Member Info for Stevo12

Kraken

You have to take a balanced view and I have detailed all the key metrics and drivers of value in comparing the two groups. No cherry picking. If I have excluded any key comparisons please details so we can all learn and improve our knowledge.

You can not just go on blind faith and ignore the reality.

BT Faith

Serica has net assets of $750m and Enquest $464m at 30 June 2023. Enquest has gross assets much higher at $3.7b but equally has total liabilities of $3.3b, of which net debt is a now thankfully relatively small component due to FCF paying down debt for last couple of years. Enquest FCF has not yet really been hit by the Windfall tax with $25m paid in 2023 and $35m in 2022. 2024 onwards is going to be a very different story with WFT in the $130-150m range (we will know later this week)

However the key asset metric is 2P reserves. Enquest reports 190m barrels and Serica approximately 140m. However Enquest 2P includes the barrel where all profit/cash flows goes to BP and Petronas. I don’t know how many 2P reserves relate to Magnus (approx 50m barrels) but Malaysia is 30m of which profit from approximately 15m is paid to Petronas.

So my estimate is that Enquest 2P reserves, which Enquest is entitled to profit and cash flow, is in the 150-155m barrel range. So slightly higher than Serica.

While Enquest debt has reduced materially over recent years, the position at Dec23 year end was net cash of approx $100m for Serica and $500m net debt for Enquest. Adjusted for net debt and net cash the Enterprise value is the same and this ignores the other financial liabilities of Enquest - leases, deferred consideration etc

I stil stand by my conclusion that Enquest is not materially undervalued compared with its NS comparator group. The whole NS O&G sector is bombed out for all the reason we know. The opportunity for Enquest is that due to its much higher financial leverage than comparators (debt, leases etc), the share price is exposed to a greater potential upside than our NS comparators as debt and other financial liabilities are repaid and if oil remains in or above the mid $80 per barrel. There is also higher downside risk if oil prices fall.

BT Faith

In looking at valuation of Enquest, it is not just Enquest it is a sector wide issue driven by the current tax regime and probably even more importantly the plans of the Labour Party to prevent any future investment through removing investment allowance.

when I compare Enquest with say Serica and adjusted for net debt and net cash the two group are similarly valued with key metrics as follows:

1. Production for 2024 similar at mid 40k BPD but Serica receives full economic benefit for its production whereas over 10k BPD of Enquest net cash flow goes to BP at Petrobas. Serica OPEX for 2024 of $20 per barrel vs Enquest $27. However need to recognise OPEX for oil is inevitable higher than gas, as is sales price per barrel.

2. Similar tax losses but Serica currently confined to using losses against Tailwind profits. Should improve in 2024.

3. Enquest much higher lease and decommissions liabilities and cash cost.

4. Similar 2P reserves adjusting for BP and Petrobas entitlements but Enquest primarily oil which is much more price stable and historically and currently higher price per BOE

5, Serica paying a dividend approaching 10% of market cap

Accordingly I am struggling to see that Enquest is uniquely undervalued and the reality is that until a sensible and stable tax regime is introduced, driven by a recognition of the need for Oil and Gas for next 30 years plus as the commercial reality of wind and solar finally unveiled, NS O&G companies are going to continue to struggle. Announcement of share holder returns is going to provide some relief if imminent and sizeable. We will see this week.

As we have discussed before, without the benefit of the tax losses to use against core 40% tax, Enquest would have really been in deep poo.

VOR

I think you are correct that capex and maintenance will be H2 biased. I receive my interest on Uk bonds twice a year (in H1 and H2) and US high yield bond interest is paid quarterly. RBL interest most likely monthly. Lease cost are most likely monthly and BP MAgnus payments either monthly or quarterly.

At $85 oil, the $100m FCF bet is leaning your way but oil is up and down like a fiddler’s elbow. Interested in what FCF/debt reduction is reported for Jan and Feb next week.

VOR

Your $685m excludes lease costs, BP Magnus payments, Malaysian PSC and tax, interest costs and our old friend EPL.

