Roundtable Discussion; The Future of Mineral Sands. Watch the video here.
VOR
My understanding is the RBL has been repaid using $108m of cash from Rockrose and $32m from Enquest’s cash reserves. This will save approx $13m of interest in 2024.
With $108m of cash received from Rockrose, a little surprised that net debt only reduced by $71m in Jan/Feb which highlights negative trading FCF of $37m. Presumably reflecting the timing of loadings.
SEK - I have had a more detailed dig into EPL and the reason EPL at $175m in 2024 is that Enquest is paying $50m EPL on asset sale to Rockrose, which is an absolute scandal.
Debt has reduced by
Good call and in particular the new CFO and Ops Guy came over very well. Key takeaways for me:
1. On the last call there were 3 or 4 M&A deals on the table. Felt more remote on this call but still a potential due to tax losses
2. No info on massive gas opportunity referenced at Davos. Malaysia is mainly a lift fee for Petronas gas.
3. Good news that Unions are getting involved.
4. CCS and hydrogen opportunity feels very distant - 10years plus
5. Bressay and Bentley still a possibility to develop but requires labour to retain investment allowances
6. EPL effective tax rate is closer to 60% ($175m for 2023) due to disallowable costs (primarily interest and ABEX)
7. 2024 an investment year but great to see start of shareholder returns.
Need to rerun numbers for 2024 FCF forecast now we have details on 2024 lease payments and EPL. Management have used $80 oil as their assumed rate. I will start their and easy to flex for higher oil price.
The Rockrose transaction takes a bit of unpicking. It appears than in addition to 15% of field and FPSO, Enquest has sold to Rockrose a 15% stake in other equipment. The proceeds for the sale were approx $140m and Enquest provided them the financing at 31 December 23 (no cash receipts). In Jan/Feb Rockrose repaid $108m of the loan and this is the key reason for net debt reduction at end of Feb. Excluding this receipt, net debt would have risen to end of Feb as a result of reversal of year end temporary working capital benefit ($50m+) exceeding operating cash flow.
Seems like a pretty smart transaction to me (although materially different to what was disclosed by RNS) but surprised Rockrose willing to put up $108m given uncertainty of Breslau development. There may be more to it and we may have guaranteed Rockrose that they will get their money back.
Unfortunately you are not reading it right. The 2024 EPL payment is going to be $175m as detailed in the tax note.
Still reading the accounts and trying to unpick the Bresssay transaction. Looks like we received over $100m in jan/feb. Any clues?
Just had a quick look at Ithaca transaction and in summary they are paying $630m for 100m of 2P reserves and mid 40k BOPD of production. The valuation of NS 2P reserves, on a debt free basis, at a little over $6 per barrel is very similar to Harbour.
No details on whether Ithaca will inherit decom liabilities.
Would not be so bad if Labour retains current investment allowance for platform electrification. Currently for every $1 spent on platform electrification, NS O&G companies receive a $1.08 reduction in their tax bill.
Sek
I am hoping that we will be getting more detailed guidance on 2025 with year end announcement. I interpreted the 2025 production guidance as moderate increase at 1-1.5k BOPD but not sure how much is Malaysia or Magnus and what our entitlement to increased production will be. Hopefully will know more later this week.
If 2024 oil price averages $86 rather than $80, the additional Uk FCF (based on 29k BOPD post BP entitlement) will be approx $60m with related EPL payable in 2025 of $21m. After royalty and corporate tax in Malaysia, approx additional FCF of $4m from oil price increase. This would take 2024 FCF to approx $110m and I would lose my bet with VOR.
Any view on oil prices beyond the next 2 weeks is equally valid but I am more confident on improved oil prices in 2025 and 2026 than 2024.
On net debt evolution, on the announcement this week I will be looking out for impact of reversal of year end temporary working capital benefit in Jan/Feb and receipt of proceeds from Bressay sale. I am expecting approx $25m per month of FCF in Q1 due to lower CAPEX and ABEX in early months with spend very back end loaded. I am also expecting a reduction in JV cash balances through the year linked to the increased capex spend but probably H2 weighted.
The unanswered question is will Enquest acquire 2P reserves and will this be for cash and timing of cash payback. The terms/ price will be better for cash than production sharing like Magnus but it all comes down to affordability. My working assumption is that if we acquire 2P reserves in 2024 that this will offset any FCF generated in year. The later in the year the acquisition, the worse from FCF terms.
2025 is still very provisional but will be better than 2024 from a FCF position and should eat into debt and fund shareholder returns
My other focus on the release of the annual accounts will be interest income on cash deposits. IR have told us the rate they are achieving and the level of interest will show us what the average cash balance has been and how much is window dressing
My BE figures are directly from management guidance on production, OPEX, CAPEX, ABEX and from disclosures in the financial statements on lease costs and interest rates on bonds and RBL. I have based 2024 EPL payment on charge for first half of year.
This guidance could be wrong but I will follow up with IR on why 2023 guidance was materially wrong so close to year end.
I disagree, I have alweays tried to give a balanced view or to balance the narrative.
when there is a board discussion which is totally focussed on the positives and ignores some of the very real challenges, I have honestly tried to add balance to the debate. I can see that it could be perceived that I am introducing negative angle. Group think is very dangerous and dismissal or hostility to alternative views is an unfortunate human trait.
I fully recognise that my call on H2 2023 FCF was materially wrong. However my forecast was based on management guidance in September and November 2023 and I still do not understand how management could get their guidance so wrong so close to year end. This reduces the confidence in 2024 guidance and whether we should use management guidance or develop our own which I think is dangerous as we do not have access to the underlying information.
Dumbly
I agree 100% that well priced M&A (which accelerates the use of our tax losses) is also my priority, just ahead of shareholder returns. It has been many, many moths ago that the Board told us there were several deals on the table but nothing has yet been announced. However I would prefer no deal to a bad deal, where we give away the Enquest specific tax benefits.
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.