Member Info for Stevo12

Meant $20m per month in final para

Aimoil

The problem is that EPL is not really 35% but over 50% for Enquest due to interest expense and decom costs. As an example, if taxable profits (use FCF as a proxy) was $250m, the EPL taxable profit would be $130m higher due to interest and decommissioning being non allowable. So EPL would be $380m x 35% =$133m of 53%.

It looks like FCF of $250m for 2023 pre EPL and Golden Eagle is a stretch but achievable assumption. FCF in H12023 was $105m excluding the $35m EPL refund received in January 2023 and OPEX is $100m higher in H22023. Accordingly we will need oil to average $20 higher in H2 to achieve $250m pre tax, pre Golden Eagle FCF.

My gut feel is that $20m FCF before tax is a Stretch target and translates to $22 per barrel from 900,000 barrels per month of NS production and requires approx $90 Brent.

Aimoil

My calculation of free cash flow for 2023 as follows

Cost Per barrel

OPEX. 27

CapEx & AbEx. 15

Finance. 10

Lease 15

The above is for Enq 30k per day entitlement for NS production of 36k per day total production (BP entitled to 6.2K barrel per day of Magnus production).

This translates to a pre tax FCF of $20 per barrel at $87 oil. EPL payable in 2023 relates to 2022 and is $75m or $7 per barrel (this will increase in 2024 as EPL payable on 12 months profit at higher rate on 2023 profits - closer to $13 per barrel at $87 oil).

So for 2023 we should see a FCF of 30,000x365x13= $142m less the $50m Golden eagle payment. This leaves FCF of $90m for year which is less than first half FCF - although first half include a $35m repayment of EPL paid in 2022. Accordingly my expectation is that second half of 2023 will be FCF negative as a result of much higher OpEx ($20 per barrel higher than H1), $50m Golden Eagle payment and $75m EPL payment in October.

My expectation is debt of approx $625m at year end at $87 oil. A little to early to project 2024 as we need production guidance but expect lease costs to be lower, finance about the same, OPEX, CapEx and AbEx similar, EPL will roughly double. If we are paying $150m EPL in 2024 then I think Enquest will do very well to generate $100-150m of FCF in 2024 from what will most likely be lower production.

I can not see shareholder return until debt down to $250-300m which is going to take 2-3 years unless Enquest is able to acquire some cheap producing assets and leverage their tax losses.

Note: Based on 2023 first half results Malaysia will not be FCF positive in 2023 so I have not assumed any FCF from 8.2k barrels a day production from Malaysia in 2023. In 2024 there is potential for Malaysia to contribute $30m FCF or $10 per barrel.

Aimoil

Unfortunately location of your head office or whether you are listed or not has no impact on EPL. EPL is payable based on UK NS O&G activities whether owned by Norwegian, Chinese, American or UK businesses.

The only way to avoid EPL is to not extract oil and gas in NS or extract it at a loss. However with OPEX at $16 per barrel and oil trading at $80+ this is highly unlikely.

Death and EPL!

Tigar

Cost oil is effectively OPEX. You are correct the PSC sharing is on revenue less OPEX (Profit oil).

It is the same in the UK, OPEX is a deduction from Revenue before EPL is calculated. The big difference is that not only is OPEX offset against revenue in calculating EPL, but we also get an allowance of 129% of capital spend in year to reduce profits subject to EPL. In Malaysia there is no allowance for capital investment in calculating PSC payments.

This is the core reason that payments to Malaysian Government will always be approximately double the amount we pay in the UK per barrel - even if we were paying full UK EPL and core tax.

Martinen

I am going to ask the question of IR as I must be missing something as we are not a charity.

Just to summarises it a little better.

At $101 oil, the operating profit in Malaysia is $74 per barrel and the total government tax take if $56 per barrel or 76%.

At $79 oil, the operating profit is $52 per barrel and the tax take is $40.5 per barrel or 78%. Note that the PSC payment as % of profits reduces as oil prices fall, but the impact of royalties increases as % of profit as oil prices fall. Accordingly the total payments to Malaysia remains in the mid to high 70% irrespective of oil price.

