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Bond of the Week: 27 November 2013
Bond of the Week : 27 November 2013
Premier Oil, a company I remember from the 1980s as a swashbuckling explorer, has launched its first retail bond. Although a well-known equity with a large private client following, it is not a name much seen in the bond market. Currently there are a few private placement USD bonds but nothing in Sterling. As an infrequent issuer the company has no rating. Premier is a FTSE 250 company with a market cap of £1.8bn. Interestingly its launch follows immediately after the closure of the tap for Enquest 5 ½% 2022, the other oil company represented on the ORB. Unfortunately time restraints meant I was unable to write up this issue but I think it should be possible to add a few compare and contrast points between the two FTSE 250 companies – there are many similarities. Here are the terms of the Premier Oil offering:
Issuer: Premier Oil plc
Tony Durrant, the CFO was kind enough to make time to talk to me over the phone. Before we got down to discussing Premier Oil itself I asked him where he thought the oil price was going. Premier Oil’s base case is an oil price of $85 per barrel, with a lower case of $65 and an upper one of $105. This of course is low given the current Brent spot price of $112 is already above Premier’s upper case. The reason for Premier’s conservative outlook, which is of course good from a bondholders’ perspective, is that owing to commodities having become an investment class a large portion of oil is held by non-consumers and should the investment winds change, fund selling could weigh heavily on the price. Nevertheless beyond this immediate concern Tony remains positive on the future oil price. At this point I should add Premier’s cost of production ranges from sub $10 per barrel in Pakistan, which is on-shore, to about $50 from their Norwegian fields. They therefore have good room for manoeuvre.
The current management at Premier Oil was installed in 2005 and this produced a sea change. They moved from being an explorer, or elephant hunter in the words of the CFO, to being a producer but still maintaining an interest in exploring. Currently 25% of capital expenditure is designated to exploration. Since 2005 Premier has pushed production up from 30,000 barrels a day to 60,000 and with projects in hand they will surpass 100,0000 per day in the medium term. I suppose you could say they have become a mini Major in the oil world. The Majors, though, have declining reserves, hence their move into large risky deep water exploration (eg offshore Brazil) where the cost of recovering oil can reach as high as $75,whereas Premier is still growing reserves at around 10% per annum. Moving into being a producer has resulted in healthy and improving free cash flow. It has moved up from $352million in 2008 to $808 million in 2012. A caveat is of course that oil companies, particularly offshore oil companies, have very heavy capex programmes so much of the cash is sunk straight back into the business.
Premier operates 20 different fields so they do have diversity to protect themselves against event risk – assuming that the event is not a crash in the oil price. This is in comparison to Enquest which is only producing in the North Sea although of course bar a break out of gunboat diplomacy over demarking the Scottish English maritime border in the unlikely event that Alex Salmond wins the independence debate, the political risk in the North Sea is very low compared to some of the exotic locations in which Premier is drilling.
The North Sea represents 42% of 2P reserves (proven plus probable) and 23% of production. However, contingent resources – ie potential reserves that are yet to be categorised as 2P – are relatively low which is not surprising given the North Sea is a mature exploration area. [Enquest operating only in the North Sea specialises in maximising extraction from “late life” oil fields]. Premier has large tax losses/ allowances of approaching $2.3bn, following a takeover of a loss making company, so it is unlikely any tax will have to be paid in the UK for 5 years. Given the corporate tax rate can be 90% this is very positive for cash flow. Indonesia accounts for 33% of 2P reserves and 24% of production. The jewel here is a contract to supply gas to Singapore (they supply a third of Singapore’s energy needs) on a take or pay basis until 2029. The gas price paid is a very good price. As to whether Singapore could re-negotiate the terms I was told it was unthinkable for Singapore to renegotiate what was in effect a government to government contract to the detriment of a much poorer neighbour. I suggested it was also a much poorer neighbour with a much larger army. Tony did not demur. Vietnam has 12% of 2P reserves and 26% of production. I asked about maritime territorial disputes with China and Tony told me they were not too near the border although they did see the odd Chinese gunboat chugging by. Pakistan matches Vietnam’s figures with 12% of 2P and 26% of production. Being onshore fields the cost of extraction is very low and this produces free cash flow of $100 million per annum. In Pakistan they employ local operators and distance themselves from the operations – I presume for obvious reasons.
