm nm nm nm EPS growth adj (%) nm nm nm nm EBITDA margin adj (%) nm 37.2 nm nm nm P/E adj (x) nm nm 10.9 ROE (%) nm 6.0 nm nm nm nm 11.1 ROCE (%) nm 9.8 nm nm nm nm 21.6 Source: Company (historical figures), DNB Markets (estimates) BUY TP: GBp142 FPM versus FTSE World Europe (12m) Aug Oct Dec Feb Apr Jun Faroe Petroleum FTSE World Europe Source: Factset SUMMARY Recommendation (prev.) BUY (N/A) Share price (GBp) 86.5 Target price (previous) (GBp) 142 (N/A) Upside/downside potential (%) 64 Tickers FPM LN, FPM.L CAPITAL STRUCTURE No. of shares (m) No. of shares fully dil. (m) Market cap. (GBPm) 315 NIBD adj end-2017e (GBPm) -78 Enterprise value adj (GBPm) 237 Net debt/ebitda adj (x) NAV per share (GBp) 135 SHARE PRICE PERFORMANCE Abs. 1/3/12m (%) -1/-3/33 Rel. 1/3/12m (%) 1/-1/20 High/Low 12m (GBp) 112/62 Source: Company, DNB Markets (estimates) NEXT EVENT 1H17 results 26/09/2017 ANALYSTS Helge André Martinsen helge.andre.martinsen@dnb.no Alex Gheorghe alex.g@dnb.no Please see the last two pages for important information. This research report was not produced in the US. Analysts employed by non-us affiliates are not registered/ qualified research analysts with FINRA in the United States.

2 2016 Revenue Operating cost Other 2017e Revenue Operating cost Other 2018e DNB Markets Faroe Petroleum Investment case overview Share price performance, DNB Markets target price, bear- and bull-case scenarios 170 GBP170 (97%) 150 GBP142 (64%) GBP87 90 GBP75 (-13%) 70 Target price methodology Our target price is based on our risked NAV estimate of USD702m or GBp142/share, and contingent on our long-term oil price forecast (USD60 65/bbl). Our bull-case scenario is primarily based on higher commodity prices, with oil in the USD 80/bbl range. Our bear-case fair value is based on a lower oil price of USD 40/bbl. 50 Sep 2016 Jan 2017 May 2017 Sep 2017 Jan 2018 May 2018 Sep 2018 Historical Share Price Performance Price Target (Sep 18) Current Share Price Source: FactSet, DNB Markets Source: DNB Markets Downside risks to our investment case Macro and external risks include lower oil and gas prices than our forecasts, and unexpected production downtime. Cost overruns, lower recovery resulting in lower resource and production estimates. Fiscal systemic changes such as tax and legislation (Norway and the UK). DNB Markets investment case and how we differ from consensus Investment case: low-risk, high-quality assets with significant exposure to growth on a per share basis. Value of recently appraised Brasse discovery has not been fully appreciated by the market in our view. We see lower downside risk for the stock due to the high cash on the balance sheet, significant tax pools/lcf and robust tax/fiscal terms. Source: DNB Markets Source: DNB Markets Source: DNB Markets Upside risks to our investment case The company is acquired. Other M&A activity such as acquisitions and divestments/swaps. Higher commodity prices, including oil and gas; for example, a linear ramp-up of the oil price to USD80/bbl by 2020 results in a GBp165/share NAV. Higher recovery, leading to higher resource and production. EBITDA bridge e (GBPm) Source: Company (historical figures), DNB Markets (estimates) 2

3 Contents Investment case summary 4 Investment case: valuation 5 Leading on key universal E&P metrics 6 Detailed NAV 9 A year from now: NAV progression 11 Brace for Brasse 12 Financing: robust and flexible 13 Exploration: focus on appraisal 16 Risks 17 Appendices 18 Producing assets 18 Developments portfolio 19 Profitability and downside from a different angle 20 Norway through the drillbit 21 Map of assets 22 Brasse discovery 23 Detailed NAV sensitivity to oil price 24 Valuation methodology 25 Commodity price assumptions 27 Licences 28 Major shareholders 30 Management and board of directors 31 Important Information 36 3