Most importantly the investment allowances are very poor in Malaysia compared to UK - 10% per year allowance in years 1 to year 10 as compared to Uk we have a 129% allowance in year 1.

In comparison the UK EPL in 2022 would have been $13 per barrel (at 35% for 12 months) and core tax would have been approx $12 per barrel if we did not have tax losses - a total of 25% of operating profit (or EBITDA) - less than half of Malaysian tax take. The challenge is in the UK we have debt to fund, leases to pay and BP Magnus earn out to fund.

Just noted there is a typo in my previous email - PSC payments in first half of 2023 was $25.5 per barrel and not $15.5.

Therapist

Thanks for digging that out and I have run the numbers.

In 2022 gross sales in Malaysia were $240m which generated royalty payments at 10% of $24m. Production was 2.36m barrels at average realised price of $101 per barrel with Opex of $27 per barrel in Malaysia. Operating profit therefore is $150m of which PSC payment was $77.8m or 52% of profit. After Royalty cost ($24m), PSC costs ($78m) and Opex costs ($64m) this leaves a profit before tax of $69m. Tax charge of $26m leaves a profit for Enquest of $43m or $18 per barrel at $101 oil.

So in summary, at $101 oil Opex is $27 per barrel, Royalty, PSC and tax payments to Malaysian Government is $56 per barrel and Enquest gets to keep $18 per barrel. With development costs of approx $20 per barrel, I cannot see we are even covering our capitals outlay even at $101 per barrel oil.

I have taken a look at 2023 interim accounts where average oil price was $79 per barrel. Royalty cost are $8 per barrel, Opex $27 per barrel and PSC $15.5 per barrel. This leaves $18.5 per barrel profit before tax or $11.5 per barrel after tax. Certainly not enough to cover Capex. PSC drops from 52% to 46% of operating profit as Oil dropped from $101 to $79 per barrel in 2023.

Unless I am missing something, I cannot see how we are getting a return on our Capex in Malaysia.

Thoughts anyone?

Sekforde

Contact law is binding on governments as well as companies and individuals. A government agency which places a contact to say lease a computer for 3 years and after 12 months there is as change of government. If new government decide they do not want the computer system and cancel the contract then the supplier is entitled to compensation per the contract.. In theory a government can pass a new law that states that government can renege on all contacts without financial consequences. This would of course be challenged in the courts and there would be international arbitration, however more importantly it would make any contracts with the government untenable.

This is why there are individual, parliamentary approved decommissioning contacts which guarantee the benefits of the current tax regime. The government can change the tax regime but they cannot escape compensation payments.

Positive having local mafia vested in Zama’s success. Also places a value of approx $100m on harbours 12 % interest in Zama’s 2C reserves.

Dumbly

The Malaysia O&G tax has elements to it. Firstly a 10% royalty of all revenues: secondly the State retains ownership of the field and the opposer factor in exchange for incurring all exploration, development and operating costs is entitled to share of field revenues via a Production Sharing Contract (PSC). This percentage is negotiated and not sure what % Enquest holds via its PSC (looks like about 50%; finally any profits made after 1 and 2 is taxed at 38%. Investment allowances to offset the 38% tax are not particularly generous.

In 2022 this resulted in Enquest paying approx $56 per barrel to Malaysia. This is principally through 1 and 2 above which is treated (correctly) a reduction in revenue. This is why Enquest only received about $45 per barrel from Malaysians O&G sales in 2022.

You are right that I am only comparing to UK EPL at approx $13 per barrel. Without our tax losses we would be paying approx an additional $10 per barrel in core UK tax. This is lower than EPL due to interest and decommissioning being offsetable.

It would be helpful to know from IR what % PSC Enquest holds in Malaysia.

Sekforde

A government can not guarantee future tax or other laws. However they can enter into a commercial agreement that agrees to compensate a company for any future changes in tax law. This is exactly what happened with field decommissioning. Each field on a case by case basis receives a guarantee which is approved by parliament that the field owner will be entitled to compensation for any future changes in tax law.

It is not a guarantee of future tax law but a legally enforceable agreement for compensation as a result of future tax changes.

Oxy

This is going to be really interesting to see if any guarantees given. I cannot believe Equinor and Ithaca would irrevocable commit to $3.8b of spend without any certainty over future investment allowances.

