Member Info for Stevo12

Harbour would have generated over $4b extra profits without the hedges in 2022 and if O&G prices remain at 2022 levels this is the benefit we can expect for 2024. However we only get to keep $1b after 75% tax and as we will have fully utilised historic losses, our core tax bill will also be up by approx $1b.

Unfortunately the benefits of the hedges expiring will be offset by increased core tax. Without significant NS Capex we will be paying over $6b a year in tax.

Baysil

CNE receives approx $4 per barrel equivalent for its 35K per day of Gas production under an agreement with Egyptian government - 97% tax rate equivalent at current market price. Generates about 85% of its revenues from its 5k BPD of oil.

Do you really want to be operating in Egypt - not sure I do.

I am not a shareholder in CNE anymore but looks like it’s cash will now get distributed now directors have been exited. Not sure residual business is worth much.

Tarmac

Hope you enjoyed your break.

Just one question on your very helpful analysis. Are the lease payments in your analysis the capital element or capital and interest? The reason i ask is the lease cash outflows look a little low. Based on interim accounts, lease capital repayments in next 12 months were $130m.

We should hopefully get an update on 2023 cap ex shortly

The crazy and frustrating reality is that with cash today will be close to £550m and generating positive cash flows every moth after EPL. Serica would most likely have a cash balance by end of 2023 greater than current market cap. How much is 60m barrels of gas reserves worth - at least $7-8 per barrel after EPL - or $420-480m.

So MR market is valuing current cash at about £290-340m, namely a discount of between 40-48% due to the likely capital misallocation or value destruction as a result of this deal. The answer should be return the cash to shareholder at which point MR market would value the cash at full value and share price would by at least 30% higher.

Bin this deal and give us our cash. We can then choose to invested in entities more experienced in overseas O&G development. Sadly maximising shareholder value does not appear to be priority.

Romeron

The great value of these boards is to bring a range of views and perspectives to the table and I certainly enjoy the challenge. The greater risk is that you get stuck in your own perspective which can lead you to a very tunnelled view of the world and the investment environment.

Keep sharing your views and challenging, it is a very healthy way of us all learning.

Romero and Londoner

I think we are broadly on the same (or similar page) in that, as I noted previously, I can only see enquest investing in short-cycle, low risk, near field “extend and expand” projects with the decision to FID Bressay or Bentley delayed until 2025 when a new Labour government reveals its O&G polices and historic losses are fully utilised.

The equation is different for other NS O&G companies that have lower losses and particularly if the Government is willing to issue a commercial guarantee for specific critical new fields (Rosebank and Cambo) that any change in tax rules will result in compensation from government. I find the current rantings on why should decommissioning cost be tax allowable as amusing. The Decommisioning deeds issued to companies to guarantee this allowance are specifically required to be filed with Parliament each year and over 100 fields have this Guarantee and Labour know this.

To Romaron’s point. O&G is high risk and yes there is and always will be uncertainty over future O&G prices when commissioning a new field that takes 3-4 years to get to production and in theory there is ask ways a risk that a new technology will be developed (Fusion) that will make all other Energy sources redundant.

This applies to North Sea and all O&G everywhere and there are very few O&G projects globally that ever get close to a 3 year cash payback. Accordingly I presume you are against any Enquest investment in O&G in Uk or overseas. Globally new developments in progress are only going to add between 25-30% of current extraction which will inevitable result in a major decline in global production over next 5-10 years. This decline is far greater than can be replaced by renewables and leads us into an inevitably higher for longer oil price.

Londoner

In response to your questions, I comment as follows:

1. The interim accounts highlighted $136m of capital lease repayments over the next 12 months and I do not have a detailed breakdown by field. I know Kraken makes up the majority and I was using $100m for Kraken as an estimate.

2. The p&L charge and the cash payments to BP re 35% of Magnus production should be broadly similar in 2023 onwards unless there is major further new capital costs.

In terms of which year was I referring to, I was using 2023 to illustrate the impact of a fully year of EPL at 35%.