4 Investment case summary High quality, with a big discount We initiate coverage of Faroe Petroleum plc (Faroe) with a BUY recommendation and GBp142 target price. We believe Faroe is materially undervalued, both relative to its peers and on an absolute basis, and the stock is trading 13% below our cash and production NAV, implying limited downside risk. Our overall view is that at current trading levels investors have a very attractive risk/reward balance, hence our strong conviction and BUY recommendation. At 1 September close of GBp86.5/share, we believe investors are getting Faroe s high-quality developments for free, and we see significant potential upside in either a takeover or going concern scenario. We see Faroe Petroleum becoming a core equity holding in any E&P portfolio, if it doesn t get acquired first. Key findings Undervalued on an absolute basis. Faroe is trading at a P/NAV of 0.61x, based on our long-term oil price of USD60 65/bbl. At this level it discounts a ~USD41/bbl oil price. Undervalued relative to peers. Faroe is trading at 61% of our risked NAV, well below peers Lundin and Aker BP, which are trading at 103% and 102%, respectively. While this can in part be explained by its smaller market cap, we believe this as a good entry point to gain exposure to a growth-focused E&P. Limited downside risk, strong balance sheet. Cash and equivalents total GBp31/share (net cash position, with an undrawn bank loan of USD250m), or 23% of our NAV estimate, and we believe they will still be near the 20% mark a year from now. Combined with significant tax pools and robust development economics, we see limited downside risk to our NAV. Significant upside potential in our risked NAV: On an unrisked basis, the stock is trading at 49% of our core NAV estimate, meaning ~USD140m or ~GBp30/share of NAV upside potential. We have strong conviction in the company delivering on its discoveries, all else being equal. We see a further ~GBp8/share potential upside from portfolio synergies as developments are combined and tax optimised with the company s producing assets. We do not assign a value for this in our NAV. Our risked exploration value of GBp1.9/share is modest. However, activity has historically been strong, and the Faroe exploration team has had a long track record of delivering over the years. While we do not assign significant value to appraisal, we would focus on this activity which could yield significant upside to our numbers. Attractive developments on the NCS. We calculate the Brasse discovery has a breakeven oil price in the low USD20s, which would put it in the top five percentile of upcoming NCS developments. This tie-back is even competitive with Johan Sverdrup on a full-cycle basis, and more importantly Faroe is the operator, with a 50% interest. We believe this could be a company maker for Faroe. Besides Brasse, the company s other developments fall into the mid-to-high economics bracket, indicating the portfolio could be an attractive acquisition target for other E&Ps. Leading on key universal E&P equity metrics. Faroe has reported production and reserve growth of 13% and 29%, respectively, since 2012 (CAGR per share, debt-adjusted). This is second only to Aker BP, and we see plenty of scope for Faroe to continue to performing on these metrics. Production set to reach over 50mboe/d in 2023 on our calculations, or well over triple current levels. Looking well-funded in a stressed case. In a USD40/bbl scenario, we see the company and its partners deferring the Fenja development, and would still expect total production to reach ~35mboe/d (just under 3x 2017e). 4

5 GBp/sh DNB Markets Faroe Petroleum Investment case: valuation Undervalued in our view Our target price is 64% above 1 September close of GBp86.5 (see below for our NAV and methodology). Although it will become relevant in due course, we do not use P/E or other multiples to value the company, given its significant exposure to development at present. In our view Faroe s growth profile and projects are best assessed by considering FCF versus financing needs. This accounts for commodity-specific and operational netbacks, as well as varying tax regimes, and aligns with the portfolio valuation used by the oil and gas industry. We initiate coverage on Faroe Petroleum with a BUY recommendation and GBp142 target price, primarily based on our risked net asset value (NAV) Undervalued standalone; attractive relative to peers The stock is trading at 0.61x our NAV estimate, and 0.51x our unrisked core NAV (we use a long-term oil price of USD60 65/bbl). Lundin is trading at 1.02x and Aker BP at 1.03x our NAV estimates. We believe it is worthwhile comparing Faroe to these two peers, despite differences in size and a slightly higher cost of capital. Figure 1: Faroe looks attractively priced relative to peers on a P/NAV basis (risked) Curr. NAV/share Last price P/NAV Implied oil (USD/bbl) Aker BP NOK % Lundin Petroleum SEK % Faroe Petroleum GBp % Source: DNB Markets (estimates), Bloomberg (prices) Implied oil price of mid-usd40s Our NAV implies an oil price of USD41/bbl on a risked basis, and USD33/bbl on an unrisked basis. Similar to companies in the oil and gas industry, we define the implied oil price as the price required to achieve a 10% NPV return based on current trading levels. Discounting USD41/bbl oil on a risked basis, USD33/bbl unrisked (i.e. still earning 10% p.a. on FCF). Figure 2: Core NAV/share sensitivity vs. oil price (excludes exploration) Risked Unrisked Last: GBp86.5/sh USD40 USD50 USD60 USD70 USD80 Oil price, per bbl Source: DNB Markets (forecasts), Bloomberg (prices) Significant upside to our NAV numbers Additional upside of achieving unrisked NAV is GBp29/share. This means additional value would be achieved, along with a 10% return (CAGR), if all our P50 assumptions are in line with actuals (including revenue, opex/capex, operational profiles). A further GBp8/share is possible, on our numbers, as all the company s developments are combined with the production portfolio. Lastly, we could see the company s exploration pipeline further contribute to value creation beyond our current assumptions. 5

6 Leading on key universal E&P metrics Not growing for the sake of growth Growth is one of the most important metrics for E&Ps, especially in light of constantly declining production. However, growth at any cost has been one of the biggest criticisms of the industry over the last decade, and is arguably one of the factors contributing to the low oil price today. Adjusting for costs and funding, particularly through the sharp oil price drop since November 2014, leads us to universal E&P equity benchmark metrics: production and reserve growth per share. We arrive at these metrics by making a significant adjustment to account for both the company s self-funding ability as well as debt. Emerging from the shadow of giants Since 2012, Faroe is second only to Aker BP in terms of both production and reserves growth per share. Following a successful exploration-focused strategy and drilling programme, the company s reserves have grown at 29% p.a. through 2016 (CAGR, debt-adjusted). Stacking up against the players that have benefitted most from the discovery of Johan Sverdrup, Faroe has been consistent in delivering value to investors while making prudent use of funding, both through the peaks of and the troughs that followed. Growth at any cost has been one of the biggest criticisms of the industry over the last decade Debt adjustment Convert outstanding net debt (cash) into an equivalent share figure. This inherently accounts for leverage, funding and M&A activity. See details on following pages. Figure 3: Reserves growth per share (CAGR, , debt-adjusted) AKERBP FPM LUPE DNO IAE TLW ENQ PMO NOR -89% -50% -40% -30% -20% -10% 0% 10% 20% 30% 40% 50% Source: Companies (historical figures), DNB Markets (further calculations) Faroe set to outperform on reserves growth With a FID at Fenja expected by year-end, there is some visibility on contingent resources (2C) moving into the reserves category (2P). The biggest impact is set to come from Brasse, however, with breakeven in the low USD20s/bbl, as the project is likely to move forward and is of much more substantial volume. This supports our view that Faroe has more credibility than peers in terms of growing through the drillbit. This leads to a discussion on production, funding, and ultimately cash flow growth. In our view Faroe has more credibility than peers in terms of growing through the drillbit Figure 4: Reserves growth set to outperform peers Resource versus reserves 3.5x 3.0x 2.5x 2.0x 1.5x 1.0x 0.5x 0.0x TLW PMO FPM AKERBP ENQ DNO LUPE NOR Source: Companies, DNB Markets (further calculations) 6

