Member Info for Stevo12

L7

While it is useful and interesting to us number geeks to calculate the EPL costs, the company told us that for first 1/2 of 2023 the EPL charge was $76m and probably the best estimate is to simply assume a similar charge in second half giving an approx $150 EPL cash cost in Oct 24. This is pretty similar to the bottom up recalculation.

I am assuming the company’s understanding and calculation of EPL will have been refined following the completion of the 2022 tax return. The EPL cost in 2025 will likely go down due to the additional CAPEX in 2024.

I still think our biggest ally in the fight for a fair tax is the unions and it is great to see them starting to flex their muscles and comparing O&G to the demise of the coal industry.

L7

I understood from conversations that Enquest has an agreement with HMRC that finance leases are treated as effectively operating leases and expensed against tax as spent, as opposed to receiving capital allowances. However this agreement would have been for CT and SC purposes and I can see HMRC arguing that interest element of Lease payments should not be deductible against EPL profit.

Have you seen specific guidance on this or are you using logic?

In reviewing my 2023 FCF reconciliation, I have made a mistake in that I have applied a 2023 EPL cash payment of $60m. It should be $25m as Enquest received a $35m EPL refund in Q1. This results in underlying 2023 FCF of $252.5m compared to debt reduction of $236m. The principal difference being the the $50m Golden Eagle payment less the $40m Working capital benefit.

So $250m underlying FCF for 2023 looks like a good baseline number for projecting forward into 2024 before the reductions in 2024 FCF as guided by management, which are approx $180m if EPL is $140m for 2024. We will know when the 2023 accounts are released and 2023 EPL liability reported.

Part 2. Not enough space

I have estimated 2024 EPL payment in oct 24 as follows:

EBITDA $800m, less lease costs $152m, less Magnus BP payment $76m, Less investment allowance ($160m - $25m for malaysia x129%) $174m = taxable profits of $398m at 35% = $139.3m.

There are a few questions on high level of FCF in November and December and there appears to be 3 components (1) $40m benefit from working capital changes due to timing of loadings - this will likely reverse in early 2024 (2) lower than projected OPEX (3) cash in JV bank accounts increased by approx $40m between end October and December. This will include cash put in by Enquest and cash contributed by our JV partners to fund 2024 CAPEX. There are no details on the how much of the cash balance belongs to our JV partners and could be in 30-40% range.

My reflections on the announcement of 2023 results and 2024 guidance. I have detailed my assumptions based on the info provided by the company so that each elements can be considered and challenged by yourselves. All thoughts and comments greatly appreciated as we collectively refine our understanding.

2023

EBITDA for the six months ended 30 June 2023 was $399m and while production in the 2nd half year was 3,300 barrels per day lower than first half, realised prices should be approx $5 per barrel higher, which broadly cancel each other out. So my assumption is that similar revenue and EBITDA in second half of year, resulting in $800m EBITDA for 2023.

Cash costs excluded from EBITDA for 2023 were EPL $60m, Lease costs $152m, Magnus BP payment $76m, Interest cost $83m, Interest income $7.5m, CAPEX and ABEX $220m. Accordingly, FCF is estimated at $217.5m as compared to the reported debt reduction of $236m.

We know that the $236m reported debt reduction is after a $50m payment to golden eagle and also benefitted from a $40m working capital reduction due to timings of loading (which will likely reverse in early 2024). Cash sitting in restricted JV accounts is broadly similar at both 2022 and 2023 year ends so should not impact FCF.

Accordingly, there is a $18.5m (8%) difference between calculated and reported debt deduction, which could be due to a range of factors and, accordingly, using the reported $236m debt reduction as a proxy for 2023 FCF is not unreasonable.

2024

While Enquest does not spoon feed us with the projected 2024 FCF, there is enough info provided to estimate the key changes from 2023 as follows.

Revenue – Revenue should be broadly similar if oil averages $80, with 1k per day reduction in production offset by $2 per barrel additional revenue.

OPEX – increases by $45m as reported

CAPEX and ABEX – increases by $50m as reported

Lease costs – reduces by $25m per 2022 financial statements disclosure

Interest costs – Bond interest increases by $10m to $72m and RBL interest decreases from $21m to $10m.

Interest income – difficult to estimate and assume $2.5m higher than 2023 at $10m

BP Magnus payment – same as 2023

EPL – October 24 payment estimated at $140m (see workings below) compared to $60m in 2023. Enquest estimated EPL for first half year at $78m so could be closer to $150-155m

Using the above assumptions / guidance, FCF for 2024 is projected at $146.6m lower than 2023 at approx $89.4m. In addition, there will be the cash generated from sale of EP/Bressay less any cash cost for acquisition of 2P reserves in 2024.

