Category Archives: Oil & Gas

Oil platform in North Sea

Four simple reasons to avoid Premier Oil plc

Oil platform in North SeaDisclosure: I have no financial interest in Premier Oil.

Premier Oil’s interim results confirmed my view of this stock: this company has good assets and is operating well, but its debt situation means the stock remains a sell for equity investors.

Here’s are four reasons why I think big losses are likely for Premier Oil shareholders.

1. Covenants would be breached if tested

Net debt rose to $2.6bn during the period and is expected to peak at $2.9bn during Q3. The firm’s net debt/EBITDAX ratio was an eye-watering 5.2x at the end of June, significantly above the firm’s covenant maximum of 4.75x. This is why covenant tests have been suspended while refinancing discussions are ongoing — Premier and its lenders don’t want the firm to fall into default.

However, the significance of this situation is that Premier’s lenders have the firm over a barrel. Premier can’t walk away and find a better deal elsewhere. It has to reach an agreement with its lenders, otherwise it will default on its loans and risk being put into administration.

2. “A full refinancing”

Premier isn’t just tweaking the terms of its loans. In the results webcast yesterday morning, Premier’s FD Richard Rose said that the current debt negotiations are “effectively akin to a full refinancing of the group”.

Mr Rose also explained that the firm has “four or five” lending instruments, each of which has multiple lenders behind it. He estimates Premier is dealing with about 50 lenders in total. So the complexity involved in the negotiations is considerable. Reaching agreement won’t be easy and the lenders have the upper hand.

Premier is hoping to agree revised covenants and longer maturities on some of its loans. In return for this, management expects to accept higher interest rates and to use the firm’s assets to secure its debts.

Management also indicated that during the deleveraging process, Premier is likely to have to get lender approval for any major new investment plans. CEO Tony Durrant indicated that no major new investment spending is likely for the next couple of years.

Details of the refinancing should be finalised during the second half of the year. Shareholders may feel that they are safe, because Premier’s current 78p share price equates to a discount of about 40% to the group’s net asset value.

However, my view is that if Premier’s lenders are having to make compromises and wait longer for their money, then shareholders are also likely to face losses. One possibility is that lenders will get a slice of Premier’s equity, perhaps through the issue of a large number of warrants for new shares.

3. $5 per barrel

One interesting figure from yesterday’s call is that Premier’s interest costs currently amount to about $5 per barrel. This could rise as a result of the refinancing. This figure gives a real taste of the burden the group’s debt pile is placing on its cash flow.

At $50 per barrel, 10% of Premier’s revenue would be absorbed by interest costs alone. Repaying the capital on these loans at sub-$60 oil prices won’t necessarily be easy or quick, especially as the group’s cash flow faces an additional risk in 2017.

4. Hedging risk?

During H2, Premier’s existing hedging positions means that the group will be able to sell oil at an average of $65 per barrel. But in 2017, this coverage tails off. Premier’s figures indicate that current hedging will only provide an average oil price of $45 per barrel in 2017.

If the oil price doesn’t make progress above $50, then this lack of hedging could have a significant impact on Premier’s cash flow.

Only one conclusion

Premier was tight-lipped about the likely terms of its refinancing in yesterday’s call. But it’s clear from management comments that other potential sources of cash — such as pre-pay agreements for oil and gas sales — won’t be viable until the firm’s lenders have agreed a new deal.

I think there’s a reasonable chance the refinancing package will include some kind of dilution for shareholders.

Even if it doesn’t, shareholders should remember that both growth and shareholder returns will effectively be off the cards for the next couple of years. Furthermore, if oil stays low, Premier’s financial difficulties could become even more severe.

I can’t see any reason to own the shares at this point in time.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

What does the DNO bid mean for Gulf Keystone Petroleum Limited shareholders?

Onshore oil installationDisclosure: I have no financial interest in any company mentioned.

I’ll update this post when Gulf’s board issues a statement or any further news emerges.

Update 29/07/16 @ 1945: Gulf Keystone issued a response to the DNO proposal after the market closed today.