7 mboe/d DNB Markets Faroe Petroleum Converting resources to production is important as it proves commerciality Faroe has delivered 13% growth per share since 2012 (CAGR, debt-adjusted), a figure dwarfed by Aker BP, but above Lundin at 9%. However, the picture is incomplete without an understanding of the prospects from here on: Aker BP s production is set to stay relatively flat, if not decline slightly through 2020, and then pick back up over the next decade. Lundin s production growth is set to be in the teens through the early 2020s. Faroe has the potential to increase production 2 3 times during the same period in both a base and stressed scenario. The key questions for us concern the cost of production growth and funding. Figure 5: Production growth per share (CAGR, 2012/16, debt-adjusted) AKERBP 133% FPM DNO LUPE TLW IAE ENQ PMO NOR -30% -20% -10% 0% 10% 20% 30% Source: Companies, DNB Markets (further calculations) Figure 6: Production could triple, reaching as high as 50mboe/d by Fogelberg Fenja Brasse Oda Njord, Hyme & Bauge UK - existing e 2018e 2019e 2020e 2021e 2022e 2023e 2024e 2025e 2026e 2027e 2028e 2029e 2030e Source: DNB Markets (forecasts) Projects, breakeven, and funding should lead to further growth Future production per share growth, adjusted for debt, compels a consideration of funding and leverage which can be measured across companies in the global E&P universe. In our analysis, we convert net debt into a per share equivalent, adjusting for dividends and share buybacks. By bringing debt into the picture, we get closer to a level playing field for oil & gas players, accounting for their primary source of funding (operating cash flow) and capital structure (funding through debt et al). This means operational leverage (netback) is accounted for, including varying exposure to oil versus gas, differentials, operating costs, and taxes. 7

8 Rebased share price performance (ytd) DNB Markets Faroe Petroleum While Faroe saw strong production growth through 2016, following the DONG assets acquisition, we project more tepid growth until the early 2020s when significant developments are set to reach first oil. The company has delivered strong historical performance relative to its peers. Over the next few sections, we elaborate on our analysis of the factors which should lead to further longterm production per share growth. Specifically, the attractiveness of Faroe s upcoming projects, FCF generation of the portfolio, flexibility in a volatile commodity price environment, and access to financing, lead us to conclude the company will likely outperform in production per share growth. M&A could significantly affect these metrics, but it has to be value-accretive We also note the company s M&A strategy has historically been effective in a high oil price environment (i.e. divestment/swap for production). Further, in the trough that followed, a change in strategy from growing through the drillbit through to inorganic growth, has continued to add value as management has demonstrated a prudent and pragmatic approach to creating value. Figure 7: Faroe s assets rank well among future developments in Norway Asset NCS rank* Brasse top 5% Oda top 20% Njord area top 45% Fenja top 55% Fogelberg top 80% Source: DNB Markets (forecasts) * Top developments on NCS with future breakeven below USD65/bbl Brasse is by far the most important development for Faroe due to its high per share exposure and attractive economics See details on the company s developments in the following chapters and the Appendix Attractive projects, FCF generation of the portfolio, flexibility in a volatile commodity price environment, and access to financing all suggest that Faroe will outperform in production/ share growth Figure 8: particularly the projects with the biggest per share impact Asset(s) boe/faroe share* Norway production 9.6 UK production 2.0 Njord area 5.3 Oda 1.9 Brasse 9.8 Fenja 6.8 Fogelberg 4.1 Source: DNB Markets * per 100 shares The stock has underperformed this year in spite of the successful Brasse appraisal and accretive acquisition: Figure 9: YTD performance vs. oil and peers Jan-17 Feb-17 Mar-17 Apr-17 May-17 Jun-17 Jul-17 Aug-17 Aker BP Lundin Petroleum Statoil Oil (Brent) Faroe Source: Bloomberg (prices) 8

