Member Info for Stevo12

Tamov

I think the key challenge with Cambo is finding 1or 2 partners and the risk that Labour pull the investment allowance in 2024/25 right in middle of development.

Cambo is affordable for Ithaca but it would be high risk to push ahead as 100% operator.

Very difficult to arrive at a 2p reserve valuation from the Equinor deal as not clear as to the quantum of tax losses which could represent the majority of the purchase price.

Looking at recent Norwegian deals were tax is a little higher at 78% is a good indicator of potential NS valuations. Spirit Energy sold its Norwegian fields in last 2021 which were delivering 55,000 BPD with 140m barrels of 2P reserves for $1.1b ($7.85 per barrel).

Londoner

The future lease payments are detailed in the 2021 financial statements (note 27), Lease payments decrease in 2024 to a little over $100m per year for 2024 -2027. Not sure what is leased beyond Kraken FPSO. 2023 lease payments likely in $120-130m range but will confirm with release of 2022 financial statements.

I have not seen any specific details on Opex per barrel for Magnus but $40 sounds pretty high. Actually the 2021 financial statements detail the projected Magnus payments each year for next 5 years (again note 27). Contingent consideration payments were projected at approx $80m per year. This was however based on a lower oil price assumption and we will see updated forecasts once the 2022 financial statements are released. I would hope 2023 lease and contingent consideration payments are closer to $200m than the $300m I had assumed in my valuation model.

I agree that significant upside for EnQuest share price if oil price stays high and we continue to pay down debt and other financial liabilities over next 12-24 months. A small buyback ($50m) would also help and affordable. Unfortunately leverage works both ways and a fall in oil price would hit EnQuest hard unless government rolled back EPL.

Sorry meant 2023 FCF of $250m not 2022.

Kraken

There are two type of lease, finance leases and operating leases. With operating leases (normally buildings) the lease payments are expensed as operating costs as you personally experience. With Finance leases, the asset which is purchased via the lease (such as Kraken FPSO) is capitalised as an asset in the balance sheet and depreciated and the discounted value of future lease payments are included as a finance liabilities in the balance sheet.

The profit and loss account is charged with the depreciation of the asset and the interest on the lease but the lease costs are not charged as an expenses. Accordingly for Enquest who have categorised $500m of leases as finance liabilities there is no cost charged in defining Opex per barrel or EBITDA (as depreciation is excluded).

The lease payments are however reflected in arriving at FCF and so the $250m FCF estimate for 2022 is after lease payments.

The O&G majors such as shell and BP differentiated between bank, bond debt and finance liabilities. They define net debt as bank debt, bonds less cash and separately define funding liabilities as debt plus finance lesses.

Hope this helps
.

Londoner

The lease liabilities due to be paid within 12 months ($137m) and due after 12 months ($400m) is disclosed in the 30 June 22 financial statements. This is the capital value and there will be interest on top.

The BP Magnus payments at 37.5% of FCF represents approx 5,000 barrels per day. At $85 oil and $25 Opex this is approx $110m per year up to a maximum of $1b. This is about 10% of EnQuest’s EBITDA (and production) and I agree this is really a 37.5% working interest which has been presented by Enquest as a deferred consideration.

I also prefer to use FCF to value business and currently the EV is approx 5Xs FCF (using 2002 FCF forecast of $250m). This is quite a high ratio for O&G companies both in UK and in US (Harbour’s EV is closer to 2.5Xs 2022 FCF) and suggests we are not materially undervalued at the moment. However as net debt reduces, Equity value rise quite substantially due to leverage.

January

Good challenge. The value of 2P reserves has a number of variables such as Opex per barrel, daily production rates and decommissioning liability. The $15 per barrel valuation pre EPL was based on average of several historical deals and I accept that oil prices were lower.

My estimate of the reduction in value of reserves post EPL was based on the change in post tax cash flows from reserves. Pre the EPL, companies retained 60% of oil profits excluding losses, post EPL it keeps 25% and this results in an approx 60% reduction in post tax cash flows (35/60) from 2P reserves. I have applied this 60% reduction to post tax cash flows and applied it to the $15 per barrel valuation from pre EPL deals.

There have not yet been any reserve based acquisitions post EPL to determine the “new normal” - Serica’s merger with Tailwind going through at the moment values Serica’s reserves at $6 per barrel and Tailwind at closer to $10 per barrel.

The rule of thumb 1/3 of oil prices as an indicative valuation of 2P reserves is a reasonable starting point to apply a gross pre-tax valuation of 2P reserves. As an example if we use $75 long term oil prices this results in a gross valuation of $25 (allowing for $25 of Opex and discounting impact of $25). The net value per barrel of reserves after 75% tax is $6.25 per barrel. At a long term oil price of $90 per barrel the value of 2P reserves increases to $7.50 (25% of $30).

Accordingly the value of 2P reserves is highly dependent on tax rates and what is undeniable is that the EPL will have reduced net cash flows from 2P reserves in the range of 50-60% and this has been reflected in the changes to RBL facilities which appear to have reduced by by 50%+.