Our cash cost per for 2024 excluding epl are approx $61 per barrel ($75 inc EPL) and we retain the FCF for approx 29k BPD for UK and 4k BPD for Malaysia. FCF approx $25 per barrel in H1 at $86 oil and -$3 per barrel H2 if EPL in Oct24 $150m.

Newkotb

You are only looking at the corporation tax rate which is a little below 44%. The Indonesian government first take 60% of all operating profit (making no contribution to CAPEX) and then apply corporate tax on HBR’s 40% share of profit. Then if HBR wants to return the remaining cash to UK to pay shareholders a further 20% tax is applied.

The 83% I referenced is the total take by Indonesia gove through the PSC, corporate tax and dividend withholding tax

I had a look at Indonesian O&G tax rates and Harbours $700m will be taxed at 40%, with a further 20% dividend tax if harbour returns any of the profit to the UK. So from the planned $2b of profit, harbour shareholders will be entitled to approx $340m of FCF over project life ($30m pa) and we are funding over a $1b of capital costs which will be repaid over project life. We wont even cover interest cost on borrowing to fund CAPEX.

Effective total tax rate of 83% and make UK tax regime look attractive. The only reasonable tax regimes are USA and Falklands.

Surprised at pretty poor returns on tuna project. In broad terms Development costs of $1b and OPEX of $2b and $2b of profit over project life (11 Years) of which Indonesia gov keeps 60%. So harbour and partner earns a profit of about $70m per year on which they pays indonesian corporate tax and harbour/partner has to upfront fund $1b of capex (which is recovered over project life). Looks like an after tax ROI of below 10% - very poor given risks involved.

Am i missing something?

Upmega

The Labour proposal is that investment allowances will continue against core tax, but no tax allowances for capital expenditure against EPL. This would effectively result in HMG providing a tax charge reduction equal to approx 45% of capital expenditure (for companies without brought forward tax losses) as opposed to the current 91.4% allowance.

The net effect of the proposed labour policy is that the operator would fund 55% of capital costs, receive 22% of operating profit during production and fund 60% of Decom costs. I think there will be very few projects where the 22% of operating profits will be sufficient to cover upfront capital costs, interest expense on borrowings and decom costs and generate a return. It will result in tax rate that will likely exceed 100% of total FCF/ economic value over the field life for most projects.

Dumbly

I would go for later. My reasoning is that over the next several month we are going to see the outcome of windfarm auction and if gas stays low for the next few months, the likes of Martin Lewis will be asking why consumer prices have not fallen back to pre Ukraine levels (thus removing the perception of a windfall by O&G).

I also thing energy policy is going to be one of the battlegrounds and it feels like we need a bit more time and noise on the impact of labours policy to decarbonise grid by 2030. If it is not looking good for labour on energy policy, they will likely drop EPL from manifesto promise.

We also need to ensure the 2024 Enquest capex programme attracts current investment allowance.

SEK

I fully agree that by interims 2025 at the latest shareholder returns will have commenced. the million dollar question is whether Enquest go aggressive and start returns in 2024 or remain conservative and wait until 2025.

In terms of net debt at end of 2025, I expect the JV cash balances to have also dropped (I struggle to understand why Enquest offsets third party cash against its gross debt) and the December 23 working capital timing benefit to reverse. I am also hoping for at least one acquisition which should have rapid payback.

I am hoping AB will be bold and start buybacks now with interim 2024 dividend in late summer if he is confident in 2025 FCF

Kraken

Enquest reported a loss after tax of $625m in 2020 and a loss of $450m in 2019. There was a profit in 2021 of $377m but a further $41m loss in 2022. The large losses of the past are due mainly to asset write downs.

The ability to declare dividends is not actually based on the distributable reserves of the group but of the holding company which is normally easier to manage. I am sure management will have taken or are proposing to take actions to ensure that there are distributable reserves available.

Just taken a look at 2023 AGm and shareholders gave management authority to buy up to 10% of shares via buyback upto June 24.

No authority is needed for interim dividends with final dividend approved at each AGM. Dividends can only be paid if company has distributable reserves which might not be the case with losses over last several years. This can be fixed with capital restructuring but this takes time and court approval,

Jan

I have always been supportive of a “steady as you go” policy to pay down debt to a more manageable level (probably in $300m level) before shareholder returns in late 2025.