Ultimately what is my gut call. I think that Enquest will confine themself to short cycle investment in extending and expanding existing fields. They will wait until next Government is in office in 2025 and see how the land lies before any major new commitments. 2025 also coincides with the likely full utilisation of existing tax losses and if the tax regimes is not amended by Labour, Enquest will then be getting 91.4% contribution to major new field development like Bentley and Bressay.

Regarding Romaron’s question as to who funds the other 91.4% of the capital cost of new field development. HMRC pays 91.4% of the cost of new developments by reducing the tax an operator is due to pay under Core and EPL tax. As noted previously, only half of the benefit arises in the year of investment and the other 1/2 is carried forward until losses are exhausted. Fully accept this is all based on the assumption that Enquest is profitable.

Londoner

Enquest has an interesting tax position and has three key features which need to be taken into account:

1. We have tax losses which will offset core 40% tax of £1b. Core tax is effectively payable on EBTA as interest is allowable for core tax. EBTDA is approximately $1b at current oil prices.

2. Kraken lease payments are offsetable against taxable profits for both core and EPL. This is approx $100m per annum.

3. We do not pay tax on BP’s 35% share of Magnus as BP has effectively retained full economic and financial interest and received payments equal to 35% of Magnus revenue less Opex. Approximately 10% of Enquest profit, so another $100m roughly.

Accordingly I estimate Enquest taxable profit for 2023 (if EBITDA is $1.1b) will be $800m before investment allowance resulting in a core tax charge of $320m and EPL of $315m (interest is not allowable). I have ignored AbEx for now. The $80m cap ex will reduce core tax by $36m and EPL by $37m (more if green elements incorporated). So no core tax will be paid and losses carried forward will be $716m (1,000-320+36)and EPL payable of £278m which will be payable in quarterly instalments during the relevant tax year.

Accordingly it will Illey take 3 to 4 years for Enquest to use its taxable losses (2022-2024). Accordingly for every $1 Enquest spends on post FID Capex it will reduce EPL payments by 46 cents and add 45c to losses carried forward. Once losses are utilised core tax and EPL will be reduced by 91.4c for each $1 spent.

In summary the motivation to invest for ENquest is not as strong as those companies with lower levels or no tax losses available who immediately receive the 91.4% benefit. For Enquest 1/2 of the benefit is deferred for 3 years but equally we are not paying core tax and as such our FCF will be higher.

All of this assumes Oil prices remain at a level that Enquest is making a healthy profit (say $75 per barrel +). If you don’t believe Oil prices will be at least this level on average over next 5 years you should not be investing on O&G companies

Romanon

The investment allowance is not an offset against future profits and it is not ringfenced to a specific field.

The investment allowance is offsetable against total core and EPL tax you are due to pay in the year you make the investment. I accept that if you are a new start up venture without existing production you would have to carry forward until you start production. However very unlikely there will be new entrants to NS.

The way that it works is a company forecasts the amount of investment it will make in the following year and offsets 91.4% against forecast tax payable in determining the quarterly tax payment accounts it makes HMRC, with a true up to actual numbers in April of following year. Accordingly the company retains the 91.4% benefit in its bank account (by paying less tax) and depending on timing of cap ex during the year, will potentially have the 91% funding before spending the cap ex. Accordingly the need for bank financing going forward for new projects is obsolete - operator only funds between 5-8.6% of development costs.

I accept this only works if you are making taxable profits (which will be the case for oil over $30), but if oil drops to this level for an extended period we will be facing bigger problems. However this will not work in the short term for Enquest and other operators with tax losses as they will only be able to offset 46% of the Cap Exp against the EPL tax payments, the balance will be added to the tax losses carried forward. Accordingly the full allowance is only available in the year of spending once tax losses have been fully used. Probably 2025 for Enquest.

Norway does not give a cash refund for post FID capital costs and is far less generous than the UK in that the investment allowance (although higher at 95%) is spread over the first 6 years of production. Norway does allow an offset of 78% for exploration costs and will cash refund operators any amount of the exploration allowance that can not be recovered against tax payable in year.

