EnQuest still has very high debt levels but could recover as oil prices rise...

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The biggest issue for EnQuest (ENQ) has always been the high levels of debt which it took on to develop its assets, and the fact that its timing in doing so couldn’t have been much worse with over-supply starting to hit the market in 2014 and Brent steadily plummeting from the $100-plus level it traded at back then. It is one of the few oil producers which hasn’t really recovered from the further drops which we saw during the peak of Covid and oil market panic last spring and, although I do still see its large debt pile as being an issue, I can also see potential from here. Even more so if we are to look at the typical cyclical nature of oil prices and what typically happens to prices following a prolonged period of low prices and a general lack of investment into bringing new oil online and exploration to keep replenishing resources.

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I accept that things are different these days in terms of the potential future supply shocks which that lack of investment can cause, as shale plays a big part and it is easy to turn supply back on as and when prices become economic once again. But I also think that those types of companies will find it harder to obtain bank loans and funding this time around, given the widespread bankruptcies during Covid, plus with Biden to be in power we may see more restrictions on shale producers – although the flipside of that is that he could also affect demand via greener policies than we have typically seen in the US. I would also argue that if and when oil prices do go on a run upwards, Enquest is in a much better position to take full advantage of them this time, with daily production for the full year in 2020 expected to have been just below the 60,000boepd level, and pretty much in the middle of the guidance range. There is also potential for a stronger performance in 2021, given that Kracken (60% owned and operated) performed strongly last year and at the last update had averaged nearly 38,000boepd, and was expected to be above the 35,000boepd upper end of annual guidance. Plus, production in the second half of last year was impacted by scheduled maintenance and an outage at its PM8/Seligi field in Malaysia – although the latter had no impact on revenue due to the structure of the PSC and cost recovery mechanism in place there. It also had issues with a lift pump system at its Magnus field, which alongside Kracken makes up the bulk of its production (over 17,500boepd net last year), but that has been resolved and the focus remains on improving production there, and making the most of the 38mmbbls of remaining 2C resources, plus other potential resources still to evaluate.

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Decommissioning of several of its North Sea fields is underway, or about to commence, but much of the production drop from that has already been seen, with cessation of production at the Thistle/Deveron and Heather/Broom fields already taken into account (they were producing a combined 7,000boepd net the previous year), and the Dons field is expected to follow towards the back end of this year now that gas lift from Thistle is no longer available and has already been impacting production rates. The company is also in the process of completing a deal for a 40.81% interest in the Bressay field, by paying Equinor £2.2 million upfront, plus a further $15 million as and when the field development plan is approved. EnQuest is hoping that its knowledge of heavy oil, gained at Kracken, will help it to unlock the 115mmbbls of 2C net resources which it is acquiring under this deal. So from an operational point of view things look promising, but we also need to consider the net debt, which stood at $1.35 billion as at the interims up to the end of June 2020, which is obviously a very high amount for a company with a market cap of around £230 million at the current share price of 13.4p.

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I would also note that despite the low oil prices in H1 2020, even allowing for the fact that the company was well hedged, it still managed to generate $87.5 million of free cash flow and reduce debt by over $60 million – although that had been reduced to around $25 million by the end of October – and cash available at the last update in November was $268 million. In terms of managing its debt, the company has agreements in place to extend the repayment of its retail and high yield notes until such time as the senior credit facility is repaid. It has been paying that down gradually and at the last update that stood at $425 million. The company also announced an automatic extension to the maturity of those notes to October 2023, from the previous date of April 2022. It is also worth noting that the debt holders allowed the company to take on the Bressay asset. Any real recovery for this company all hinges on future oil prices continuing to increase and get back to higher levels than they are at currently, if it is going to have a chance to pay off those debts. Plus of course avoiding any major production issues, which also always presents a risk. Overall though, given my expectations of where oil prices will go in the coming years, I think this has potential to generate a good return for shareholders during that period of time and can see why some people are interested in buying the shares at the current share price, especially if you have a bit of patience to hold and see where it is later this year. So for me it is a speculative buy.

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