Member Info for Stevo12

Romeron

On tax treatment of capital expenditure under EPL. If company A spends $100 on capital it receives a tax allowance of 121% of actual Capex in year of spend. Accordingly it receives a tax deduction of $121 which reduces profits subject to core tax and EPL. Tax saving $121*75% or $91.

Accordingly for each $100 spend the core tax and EPL is reduced by $91 and company funds remaining $9 from debt / own reserves. Because Enquest is not paying core tax it would receive a tax reduction of $46 for each $100 of spend until UK losses are fully utilised. Accordingly Enquest is less motivate to invest in new development than peers who have used all or most of their tax losses. However it is highly motivated to buy producing assets and use its tax losses to improve post acquisition cash flows.

Romaron

Agree with your point. The core debate started at to whether the oil futures market is a useful/best predictor of the likely future oil price in say 3, 6,9 and 12 months. While there is no perfect predicator, my contention was that it is the best guide available given it is derived from millions of market transactions/ bets.

Of course individual commentators come up with their own thoughts on future oil price and some are more credible than others.

On Rosebank, I cannot see how 100m barrels of 2C can possibly by worth $15 per barrel or $1.5b. Development costs would be a further $1b for 20% share, totalling $25 per barrel before investment allowance.

If labour leaves current investment allowance in place (which they have stated they wont), the government would effectively fund $910m of $1b development costs.

Currently 2P reserves (after all development cost incurred) are in the $6-10 per barrel range - down from $15-20 pre EPL.

Romeron

A couple of observations.

Firstly the oil futures market is significantly larger that the physical market. Between 1 and 2 billion barrels of future WTI barrels trade a day on the futures market (10 to 20 times more than the total global physical oil market) and there are currently 4 billion barrel of just WTI oil on open contracts. Accordingly the vast majority of oil futures contracts -95% plus never actually get settled in oil.

You contradict yourself in your third paragraph. In your example where the current spot is $80 and March future is $79.21 and current spot moves to $90 dollars due to geopolitical incident. You correctly state that the March future would potentially not change or move much less than the $10 movement in oil spot price if the market sees the issue as a short term incident. Accordingly as I stated the oil futures price is inherently less volatile than the spot as an indicator of future oil price. Your assertion that there is greater volatility to the futures price than spot is simply wrong. You can track 6 months oil futures and oil spot and the volatility in spot is significantly higher.

While the futures market was initially developed to allow producers to lock in and guarantee future prices and pass the risk of market volatility to traders, it has now moved to be a primarily speculative market where traders are betting on the oil supply/demand balance at a future date and the resultant oil price. The futures oil price is effectively the average bet of all sellers and buyers of future options.

Spot prices are always going to be volatile and the futures market is a much more stable predictor of future oil prices which remove short term anomalies - both up and down.

The RBL will require Enquest to hedge (I think it is 40%) of 2024 production and a lower % of 2025. I am hoping that hedges were taken out at the recent highs and have locked in mid to high $80s for good chunk of next years production. We should know more with the November update.

Enquest should not be gambling too much on future oil prices.

DENIS

While 75% tax is abusive, the gov also pays for 91% of all capital costs of new developments. Sounds like we have been nationalised by the back door.

Nitro

I hope you are right that there is something substantive in tomorrow’s kings speech. However I suspect it will just be warm words about how Conservatives support O&G from North Sea over imports and that it is in best interest of UK jobs, economy and energy security to extract in NS rather than import until we have fully transitioned.

If by some miracle conservatives win next election then I do believe EPL would be seriously amended. I hope that Labour government will sober up when faced with governing rather than objecting but who knows whether reality will trump ideology.

There may be an alternative reason for the delay in releasing trading update compared to prior year and hoping that may be to announce some form of transactions. Could be totally wrong and its just that LC is taking an extended cruise around the Caribbean or IR have lost the company calendar!

No bull

EPL for H1 2023 was $76m which is a tax rate closer to 55% as opposed to the headline rate of 35% due to interest and decomm not being an allowable offset. There is also a deferred tax charge in H1 2023 which will not result in a cash tax costs.

When you add in the Malaysian Corp tax rate the cash tax rate is approx 62%. The EPL is paid in October of the following year (H1 2023 EPL payable in Oct 24) and no EPL was paid in cash in H1 2023.

Without the tax losses our cash tax rate would be closer to or possibly higher than 100% - absolutely absurd. Thankfully the tax losses should shield Enquest to end of EPL.So an assumption of UK cash tax rate of approx 50% for next 2-4 years (interest costs should fall as debt reduced) and a Malaysian tax rate of 38% (after PSC and Royalties)

Based on last years timing we should get November update later this week.

Not expecting any fireworks on trading or cap exp. EPL paid in October so debt update at end of October would be helpful. Personally expecting:

190k BPD production at $16 OPex. $1b of FCF forecast maintained after $400m of tax in October. Hopefully reserve replacement improved on 2022. Possibly new buyback programme to commence. Earn field update and more info on Mexico, Tuna etc.