Current U.K. tax system more generous than Norway but political sentiment in Norway towards O&G is much more positive and Norwegian government are trusted not to change tax rules. The real problem is that Labour hate O&G and will inevitably seek to destroy the industry.

L3

I attach an article from PWC which pulls together at a high level all the different elements of Decommissioning in UK.

https://pwc.blogs.com/energy_spotlight/2015/04/decommissioning-a-tax-perspective.html

The key basis of Decom taxation in the UK is that it is only a deduction when spent at the end of field life and given our decom expenditure at the moment is quite low, the difference between 50% and 75% allowance is not really material in the scheme of things. Also if Harbour paid PRT on the fields currently being decommissioned they will be getting 75% relief.

The taxation of Decom is quite a minefield and I can sort of understand why it was excluded from EPL.

In respect of a comparison with Norway. In respect of capital cost on field development Norway effectively funds 95% of the costs (costs incurred x1.22x78%) through capital allowance offsets. The difference between the UK and Norway is that in Norway this benefit is given equally over first 6-8 years of field operation. In the UK you get the benefit in the year you spend the money. Cash refund in Norway only applies in relation to exploration costs. Norway allows exploration costs to be offset against profits from production (thereby funding 78% of cost) and will repay in cash any amount of the 78% that exceeds tax payable in that year (only really relevant for new ventures with no existing production). In the UK the government funds 75% of exploration costs through offset against tax on production, but any unrecovered losses are carried forward to the next year rather than paid in cash.

You wont be surprised that our new EPL has effectively mirrored Norway’s tax system with a more generous allowance to support new field investment and a 3% lower rate. There are differences around decom and interest but the key difference is the timing of the investment allowance for new field investment - year 1 in UK and over 6-8 years in Norway.

Overall - if you could trust it not to change again under Labour - the current UK tax regime under EPL is more attractive than Norway.

Bensi

We should absolutely diversify to another region with our without EPL. I was a bit surprised that HBR got close to a deal with Shell principally in Norwegian North Sea. Firstly same basin and secondly 78% tax in Norway is higher than the UK. I would prefer Asia to Africa as more stable. Would have loved to have seen harbour develop Falklands.

The reason I believe that the North Seas is not dead is that no other Country pays 91.4% towards capital cost of developing a new field (probably more like 95% if you add a few green bells and whistles) as long you are paying equivalent tax on producing fields. However Labour’s threat of removing the allowance puts this in doubt for developments than can take 3-5 years to complete.

However if the government offered a “development deed” which enables the operator to claim compensation from UK government for any charge to the investment allowance before 2028, this would provide operators the guarantee that the allowance will not be pulled mid-development. It worked for decommissioning and over 100 “decommissioning relief deeds”have been issued guaranteeing the future tax reliefs for decommissioning expenditure.

I would be surprised in Eqinor, Ithaca et al are not asking Gov for this type of guarantee to FID Rosebank and Cambo.

If a guarantee was in place why would Harbour not invest in UK alongside overseas. There are a number of proven but undeveloped fields such as Bressay and Bentley owned by Enquest. They would not require funding as effectively paid for by reducing tax billl (Harbour would need to fund $50-86m per $1 billion of capital spend) and focus our own capital on overseas diversification.

Zebbo

Why would Mercuria pull out. On their own they are highly indebted, tax allowance for capital spend being pulled and they have a relatively hig cost of production. They would struggle to pay down their debt from lower post tax cash flows.

Whereas Serica is stuffed full of cash and the merger relieves them of all their debt problems.

The worse things get the more valuable is Serica’s cash

L3

The decom liability in the accounts is discounted, but it also disclosed gross of tax benefit. The gov contribution via tax reduction is approx 50% of the decom expenditure, which is offsetable against current year or earlier year tax payments.

Net liability is around £2.5b or £5 per barrel of remaining production.

