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North Sea oiler receive tax deduction for capital expenditure (both core and WFT) as a first year allowance. As a result the accounting charge for depletions and amortisation is not an allowable offset for taxable profits.

Unfortunately Enquest did not provide any details on the likely WFT charge for 2022 but Harbour energy did. They disclosed WFT of $400m for 7 month to 31 December at 25%. This translate to an annual WFT tax charge at 35%, if 2023 profits are same as 2022, of $1.1-1.2m. Harbour has roughly 4 times the U.K. production of Enquest and so why would $300m (a 1/4 of Enquest) be so out of line? Also Harbour are spending more on Cap Ex proportionally than Enquest and will have higher deduction.

We might not like to hear now much the government has stuffed us, but burying head in sand and hoping it goes away is not the answer.

As previously noted taxable profit for WFT will be very close to EBITDA as interest, depletion and ABEX is not an allowable offset for WFT.

I may be over simplifying but I used $1b U.K. EBITDA for 2023 which is a reasonable proxy for taxable profit for EPL (interest and AbEx not offsetable) at 35% to give $350m. I have then used $100m of cap exp for which we get a 45% deduction against EPL (not the 91.4% because of use of tax losses) - rounded to $300m. This generates giving $600m of U.K. FCF before EPL ($1b -$135m lease - $54m contingent consideration - $100m interest -$100m cap exp - $20m AbEx). I do not have estimate for Malaysia.

If I have got any of these assumptions]s widely wrong then please share. What we might see in operational update is an estimate of EPL for second half at old EPL rate. If this is around $80-100m then $300m for 2023 is in the ballpark. I hope I am wrong but not long to wait.

In addition to what I am expecting to be a positive trading update tomorrow, I hope we will get guidance on the likely EPL impact for second half of year. This will allow a relatively accurate forecast for 2023 full year impact. I am estimating an additional tax grab of $300m per year or about half of free cash flow.

Continuing oil’s house analogy,. It may have been buying the house at £4 when you perceive the value to be £7 was a great deal at the time. However when the mafia come along, without any warning, and decide to take 75% of the house off you for no compensation, the value of the house goes down. What might have legitimately been a great deal at the time now, with the benefit of hindsight, looks crappy..

Ultimately I don’t think anyone could have predicted the size and scale of the tax grab.

I would add to the debate that share buy backs are also a more tax efficient way of returning excess cash back to shareholders as it generates a capital gain for shareholders as opposed to more highly taxed income.

While a difference between the share price and Board’s view of worth is a driver it should be driven by the fact that the company has excess cash which cannot be invested at a greater return than of its shareholder cost of capital. In the real world it also a tool to manipulate the share price to allow companies to improve comparative share price performance to trigger director bonuses.

I agree with others that the priority should be to pay down debt as once our historical tax losses have been used, annual Free cash flow will be in $1b region and we will need that to fund overseas diversification.

There is going to be a seminal moment in Q1 2023 when shell, Elinor and Ithaca Fid Rosebank, one of the biggest recent NS projects. If they pull the project there could be a change in policy, if they proceed the government will conclude the new tax arrangement are generous enough to encourage investment.

Infor

The 91.4% relief only applies if you are paying both the normal 40% tax and EPL. Because harbour have tax losses which will offset the normal tax for 2023 and some of 24, we will have a cash benefit of roughly 45% of qualifying investments. The other 46% will be added to our tax losses and we should get the benefit in 2024/25.

Accordingly the incentive for NS oilers with tax losses brought forward it is not quite so attractive.

I think the real challenge for Enquest is that there is an additional $1b of quasi debt in contingent consideration and lease liabilities - so really debt is $1.75b. If you value FCF at 5 times (20% cost of capital) gives an enterprise value of $2b and equity value of $250m. This will however rise by $400m per year as debts are repaid and production replaced as long as oil remains high.

Tarmak

I think your estimates are quite close. The additional EPL will be $350m before investment allowance, which based on 2022 cap ex (€165m) will reduce the additional tax to $200m on a proforma basis for 2022 (actual EPL for 2022 will be quite low at $30m due to timing of capex, 7 months and lower rate.

Accordingly unless Cap exp is increased above 2022 level, Enquest will pay $1.2b extra tax over next 6 years if oil prices remain at current levels. That is almost double our market cap!

Legalised robbery. at least Dick Turpin had the decency to wear a mask.

Comrie - I am afraid that EPL is here to stay irrespective of oil or gas price. The government were clear in the briefing paper that it would not be removed even if oil and gas prices fall. However a working group was established to consider an alternative tax an incentive structure for NS oil and gas and is due to report towards end of 2023.

We all knew there was a Brexit trade off. More freedom and self control in exchange for a poorer economy. The BofE forecast a 3% Brexit related contraction in the U.K. economy and they reported last week that there forecasts have now been realised.

No point in moaning now - just need to play out a bad hand as best we can. Maybe in 10 years we will be in better shape but what is clear in the short term is that the U.K.in 2010-2016 was a top choice for foreign direct investment, we are now a pariah.

