Roundtable Discussion; The Future of Mineral Sands. Watch the video here.
Stevo I think that Enquest would be in a position to demand 20% (1 to 4) because its tax losses alone are worth at least $800m to the combined company (ie say $900m in saved tax in 2 years) That is a sum which exceeds its net debt. All the bonds could be bought up over the next 5 months or so. It is producing not far off 20% of Harbour (36,000 (say) v 189,000) but has much greater reserves proportionately. It has a better hedging position. Harbour's operating costs went up a lot. Enquest's came down. But frankly I would take 18 to 82%.
Enquest should be enormously valuable to Harbour because of its tax losses. Enquest will take 10 years to fully use them. The combined entity can use them in 2 years or so. There is just a huge marriage value and a deal can be done if both sides are fair and pragmatic.
I remain optimistic that there will be a deal with Harbour soon. It will in effect be Enquest buying Harbour with new shares being issued in the merged entity at a ratio of 1 to 4. HBR announced that they have FCF of $1bn for the year. But next year they face penal levels of taxation. The combined entity will have net debt of about $800M at very low rates of interest. It should be able to generate FCF of $1.5bn in 2024 and $1.7bn in 2025 by using Enquest's tax losses. No cash need change hands and the operations can be run as they are now with some costs savings made.
The update is good news. I was not expecting net debt to come down to just $585M. It is not just the lower opex ($25m) but the EPL was only $60m against the $75m we were expecting. The real point is that if you treat the EPL as a one off, we have reduced net debt by $45m a month in September and October. With now lower Brent but some good hedging at $88 we could be close to just $515m at the year end. That is far better than any one could sensibly have expected. It would mean in the second half we have FCF of $77m when I (and indeed Stevo) thought it would be at best zero.
There is no chance that share buybacks will commence any time soon. Nor should they. The debt will in fact have risen to the end of October because of the EPL payment. I think we should expect something around $650m. Part of that debt is costing around 13% a year. We simply must deleverage before any buybacks. The good thing is that from now on we have no major payments to make until next October. I am hoping we can clear debt at a rate of around $20m a month even with Brent at $80.
The company did talk about setting out a pathway to shareholder returns in February 2024 when the end of year results are announced. But frankly they do not make any sense whilst the debt levels remain so high in relation to market cap. The most expensive debt is at 13% and it needs to be paid off as soon as possible. The recent fall in Brent is going to make that much more challenging. The answer is of course a reverse takeover by Harbour or a sale of assets by Harbour on a deferred consideration basis. It could be structured so that both sides benefit from Enquest's tax losses. Why this has not happened yet is hard to understand.
The November update is all important. Negative FCF for the second half would be a disappointment. We do know that there was positive FCF of $27m in July and August if you ignore the golden eagle payment. And we do know that production and prices are significantly higher since August. I am expecting net debt at the end of October to be around $650m but with the EPL paid. We then have a completely tax free period until October 2024.
Stevo I think you could be about right for 2023 although your interest rate assumptions are pessimistic. Average debt in 2022 was about a billion, in 2023 about $600m. My interest is in 2024 and 2025. I like to assume Brent will be the spot price plus likely inflation and that gets us to around $90 a barrel for 2024 - far more than in the first half of this year. I do not believe in the futures market which I think is all to do with interest on money paid for future delivery which is why the price falls in a linear way the further out you look. I am taking Craig Baxter at face value when he says they intend to maintain production levels. Really when calculating FCF for 2023 one should include the Eagle payment. So we are about $185M for this year on your figures. I would settle for $200M FCF for 2024 and 2025 after payment of EPL . Big reduction in interest and leasing costs are required and on the horizon.
Stevo no need to apologise. We all need to be realistic. But what you cannot escape from is the 2022 figures for FCF $518m. We averaged a realised price of $89 per barrel in that year. At 47800 barrels production a day we produced 17,447,000 in the year. So that is $29.68 per barrel FCF surplus. That takes into account payments to BP and the Malaysian government. Although capex and opex will be higher, finance costs and leasing costs are coming down rapidly. I accept that production will be slightly lower. To assume a surplus of just $20 a barrel overall as compared to $29 plus seems reasonable.
Even at today's slightly lower prices, we should be reducing net debt quite rapidly. The Malaysian situation is extremely difficult to work out. But overall production I think is holding up well and assuming 45000 a day and a surplus of $20 a barrel we are making $900 k a day. If net debt is $650m by the end October (after paying the EPL) that allows us to reduce net debt by $328m before October 24. It is the elimination of debt that is so crucial to the future SP. 2025 is a long way off but interest charges and leasing costs move very much in our favour during that year. The market will see the end of the EPL on the horizon by then. The Labour party has never suggested that it will be extended beyond 2028.
