Member Info for Stevo12

I truly hope for both UK businesses and citizens that the truth regarding the realistic cost of wind as the green replacement for hydrocarbons is finally revealed. We are on a road that will impoverish our nation.

Regarding ABs comments to you at the AGM “that it does not work that way” regarding running the company to maximise short term cash, by not investing in new CAPEX. My interpretation of his comments was that by not investing, the volume of oil flowing through the various infrastructure hubs reduces each year through natural depletion and at some point OPEX per barrel exceeds revenue per barrel. At this point the fields and platforms move to decommissioning.

By not investing in field extensions which feed these platforms and infrastructure the $700m of decommissioning liability is pulled forward by potentially several years. Pushing back Decommissioning of mature fields is one of Enquest key purposes and, my interpretation, as to AB’s comments to you.

Londoner

I reread your message and your workings ar spot on. However it is both the payback period and the initial borrowing that need to be considered. Under current tax rules in year 1 the operator would “self fund” $89m of the $600m as compared to $150m if EPL special allowance was removed. This additional borrowing comes at a cost and assuming a 10% interest rate, it pushes cash payback by approx 8 months to 3 years 5 months, compared 17 months under current tax regime.

This is quite a material difference in risk profile and significantly impacts project IRR.

However to Roms point, a party in power and opposition are two very different things. We certainly have the trade unions on our side and their influence should not be underestimated. It now sort of depends if Labour row back on their green energy intent in their manifesto. I think they will if the tide of public opinion turns, which seems to be starting and the Tories, if smart, could really exploit the Labour current green position.

However to address an early question - if UK tax regime is so generous why has CAPEX been falling?

I think there are a number of reasons for this. Firstly many of the NS operators such as Enquest have tax losses which totally changes the equation. Harbour fully use their tax losses in H1 2024, but many others still have tax losses (Ithaca, Serica etc). Harbour are substantially boosting CAPEX in 2024 from $700m to $1b.

Secondly, the uncertainty created by Labour’s threats “to introduce a proper windfall tax” and thirdly the risk appetite of NS operators seems to have changed as RBL facilities have been slashed due to reduction in 2P reserve valuations. I also think there is an emotional response as many CEO’s feel mugged by HMG.

Londoner

The 121% of capital cost is a shortcut to arrive at the 91.4% (121% of investment at 75% =91%). Accept it is a simplification and is an aggregation of several different allowance, but keeps it simple.

The additional EPL 29% allowance can be offset in the year of spend as opposed to the year of first production, unlike the supplemental charge additional allowance.

So currently allowance benefit is 85.15% in year of spend and a further 6.25% in first year of production - total 91.4% of CAPEX funded by taxman. The removal of the EPL additional allowance as threatened by Labour would reduce this to 75% on spend and further 6.25% in first year of production, total benefit 81.25%. While appearing quite modest, it changes the operators net cash contribution from current 8.6% of CAPEX to 17.75% of CAPEX and doubles the net cost of CAPEX to operator. I oversimplified in my example.

I guess the point i was trying to make is that there is no other O&G tax regime that provides this level of incentive/ support for new CAPEX. Norway is closest where Gov provide a year 1 allowance of 72% of CAPEX and a further 6% over years 2-4.

Sorry to bore everyone as does not apply to Enquest.

Londoner

I don’t think you have got the tax allowance quite right. I used a121% of investment as a proxy, the detailed workings are as follows:

RFCT -30% - first year allowance 100% - $30 benefit for each $100 spend

SC - 10% - first year allowance 100% - $10 benefit for each $100 of spend

SC - 10% - additional investment allowance 62.5% - $6.25 benefit for each $100 of spend

EPL - 35% - first year allowance 100% - $35 benefit for each $100 of spend

EPL - 35% - investment allowance 29% - $10.15 for each S100 of spend

Total tax reduction for each $100 of spend = $91.4. Decarbonisation spend benefit higher at 109% of spend.

Rom

Really interesting report and just highlight the highly aggressive assumptions being used to arrive at a conclusion ‘your energy bills will not rise”. To assume the capital cost of windfarms will fall by over 50% when cost of steel, concrete, copper, labour etc will continue to rise. The recently aborted wind farm projects in US and Europe have highlighted that costs are actually rising by 60% rather than falling..

That is just one of the ridiculous assumptions which include that each household will use materially less energy through mass insulation (which is not costed0 and being compelled to have lower temperatures at home. The assumption that low cost Hydrogen will compensate when wind does not blow is totally unproven technology and the assumption that cost will fall by 90% from current levels is just nuts.