However the current and prospective government policy calls for more radical action. The level of buybacks will be capped by approved levels at last AGM (I have not gone back and looked at AGM resolutions) but normally in 10-12% range. An increased level can be approved at next AGM.

I agree that that the initial rounds of buyback will likely enable those looking to exit to jump ship, but in a relatively illiquid market it would drive up share price after initial exits.

It feels like we have hit or approaching maximum negativity regarding Enquest and O&G more broadly (even the ever optimistic Kraken sounds like he is close to capitulation) and this is normally a good buy signal. Whilst the night looks long and dark, it will change and a more sensible O&G policy will be implemented - probably 2025/26 at the earliest.

In the meantime if Enquest can generate $100m a year FCF per year on average to 2029 ($10 per barrel after EPL) and split 50:50 between debt and shareholder return, then certainly an SP of 40p plus is attainable. I am assuming that Labour see sense on removing investment allowance.

Taverham

Accept there are other costs, but the majority of these, excluding VAT, are a component of the daily fixed charge and not the per unit cost of energy.

It will be interesting to see over next couple of quarters if gas prices stay low whether the unit cost of gas and electricity returns to pre Ukraine prices. This would also drive down inflation but I fear that as renewable subsidies grow, energy prices will never return to pre Ukraine levels.

A good sign would be competition returning among the suppliers.

Kraken

You are sounding more depressed than I am!

I am sure Enquest are running a worst case scenario if Labour implement their policy to remove all investment allowances against EPL. This will likely look like no new investment as the post tax FCF will not be sufficient to cover investment and future decom costs. This is the scenario that Romeron put to AB at a recent AGM.

This scenario could generate increase FCF for a few years as we save $150m plus on CAPEX and pay additional $70m of EPL, but production will decline pretty quickly and Decom will be accelerated. Would this managed decline result in significant dividends? I guess we would have to pay down bonds first.

In reality I can not believe Labour will be allowed by Unions to implement a policy which will destroy thousands of jobs. Labour are proposing a tax which is over 100% of profits generated over asset life - surely reality will bite at some point.

Separation of Veri for listing or sale would be interesting. Not sure how you would put a value on it though as revenues probably 7-10 years away. Might be a few grants for feasibility studies but need to part of the government selected track 1 or track 2 (there might be track 3 at some point) to get access to material government funding. However all could change under new Labour Gov.

The selected Track 1 and 2 projects should be delivering CCS by 2030 with a ramp up to 2035. I have not yet seen clarity from ENQUEST and Veri on their timelines to revenue. Not sure how much Enquest is currently spending on Veri but if it is significant I would prefer a dividend.

What really rattles my cage is that no one is talking about the fact that wholesale electricity and gas prices are now lower than they were before the start of the Ukraine war. Gas is 2p per KWH and wholesale electricity is 6p per KWH and yet households are being charged almost 4xs the wholesale price. I appreciate there is a lag between wholesale prices and retail prices catching up but the revised price cap in April only marginally reflects the current cost of gas and electricity.

Also interesting that the latest offshore wind farm auction is guaranteeing a minimum price that is 80% above current wholesale electricity prices.

My only concern with the update was the lack of 2P reserve additions. HBR produced 35m barrels of oil but only added 1m of new 2P and produced 38m BOE of gas but only added 17m BOE of new 2P. This is the third year of really low reserve replacement ratio which is a key KPI of most O&G companies, but HBR is silent.

Yes there has been a good addition of pre FID 2C reserves but for the $700m plus a year of CAPEX over last few years, I would expect more 2P reserves to be added.

Happy they have reset the gas price to 75p per therm which has not had major impact on forecast cash flows, but scratching my head a little on 2024 gas hedges. Not sure when these were taken out and pretty poor rate.

VOM

Always trying to get a few extra points on a bet. Win win for me as I would be very happy to be wrong. A friendly bet always makes life more fun!

Agree any dividends or buyback excluded.