9 Detailed NAV Risked NAV of GBp142/share Our NAV methodology consists of modelling the company s producing assets on an individual basis, consolidated on a portfolio by country to account for tax effects. We further model and risk future developments individually, and net (add) debt (cash) to arrive at the core NAV (CNAV) of GBp140/share. This is further enhanced by our calculated exploration exposure (EMV basis), reaching a risked NAV of GBp142/share. We highlight some of the key aspects of the NAV below, with further details on the following page and additional comments on methodology in the Appendix. Other details on key assets follow in the upcoming chapters and Appendices. Figure 10: NAV waterfall Significant upside to trading levels Target: GBp142/share 140 Upside to target price: GBp56 (+64%) Based on our risked NAV Additional upside: GBp31 (+36%) Based on our unrisked CNAV 120 GBp/sh Last: GBp87/share Source: DNB Markets (forecasts), Bloomberg (prices) Key observations Inherent upside potential to NAV. There is an additional upside potential of GBp29/share or ~20% to our NAV on an unrisked basis (i.e. strictly looking at a PV of FCF, discounted at 10% based on our commodity price and FX assumptions). Risking methodology is detailed in the Appendix. Cash is king. Cash of GBp31/share (negative working capital) accounts for almost a quarter of the NAV, in stark contrast to peers that have a net debt position. Trading below cash and production: takeover candidate? The stock is trading 13% below the NPV of producing assets and cash, which amounts to GBp101/share. The key implication is that investors get Faroe s developments and discoveries for free. Coupled with our positive view of upcoming projects, we see this contributing to a higher likelihood of the company being a target for acquisition. This should not be surprising in light of Delek Group s acquisition of 13.2% of outstanding Faroe shares late last year (~GBp89/share), making it the The stock is trading below cash and production, meaning investors can get discoveries for free 9

10 company s largest shareholder (now holding ~15%). The acquisition came shortly before Delek s USD1.24bn acquisition of Ithaca Energy (primarily UKCS assets), which added further fuel to the market speculation. Exploration less substantial than historically. Risked exploration of GBp1.9/share is modest on a historical basis, when Faroe grew primarily through new discoveries. In part, this is a result of a successful exploration programme, but we do not put a value on most of the company s 1.0bn+ boe prospective pipeline, which will be high-graded over the years. That said, a successful test at Goanna could have a GBp2 3/share impact on a P50 basis. Our NAV 10% estimate is detailed below, with risking and other comments on methodology in the Appendix. We believe a focus on Faroe s appraisal activity is more pertinent than pure exploration. More details can be found in the following chapter and the Appendix. Figure 11: Detailed NAV As at Resources, net NPV Unrisked Risked [WI] [mmboe] [gas%] [USDm] [GBPm] [USD/b] [USDm] [RF] [USDm] [USD/b] GBp/sh fd] Production & tax assets Norway var % % UK var % % % % Developments Njord, Hyme & Bauge 7.5% % % Oda 15.0% 7.2 4% % Brasse 50% % % Fenja 25% % % % % Discoveries & contingent Fogelberg 25% % % Other contingent (incl. Fenja 2C) var % % % % Upstream value % % Net cash (debt) % Blane acquisition % Current assets % Current liabilities % G&A % Core NAV Exploration (excl. appraisal): Likely '17 & '18 activity [Unrisked disc.] [EMV] Completed, committed, and possible (1 var % NAV Notes Net cash (debt) as at YE 2016 Commodity assumptions 55 USD/bbl USD/bbl long term FX 7.77 NOK/USD 1.30 USD/GBP G&A 15.0 USDm pa, pre-tax Discount rate 10.0 % Shares outstanding mn mn fd (1) Exploration: includring dry well costs of completed prospects, after tax. Appraisal costs included in discoveries. Possible wells on an NPV > 0 basis only. Source: DNB Markets (forecasts) 10

11 A year from now: NAV progression NAV to move +/- 15% Rolling forward one year, ceteris paribus, our NAV would increase by 5% to 10% by 2018e, assuming the expected progression of FCF, no further exploration success, and following our de-risking methodology. In this 1-year outlook we note that cash and equivalents (i.e. positive working capital) would still account for ~20% of NAV, compared to ~25% currently. Below we reflect on the most likely scenarios that would affect our NAV to determine whether the unrisked value is being unlocked, destroyed, or needs re-assessment. We qualitatively address the potential effects of divestitures, but exclude capital markets and an outright acquisition. We see the latter as possible and more material, but naturally unpredictable. Rolling forward one year, ceteris paribus, our NAV would increase by 5% to 10% by 2018e, assuming the expected progression of FCF, no further exploration success, and following our de-risking methodology We exclude sensitivities to commodity prices, which are found in the Risks section. Conclusion: our risked NAV could fluctuate +/- 15% over the course of a year, in our view more likely on the positive side. We suspect appraisal activity could have the largest impact, but do not discount M&A coupled with funding making a bigger splash on our numbers. Scenarios and impact Exploration. The company s two wildcats (Goanna, Aerosmith/Iris prospects on the NCS) are slated for testing later this year, although the results may not be available until early next year. Total unrisked exposure is modest at 21mmboe. Impact: 0 to 5%. Appraisal activity is high. Fogelberg is set to be appraised mid That said, further details on what the company is expecting may be provided later this year. Likewise, additional information on a possible extension of the Brasse discovery to the north may also be detailed by the licence partners, leading to further upside potential. This has added significant visibility to commerciality in the past, and we see further appraisal work as potentially being highly accretive for Faroe. Impact: 0 to 15%. Change in resource estimates: Brasse. Faroe has already reported a material increase in resources this summer following a successful appraisal. We expect the resources at Brasse to qualify as reserves (2P), although we see the impact as modest on a risked NAV basis given our risking factor of 60%. However, a tightening of the resource range could easily see a +/- 10% swing. In this case we caution that unless the licence partners signal a significant change in production profile, the impact would again be modest. In this scenario we exclude the impact of further appraisal (see above). Impact: -5 to 5%. Capital expenditure, lest we forget. The oil & gas industry has consistently shown cost creep and in spite of the deflationary cost environment, investors are always cautious of expanding budgets. In this scenario, we consider a +/- 20% swing in capex in the Njord area. The NAV impact is remarkably limited, as ~90% is mitigated through tax incentives. However, investors can count on a bigger impact on the company s funding needs. Impact: -5 to 5%. Our risked NAV could fluctuate +/-15% over the course of a year, in our view more likely on the positive side We expect the resources at Brasse to qualify as reserves (2P) The estimated NAV impact of a +/- 20% swing in capex in the Njord area is limited, as ~90% is mitigated through tax incentives Divestitures. Traditionally, Faroe s management has used divestitures to fund part of the business when oil was on the climb. A farm-down in Oda/Brasse has long been a discussion point for the company, and we do not rule out a creative transaction that alleviates funding pressure. With Brasse turning heads on the NCS, we expect management will be open to discussing alternatives while retaining some upside. Impact: 5 to 10%. 11