On CAPEX point, the simple way to look at it is that the Operator pays the subcontractor $100 for his work and HMG sends a cheque to the operator for $91. The reality is that the operator just pays $91 less tax through quarterly payment on account regime. The net impact however is that at the end of the year the operator’s bank balance will be $9 lower as a result of spending $100 of CAPEX.

You are correct that all countries offer tax incentives to encourage investment. However there is nowhere in the world (that i know of) where a government allows you to reduce your tax bill by 91c for every $1 invested. It massively derisks investment as long as your core business is paying a sufficient amount of tax from core trading.

Romeron

The way it works is that the $600m CAPEX results in a $726m tax deduction against taxable profits in the year of spend ($600m *1.21). Accordingly the tax payable is reduced by $726*75% =£545m, leaving the company to fund $55m or 9% of the Capital expenditure.

There might be a small difference either positively or negatively on cash flow timing. For companies without tax losses, tax is paid on account during the year based on the companies estimated tax bill, which will reflects planned cap ex.

So during the year, tax is reduced by $545m which funds 91% of CAPEX.

There was also a typo in my workings in that net investment is $54m and not $60m, compared to $45m annual cash flow.

Again apologies to all as my posting was intended for Harbour Board and does not apply to Enquest due to tax losses. Enquest would have to fund $330m of $600m CAPEX but would benefit from annual FCF of $117m, before interest cost of approx $35m per annum on $330m borrowing.

Feeling like the defence lawyer at Fred West’s trial, but give me a moment to explain.

Yes, we have moved from an incredibly generous tax system whereby O&G operators kept 60% of profit, but equally had to fund approx 60% of capital costs of development. Yes, because of the EPL, the value of existing 2P reserves have halved from $20 per barrel to $8-10 per barrel and 2C pretty much worthless. This has destroyed the market value of listed groups and has effectively nationalised 75% of 2P reserves which were funded by the private sector.

So yes the EPL has decimated the value of existing reserves and has clearly left more than a bitter taste for operators and investors. However, putting aside the emotional and financial impact on past values (very hard to do I admitted) and looking objectively as to the attractiveness of new investment, the picture looks very different.

Let me explain - and this only applies to companies like Harbour paying full 75% tax.

Let me use the example of a new field of 40m barrels which costs $15 per barrel CAPEX to develop ($600m - similar cost per barrel to Rosebank) and $18 per barrel OPEX. The net CAPEX cost to the operator is $54m after 91% allowance.

Production 3m barrels per year over 13 years. Oil price $78 per barrel and FCF pre tax $60 per barrel and post tax $15 per barrel or $45m per year post tax FCF.

So under the current regime, net CAPEX per barrel is $1.8 per 2P reserve and FCF $15 per barrel resulting in annual $45m return from a $60m investment - payback 1 year and 4 months. I am not aware of any other tax regime that derisks O&G projects to this degree and provides such rapid payback for new investments.

However this is contingent on the current investment allowance remaining. What is the financial impact of Labour removing the additional allowance uplift (reducing the allowance from 91% to 75%)? The result is net CAPEX increases from $54m to $150m ($5 per barrel of 2P reserves) and FCF payback extends to 3 years and 4 months - no where near as attractive.

Accordingly it is understandable why there has been some hesitancy into committing to post 2024 investments until Labour shows it colours. The real unfairness of the EPL is that it does not allow past losses to be offset and interest on debt, which funded historical capex, to be offset.

We have to accept that unless the tax regime dramatically changes (and I think it will pre 2028) that we are effectively an operator of Nationalised assets, where the State funds 91% of capital costs and allows the operator to keep 25% of pre CAPEX FCF. Not a bad deal if you ignore the transition. Norway only funds 78% of CAPEX (72% in year 1 and 2% a year for 3 years) and allows the operator to keep 22% of pre CAPEX FCF.

I rest my case after applying for Police protection

Sorry meant to post on harbour website

Feeling like the defence lawyer at Fred West’s trial, but give me a moment to explain.

Yes, we have moved from an incredibly generous tax system whereby O&G operators kept 60% of profit, but equally had to fund approx 60% of capital costs of development. Yes, because of the EPL, the value of existing 2P reserves have halved from $20 per barrel to $8-10 per barrel and 2C pretty much worthless. This has destroyed the market value of listed groups and has effectively nationalised 75% of 2P reserves which were funded by the private sector.

So yes the EPL has decimated the value of existing reserves and has clearly left more than a bitter taste for operators and investors. However, putting aside the emotional and financial impact on past values (very hard to do I admitted) and looking objectively as to the attractiveness of new investment, the picture looks very different.

Let me explain - and this only applies to companies like Harbour paying full 75% tax.