Harbour did provide a decom forecast a year or so ago at $300m per year for medium term. It has been lower over the last couple of years but $300m feels like a good number for next 5 years say.

Agree on long term tax take but we need to accept this was about politics and the impact of consumer energy bills. If the EPL was a 100% tax on revenue over $90 per barrel (+gas equivalent), I think everyone would have said fair enough given need to subsidise energy bills. However I do not understand why government has not decoupled renewable energy pricing from the gas price. This would have at least stabilised the price of 40% of UK electricity costs.

There is a working group from Treasury currently looking at a branch and root redesign of the O&G tax regime and they are due to report in Q4. It s brief was to design a tax system for world posed post EPL but not sure we can wait until 2028.

L3

The tax treatment of decom costs is a whole subject in itself. There is specific tax legislation which for instances allows a company to claim a refund against prior year tax paid, if not enough taxable profits in year of expenditure (which Shell has done for last couple of years). Companies have also been offered indemnity agreements by the UK government since 2013 which allows them to seek compensation from UK gov if tax allowances related to Decom change in future (there are over 100 field specific indemnity agreements currently in place). I think this provides a potential precedent for current 91.4% investment allowance and would enable companies with projects at FID stage to be indemnified against subsequent government’s changing the tax rules.

To your question of current decommissioning costs per barrel of 2P reserves, I divided that current after tax decom liability of $2.5b by 980mb of reserves. However I have just spotted that the 980b of reserves includes 2C and 2P is closer to 500m barrel. so should be $5 per barrel of reserves and not $2.5.

I also agree with you that if only currently discovered fields are progressed it is as stay of execution, rather than a solution. It will be interesting what the current licensing round reveals - although it is very different to taking a licence and spending on exploration. Is 75% tax allowance enough - I personally don’t think so.

Kign

It does not matter if the field is successful or not, you get you 91p back as long as your are paying tax on other producing fields (the investment allowance is not ringfenced). With an Opex of $16 per barrel, it is almost inconceivable that we wont be tax paying. If oil does flounder in $20 range for multiple years we will have a lot bigger problem to face and our new overseas investments will be worthless.

While production is forecast to be down next year and opex up, we will still be paying approx $1.5b of tax (after benefitting from PMO tax losses) and this will likely rise to $3b+ in 2024 once the PMO losses are exhausted (on the basis we are still making $4b EBITDA after hedges end - should be $6-8b).

What is even better, the UK corporation tax payment on account regime requires quarterly payments of tax for the year ahead based on estimated annual tax bill after capital investment allowances. Accordingly we will get a good chunk of our 91p back (by paying less tax each quarter) even before we have spent the £1 on the project.

However the above only apples to post FID costs, exploration costs do not attract 91% allowance. The gov only picks up 75% cost of exploration (as a tax offset).

I think the real world test of the above will be whether Rosebank and Cambo are approved in the next few months. If they can count on the government funding 91.4% of the entire capital costs of several $billions, the answer is most likely yes. The wild card is the risk of Labour Party getting into office and pulling the allowance mid project which, based on current rhetoric, is very possible. If I was equinor and partners, I would be looking for a guarantee from Kier S that it wont be pulled. If no guarantee then walk away - this would really shake up the establishment and provide the conservatives with political capital in next election. “Labour compromises UK energy security and damages Green potential as UK now needs to import expensive foreign oil and LNG from US, while Aberdeen becomes a ghost town”. Not that I am saying conservatives much better.

However until the general public understands and values our country’s NS assets as part of a properly planned green transition then we are pushing water uphill. Our tax system is still more generous than Norway but the difference is that Norway values its O&G sector and it is not seen as the whipping boy.

L3

All analogies are flawed to some degree. However I think we can except that unless oil drops to $20 per barrel and stays there for a prolonged period, harbour will always be paying tax. Accordingly there will be capacity to offset investment allowances against annual tax bill. My estimate is that at $50 per barrel Harbour will be paying approx $1.5b of tax.