12 mboe/d USDm NPV/boe IRR DNB Markets Faroe Petroleum Brace for Brasse Why is Brasse so important? We see Brasse as a company maker. Faroe discovered the field, a feat in itself following a previously successful exploration programme. With its partner, Point Resources, Faroe has further raised resource estimates through successful appraisal this summer. And while it is a relatively small discovery (<5% of Johan Sverdrup), the tie-back economics are attractive and robust, with the per-share impact being significant for Faroe. We expect the resources to move into the reserve category, and thus see potential upside to our numbers, especially if the field extends onto the adjacent PL740B licence (where Faroe has a 50% working interest). Key considerations Faroe is the operator of licence PL740 (50% WI), the other partner being Point Resources (50% WI). We believe both are highly motivated and capable of funding the development. The field is a stone s throw (~10km) from the production facilities at Brage (Faroe 14.3% WI, Point 12.3% WI), Oseberg and Oseberg South (Faroe has no interest), making it an obvious tie-back candidate with regional synergies for the company. Resource estimate increased to range between 56 and 92mmboe (significantly increased the lower boundary estimate). Gas makes up less than 20% of the resources. We model 74mmboe gross, with production peaking near 30mboe/d in the early 2020s. We value the discovery at USD4.5/boe, or USD2.7/boe risked at 60%, or ~GBp20/share. Faroe sees development cost of USD500m; we model slightly higher at NOK4.5bn incl. inflation. Figure 12: One of the most robust NCS developments Unrisked value vs. oil price Capex sensitivity % Base -25% IRR -25% IRR Base IRR +25% 80% We see Brasse as a company maker Brasse has a breakeven oil price in the low USD20s, making it one of the most attractive tie-back NCS developments. We expect a FID at Brasse later this year, or early 2018, along with a possible transfer of resources into reserves % 60% 50% 40% 30% 20% % $40 $50 $60 $70 $80 Oil price (USD/b) Source: DNB Markets Figure 13: Brasse gross production profile (50% WI) Figure 14: Brasse gross FCF profile, standalone (50% WI) Oil Gas e 2020e 2023e 2026e 2029e e 2019e 2021e 2023e 2025e 2027e 2029e 2031e 2033e Revenue Opex Capex Abex Tax FCF Source: DNB Markets Source: DNB Markets 12

13 Financing: robust and flexible Key takeaways In our view, the slack variable for funding would be a FID at Fenja later this year. As the project breakeven hovers in the low-usd40s oil price, and with all partners in the licence weighing growth ambitions against financing, we see a delayed investment decision as the right option should the oil price outlook worsen. Under this scenario, the company could withstand a USD40 oil price environment with ample liquidity through 2020, coinciding with first oil at Njord and Brasse the following year. Company production would still more than double in this scenario. A delayed investment decision would be the right option should the oil price outlook worsen, in our view Our projections assume banks will slowly include sanctioned developments in the borrowing base, but also maintain commodity price assumptions 5 10% below futures. Figure 15: DNB base FCF forecasts, with projects up to and including Fogelberg USDm e 2018e 2019e 2020e 2021e 2022e CFO Capex FCF The company has a USD250m reservebased lending facility (RBL), with a USD100m accordion. Faroe has yet to draw on this facility, with ~USD150m cash on the balance sheet as of mid-2017 Source: DNB Markets (forecasts) Figure 16: Capex of USD1.4bn over the next five years USDm Norway prod. UK prod. Njord Hyme Bauge Oda with ample discretionary spending flexibility USDm Production Sanctioned Brasse Fenja Fogelberg Brasse Fenja Discretionary spending e 2018e 2019e 2020e 2021e 2022e Fogelberg e 2018e 2019e 2020e 2021e 2022e Source: DNB Markets (forecasts) Source: DNB Markets (forecasts) 13

14 Figure 17: FCF at varying oil prices (incl. ALL projects) e 2018e 2019e 2020e 2021e 2022e Oil, USD/b USDm Source: DNB Markets (forecasts) 14