An announcement of an accretive acquisition would be nice.

Never

Harbour did not bid for any lots in this licensing round

Smokin

If you read my posts, I am forecasting a 33% increase in share price per year through debt retirement over next 2 years and a doubling of share price by end 2025.. However there is a difference between unfounded and unrealistic optimism and the current post EPL reality. However if you want to believe that Enquest is generating $250m+ of free cash flow then that is your prerogative but at least try and work out how.

I am not sure how much forward looking details will be provided in November update but if I am wrong I will be the first to put my hands up. The update should at the least include Oct net debt position and year to date and full year production forecast.

Kraken

I have just realised I have made an error in estimating H2 23 EBITDA in that I have not taken account of the higher OPEX in H2 as notified by the company. H2 Opex is projected to be $100m higher than H1 and so will broadly offset the increased revenue due to oil price improvement.

Accordingly H2 EBITDA and EPL similar to H1 so closer to $120m to be paid in Oct 24 and not $150m I had originally estimated.

I still think we are going to see small negative FCF in H2 23 due to Golden Eagle and EPL payments of $125m. H1 FCF of $140m was flattered by repayment by HMRC in Jan 23 of EPL paid in Dec 22 of $35m. Anyone fancy a small wager?

Kraken

I am treating lease payments as deductible costs for EPL calculations (added to Opex).

I calculated 2024 EPL tax payments based on H1 23 EBITDA less BP Magnus payment, less Lease payments, less 121% of UK CApEx. I then adjusted H2 EBITDA for higher realised oil price.

Calculated as follows

H123 EBITDA $400m, less Malaysia $30m = UK EBITDA $370m

Less lease costs $63m, less Magnus payments $38m, less $100m Cap ex allowance ($80m x1.21)

Profit subject to EPL = 169 @35% = $59m for H1 2023

H2 EBITDA $100m higher due to realised oil price of $90 in H2. EPL in H2 23 = $94m.

Total 2023 EPL= $153m - I have used $150m as estimate for Oct 2024 payment

Kraken

Please let me know which of my workings you disagree with and why. I may have got something wrong and, if I have, I will have improved my understanding of Enquest. That is a win for me

Sekforde

I have also reconciled the 2022 FCF of $518.8m to my 2023 forecast which I summarise as follows

2023 FCF $518.9

Lower UK production. (150.3)

Increased Cap Ex. (45.0)

Increased OPEX. (30.0)

Lower average Oil Price. (67.9)

Increased Malaysia FCF. 20.0

Interest reduction. 10.0

—————

255.3

Golden eagle. (50.0)

EPL. (75.0)

————-

2023 FCF. 130.7

Lower production

NS production in H12023 was 3,500 BPD lower than 2022. However Magnus production was 3,900 BPD higher of which 37.5% belongs to BP. Accordingly Enquest NS oil entitlement was 4,962 BPD lower in H12023 than 2022. I have assumed 2nd half production is same as H1 (very top end of guidance) and so Enquest revenue and FCF down by 4962x365x 83 = $150.3m

Average realised price

Average realised price in 2022 was $89 per barrel. H123 was $76 per Barrel and I have assumed an average of $90 for H2 23 giving an average for 2023 of $83. NS production entitlement 31kx365x6 = $67.9m reduction.

Malaysia

Oil production 1,800 BPD higher and I have assumed FCF increases from $12m in 2022 to $32m in 23 but just a guesstimate

Let me know if I have missed anything based on your workings. We also know that FCF in H1 23 was $140m and was $198m lower than H1 22. The real difference was higher as Enquest received a refund of EPL in H1 23 of $35m

Sekforde

Apologies if I keep coming over as Dr Doom but of the 45k BOPD, BP receives all FCF related to about 6.5k BPD and of Malaysian 8.5k BPD, lets be generous, say Government has entitlement to 2/3 of FCF via PSC and royalties. Accordingly while I think real FCF per barrel is closer to $24 ($86 oil and $62 cash cost exc BP Magnus payments) it should be based on Enquest real entitlement which is approx 32.5k BPD. Accordingly if Enq can maintain production at 2022 levels from $180m pa CAPEX, this would yield $284m pa before EPL and Malaysian corporation tax (£150+20m) which leaves approx $115m pa debt reduction in 2024 and beyond. This will I believe be very close to 2023 FCF which will only include $75m EPL payment as opposed to $150m in 2024 - so actual $75m higher than 2023 FCF pre EPL. Every addition $1 of oil price over $86 puts an additional $10m into bank after tax.

Whilst this sound a little more modest, a £100mdebt reduction per year this translates to a 5.5p increase in share price per annum from debt reduction alone. Factor in reduced debt risk after a couple of years of further debt reduction and 30p should be realistic outcome by end of 2025.

