According to the latest figures from industry body Oil & Gas UK, it costs an average of £17.80 ($25) to extract a barrel of oil from the North Sea.
One factor that’s excluded from this figure is finance costs. Heavily-indebted North Sea operators have avoided problems in this area so far with hedging, which guarantees a minimum sale price for future production.
But most companies’ hedging coverage is starting to tail off. If oil prices remain below $50 into 2017, I expect to see companies such as Premier Oil (LSE: PMO), Ithaca Energy (LSE: IAE) and Enquest (LSE: ENQ) facing problems servicing and refinancing their debts.
This could lead to emergency fundraisings of the kind we saw with Afren last year, in which shareholders lost almost everything.
Premier Oil
Shares in this former FTSE 250 company have fallen by 86% over the last year. The firm’s equity is now valued at just £97m ($138m), while its net debt is $2.2bn. The group has already been forced to negotiate more relaxed terms from its lenders, but I believe things could get worse.
During the second half of 2015, 60% of Premier’s oil production was hedged at an average of $92.3 per barrel. In 2016, this hedging cover falls to just 25% of forecast oil production, at an average of $69 per barrel. That’s a massive reduction in cash flow from hedging.
Although the firm’s planned acquisition of E.ON’s North Sea assets should help to improve cash flow, it’s not clear to me whether this will be enough.
Ithaca Energy
Shares in Ithaca rose sharply on Thursday, as oil hit $34 amid rumours that Russia and OPEC may agree to cut oil output.
However, even if this happens, it may not be enough. Ithaca’s net debt at the end of 2015 was $665m.The group’s latest update indicates that while most oil and gas production during the first half of 2016 will be hedged at about $60 per barrel of oil equivalent (boe), this coverage will tail off during the second half of this year.
In 2017, hedging coverage will drop to 7,000 boepd at $62. By 2017, Ithaca expects to be producing 25,000 boepd following the start-up of the Stella field. The majority of this seems likely to be unhedged.
I suspect Ithaca could face serious problems in 2017 if oil prices remain low.
Enquest
Enquest’s net debt was expected to be $1.55bn at the end of 2015, thanks to the ongoing costs of developing its Alma/Galia and Kraken fields.
For 2016, Enquest has hedging in place at $65 to $68 per barrel for 10m barrels of its forecast production. This is around 60% of total expected production and is similar to 2015. A lower average oil price could push Enquest’s revenue lower this year, but I think the big risk is 2017.
Enquest is due to start repaying debt in 2017. With expected operating costs of $26 to $28 per barrel, it could take several years for the firm to make much of a dent in $1.55bn of debt.
In my view, this risk is why Enquest’s share price has fallen by 90% over the last two years. Until the group’s debt levels come down, shareholders won’t be entitled to any of Enquest’s earnings. Buying now looks risky, in my view.