Accordingly it is almost guaranteed that the House will pay you back 91p for every £1 invested as long as the House does not change the rules (big IF as a new dealer in town in 2025). Even if the well is a duster and you lose the bet you still get your 91p back.

In reality the 91p only applies to post FID expenditure and I do fully agree with you that new green field exploration is dead and the projects which will progress are those that are already discovered or near field expansions. I deliberately excluded AbEx as it has its own unique tax regime and will roughly cost harbour $2.50 per barrel of 2p reserves after government contribution.

My view is that there is only the US where you can rely on O&G not being totally shafted due to strength of lobbying and consensus needed to pass new tax laws. Would you really trust a Central African government not to streak your profit once you have spent the £billion needed. I think we will see with the Tuna deal that Harbour is putting up all the risk capital and we are capped at a very modest return if successful with 100% of downside if not.

At least in the UK the government picks up 91% of the downside on the capital costs of a failed project as long as you are tax paying on your other in production assets.

KIGN

Not quite right.

If you decide not to continue investing you keep your £1.30 as you say and go away.

If you continue to invest your £1.30 goes down to £1.21 (spend £1 and get 91p back) and you then received your 30P after tax profit. So at the end of year 1 you have £1.51 in your pocket which rises by 21p every year there after. Your cash in pocket never goes below £1.21 and is £2.57 at the end of year 6. Not great but solid.

Or you take your £1.30 and spend it in a foreign land and at the end of year 1 you have nothing in your pocket and the hope that you will make a greats return and that country’s government wont then steal it off you.

ultimately you need diversification but the “grass is greener” is usually a myth. The great unknown in all this is whether, under labour, you will get back 91p for each £1 invested.

Normasits

An “as you are Serica” would probably only reverse the share price decrease on announcement.

However a Serica which commits to distribute all cash by 31 March 2023 of an amount approaching £2 per share and then run the business with a dividend distribution of 60% of FCF with sustaining cap ex only would be very interesting. our share price is valued at $6 per barrel of reserves after adjusting for cash (probably closer to $5 now), Which is the lowest in the sector. This is principally due to a heavy discounted applied to the company’s cash balance by the market due to risk of poor capital allocation. This discount could be removed by agreeing to return it to shareholder.

Well the market certainly got that right. This deal reduces net cash per Serica share by over £1 and generates a few pence of earning and cash flow accretion.

The challenge for UK M&A is why would you buy and pay over $12 per barrel of 2P reserves yielding say 50,000 barrels a day when you can invest in a couple of new, proven but undeveloped fields at a cost of around $15 per barrel of reserves . Under the EPL the government will fund almost $14 of the investment via reduction in tax bill and so only just over a $1 per barrel for the operator to fund.

Even if oil drops to $50 per barrel harbour will be generating $2b of taxable profits and paying $1.5b in tax per year once our PMO tax losses run out - So more than enough tax to offset the most ambitious capital programme. I am trying to work out whether Linda is throwing her toys out of pram but my guess is the greater concern is whether the next government will materially reduce the investment allowance and increase the tax rate. While EPL is back door theft, I believe that NS could still be investable if you could rely on the investment allowance not being pulled mid-project, combined with a sensible price floor and certainty of EPL rate.

If you went to the Casino and the house paid you back 91p for every £1 you gambled and they let you keep 25% of the winnings there would be a big queue.

Jan

Good question. if you assume $600m of debt at year end and include $1b of liabilities for leases and unpaid Magnus consideration, Enquest is valued at approx $11 per barrel of 2P reserves. Tax losses are worth at least $5 per barrel of 2P reserves. Thus compares with Serica’s valuation of Tailwind at $18 per 2p reserves including a similar level of tax losses per 2P reserves.

A premium of 50% above current share price would add $1 per barrel of2P and would still be relatively cheap. Plus Harbour would get Bentley and Bressay as relatively low risk developments which could be delayed until next Government confirms O&G tax policy in 2024

How would shareholder regard an offer of 33p. Would they need to go to 40p?

However I don’t think Linda could contemplate a UK deal given the position she has taken. Not for 2023 at least.