Of course we are exposed to vagaries of Brent Price and my preference would be to lock in over 1/2 of future production with hedges in mid 80s and protect the downside risk of oil price falls. Enquest is more exposed to oil price falls than other NS operators due to high cost per barrel and I would prefer a low risk journey of debt reduction and share price appreciation over next couple of years. It is going to be really interesting to see in the year end updates how much new hedging has been taken out.

Of course a change in EPL changes the game or even a confirmation from Labour that investment allowance remains in place will help unlock Bressay and Bentley. My personal view is that we will get a new NS tax arrangement coming out of current review but that it will not be implemented until post election.

Last comment on Malaysia as I am sure lots of folk are getting bored by debate. I have reconstructed Malaysian profit and loss account as follows for 2022

Revenue $240m (6,500x365x$101)

OPEX ($64m) (6500x365x $27)

Mal Gov. (124.6m) per RNS June 23

Cap ex. ($39m). Per annual statements

FCF to Enq. $12.4m

Accordingly Malaysian took 91% of FCF in 2022 from EnQuest’s 50% working interest.

The reason this debate started was to emphasis that while there is an understandable desire to call on Enquest to invest overseas as opposed to he UK, many overseas regimes are worse than the Uk even with EPL.

The challenge is that the UK has gone from one of the lowest O&G tax regimes to one of the highest overnight. The treasury made a calculated bet that the investment allowance which is equivalent to UK gov funding 91% of CapEx (through reduced EPL and core tax) would be sufficient to motivate invest.

Personally I think if it was not for the spectre of a labour removing investment allowance, there would be ongoing investment. However this uncertainty renders any CapEx beyond late 2024 untenable.

No more Malaysian comment from me - promise.

Tarmak

My understanding of Malaysia is that Enquest is operator with 50% interest in PM8/Seligi. Gross production 17k BOPD ish of which 8.5k BPD net to ENquest.

On Enquest 50% share of production/ revenue it pays a 10% royalty to Malaysian Government and a share of operating profit (on Enquest 50% entitlement) via the PSC which changes according to oil price (profit) and looks to be around 40-50%. Enquest is responsible for all CAPEX on its 50% working interest but the depreciation is deductible in calculating PSC.

In addition there is then a “normal” 38% corporate tax on residual profit after paying royalty and PSC.

What we know as facts are

1. Enquest paid $124.6m to Malaysian Gov in 2022 and $51.5m in 2021.

2. Enquest 50% shares of production increased from 4.2k to 6.5k BOPD in 2022

3. Malaysian Profit after tax was $45m in 2022 and $17m in 2021.

4. Enquest share of Malaysian CapEx was $39m in 2022 and $17.4m in 2021

Tamark

I meant to add that Enquest includes 100% off Malaysian production in its BOPD disclosures but deducts the royalty and PSC payments from revenue, which results in a relatively low revenue per barrel ($46 per barrel for H1 2023). 100% of costs of Malaysian OPEX and CapEx are included but these are reflect in calculating PSC payment

As an example oil at $90 and OPEX of $25 with no CAPEX results in $9 of royalty, PSC of $28 and corporate tax of $11. This results in $48 payable to Malaysia Gov, $25 in OPEX and $17 to Enquest per barrel. EPL payments to Uk gov are approx $13 per barrel.

Tarmak

Note 24 leased payment only includes the capital element of future lease liabilities and excludes the interest/ discount element. Note 27 discloses the actual future lease cash outflows. Have you included lease interest in your finance charge?

On Malaysia - note sure I fully understand your point. Malaysian gov receives 3 forms of payment - 10% royalty on gross revenue, 50% of operating profit via PSC (although this marginally changes based on oil price) and 38% tax on residual profits after royalty and PSC. payments.

2023 payments should be similar to 2022 with higher production and lower oil price in 2023.

Sekforde

A couple of observations. Firstly the futures oil market significantly exceeds the real oil market and there is far more paper trades of oil than physical. Secondly, There is logic to your thought that anyone holding oil should sell at spot and take out an option to buy back at future lower prices. However unless demand for oil exceeds supply this is purely moving oil ownership from one trader company to another and any significant sales of oil in storage (between traders) will drive down spot (which was the intent of the SPR releases) and will reduce the premium over futures. The big trading houses like backwardation as they offer producers lower hedge prices. Over the last year oil in storage has fallen by a little over 10% which is supportive of the spot price and indicates that demand is currently exceeding supply.

The expectation of the oil futures market is that in 2024 and 2025 demand and supply will come closer into balance and as such future prices are expected to ease from current spot. This could be because OPEC removing their voluntary reductions or demand falls due to economic activity or a multitude of other drivers.

I have always though of spot being indicative of the demand supply balance in the very near term (a couple of weeks) and the futures price based on the markets view of expected demand supply balance in 3,6, 9 12 months time.