I absolutely accept these are all theoretical values but we should see some deals over the next 12 months which will provide real world evidence of 2P reserves. I would love to know the price per 2p reserves Harbour was discussing with Shell regarding their Norwegian assets, where tax is 78%.

I think I have got my estimate of remaining 2P reserves wrong - looking at details from last years financial statements it is probably closer to 175-180m barrels and not the 160m barrels I estimated.

Thanks again for sharing your thoughts and this is the type of positive challenge needed to make these Boards valuable.

Tamov

Interesting article and it sounds like Ithaca is struggling to find partners for Cambo. In many ways it would be really helpful for Cambo to be deferred to get Governments attention.

From a cash flow perspective, Ithaca has tax losses which will result in their investment allowance only covering about 46% of the development costs with balance of allowance carried forward until tax losses utilised. Equally Ithaca will only be paying EPL at 35% so should have strong cash flows over next couple of years.

I think the greater concern is labour pulling the investment allowance if they get into government in late 2014/ early 2015 and this is probably a greater concern for banks and investors.

January

I was trying to consider the fundamental value of Enq from a third party’s perspective and my ground up analysis was as follows.

Enq 2P reserves are approximately 160m barrels. Value of producing reserves were worth up to $15 per barrel pre EPL when companies got to keep 60% of taxable profits, now it is 25% (excluding brought forward tax losses) and accordingly reserves now worth 40% pre EPL values or approx $6 per barrel.

This provides a gross value of $960m and I am not attributing any value to contingent reserves. However buying Enquest comes with an obligation to repay debt, fund the remaining lease payments and settle the deferred consideration which is approximately $1.6b in total. However the tax losses are worth approximately $1b as a shield against core taxation which leaves an equity value of $360m which is pretty close to our current market cap.

Not great news but the positive side is that lease and deferred consideration is being repaid by approximately $300m per year, in addition to the $250m of FCF to repay debt. Accordingly market cap should increase each year by $350m ($550m reduction in funding liabilities less $200m of tax loss utilisation) if Oil stays in the $90 range.

FCF excluding tax losses is $50-100m but the tax loss shield of $200m per year should last for at least a further 4-5 years at which point the lease liabilities and deferred consideration will have been fully repaid which will increase FCF by $300m to offset $200m increase tax.

Conclusion - In theory share price should increase by approximately 1p per month for next 3 years on a steady as she goes basis. The reality is always different and Enquest is currently viewed by credit agencies as highly leveraged and high risk with Bonds yielding 10%, compared to Harbour’s Bonds which yield 5%. This I believe is why AB is focussed on reducing total funding liabilities (debt, leases and deferred consideration) to improve credit rating and reduce the cost of debt.

Aimoil

Slightly misleading in that it has been revealed that shell considered (not considering) moving its head office to US in 2021 from Netherlands but chose UK as its HQ. This is an historic statement and there is no evidence that it is reconsidering its move to UK in early 2022.

It may now be regretting its decision to move to UK given the outright hostility to O&G and these stories are not unhelpful in discussions with Government.

Good points Zippy.

I very much like Bressay and Bentley and the ability to link it back to Kraken. However I do believe we need to partner with other NS oilers to take this through development and I am not sure who will have the appetite. Ithaca have their hands full with Cambo and Rosebank, HArbour and Equinor are out, Super majors will not be interested. Serica is a possibility post merger with Tailwind as they will still be cash positive.

However the greater concern is the LAbour commitment to pull the investment allowance and end all new field developments in North Sea. Unless labour’s policy to 100% renewables by 2030 changes there is not going to be any appetite for projects that have not achieved FID in 2013 and in development in 2024. Labour seems to be ignoring that Renewables are intermittent and can not be relied upon for base load requirements and would prefer to import fossil fuels than develop our own

Why would we need to raise equity to fund development costs when UK Gov funds between 91.4-105% of costs. The fact that 2 of the biggest NS operators, Harbour and equinor, have walked away from Bressay is worrying.

I also do not think any proceeds from selling Kraken would be meaningful. I know EnQuest has taken out 50m barrels to date and I recall there are about 50m left. This would be worth about $300m at $6 per barrel and we still have $300m+ to pay on the FPSO - so probably no value to an acquirer unless that have uk tax losses.

While it is difficult to accept, UK tax losses are contributing $150-200m per year of FCF are worth more than our market cap and without them EnQuest share price would be close to zero. Unless oil is consistently north of $100, the fact that we are paying 35% tax and not 75% tax is enabling Enquest to pay down debt and this may be the reason AB is seeking to minimise debt while the tax shield continues - and tax losses will continue to benefit FCF for a few more years yet. AB also most likely recognises he needs to repay over $1b of deferred consideration and lease liabilities alongside the $700m of debt which may be making him more conservative in starting shareholder distributions.

However while Enquest is probably the most leverage NS oiler, it provides a great opportunity for share price progression if Brent stays north of $80. $250m debt repayment per year will over time translate to 10p share price increase per year but will probably need some form of shareholder return to get it started - my preference is share buybacks.

