EnQuest acquisition: Ability to extract net economics (NAV) will be demonstrated over time

EnQuest’s agreement to take over operatorship of Magnus, SVT and associated infrastructure is a material operational undertaking, especially when considered in parallel with commissioning and ramp-up of production at Kraken. The transaction will involve EnQuest taking on several hundred onshore and offshore staff and contractors. With this in mind, EnQuest’s staged approach, which involves taking on just 25% of Magnus and an additional 3% of SVT at the outset, appears to be sensible. The combination of deferred consideration payments, a ‘call’ option on additional equity in the transaction assets and downside protection mechanisms suggest that EnQuest is backing its ability to maximise value from late-life assets without exposing shareholders to potential downsides. EnQuest has until 15 January 2019 to exercise its option over an additional 75% of Magnus and related transaction assets, giving it time to understand the operational complexities as well as study decommissioning options before taking on risk.

The net economics of the transaction (and net NAV impact) will be largely driven by EnQuest’s ability to reduce opex costs from current levels (we estimate that these may currently be around current spot oil prices) by increasing oil production and production efficiency, increasing oil recovery (significant potential exists in the Kimmeride Clay where current oil recovery is just 30%) and through deferring and reducing decommissioning costs. From an opex perspective there is a material opportunity to reduce Magnus onshore costs and overheads, as well leverage logistical synergies (supply vessels and helicopters) to bring down costs closer to group levels (c 25$/bbl).

Given the size of the Magnus platform (over 70k tonnes), decommissioning is likely to be an important consideration when it comes to deal value. Before exercising its option, EnQuest’s liability is restricted to the maximum of 7.5% of BP’s actual post-tax decommissioning cost and cumulative positive cash flows from the transaction assets. On exercising its option, its exposure is uncapped on the additional 75% it would acquire of Magnus.

The deal does come at a price. In the event of option exercise whereby EnQuest acquires 100% of Magnus, 9.1% in SVT, 27% in the NLGP and 11.5% in NPS, BP will receive 100% of net cash flows from the transaction assets until the non-cash consideration of $285m is recovered. This is followed by a BP cash sweep of 37.5% of net cash flows until a further $1bn is recovered. Shareholders will need to be aware that while the anticipated step-up in production from Kraken in H217 will drive a corresponding step-up in cash flow from operations, EnQuest expects it will take around two years (at current oil prices and assuming a three-well programme on Magnus) to see a cash benefit from the transaction assets. Depending on the tax structure of the deal it does sound like BP is benefiting from EnQuest’s fortunate tax position (we do not expect EnQuest to pay cash tax on Magnus) – BP is divesting an asset while still receiving a significant percentage of transaction asset cash flows in the early years that are protected from cash tax through EnQuest’s historic tax shield.

The transaction highlights EnQuest’s confidence in its ability to drive the recommendations of the Wood Review, maximising economic recovery from late life assets, and the use of innovative transaction structures to facilitate the transfer of mature assets from the hands of the majors to ‘leaner’ operators. EnQuest analyst NAV upgrades are understandable, but we expect there to be significant uncertainty over the pace of opex reductions as well and the timing/cost of decommissioning (we believe the gross decommissioning cost for Magnus and the transaction assets could be well over $700m), which will ultimately drive net economics. With EnQuest now on the verge of producing over 50kboe/d we expect management focus to shift from growth to operational execution to extract maximum value from its expansive asset/resource base.