I am looking at 2024 as a year of investment to max out EPL allowance before potential labour changes in 2025 to sustain/grow 2025 production. EBITDA for 2024 is estimated at $755m ($800m-$45m) and using 0.5 ratio requires debt to fall to $377.5m to commence shareholder return. This appears broadly achievable by end of 2024 or early 2025 with EP/Bressay cash receipt and a

A really positive update. I am back to back today and will do a more detailed dive into the numbers this evening.

Well done AB and team.

For once we agree Kraken. The EPL has reduced market value by approx £0.8-1b or $10 per barrel of 2P.

Looking it another way we will be paying approx $150m per year of additional tax for 6 years.

I would not feel so bad if there was an actual windfall. Oil is pretty much at historic levels now and that is not accounting for inflation in O&G costs. Show me one product in a supermarket that is at or below its average price over the last 20 years

I do agree with Romeron that this could be, or close to, the darkest days for NS O&G companies and all WFT taxes in the past have been removed after a couple of years. However this is unlikely before 2025, so just need to get through 2024 and repay as much debt as possible.

Tomorrow is going to be interesting.

Just speculation, but there must be discussions going on at Shell and BP HQ about relocating head office and principal listing to US.

Shell actively considered US a few years ago when it relocated from the Netherlands to the UK because of anti oil and gas sentiment in Netherlands. The market valuations of the US super majors are at least 50% higher than BP and Shell on all metrics and the US is the most significant producing location for both Shell and BP.

We know the UK is now less than 5% of their production and why would you remain in a country (particularly under Labour) which despises O&G. Perversely both Shell and BP are committing proportionally more to UK’s Green transition than warrants based on size of UK business and a relocation of HQ and listing to US would allow them to avoid ‘POLITICAL” value destroying investments in the UK.

I am calling it early that definitely Shell and potentially BP will move HQ and listing to US in 2025.

Thanks L7

Interesting. I had never really factored in that Enquest was making a $60m ish margin on the gas pass through arrangement.

CAPEX spend in 2024 makes good business sense as HMRC effectively funds 91.4% of spend through reduced tax payments (at least for the legacy Serica business). If Labour wins election and implements their stated policy then all CAPEX becomes value destructive.from 2025.

Labour is effectively proposing to take 100%+ of all FCF over field life.

L7

Just one additional point to your decom costs. The UK and most other countries (including Norway) permit tax deductibility for decom costs on a cash paid, rather than accruals basis. If there are insufficient taxable profits form oil sales to offset the Decom costs, HMRC pays a cash tax refund. Accordingly when a company decoms its final field, HMRC repays the company in cash approx 40% (and up to 50%) of decom costs. Each field has a specific agreement with HMRC which is approved in parliament such that future governments cannot change the agreement without compensation.

This is why pre 2022 Shell was receiving a net tax refund from HMRC due to their decom spend.

I have a question. I have never understood the background to the Magnus gas resale. It appears we are buying and selling approx $250m of gas each year. There is reference to it being excess gas not required for injection.

Does anyone have any better insights into the nature of the Magnus Gas arrangement?

Londoner

I am a recently retired chartered accountant who initially specialised in tax advisory, until i moved to M&A (principally due diligence investigations on behalf of buyer) over 20 years ago. i have always retained an interest in corporate tax but i have never professionally work on O&G companies.

In terms of your question there is a significant difference between taxable profits and financial reported (accounting) profits. Depreciation or depletion is not an allowable cost in calculating taxable profits, but is replaced by capital allowances which normally accelerate the tax benefit.

In O&G the best estimate of taxable profit is EBITDA less capital allowance on in year CAPEX. Current tax law allows 100% of CAPEX (plus the special allowances in SC and EPL) to be offset against EBITDA in calculating taxable profit, whereas for accounting purposes the CAPEX is depreciated over the life of the field. Interest expenses is allowable as an offset against core CT but not EPL.

The reason we have tax losses is that over several years Enquest’s capital allowances have accumulatively exceeded EBITDA resulting in tax loses which are carried forward indefinitely to use in periods where EBITDA exceeds in year Capital allowances ie 2023. This is not unusual when there are long life, high cost capital projects.