Chilting

I would add that the EPG (energy price guarantee) provided by the government to cap consumer energy bills is projected to cost HMG about £25b from Oct to March 23. The EPG from April to MArch 24 was projected to cost £15b but now is forecast to cost 90% less less at £1.5b with energy costs at current future wholesale gas prices. The EPG is forecast to not require any government support from May/June 23.

Accordingly if the government is no longer funding EPG and in mid 23 customer bills drop from current levels, there is no rationale for EPL. However removing taxes is always more difficult than imposing it and unless there is a demonstrable reduction in investment in NS, then no great rationale for Government to come to table.

Chilting

I think the gas price is more important than oil price. The real sensitivity is consumer gas and electricity prices and once retail prices start to reflect current wholesale prices both public and political interest will move on.

The question is how long will it take for retail prices to reflect wholesale prices and why have renewable electricity prices not fallen as they are linked to wholesale gas prices - which is nuts in itself.

Chilting

The problem is that the value of 2p reserves will have decreases by approx 60% as a result of EPL for companies without tax losses to shield core UK tax. Accordingly Kraken cash flows worth more to Enquest than a third party and probably the worst time to sell from a value perspective.

Debt at $0.5b, which is approx 0.5x EBITDA, is a very manageable number and should be achieved in late Q3 2023. Enquest would be better buying heavily discount UK production and use its losses to shield the core 40% UK tax. I would also be surprised if EPL is still in place in current form by March 2024.

While 2023 FCF of $250m looks achievable for 2023 if Oil averages high $80s, this benefits by approx $150m from using UK tax loses which will not last forever. Accordingly without benefit of tax losses our FCF would be closer to $100m pa which is the medium term outlook if EPL remains. FCFs are impacted by Lease and contingent consideration payments which are approx $300m per year and these will continue for foreseeable future.

My preference would be to initiate a £50m per year minimum share buyback programme which at current prices has a very substantially ROI and better than could be generated from buying producing assets or new development. I am surprised AB has not been a little more positive on this front but might be announced with full year reporting in late March

Londoner

My thoughts on relative values of HBR and Ithaca was based on the two companies having similar enterprise values - i think HBR is approx 5-10% higher based on debt at Sept 22..

However HBR has approx 65% more 2P reserves, HBR’s 2022 production (210k bpd) will be a little under 3 times higher and EBITDA is more than double Ithaca’s. Ithaca has better hedges for 2022 and 2023, but has higher OPEx per barrel than HBR.

Ithaca has slightly higher debt than HBR and not sure about tax losses carried forward.

Ithaca has a more attractive 2C pipeline in the UK which are very close to FID and will materially reduce there EPL going forward. Based on 2022 results and metrics, I would say that HBR is materially undervalued compared to Ithaca but I do not have enough insight into Ithaca for 2023 to compare - although Ithaca’s production is growing, whereas HBR will decline but will still be well over double Ithaca’s 2023 Production.

Tamo

DDA is not an allowable offset in calculating EPL or regular taxable profits - the investment allowance is effectively an accelerated tax deduction of capital investments which are then depreciated for accounting purposes over their productive life. Accordingly profits subject to EPL are $1.5b higher than your analysis.

Ithaca still looks expensive compared to harbour based on existing 2P, production and profitability. However it does have a pipeline of big North Sea projects which UK government will fund over 91% through reduced EPL and, as such, their production will grow substantially.

I still prefer HBR at present and recognise HBR much prefer to buy producing assets than develop new fields. Interesting the EPL will have reduced the value of producing fields by about 60% due to reduced post tax cash flows and so if HBR can pick up producing fields at 60% less per 2P than pre EPL, the returns will be the same as pre EPL.

In reality 2022 HBR dividends and Buy backs has also generated a 20%+ return - it just does not feel like it. I expect a similar shareholder return in 2023 from HBR.

Happy

This is the third NS windfall tax and the last 2 fell away after a couple of years once the impact on investment levels were visible and the political rhetoric subsided. Once the reduction in gas prices flushes through to consumers i hope the noise in press reduces.

The material difference this time is the quantum of the investment allowance which at 91.4%+ of capital costs is huge. However Enquest only gets 46% in cash due to historical tax losses with the balance carried forward until losses utilised.

While the green agenda is a vote winner, the reality of energy security and UK jobs becomes a priority once a party is in office and I would hope that a Labour Party in office is different to the one in opposition. Certainly if Labour want to recapture Scotland from SNP then a more positive policy to O&G needed.

Sekforde

I don’t think you have include the lease payments, interest costs and contingent consideration payable on Magnus in your FCF estimate. Lease and contingent considerations in the $200-250m range.

I anticipate 2023 FCF guidance is $250-300m range. Roughly consistent with second half of 2022.

I have interpreted the 2023 guidance as EBITDA of approx $800m (44k BPD at $75 and OPex of $26 per barrel). This would result in net debt target of $400m and a $300m of FCF needed to achieve target, which looks achievable for FY23. Accordingly I am not expending dividends or share buybacks until 2024 unless oil price averages over $85 for FY23.