Stevo
Contango makes sense. The value of money is always declining in real terms so would would expect to pay more in the future than now. In addition one could understand backwardation for some commodities that cannot be stored such as gas. But oil can be stored and in relation to the US strategic reserve it is for years. What makes no sense is for someone who has the commodity in storage not to sell into the present spot market to save the cost of storage and buy back in the future market. This trade would not have any possible downside and I cannot work out why any one in that position would not do just that.
Stevo it still does not really make sense for the futures prices to be lower than the current prices. Much oil bought today is simply stored. There is a great deal of oil already in storage. Any one who has oil in storage could sell into the present market and buy into the future market making a certain profit. A rational market would eliminate that risk free trade.
Tarmak
Thanks for your helpful and encouraging analysis. I suppose the key assumption is that Brent averages $95 in 2024 and 2025. Not so unreasonable given the spot price today and the effect of future inflation. But Stevo would point out that the forward market is lower and that is what one should use. I am struggling with the extent of backwardation. The forward prices for 2030 are in the mid $60s. Is this not just because, in effect, anyone buying oil for delivery in 2030 pays now and so the seller gets the use of the money for seven years? Otherwise it makes no sense at all.
After today's long overdue and modest rise we now have a market cap of $368m. Yet if the present price of Brent holds, we should be able to strengthen the balance sheet by $5m a week on the most conservative assumptions. That is around 1.36% of present market cap each week. And with every reduction of $5m in debt we save around $600,000 a year in interest payments. I think this is very cheap indeed. JP Morgan were being far too conservative.
With Brent already at $91, we could see averaged realised prices for 2024 of a few dollars higher than 2022 when, to repeat, we had a FCF of $518m with realised average prices of $89. So far we have just a few put options at $60 so we will be receiving the actual prices for all of our production. I see a very slight reduction in output compared to 2022 and higher opex and capex. But that largely is balanced by lower financing costs and lower leasing costs. If something approaching $400m of FCF can be generated between end of October 23 and end of October 2024 before payment of any 2023 EPL it will be completely transformative. After payment of the EPL this month the net debt should be around $640m and we have therefore the prospect of net debt coming down to just $240m before payment of the October 2024 EPL. The focus should of course be on paying off the most expensive debt first.
Stevo I have included the BP Magnus payments in my calculation of costs for 2024. I do not think FCF $400m should be considered unrealistic before EPL. As a cross reference, I go back to 2022 when the FCF was $518m. We have to assume slightly lower production levels, similar realised price per barrel, materially higher opex and capex, but lower leasing and finance costs. The other thing that we will not have in 2024 is all the upfront fees for all that expensive debt restructuring. It is a huge advantage that we pay the EPL so late in the year - 31st October 2024. Oh and of course the savings on the Swedish delisting.
Stevo's forecast was for $150m FCF a year whilst the EPL lasts whcih would hardly make the company worthless. Like all our forecasts, even for 2024, it is just a stab in the dark. We simply do not know what the price of Brent will average and what the total production numbers will look like. I would settle for $150m a year for the next 5 years against a market cap of just $340m. I think a modest and fair assumption is that prices remain the same and that production holds up. I am guessing 45000 barrels a day and surplus a barrel $25 which gives us $410m before EPL due in October 2024. I do think it would be insane to pay a dividend whilst paying 13% interest on debt which is not even deductible for the purpose of EPL. A company with just say $300m of debt paying just $30m a year interest will look very different in terms of risk. Patience is required.
Stevo is right that we do not get much FCF, if any, in the second half. We need the debt to come down to save on interest and at the same time improve the marginal tax rate from around 50% to more like 40%. But there is a possibility debt could come down a bit by the year end. We know that brent averaged $83 during July and August. During that period we reduced debt by $13.5m in each month (after accounting for the $50m paid for Golden Eagle). It is reasonable to assume that Brent will average $90 per barrel for the period September to December - $7 higher. It is also reasonable to assume that we will average around 4000 additional barrels a day during the last four months over the July and August period because of all the shutdowns. Simple maths would imply that in addition to the £13.5m a month reduction or $54m over 4 months, we will receive 4000 x $90 x 122 = £43.9m and $7 x 46000 x 122 = $39.2m. This all comes to $137.1m. One then has to deduct the EPL of $76m and around $5m extra payable to BP. This gives us an overall reduction by year end of $56m. The net debt would on this basis be $615m - $56 or $559m. I have of course assumed that capex and opex are evenly spread over the 6 months. There are of course many dangers with extrapolating from two months of figures and frankly I would be ok with $600m by year end. Because after that I see a period of 10 months of steady debt reduction supported by higher oil prices, reducing interest and leasing costs. We may start 2025 with around $400m of net debt and a EV of $1.2bn implying a comfortable doubling of the share price. We are very highly leveraged still but that can bring quite spectacular gains if oil prices do not collapse. I do not think there will be any disruption to supply and I do not see the conflict in Gaza spreading so the present small surge may not last. But the balance of supply and demand is still very tight and no one wants to be caught short of oil in a crisis.