The firm says that as the DNO proposal is for a post-restructuring takeover, the firm’s focus remains firmly on executing the restructuring successfully. Significantly Gulf emphasises that:

“we will not engage in any additional process that causes the Company to be distracted from that objective” [the restructuring]

In my view this implies support for the DNO proposal. But even if I’m wrong, this story can only end one way. Gulf Keystone shares remain dramatically overvalued, in my opinion.

Update 29/07/16 @ 1010: Gulf Keystone has issued a holding statement saying it is reviewing DNO’s proposal.

Update 29/07/16 @ 0945: Gulf Keystone shares continue to trade up on the day at about 4.2p versus the restructuring share issue price of c.0.83p and the DNO offer price of 1p.

This is crazy in my opinion. Although the DNO bid arguably undervalues the long-term upside from Shaikan, it certainly doesn’t undervalue it by a factor of 300 per cent or more. I remain confident that Gulf Keystone shares have much further to fall.

DNO makes $300m offer for GKP

Norwegian operator DNO ASA has launched a $300m takeover bid for Gulf Keystone Petroleum Limited (LON:GKP).

The cash and shares deal is intended to be implemented after Gulf’s proposed refinancing has been completed.

DNO’s offer is priced at a 20% premium to the equity value of USD 0.0109 at which Gulf Keystone plans to issue new shares under its refinancing plan.

DNO appears to have designed the offer to attract Gulf’s bondholders. This makes sense, as with Gulf in default on its bonds, the firm’s bondholders are in de facto control of Gulf Keystone.

According to this morning’s release from DNO, here’s what’s on offer:

  • For the Gulf Keystone guaranteed noteholders, the DNO terms reflect 111 percent of par value compared to 99 percent under the contemplated restructuring;
  • For the convertible bondholders the DNO terms reflect 18 percent of par value compared to 15 percent under the contemplated restructuring;
  • For ordinary shareholders, the offer represents a 20 per cent premium to the share price of USD 0.0109 at which Gulf Keystone is planning to issue new shares as part of the planned restructuring.
  • $120m of the offer will be in cash, with the remainder in shares. This will provide bondholders who don’t want to hold equity to make an immediate exit in cash (rather than having to try and dump their equity into a soft market).

There’s no response yet from Gulf Keystone’s board. I’d imagine that this is because they need to consult with their bondholders before issuing a statement.

My view is that this offer is likely to be attractive to Gulf Keystone’s bondholders.

Will anyone outbid DNO?

DNO is the largest of the Kurdistan producers in terms of both production and reserves. This morning’s statement made it clear that DNO is top dog in Kurdistan, and points out that Gulf Keystone is already dependent on its pipeline connection facilities.

I particularly liked the way that DNO emphasised that its oil is better quality (higher API number = lighter oil) than that of GKP. Here’s an extract from DNO’s proposal:

DNO has been active in the Kurdistan region of Iraq since 2004 and ranks number one among the international oil companies in oil production (50 percent), oil exports (60 percent) and proven oil reserves (50 percent).

DNO holds a 55 percent stake in and operates the Tawke oil field at a current production level of around 120,000 barrels of oil per day (bopd) of 27 degree API crude. Gulf Keystone holds a 58 percent stake in and operates the Shaikan oil field at a current level of around 40,000 bopd of 17 degree API crude.

Production from Shaikan is transported daily by road tanker to DNO’s unloading and storage hub at Fish Khabur for onward pipeline transport to export markets.

In my view, this is an opportunistic but pragmatic and fair offer from DNO. The reality is that companies in financial distress — like Gulf Keystone — can’t pick and choose. Gulf may not have the luxury of waiting until the market improves before selling up.

Gulf Keystone bulls will presumably believe that today’s offer from DNO is the opening salvo in a bidding war. Personally, I doubt this. My view is that other Kurdistan firms are unlikely to make a competing offer. DNO’s deep connections in the region give it an advantage. I can’t see an outsider wanting to get involved given the complexities and risks of operating in Kurdistan.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

Answering questions about Gulf Keystone Petroleum Limited

Onshore oil installationDisclosure: I have no financial interest in any company mentioned.

I’ve received a couple of emails from readers regarding Gulf Keystone Petroleum (GKP.L).

The bulletin boards are awash with complaints suggesting that the board of directors have failed in their duty to shareholders — and that a takeover bid at a ‘fair’ price may be just over the horizon.