Comrie

As you note the great unknown is gas prices going forward - oil more predictable. Quite hard to hedge gas at long term attractive rates. If you believe that gas will remain at 4-5 times the price pre Ukraine invasion forever then your revenue assumptions are correct. I have no idea but I hope for British homeowners gas returns to something below 100p per therm.

Comrie - you realise that 79p therm gas is equivalent to about $50 pbbl oil.

Pearls

Harbour have no choice but to continue investing in NS to receive the 91.4% tax offset. The existing NS operators are trapped! Would you invest in a business if the government offered to give you 91.4p for every pound you spend and you could keep 25% of any subsequent profit.

This motivation only works if you have an existing business and certainly there will be no new international equity flowing into NS for new ventures. Also banking sector will not lend to fund new projects unless you have an established core business to use tax offsets. Also there will be very little new exploration and focus will be on developing low risk proven reserves which attract the tax offset. There is also little motivation to be highly efficient in allocating capital if government picks up 91.4% of bill - over 100% for decarbonisation projects. It will be interesting whether the new licensing round attracts any interest. It would be a fantastic statement if there were no bidder for new licenses.

NS has been effectively nationalised with the equity holders getting some crumbs off the table to continue as operators.

Another very simple way of looking at the impact of WT is that after investment allowance we will be paying $0.5b of extra tax per year for 6 years ($3b) which in sterling terms is £2.9 per share. I had a value expectation of £8 per share once hedges fell away in 2023/4 which if now closer to £5 thanks to WT.

The good news is we have only fallen by £1.8 per share so far.

Comrie

Apologies I have not been clearer in my explanations and let me take it back to first principles and hopefully it will be clearer.

I have assumed 2024 revenue of $6.5b (200k per day at $90 pbbl equivalent). Operating costs at 15 pbbl equals $1.1b and admin, overheads and central costs of $0.4b. This results in operating cash flows (EBITDA) of $5b. This will also be close to the taxable profit before investment allowance.

$b
Taxable profit 5.00
TAX AT 75% (3.75)
Post tax 1.25
Tax rebate capex . 0.91
____
Cash pre cap ex 2.16
Capex (1.0)
Abex (0.3)
____
FCF 0.86

Comparing the above to FY2022 projected FCF of $2.2b the key differences are.

WT for 7 months projected by the company at $400m. Annualising and increasing rate to 35% results in a 2022 WT full year charge of $960m which compares to $240m paid by 31 Dec 2022. So if WT had been in place for 2022 the $2.2 would have been $1.5m. The core tax has also been reduced by £500m due to historic loses carried forward which will be used by end 2023. In addition 2022 cap ex was $300m less than expected run rate. So adjusting 2022 to apply full year WT, remove benefit of remaining historic PMO losses and normal Cap exp, results in proforma FCF of $700m. The increase from 2022 proforma of £0.7m to 2024+ of $0.9b is $10pbbl of additional revenue ($730m) of which we get to keep $180m.

You can make your own assumption on long run energy prices. I personally think oil will be closer to $100 pbbl but gas lower in the long run.

Hope this helps explain

Comrie

I cannot answer the CCS question but I am assuming g their will be very attractive tax incentives. I also do not understand the carbon capture business model -how much do we get paid for carbon offsets and by whom.

On the post tax cash flow model it is quite simple - I have used EBITDA as a proxy for taxable profits and assumes it is $5b as hedges start to fall away. I have assumed an effective tax rate of 80% rather than headline rate of 75% due to certain costs like decommissioning and interest not being offsetable. This results in tax of $4b and $1b for harbour. There is then the allowance for new project investments. Assuming we spend £1b we receive a tax refund of $910m so net cash cost of $90m. So cash available for shareholders is $1b less $90m net capital expenditure -$910m.

The EBITDA could be higher and the effective tax rate might sit somewhere within the 75-80% range depending on the amount of decommissioning in any year. However I think €0.9-1.2b pa for shareholder distribution, if oil and gas stays high in the long run, is a reasonable forecast.

Comrie

Take a look at slide 29 of neptunes latest presentation. Neptune are forecasting pre cap ex cash flows of $2.5-3b after paying $1.3b of tax. Post capex and tax their forecast is $1.8b to $2.3b.

Your question is a good one, namely how can they yield free cash flows of over $1.8b or €1.3b assuming similar CapEx in long run. Their U.K. business will certainly generate less cash flow going forward but this is only 15% of their production.

Neptune have a Q3 presentation on their website. However basic reason is their operating costs are lower per barrel and they are realising higher revenue per barrel as they have less and better value hedges.. They are also spending about $0.5b less on Cap Ex and AbEx than harbour.

Baysil

It would be nice to see what offer they would come up with. I think they would struggle to fund a $4b cash offer in the current market so more likely a merger. Also they would have to merge via a reverse takeover to maintain london listing.

Their Results for first 9 months of 2022 are impressive and 2022 guidance is similar FCF to Harbour from 75-80k barrels per day less thanks to lower hedges and higher gas mix. They are also paying 75% tax!

Sekforde

I will be very happy if we hit the $2.2m upper threshold - anything above will be a Brucey bonus. But this will have benefited from $300m less cap ex and abex than planned and we will not have paid half of EPL until January 23.