Let me use the example of a new field of 40m barrels which costs $15 per barrel CAPEX to develop ($600m - similar cost per barrel to Rosebank) and $18 per barrel OPEX. The net CAPEX cost to the operator is $54m after 91% allowance.

Production 3m barrels per year over 13 years. Oil price $78 per barrel and FCF pre tax $60 per barrel and post tax $15 per barrel or $45m per year post tax FCF.

So under the current regime, net CAPEX per barrel is $1.8 per 2P reserve and FCF $15 per barrel resulting in annual $45m return from a $60m investment - payback 1 year and 4 months. I am not aware of any other tax regime that derisks O&G projects to this degree and provides such rapid payback for new investments.

However this is contingent on the current investment allowance remaining. What is the financial impact of Labour removing the additional allowance uplift (reducing the allowance from 91% to 75%)? The result is net CAPEX increases from $54m to $150m ($5 per barrel of 2P reserves) and FCF payback extends to 3 years and 4 months - no where near as attractive.

Accordingly it is understandable why there has been some hesitancy into committing to post 2024 investments until Labour shows it colours. The real unfairness of the EPL is that it does not allow past losses to be offset and interest on debt, which funded historical capex, to be offset.

We have to accept that unless the tax regime dramatically changes (and I think it will pre 2028) that we are effectively an operator of Nationalised assets, where the State funds 91% of capital costs and allows the operator to keep 25% of pre CAPEX FCF. Not a bad deal if you ignore the transition. Norway only funds 78% of CAPEX (72% in year 1 and 2% a year for 3 years) and allows the operator to keep 22% of pre CAPEX FCF.

I rest my case after applying for Police protection

NSS

thanks for forwarding presentation. Not a lot of new insights but my takeaways were as follows:

1. Majority of development CAPEX UK and exploration spend overseas. I estimate $800m of the $1b spend is UK related which makes a lot of sense as 2024 could be the last year of 91% investment allowance.

2. No details on 2025 CAPEX but I would say majority overseas on Zama, Tuna and possibly Indonesia

3. CCS starting to feel real but probably still 3 years away from first revenue. It will interesting to see how much revenue 15m tonnes pa of carbon storage generates. Could be a nice annuity which will be taxed at normal corporate tax rates. I had previously discounted CCS as an O&G PR campaign but looks like there is a business model behind it and government money to access.

4. WD is certainly a transformational deal but at a fullish price. The loan notes at 1.8% gives Harbour 3-4 years from completion to pay down debt and optimise debt/equity structure.

5. I am struggling to understand how 2025 is going to generate a significant cash surplus. I thought it might be as a result of lower tax bill in 2025 but I am now not so sure. Ultimately Harbour will never be measured against this statement as long as WD deal completes.

6. I am interested to see with full year results how many 2P reserves were added in 2023. It has been very poor over last 2 years which is why we are seeing production drops.

7. UK gas prices looking sluggish with forward market for 2024 ranging from 70-80p per therm. This should be great for UK consumers but benefit never seems to fully pass through to consumers.

NSS

The investment grading rating means two things: firstly we will pay lower interest on borrowings and secondly the pool of lenders is expanded as some lenders are only allowed to lend to investment grade rated companies.

The German CCs challenge is a redherring. Harbour and WD are not developing the technology to extracts C02 from industrial processes such as cement, chemical and power plant. We are providing the ability to transport the CO2 once captured through our pipeline network and safely store in exhausted oil and gas fields. The licenses that WD have are storage licences in the NS and are not track 1 or track 2 projects.

I am sure there will be a market for storing German CO2 in NS and the market will determine the price. The core challenge with CCS is capturing the carbon cost effectively, the transport and storage appears fairy straight forward.

Gordon

My understanding was that the UK Government does not have a veto on the development but originally Premier and now Navitas were looking for UK Gov loan guarantees to facilitate the third party funding. Historically the UK has provided the above guarantees if UK companies are heavily involved in projects.

I do not believe there is any appetite in UK Gov to provide financial guarantees at present. Hopefully this changes.

Asartara

I really don’t know enough about VAR to comment in detail. My 8-10X valuation was based on BP Aker who are FCF around $1.5b and are valued over $15b. I certainly hope there will be a rerating of Harbour post deal - how much is the $1m question.

I will do a litttle research on VAR when I have time. There is clearly a lot going on with Neptune acquisition and some big projects under development.

Asartara

I took a brief look at VAR following the Neptune deal and they certainly have a great pipeline of opportunities. Looks like a 500,000 BPD in 2025

I have always followed BP Aker a little closer following the merger with Lundin.