15 USDm DNB Markets Faroe Petroleum Fenja is the slack variable Under a stress test scenario, the choice is clear. With Fenja capex USD50m 100m (25%) more than Brasse, a USD15 20/bbl higher breakeven, and ~5mboe/d lower production (all figures net to Faroe), the project stacks lower in the pecking order. In our USD40/bbl oil price stress scenario, removing Fenja from the starting line-up brings Faroe significant liquidity and the company clears the financing hurdle with ample wiggle room. On maintaining optionality and deferring the project, we note that Faroe is likely aligned with its Brasse partner, Point Resources, which also holds a significant stake in Fenja. In our view, convincing the operator, VNG Norge, to delay a FID would be simple in a stressed scenario. Alternatively, the company has the option of walking away from the project, with a minimal NAV impact of GBp6/share. This winter: we expect the company s RBL facility to remain relatively unchanged under current strip prices: On the positive side, we expect sanctioned developments to be credited by lenders under a risked profile. This could be balanced by a potentially lower oil price outlook compared to Q Figure 18: Faroe s net cash (net debt) position USDm Oil, USD/b RBL: $250m +$100m e 2018e 2019e 2020e 2021e 2022e Source: DNB Markets (forecasts) Note: excluding Fogelberg is drastically improved if Fenja is removed under a stress scenario Oil, USD/b RBL: $250m +$100m e 2018e 2019e 2020e 2021e 2022e Source: DNB Markets (forecasts) Note: excluding Fogelberg, Fenja. 15

16 Exploration: focus on appraisal Key takeaways Faroe has historically delivered strong results on the back of a dependable exploration strategy. This has ultimately resulted in significant outperformance versus the peer group on reserves per share growth since That said, we see the future potential as more muted and do not ascribe any qualitative value to future exploration success. We note that Faroe s strategic shift towards development and production is deliberate, and will update the pure exploration outlook as the portfolio is high-graded and matured. Faroe s strategic shift towards development and production is deliberate More importantly, we believe investors should seek to hear more on the company s appraisal programme, which has a lower risk and could lead to more visible value creation. It s a probability game, and we value it as such Our valuation methodology is based on the Expected Monetary Value principle, which essentially results in ascribing value to the company s committed and possible wells (while still distinguishing between these two). This means that despite having 1.0+ billion boe of prospective resources, our NAV credits only about 50mmboe of potential resources while accounting for sunk exploration costs to date. For more details and risking, particularly mapping onto SPE-PRMS treatment of prospective resources, see our methodology in the Appendix. The company has had a successful exploration track record over the last decade (see Appendix) Figure 19: Valuing exploration pipeline Source: DNB Markets Expected Monetary Value (EMV) = { P(disc.) x P(commercial) x PV 10% - P(cost incur) x Cost } Only GBp1.9/share? The risked value of ~USD9m, or GBp1.9/share, includes most of the ongoing, committed, and possible exploration wells announced by the company. This includes sunk and future costs along with the geological and commercial probabilities of prospects. However, medium/longterm prospects along with leads are excluded from our NAV, indicating that a vast portion of the +1.0 billion boe exploration pipeline is incremental to our numbers. Wildcat success of GBp2 4/share but P50 is modest The company has five possible wildcats through the end of 2018, including two committed wells. On the upside (P90), the committed wildcat wells (Goanna and Aerosmith) could easily generate GBp2 4/share upon discovery, if not more. The possible wells (SE Tor, Rungne, Oshun) could have a similar impact, but on a P50 company guidance we forecast a more modest impact. The company has five possible wildcats through the end of 2018, including two committed wells Focus on appraisal Our near-term focus will be to look for decisions on further appraisal of the Brasse extension and Fogelberg. As there is no guidance from the licence partners, we have not ascribed significant value, but suggest the de-risked petroleum systems around these discoveries are prudent ways to consider additional value creation from the exploration team. Figure 20: Exploration schedule, as of July 2017 While speculative, we think appraisal at Brasse extension and Fogelberg offers reasonable risk-adjusted value over the company s wildcat programme, and builds on the company s historical success Source: Company Note: * ongoing; ** committed; *** possible 16

17 Risks Some of the factors that affect our valuation include: Commodity prices (oil & gas): USD10/bbl change in Brent oil has a 15% NAV impact 5% change in NBP as fraction of Brent has a 2% NAV impact Figure 21: NAV/share at various oil & gas prices 200 Risked Unrisked 175 Leverage to oil: NAV moves 15% with a USD10/bbl change in underlying oil price assumptions Last: GBp86.5/sh GBp/sh USD40 USD50 USD60 USD70 USD80 Oil price, per bbl Source: DNB Markets (forecasts) Foreign exchange: Impact of +/ USD/GBP results in a 5.0% NAV change (2017 base 1.30 USD/GBP). Impact of +/ NOK/USD results in a 0.7% NAV change (2017 base 7.8 NOK/USD). Changes to oil & gas fiscal regimes (UK, Norway). Exploration drilling, project development. Downtime at existing production facilities. Downtime & access to infrastructure. Oil and gas service costs, including drilling and construction. Environmental impact of oil & gas activity, legislation. Timing of project developments and wells. Emerging technology, including increase in recovery factors. Aging of facilities and abandonment costs. M&A activity involving assets related to the company s production licences. Global capital markets and funding. 17

