You might have noticed that recently I have started covering a few companies in the oil and gas sector as being worthy of a long term investment, and in case you are wondering if I’m mad to be doing so given what is going on in the world, I believe that it is the right time in the cycle to start positioning again. Oil and gas are extremely cyclical in their nature and every few years we seem to see a swing between the ‘boom’ and ‘bust’ extreme of the spectrum, with the reaching of that point usually playing a big part in the resulting steep reversal – when oil prices peak it means a lot of production with high Opex costs floods onto the market; and conversely when they crater, there is a lack of investment, uneconomic fields stop producing, and at some point this usually results in a supply squeeze which causes the move towards the next ‘boom’. Given where oil prices have been this year, and the level they have recovered to so far, I believe that we are still close to the bottom of the cycle, but at a point where there is light at the end of the tunnel, even if it takes a while for a proper recovery, and thus now is a good time to buy – allowing for the potential for further short term dips in price and taking an investment view over a period of several years.
The last couple of years have not been the time to be buying oil producers with large amounts of debt, but for those which have managed to survive relatively unscathed during that period and which have used the money borrowed to create a large production base, they could do very well as oil recovers and the servicing of the debt becomes more manageable again via the free cash flow being generated by the business, and even more so if they have the potential for substantial increases in output via near term projects that have already been sanctioned and finance agreed. Kosmos Energy (KOS) is very much a company which I see falling into that category, and even more so when you consider that at the start of this year, even with oil prices already looking weak before Covid really got a hold, its shares were trading at around the 500p level, compared to now around 150p. The company has a decent spread of producing assets in Ghana, Equatorial Guinea and the Gulf of Mexico, and the most recent update showed production of 57,000boepd (full year guidance remains at 61,000 to 62,000boepd), which was slightly below guidance as a result of the storms in the Gulf. In terms of current production, a lot of that comes from West Africa, and it holds a 24% stake in the Jubilee field and 17% of the TEN field, both in Ghana, which account for roughly 36,500boepd of current total production. Those two names are probably already setting alarm bells ringing for anyone reading this who has had the misfortune to be invested in Tullow Oil (TLW), but a lot of that has come as a result of the inability of the company to service its large debt burden, and in terms of these fields, both have performed inline with expectations during 2020 and produce substantial amounts of oil for Kosmos.
Another producing field which it has in common with Tullow is Block G (Ceiba and Okume) in Equatorial Guinea, in which it acquired over a 40% interest in 2017 for around $240 million, as part of a deal with its partner, Trident Energy to acquire the asset from Hess. At the time the field was producing around 13,500boepd, and given that net 2P and 2C recoverable resources were 45 million barrels, even though that rate has now dropped to 11,100bopd it should still generate significant amounts of free cash flow annually at current Brent prices and above. Looking further forwards there is also exploration potential here via its share in the surrounding blocks, and drilling is expected to resume next year. The company also has plenty going on in the Gulf of Mexico, and although net production fell to 18,000boepd across its operated and non-operated fields there in Q3, everything is now back online and original guidance was in the 24,000-28,000boepd range, even allowing for non-storm maintenance related shut ins. The Tornado water injection well came online as planned with good initial results, and the completion of Kodiak should have been completed by now as well. There is also exploration upside in this region as well, with results from the Winterfell drill expected to be known in early 2021.
To me all of that sounds very encouraging and points to good recovery potential here, given that the corporate breakeven price per barrel is around $35, and that gives plenty of room for substantial excess cash flow generation at higher prices. Given that the net debt was $2.1 billion at the end of Q3 it needs to perform strongly, although it is worth noting that it had around $500 million in headroom and had recently negotiated a big chunk of that debt, plus had little in the way of debt coming due in the near future. It also received a boost from the completion of a deal to offload its Sao Tome, Principe, Suriname and Namibia exploration licences for roughly $95million upfront, and the potential for further future payments of up to $100 million. So, based on its current producing assets and the work being carried out on those, the future looks positive to me. But what really gets my attention here is its 30% stake in the BP operated Greater Tortue Ahmeyim LNG field in Mauritania and Senegal which is expected to produce 2.5MTPA during phase one, which is already pretty much funded through to first gas (via a combination of a FPSO leaseback deal, and outside investment/financing), and where preparations are already underway, with first gas expected during H1 2023. Whilst that is still some way off, it is something for longer term investors to take into account, especially as by then we could well be at the opposite end of the oil and gas cycle with substantially higher commodity prices, which would have the potential to have a significant additional impact on the share price.
So, whilst I can still see some uncertainty here, and there is of course risk due to the high levels of debt, and we’ve seen what can happen with other similar sized producers that can’t keep on top of servicing that. I do also see plenty of potential, even allowing for its market cap of around £600 million, as there are not only opportunities to expand production, but the company is already actively doing so and isn’t spending vast amounts of money in the process. This is one to invest in with a view to holding at least until Tortue is producing, but also be mindful of commodity prices and any prolonged significant drop in those would change the fundamentals here and you should be prepared to respond accordingly.
Filed under: Kosmos Energy, Remote Monitored Systems, [email protected] Capital, Microsaic Systems, Versarien
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