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Bond of the Week: 28 January 2013
Bond of the Week : 28 January 2013
· Could they suffer a North Sea version of the Gulf of Mexico BP Macondo blowout? This is very unlikely. The BP platform, employing previously untried technology, was drilling at much greater depths. More importantly the BP field gushed whereas Enquest’s mature fields only ooze.
· How vulnerable are they to a fall in the oil price? Not very; their operational cost per barrel is $31.6 per barrel. There is an additional capex cost of $10-15 for existing fields and $20-25 for new fields. However, capex costs are sunk expenditure. I cannot see oil prices getting anywhere near this breakeven level even if capex costs are included.
· What about the costs associated with decommissioning – could they get out of control? The words “decommissioning costs” bring to mind the nightmare experience of the nuclear power industry. However, to compare the two would be a fallacy. The environmental risk is largely dealt with by sealing off the well which is a “simple” task. Then it is a question of disposing of the rig. Fixed rigs are expensive to decommission but with Thistle the decommissioning costs have entirely remained with BP and with Heather (Enquest has a 100% working interest) they are only liable for 37% of the costs. Elsewhere they have floating platforms. These are much cheaper to be disposed of as they can be towed away to a low cost destination for break up (away from the eagle eye of Greenpeace?).
· How good is their cash flow? By the nature of their assets Enquest has excellent cash flow. In 2010 it was $267 million, in 2011 $656 million and $240 million in the first half of 2012. Typically these fields will provide declining streams of oil. Therefore cash from investments gets returned quickly. I give as an example the Alma Galia fields which are shortly to come on line. In 2014 26million bpd are expected and this declines rapidly to under 4bpd 9 years later, only a sixth or seventh of initial production.
· What about capex expenditure, how controllable is it? Capex is flexible and largely at the discretion of the management. The amount spent, as appears on their balance sheet, is certainly volatile. In the first half of 2011 it was $108 million and this leapt by a magnitude of nearly five to $504 million in the first half of 2012. This leap can largely be explained, I believe, by the approach of:- have money at the bank, will spend/ invest. In 2012 the largest item by far of capex was investment in Alma/ Galia to bring it online in 2013 (cash flows back pretty quickly from this) and the third item was acquisitions. Apart from that most capex is spent on improving platform facilities, replacing 1970s equipment/ technology etc. leading to improvements such as increasing oil produced from 70% to 95% watercut. (The watercut is the point at which the ratio of oil to water that comes out of a well pipeline ceases to be profitable. I.e. 5% oil can now be recovered profitably whereas it used to need to be 30%. It is always good to learn something new!).
· How indebted are they? As of today, this might surprise you, they have no debt and their first debt will be this issue. They have a committed loan facility from the banks to the tune of $525 million which has a floating charge on the assets of the company. However, this facility is currently undrawn. Finally it should also be noted they have deferred tax liabilities of $638 million. Oil taxation is fiendishly complicated. Corporation tax was increased last year to 62.5% from 50% in a last minute Osborne lunge for revenue (knocking the shares at the time). But since then, after howls of justifiable indignation, additional allowances to encourage further brown site and marginal production have been introduced. The effect of all this is that very little money, if any at all, currently passes to the exchequer (in the confusing jargon of Enquest they refer to paying no cash tax). So long as Enquest expands and takes on more capex taxes keep getting delayed. They can write off, for instance 100% of capex against tax. The deferred tax, which is not a precise sum as to what will eventually be paid, appears on the balance sheet as a provision. While an ever upwardly creeping number may of course look worrying you can take the view that as the tax that is deferred can be used as cheap financing for future development.
Given the lack of debt, good cash flow and seemingly good outlook for the oil industry where might the problems arise? Potentially problems could come from too fast expansion (interestingly since launching their bond road show Enquest have bought an £18.75 million stake in the Alba oil field – they are already spending their bond proceeds!). The company is in expansion mode and they do not pay a dividend on their shares for this reason. This is natural given their claim they are able to make returns of 20-30% on new investments. The current pristine debt picture cannot therefore be expected to last.
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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