18 Appendices Producing assets Key takeaway The company participates in seven fields in Norway and six in the UK. With the exception of Blane, the fields in the UK are fairly mature and could arguably have a negative value due to their proximity to abandonment. But despite the maturity of the portfolio, production has been relatively stable, with upside from increased recovery. Two key takeaways are: 1) tax pools are a material source of value (~20% of production NPV); and 2) the company s deliberate strategy to beef up around production hubs is essential for further squeezing value out of its mature assets. mboe/d Of note Producing assets are valued at GBp70/share, or USD348m. Of this amount, tax pools and LCF in Norway and the UK along with portfolio synergies result in about GBp15/share of our NAV. Total reserves amount to ~44mmboe (19% gas), with over 80% weighted in Norway. Due to the tax regime tax pools/lcf, barrels in the UKCS are worth over twice as much as they are in Norway. That said, the valuation of the Norwegian assets is less affected by changes in the oil price. In light of the maturity of the assets, we model ~USD85m in decommissioning through 2020 (nominal, pre-tax). Despite the maturity of the portfolio, production has been relatively stable, with upside from increased recovery Figure 22: Stable production May 2017 YTD 4000 boe/d Trym Schooner & Ketch Brage Tambar Ula Oselvar Njord & Hyme Blane Ringhorne East Other Source: Company Figure 23: Currently producing fields production forecast Norway UK e 2018e 2019e 2020e 2021e 2022e 2023e 2024e 2025e 2026e 2027e 2028e 2029e 2030e Source: DNB Markets (forecast) 18

19 USD/bbl USD/bbl DNB Markets Faroe Petroleum Developments portfolio Key takeaway Besides the de-risking value (>USD100m or ~GBp15/share), there is further upside potential to our NAV as developments are consolidated with the producing portfolio (~USD40m or ~GBp8/share). The economics of undeveloped assets range from middle-of-the-pack (Fenja/Njord) to very attractive (Brasse), and the discoveries are all located in Norway. Coupled with the NAV impact of de-risking and portfolio effect, the upstream value of Faroe is very attractive in our view. There is further upside potential to our NAV as developments are consolidated with the producing portfolio Figure 24: Low breakeven for developments Source: DNB Markets (forecasts) Brasse Oda Njord area Fenja Fogelberg Figure 25: Faroe assets ranking among developments on the NCS (breakeven) $70 $60 $50 $40 $30 $20 $10 $0 Source: DNB Markets (forecasts), Wood Mackenzie 19

20 Profitability and downside from a different angle Key takeaways The Norwegian fiscal regime for upstream assets is robust yet simple. Aside from the unique exploration refund, irrespective of tax position, the regime provides a reasonable assurance for recovering development costs. And while the risk of new legislation eliminating this incentive is greater than zero, the regime has a reputation for being stable and predictable. A combined offshore tax of 78% may be off-putting, but an almost certain 90% cost recovery irrespective of profitability will limit downside risk much more than in other regimes. Adjusting for the PV of tax shield (corporate, special, and uplift), the profitability ratio for Faroe s upcoming developments is greatly improved. This is beneficial to many potential investors, including: Norwegian fiscal regime for upstream assets is robust yet simple. Aside from the unique exploration refund, irrespective of tax position, the regime provides a reasonable assurance for recovering development costs. Majors, with constrained portfolio capital allocation; Private equity players, with capped downside constraints; and Bank loan and debt instrument financing. Figure 26: What we mean by robust, attractive E&P economics in base DNB Markets $40 oil Asset WIResources NPV 10% BE 10% Status IRR PIR 10% PIR-adj 10% PIR 10% PIR-adj 10% [mmboe] [USDm] [USD/b] [standalone] [standalone] Njord area 8% sanctioned 25% 1.3x 2.0x 1.1x 1.4x Oda 15% sanctioned 25% 1.4x 2.1x 1.1x 1.4x Fenja 25% FID % 1.2x 1.5x 1.0x 1.1x Brasse 50% FID 2017/18 43% 1.8x 3.3x 1.5x 2.4x Fogelberg 25% ~55 appraisal TBD 11% 1.0x 1.1x 1.0x 1.0x Adjusting for tax shield, PIR is very attractive..even at $40/b oil Note: All figures are net to Faroe Source: DNB Markets 20

21 Norway through the drillbit Figure 27: Net discovered resources, based on original reported size (NPD) mmboe mmboe Maria Fogelberg Butch T-Rex Rodriguez Snilehorn Solberg Bue Pil Novus Skirne Øst Boomerang Brasse Njord NF Discoveries (LHS) Cumulative resources (RHS) Source: DNB Markets (further calculations), NPD 21

22 Map of assets Figure 28: Most production and especially future developments are located on the NCS Njord area 12.7 GBp/sh 46.0 mmboe Brage area 8.3 GBp/sh 7.1 mmboe Brasse discovery 22.1 GBp/sh 37.3 mmboe Ula area 36.5 GBp/sh 36.7 mmboe UKCS assets 22.0 GBp/sh 7.5 mmboe Asset(s) GBp/sh Production Norway 48.8 Production UK 22.0 FID Projects 10.8 Pre-FID Projects 28.5 Other discoveries 2.0 Cash & financial 28.6 Exploration 1.9 Total Source: DNB Markets (forecasts) 22

23 Brasse discovery Figure 29: Brasse is located near existing infrastructure and has the potential to extent onto the adjacent PL740B licence Brasse Source: NPD 23