Warm words behind the scene will not be enough as politicians change. Any guarantees will need to be approved by parliament (same as decommissioning) and so will be public.

Interesting times

Rosebank is certainly going to be the litmus test for economics of future NS oil development.

Environmental approval is an important step but the timing of FID will be really interesting. Personally I do not think FID will happen until post election (with labour promising to pull the investment allowance), unless the government can provide an individual field guarantee as to investment allowance.

Dumbly

Take a look at the RNS issued by Enquest on 22 June 2023 which details all payments to governments during 2022. $124.6m paid to Malaysian Gov and $39m to UK (principally initial EPL payment).

Enquest paid $56 per barrel in tax to Malaysian Government. EPL for 2022 was approx $75m for 7 months at 25%. This converts to annual EPL of $180m. NS oil production was 14m barrels in 2022 which results in EPL of $13 per barrel.

So yes we are paying 4 times as much tax in Malaysia per barrel than we pay EPL in North Seas. The reason I emphasis this is that there is an underlying belief that overseas tax regimes are better than the Uk - many including Malaysia are much more punitive.

Malaysia loves their oil industry,. Why would they not given the amount of tax it raises!

Enquest will pay more tax to Malaysian Government on 8,000 barrels a day that it will pay to the UK in EPL on 37,000 barrels a day. The problem is that UK has gone from one of the lowest tax regimes to one of the highest and that is taking some digesting.

I think a takeover is highly unlikely in current UK market.

Enquest market Cap is very low relative to the size and scale of the business, but this is a reflection of a few factors, namely:

1. We have a high Opex which is forecast at $25-26 per barrel for 2023 which is significantly higher than NS average (Harbour $15-16 per barrel)

2. We have significant debt (more than twice market cap) and in addition there is a substantial lease obligation and $100s of million still to pay to BP for Magnus

3. EPL tax rate is closer to 50% than 35% of FCF as interest and decommissioning is non deductible

The net impact of all of the above is that Enquest share price will be inherently more volatile than lower risk/less indebted businesses like HArbour/ Serica and more exposed to oil price movements.

This is why I remain invested (although a little more in Enquest bonds than equity) as a material change to EPL or a change in market expectations that oil prices will remain high beyond 2024 (over $85 per barrel) then ENquest will have a major re rating. I am not expecting any of this to happen in 2023 but I remain patient and collect my interest on the bonds.

Sekforde

Payments to governments are required to be RNS’d each year and Enquest published its payments to governments on 22 June 23 via RNS. Enquest disclosed it paid $124.6m to Malaysia in production entitlements and taxes.

The reason you do not see it is that the production entitlement and I think the supplemental charge is deducted from revenue (rather than treated as a tax expense) which is why Enquest only received $45 per barrel in 1st half from Malaysian oil sales. Enquest is following accounting standards in deducting production entitlements from revenue

Sekforde

Thanks I listen to the presentation again.

Did a little more digging on Malaysian o&G tax and there are effectively three element of state take. Firstly there is a 10% royalty payable on all revenues, secondly Petronas has all rights and contractor (Enquest) pays for all exploration, development and takes on all risk and is then allocated an agreed share of Revenue less certain costs under a PSC. I don’t think it has been disclosed by Enquest what % is allocated under the PSC. Then finally there is a 24% tax on any residual profit after payments of 1 and 2 above.

The net impact appear to be that we pay about 50% of revenue to Petronas which is a government entity (given we receive $42 per barrel of oil) and then pay tax on residual profit. Opex is also expensive at $27 per barrel.

Ultimately my take is that it makes the UK with EPL look like a low tax regime.

I am

Th

Tigar

You are right that Magnus payment is after all Opex and Capex relating to Magnus and capped at $1b.

My understanding is that the payment to BP is made gross and deductible for EPL and core tax. However if paid net of use of Enquest losses this will help use historical losses and reduce cash outflows.

However i have not read the Magnus agreement and stand to be corrected

In reality BP has retained a 37.5% working interest in Magnus but Enquest discloses 100% working interest in Magnus revenue and profit though accounting trickery.