Rather than responding to emails individually, I thought I would comment on some of the points raised here.

For what it’s worth, I think a takeover bid is unlikely.

I think the real problem is that shareholders have misunderstood the significance of Gulf Keystone’s debt. The interests of the firm’s lenders rank above those of shareholders. Because Gulf is in default, shareholders are not entitled to anything until the firm’s lenders recover both the money they’ve lent and the interest due on it.

This is  how corporate financing works — debt is senior to equity.

It’s exactly the same as when a homeowner is in arrears on their mortgage. The mortgage lender can repossess and sell the home without any regard for the interests of the homeowner (who is the shareholder in this scenario).

A takeover would be expensive

The other point is that Gulf’s debt would inflate the true cost of any takeover.

For example, in a regular takeover situation, a buyer would have to accept and fund Gulf Keystone’s $575m of bonds, plus interest. In April, Gulf said that $71m of expenditure would be required just to maintain production at 40,000 bopd. So that’s $646m in total, plus interest, without any production increase and with the shares valued at 0p.

Adding interest payments plus a notional (and very generous) 20p per share would take this total close to $1bn.

And that’s without considering the investment needed to increase Shaikan production to Gulf Keystone’s medium-term target of 100,000 bopd. We don’t know what the cost of this would be, but Gulf said earlier this year that $71m would be needed just to maintain production at 40,000 bopd, while $88m would be needed to increase production to 55,000 bopd.

It’s probably fair to assume that the total needed to get to 100,000 bopd would be significantly higher, or else the firm would have mentioned it in April’s update.

Given the low oil price and the difficulties that Kurdistan producers have in collecting payment for oil exports, an upfront investment of $1bn+ in Shaikan may not be a very attractive opportunity. The return on investment could be lower and slower than expected.

What next?

As I write this on Monday morning (18 July), the shares have spiked up by 20% to 3.8p. In my opinion, this is a good selling opportunity. I expect them to fall to the refinancing price of 0.82p and perhaps below in due course.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Onshore oil installation

Lamprell delivers solid results but faces uncertain outlook: what should I do?

Onshore oil installationDisclosure: I own shares of Lamprell.

Yesterday’s results from Dubai-based oil rig builder Lamprell reported a net profit of $66.5m, ahead of forecasts for $59.4m. The firm’s balance sheet remains strong, with year-end net cash of $210.3m.

As I discussed in December, my concern is over what happens when the firm’s current order book starts to empty. Yesterday’s results provided a bit more detail on this.

Lamprell currently has an order backlog of $740m, of which 90% is attributable to 2016. That’s a big decline from a backlog of $1.2bn one year ago, but I can live with that in the context of the industry-wide downturn.

A more serious concern is that just $74m of revenue is attributable to 2017 and beyond. Investors need to pin their hopes on Lamprell’s bid pipline, which the group says is marginally higher than last year at $5.4bn (2014: $5.2bn).

Lamprell says it has massaged and reshaped the bid pipeline to focus on opportunities closer to home in the Middle East. As I’ve suggested before, Middle Eastern producers with low cost production (mainly NOCs) have not cut back as much as the supermajors and indepedent E&P companies.

Lamprell has modernised its facilities and is currently busy. The group is playing to its strengths, and focusing on core customers close to home. Despite all of this, I fear that 2017 could be painful. However, having halved my position in December, I’ve decided to sit tight and continue to hold.

But I’m still a little nervous.

Disclaimer: This article is provided for information only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.

Offshore oil or gas platform

7 oil stocks with long-term recovery potential?

Offshore oil or gas platformDisclosure: I have no financial interest in any company mentioned in this article.

This isn’t an article calling the bottom for the oil market — although I do expect this to happen at some point in 2016.

Instead, what I thought I’d do would be to suggest a few small and mid-cap oil stocks which appear to me to be well-positioned to ride out the storm and have attractive fundamentals for a long-term recovery.

This post was prompted by an article I wrote for the Motley Fool last week, in which I commented:

With oil now trading below $28 per barrel, I believe investors looking to invest in oil stocks need to ignore revenue and profit forecasts and focus on assets.

I’m looking for companies with cheap oil and gas reserves and enough cash to ride out the slump. I believe this approach has the potential to deliver big gains when oil prices do recover to more sustainable levels.