24 Detailed NAV sensitivity to oil price Figure 30: Asset value is robust UNRISKED (USDm) Base DNB Oil price: $40 $50 $60 $70 $80 Norway UK Production Njord, Hyme & Bauge Oda Sanctioned projects Brasse Fenja Unsanctioned projects Fogelberg Other contingent (incl. Fenja 2C) Other discoveries Upstream value (excl. expl.) Net cash (debt) G&A Core NAV ,121 Exploration NAV ,107 1,366 NAV/sh (GBp) RISKED (USDm) DNB RF (%) Oil price: $40 $50 $60 $70 $80 Norway 100% UK 100% Production Njord, Hyme & Bauge 70% Oda 65% Sanctioned projects Brasse 60% Fenja 60% Unsanctioned projects Fogelberg 25% Other contingent (incl. Fenja 2C) 23% Other discoveries Upstream value (excl. expl.) Net cash (debt) 100% G&A 100% Core NAV Exploration 13% NAV NAV/sh (GBp) Source: DNB Markets (forecasts) 24

25 UNDISCOVERED PIIP TOTAL PETROLEUM INITIALLY IN-PLACE (PIIP) SUB-COMMERCIAL DISCOVERED PIIP Chance of Commerciality COMMERCIAL DNB Markets Faroe Petroleum Valuation methodology Focus on net asset value Using a valuation based on multiples (EV/EBITDA, EV/DACF, P/E, P/B) is challenging for Faroe s peer universe, and potentially the oil & gas sector as a whole. Our main reason for focusing on NAV is the industry itself: discounted cash flows (DCF) are the basis for oil & gas companies making investments and allocating cash across their portfolio of assets, ranging from producing assets, upstream developments, midstream and downstream projects, and exploration activities. Discounted cash flows (DCF) are the basis for oil & gas companies making investments and allocating cash Benefits and insights from NAV: Resource size, production and product profile. Varying opex over asset life. Future capex, rather than historical depreciation. Timing of revenue streams. Undeveloped discoveries and projects. Tax consequences of investments. Acquisitions and divestments. Fiscal terms and historical tax pools (depreciation, LCF). Profit oil in production sharing agreements. Risk profiles. Future cash flows are modelled on an asset level, resulting in an unrisked valuation of the company (gross asset value, or GAV). This allows for evaluating assets beyond reserves (see next page). Transparent risking factor (RF) Risking assets is based on our experience. The process is a proxy for the probability of commerciality, including chance of discovery, but ultimately the risking factor is our opinion of how a reasonable investor would value exposure to the company s assets. Figure 31: DNB risking PRODUCTION Project Maturity Sub-classes Typical DNB RF Range Reserves On Production % 1P 2P 3P Approved for Development 60-90% Proved Probable Possible Justified for Development 40-75% Contingent Resources Development pending Development Unclarified or On Hold 10-60% 1C 2C 3C UNRECOVERABLE Development not Viable 0% Prospective Resources Prospect 0-20%* Low Best High Lead Play 0% Source: DNB Markets UNRECOVERABLE Uncertainty of Recoverable Volume *Exploration: Prospects are modelled as risked discoveries, further multiplied by the geological chance of success and adjusted to reflect expected monetary value (EMV) 25

26 Reserves and resources Assets are modelled on resources as defined in the Petroleum Resources Management System (SPE-PRMS). We aim to align our valuation and specifically risking factor in line with the SPE-PRMS framework because the system has gained worldwide adoption in the petroleum industry. This means that we include resources beyond 1P reserves (proved) and 2P reserves (proved plus probable). The SPE-PRMS framework because the system has gained worldwide adoption in the petroleum industry Contingent resources (2C) are technically recoverable, contingent on factors including economic feasibility, legal restrictions, fiscal and regulatory impediments, environmental limitations, capital availability and commitment, and technology. When looking at exploration we model prospective resources. Best does not translate into most All three resource categories defined in SPE-PRMS (Reserves, Contingent, Prospective) are further statistically categorised to capture size estimate and risk of ultimate recovery. Resources are organized into Low, Best, and High, with the associated chance of recovering the amount or more being 90% (P90), 50% (P50), and 10% (P10). The best estimate (P50) is therefore the median resource estimate, where there is a 50% chance ultimate recovery will be higher and a 50% chance of being lower. SPE-PRMS maps to various standards governing the oil & gas industry: Norwegian Petroleum Directorate (NPD 2001). US Security and Exchange Commission (SEC 1978). United States Geological Survey (USGS 1980). UK Statement of Recommended Practices (SORP 2001). Canadian Security Administrators (CSA 2002). United Nations Framework Classification (UNFC 2004). China Petroleum Reserves Office (PRO 2005). Russian Ministry of Natural Resources (RF 2005). Discount rate 10% across the board We use a 10% annual discount rate for assets in OECD countries. Upstream assets, including producing and undeveloped fields, have distinct risk profiles. However we use a 10% discount rate across the board: Ease of conducting transactions of oil & gas assets (common use of partnerships and JVs, ease of managing acquisitions and divestitures (A&D) compared to other industries). Align time value of money using the same discount while assuming commodity prices across oil & gas assets. Company discount rate is not appropriate. We present our valuation of equity net of debt because financial leverage is part of the corporate structure, within management s control. Therefore the net value is based on a figure we would expect the company s liabilities could be liquidated, or at least a proxy of their fair value. Operating costs and spending are accounted for in the cash flow profile, focusing on sensitivities and results compared to assumptions. The risk of uptime and production variance is not captured by a single discount rate; hence we focus on observing operations and updating the profiles as expectations change. We risk undeveloped assets (sanctioned/unsanctioned projects, old or unclarified discoveries), rather than use a different discount rate. Our risking methodology is outlined on the previous page. 26