Romeron

Starmer is doing effectively what Thatcher did to the coal industry. It would be very helpful if this comparison was drawn in the Media

Londoner

Tax law does not allow depletion of assets to be offset against CT or EPL. Depletion is is replaced by capital allowances which currently provide a 100% allowance in year of investment for all uk companies with O&G currently being entitled to an additional allowance. Effectively we get the full depletion write off in Year 1.

I think the Unions are going to be key to bringing some common sense to this ridiculous Labour policy. I can imagine there are some very interesting conversations going on at Labour HQ .

It is the pure illiteracy that concerns me or more likely Miliband has got his way.

Sorry i got my maths slightly wrong. Equinor/Ithaca will fund $2b of initial investment or approx $8.5 per barrel of 2P. This raises interest costs to $100m per annum initially and operator FCF of $164m per annum for $2b investment.

Excluding interest costs, total operator FCF over field life equals 245m barrels x $13 per barrel = $3.1b. Initial investment $2b, decom at $5 per barrel equals $1.2b. Broadly no return from operator and tax paid $11.4b. Madness!

i think rosebank will be the bell weather. i am expecting/hoping that equinor and ithaca announce that plans to develop rosebank are put on ice until after the election and labour’s policy implemented (if they win the election).

i don’t believe equinor received a guarantee from conservatives regarding tax treatment and accordingly back of the *** packet calculation of the new economics of rosebank

phase 1 cost $3.8b of which equinor will have to fund $1.7b ($7 per barrel of 2p) - due to all investment allowances against epl being removed.

production target of 55k per day equals revenue of $1.6b per annum at $80 oil.

opex of $20 per barrel generates taxable profit of $1.2b per annum, operator share at 22% equals $264m ($13 per barrel)

interest coast at 5% equals $85m or $4.25 per barrel.

so in broad terms, $1.7b of investment required to generate $179m of fcf per annum with is approximately a npv of 10%, excluding decom costs. when you add decom costs of which operator will pay 60%, the npv drops to low single digits and makes any investment value destructive.

we really need the sector and equinor in particular to call out the labour idiocy. over the life of any new project under labour, the government will pretty much tax 100% of fcf over project life once you factor in initial capex and decom costs

Buzzard

Firstly this is currently a labour proposal not tax law yet.

If the labour proposal was enacted in early 2025 then it would be number of years before fields are decommissioned. The cessation of all UK CAPEX would result in several years of declined production until fields became uneconomic. It may be that Harbour can generate a positive FCF during those years from their 22% share of profit - $600- 800m per year- which covers the relatively low level of current decom of say $300m per year before decom costs ramp up.

It will be a slow death but enough time to diversify overseas and we really need the WD deal which secures the future of Harbour.

Sek

The cash advance from our JV partners is normally for Capex and not OPEX. The JV partners share of OPEX is deducted from their share of revenue and the net operating profit distributed to the JV partners on a periodic basis (could be monthly or quarterly).

The JV partners share of ongoing CAPEX is paid to the operator by a cash call once the agreed investment programme is agreed by the JV partners. The $40m advanced in H1 2023 was classified as not due to be spent until after Q3 2024 at the earliest which is interesting.

I agree that FCF around the year end looks strong and we will see next week what 2024 will hold. Short term cash flows over a couple of months can be impacted by timings of loading or working capital movements. Need to be careful. I am also concerned that while Enquest is reporting $300m plus of cash, it is not generating a lot of interest income given deposit rates have been 4%+.

Great insights from Romeron and it has been recognised for a long time that Ukraine has incredible gas reserves under the Donbas and down through the Sea of Azov to Kherson. SUrprisingly the Russian areas of occupation almost exactly mirror the Ukrainian gas reserves. It has always been thus.

Buzzard

I think ultimately Labour will have to change their policy as a removal of all capital allowances against EPL, increased rate, no interest offset and operator responsible for 60% of decomm would mean no further investment.

However if the current Labour intent stood, i just can not see how operators (inc Harbour) can fund decom costs from what will be limited FCF., particularly if decom timing is pulled forward.

The problem is that joe public still think oil companies are making windfall profits and they have deep pockets.

Sekforde

There are one off cash costs such as Golden eagle and, as the company highlighted, there was also a one off $40m cash advance by one of our JV partners. This is not Enquest”s cash and belongs to our JV partner, although Enquest reported it as a component of its FCF. The advance is to cover our JV’s partners share of future Cap EX and we should exclude both the Golden Eagle payment and our JV partner’s cash advance in determining 2023 FCF as a basis for future projections.