That’s the premise for this post. I’m looking for companies with three key qualities:

  • Net cash and minimal debt
  • Low valuations relative to their 2P (proven and probable) oil and gas reserves
  • Low production costs

To help create a short list, I used Stockopedia (disclosure: I work as a freelance writer for Stockopedia) to screen for oil and gas companies with net cash, as this is non-negotiable for me*. With hedging benefits fading away and debt becoming scarce and expensive, any company that may need refinancing in the next 18 months is a non-starter, in my view.

*With one exception, see below!

Here’s the short list of UK-listed companies I came up with. This isn’t a complete list — I manually filtered it to remove obvious junk, micro caps and companies with no significant production:

  • Amerisur Resources
  • Cairn Energy
  • Exillon Energy
  • Faroe Petroleum
  • Genel Energy
  • Ophir Energy
  • SOCO International

This is intended to be a fairly mechanical process. I’m not speculating about any of these firms’ future exploration/appraisal successes nor about their bid potential.

Company EV/2P Production Op. cost/boe Net cash/gross debt Market cap
Amerisur Resources $8.50/bbl 4,524 bopd $16/boe $55.6m/none £184m
Cairn Energy $6.60/boe 0 boepd n/a $603m/undrawn £740m
Exillon Energy $0.36/bbl 15,298 bopd $6.50/bbl $6m/$54m £130m
Faroe Petroleum $2.10/boe c.10,350 boepd $22/boe £81.7m/£21m £117m
Genel Energy $1.55/bbl 75,900 bopd $2/boe Gross cash $455m/Net debt due 2019 $230m £309m
Ophir Energy $7.62/boe 13,400 boepd $7.36/boe Est. 2015 Y/E: $250m/$325m £593m
SOCO International $12.46/boe 12,000 boepd $9.88/boe $96.6m/none £459m

Based on share prices at 24 January 2016. I can’t guarantee the accuracy of these figures: they were compiled after a quick trawl through each company’s latest results/website to gather the relevant information. DYOR.

A few comments:

  • Operating cost/boe are not comparable between companies as they are not all calculated the same way. I’ve relied on company provided data or made my own estimates, but the methodologies vary.
  • Operating cost/boe is not an analog for cash flow breakeven (which is far more important). For example, SOCO says it can achieve operating cash flow breakeven with an oil price in the “low $20s”. Genel says it can breakeven with Brent at $20. Yet both companies have much lower production costs per barrel.
  • Obviously some of these companies have specific political risks. For example Exillon (Russia) and Genel (Kurdistan/Iraq/ISIS). Funnily enough Exillon and Genel are the cheapest two in the list, based on a sum of operating cost/boe and EV/2P.
  • Ophir’s valuation should probably also take into account its 900mmboe of 2C gas resources — but who knows when they will be commercialised or how much equity the firm will give away to fund their development? I suspect this could be a great long-term asset play, though.
  • Cairn doesn’t yet have any production. We also do not really know what the operating costs for its North Sea developments will be when production does start in 2017.

Overall, it’s clear that even some oil companies with strong balance sheets and exceptionally low costs are currently valued very cheaply, relative to their 2P reserves.

I’d hazard a guess that at least some of the companies in the list above will deliver multi-bagging recoveries over the next 2-5 years. But I suspect one or two may not do, or will perhaps be forced to do heavily dilutive fundraisings.

Finally, I’d like to reiterate that these aren’t buy tips and I am not suggesting we’ve seen the bottom. I have no near-term plans to buy these stocks myself, although I do intend to monitor how they perform.

It’s worth remembing that even if we have seen the bottom for oil, it would be unwise to bet on a rapid recovery.  In my view, there’s a strong likelihood that prices will to stay below $50 for an extended time. Certainly I think it’s likely that companies which still have hedging protection, such as Faroe, will see theses hedges expire while oil remains well below $50. This is likely to have a very significant effect on cash flow.

Indeed, I suspect hedging expiries could trigger something of a shakeout among the more indebted North Sea operators, whose costs remain relatively high.

Disclaimer: This article represents the author’s personal opinion only and is not intended as investment advice. Do your own research or seek qualified professional advice before making any trading decisions.