The great hope for the future is the Sea Lion field in the North Falklands basin (about 80 miles North of the Islands). At 233 million barrels of contingent reserves this represents 50% of total contingent resources. The board of directors are waiting for various engineering reports and, following approval, are then likely to move some of the 233million barrels up the tree to show up as 2P reserves. I asked a bit about the Falklands exploration and whether it had proved a disappointment in general. Apparently the problems had occurred with the South Falklands basin where so far only gas has been found (which no-one wants down there) and is geologically much more challenging. The North Falklands basin on the other hand is not dissimilar to the North Sea from an engineering point of view. It was also early days as so far only 20 wells had been drilled compared with several hundred in the North Sea – a similarly sized potential area of production. Nevertheless the Folklands is not going to turn out to be the bonanza that some at first thought.
While looking at Premier’s production, I should make the final point that technology for offshore extraction is always improving. They do not use the older fixed concrete platforms but rather large floating platforms that offload straight onto oil tankers. This method is cheaper to construct and cheaper to decommission and is known as F(floating) P(production) S(storage) and O(offloading) to be technical about it. I note Enquest is converting their North Sea Kraken field to FPSO. I am not sure I would like to spend much time being tossed around on a floating platform in the Southern Ocean – perhaps Premier targets their job advertising heavily at the Icelandic deep sea trawling community.
And now for a look at the financial side; Premier has been profitable for the last 5 years, finishing 2012 with post tax profit of $252million. The company is 40% geared which is higher than Enquest’s gearing. However, and this is the point that the managers of Premier’s new issue are keen to point out, much of Enquest’s debt is secured and therefore bond holders are structurally subordinated. Premier on the other hand does not give security to its lenders so bond holders will rank pari passu with the banking syndicate. I was told that the company had now “graduated” to a level where it does not need to offer security on its debt. Premier Oil’s facility is for $3bn and $2.1bn is drawn. The facility is to be renegotiated by 2015 but I do not see that as presenting any problems. The reason for the ORB bond is partly to diversify sources of funding but mostly to extend the maturity profile of their debt. Their $ private placements are all in the 2020 to 2024 year range. The company also has a conservative hedging policy and has sold 38% of 2014 production forward at a price per barrel of $104. 24% of Indonesian gas supply has been hedged for 2014. Finally the company’s oil reserves have an average life of 13 years (2P/ current production rate). In practice the life will be longer as flow rates start to decline as fields age – maximum flow is normally only for the first two or three years.
Conclusion. I think this issue will go well and should trade up to a good premium (although I don’t expect its performance to be as stunning as A2 Dominion’s 4.75% bond). There is a dearth of good quality issuers and I think it fair to say Premier Oil is good quality. Since the new management has taken over the share price has trebled, even if it has rather trodden water since 2011. It has very good cash flow, operates diverse fields and is not heavily geared. Should something go terribly wrong the fact that the ORB bond will rank pari passu with the banks is a major plus. I prefer it to the Enquest tap (which has closed now anyway). That was offered at 5.23% yield (101.75) but it has a year and a quarter longer maturity. While I think Enquest is a good credit, I think it worth giving up the extra 23bp for the lack of structural subordination, the diversification of areas of operation and the better name recognition (as well as the shorter maturity). As an inaugural issue you are also likely to get more oomph as far as price performance goes compared to a tap. I have put in for some myself. I leave you with a final point. Premier Oil’s CFO told me that their share and indeed the whole sector was trading at an all-time low valuation. I am no equity analyst but maybe the Ords of both Premier and Enquest are worth a peek. You will need to do your own research on this. Frequently retail bonds have pointed the way to interesting opportunities in the shares of the issuer.
PS A short word on taps. The Enquest tap produced a rather disappointing fund raising of £10 million as the Premier Oil issue rather shot their fox. However, the recent IPF tap, although raising a more respectable £35 million, still did not fly out the door. I understand it was a somewhat difficult birth. I think the lesson is that we in the retail bond market want new issues, not taps. We want to pay par and not an elevated price for some second hand pass me down paper. And I think we are right. It is much better to have a choice of maturities and a pristine bond with tempting features dangled before our eyes; we need motivation to heavy ourselves out of our bath chairs.
Oliver Butt is a Partner in City and Continental LLP, a leading independent broker in fixed income. The author and or the LLP may hold a position in or trade in any of the securities mentioned above.
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