I do like the simplicity and honesty of the business model in Norway. Effectively the state is the majority owner of the assets and funds 78% of appraisal costs, development costs and decom costs. The operator receives 22% of effectively FCF and funds 22% of costs. I have always viewed Norway as an efficient operator model whereby the operator gets to keep the difference between OPEX (normally below $10 BOE equivalent for gas) and gas prices on 22% of production.

However my only concern is that the Norway operators are fairly highly valued in O&G terms at close to 8-10 x FCF.

I appreciate the support and encouragement from many on this board. I will post my thoughts on the FY24 guidance once published in mid Feb, together with FY23 outturn. Until then radio silence as we are just speculating.

Cheers all.

Londoner.

We need to be adding 60m of 2P reserves a year which should be achievable from $1b spend. I recall rosebank is costing $15 per barrel for phase 1, 250m barrels. Reserve replacement has been pretty poor over 2020-2022. Hopefully 2023 better.

Londoner

You are correct that I was using a 1.27 sterling to dollar conversion rate which has approx $2 increase in average gas prices or $1 on overall realised prices, so average revenue of $74.2 per barrel at current dollar rates. Given $200M FCF which translates to $3.5 per barrel, fully loaded cash costs $71.7 per barrel.

Why does this matter? Well it gives us a good idea of the FCF break even point and the impact of future oil and gas price movements. A $1 reduction in oil/gas price reduces FCF by $14m(post tax) - so oil/gas could reduce by $14 per barrel ($71 oil and 80p therm gas) to hit cash flow break even.

We can also see that CAPEX at $21 per extracted barrel should result in 100% 2P replacement rate and maintain production at the 160k BPD rate.

InSdn

All your bearish points are valid concerns.

I would counter with the following.

1. While I concur that BASF would want to window dress ahead of a disposal, you are selling to industry buyers that will be doing detailed DD on future field production. WD have certainly been active with new licences and drill in Norway - why would you not given Norways high incentives and the ability to mitigate Norways 78% tax. They have also been active and investing in Mexico and Argentina. However I accept that you can not defy gravity on declining production rates unless you are investing and replacing 2P resources, which is in the range of $20 of capex for each barrel of production. This would be approx $3.6b per year for 500k BPD of Newco. Sounds a lot but majority would still be in UK and Norway where Gov funds 91% and 78% respectively.

Definitely possible to maintain a 500k BPD business but combined CAPEX needs to increase by at least a $1b over current levels which would have net cash cost of approx $150m if majority in Norway and UK. If we spend big in Mexico we have to fund 100% of CAPEX until production starts.

2, BASF will want to start exiting after lock in ends in mid 2025. I would hope and expect that the majority of their shares will get placed with II’s and trackers as Harbour enters the FTSE 100, rather than sold on open market. However agree that it will take a long time to clear this overhang. However on an equivalent market value to BP Aker, the share price will be approaching £9, so even a 30% discount due to overhang would put us in £6 range.

There will certainly be a stick, twist or fold decision for PIs in Q1 2025 if share price is in the £6+ range ahead of end of lock up. I see Q1/Q2 2025 as crucial decision window as we get guidance on 2025 combined production, costs, FCF, shareholder distributions etc and we should also get guidance on UK O&G tax from new Gov (be they labour or conservative).

Londoner

Great analysis. I have taken a deeper dive into the forecast average realised price of 2024 (using Harbour assumed market prices and my take is $85 oil (minimal hedges at $84) and $70 gas (hedges at $35 PB for 10% of production with 100p a therm translating to $74 PB oil equivalent). So average $77 realised price - pretty close to your estimate.

So at $200m FCF this still results in fully loaded cost of $73 per barrel using my averaged 2024 realised price of $68 using your average realised price. If you add lease and interest cost of $400m to guided OPEX, CAPEX, ABEX and Tax this results in fully loaded cost per barrel of $67 per barrel - looks like your average realised price is somewhere close to $70 per barrel.

In 2023 the fully loaded cash costs were $43 per barrel ($58 realised price- 15 FCF per barrel). OPEX was $16, CAPEX and ABEX $15 and tax $6 PB = $37 PB difference of $6pb which equates to lease and interest payments of $400m.

I think the 2025 guidance was to demonstrate the 2024 drop in production was an anomaly and to indicate that FCF per barrel will increase, which can only come from lower tax and or lower cap exp. Ironically Taxable profits would actually be higher in FY25 if Cap ex reduction is in UK - $200m lower UK cap ex increases tax by $180m. Accordingly it must point to 2024 being a double tax year paying both 2023 EPL and substantial part of 24 EPL. We should get this guidance with year end results.