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Premier Oil looks to offer more risk than reward at the current share price

By Gary Newman | Thursday 12 January 2017

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.

Like many producers, Premier Oil (PMO) has been struggling with debt since the oil price crashed a few years back. Some have managed to refinance the debt on their balance sheets, but for Premier the process has been dragging on for far longer than many expected and hasn’t exactly helped sentiment surrounding the company. Following today’s update though it looks as though that is finally about to be resolved.

The trading update includes that net debt had been reduced to $2.8 billion during Q4 – to some of you it may seem crazy that the company has that level of debt, considering that the market cap of the FTSE250 listed company only stands at around £475 million.

But the reality is that many oil fields cost a fortune to actually get to production, and Premier, along with others, was a bit unlucky to have invested so much money in its fields at a time when the oil price was high and few would have predicted it trading back down in the $50-60 range, let alone the lows that we saw last year.

It still remains to be seen what the exact terms of the refinancing agreement are with the private lenders, and this is expected to be announced soon, but today’s update did mention that it won’t be conditional on equity being issued, but will include equity warrants as part of the deal. This deal only relates to the private lenders, represented by RCF Group, but the same terms of the finalised deal will also be offered to the bond holders.

Given how long the deal has taken to finalise, and the fact that the lenders have continued with that process despite various breaches of covenants when they could have forced the issue, I would expect Premier to obtain the refinancing and headroom that it needs, it just depends at what cost that comes at – but things certainly look a lot better on that front than at this time last year when the share price hit a low of 19p!

Despite the debt problems, the company has also been able to carry on as planned operationally – including the purchase of a portfolio of assets from E.On, which has been producing an average of over 16,000boepd, and is set to repay the $120 million invested in it by H1 2017, which is earlier than anticipated – the deal came at a time when the oil price was on its knees.

Unfortunately though the Solan field has suffered from problems since production started, with rates being lower than expected, with just 10,000-13,000bopd expected during 2017. This has been as a result of the reservoir underperforming and limiting water injection, and it is unlikely that will be resolved before 2018.

Production could well receive a significant boost later this year though when one of the company's other UK assets, Catcher, is expected to come online. Operations have been ongoing at this field for some time, and better-than-expected flow rates from the development wells already drilled mean that the total cost has been reduced by 29%, compared to the original estimate, and now stands at $1.6 billion – obviously a fair bit of investment has already been made so that isn’t what it is going to cost this year. Total capex guidance for 2017 has been stated at $350 million, as compared to nearly double that figure last year.

In terms of overall production, 2016 saw that hit its highest level ever at 71,400boepd, which was up 24% on the previous year, but in reality that means that production from Premier’s existing assets actually must have dropped. That equates to an increase of 13,800boepd, but of course 16,000boepd came from the new E.On assets.

Currently 2017 guidance is at around 75,000boepd, allowing for the lower than expected contribution from Solan, but once Catcher starts producing that figure will be significantly higher.

The company is continuing to grow and replenish its reserves as well, with several projects in Indonesia being at the Final Investment Decision stage, and it is still progressing with the Sea Lion project in the Falklands, although it will likely be a good few years before that ever produces any oil.

Nearer term growth will come from the Tolmount gas project, part of the assets acquired from E.On, with good progress being made and gas prices being far stronger now than when the asset was acquired.

The share price has risen a lot in the last couple of months and is now around 92p to buy, but I’m not convinced that the finances of the company justify that currently.

Revenue for 2016 is expected to be $980 million, but that came from an average post-hedge oil price of $51/bbl – this compares to revenue of $1.1 billion in 2015 with an average price of $79/bbl achieved post-hedge.

So with spot prices for Brent currently bouncing around in the mid-50s, and 33% of its expected 2017 production hedged at just under $51/bbl, that suggests that the figures aren’t likely to improve much during the coming year unless the average spot price rises significantly. Although operating expenses have reduced, which will help the bottom line.

In conclusion, I do think that Premier is now largely back on track, barring another collapse in the oil price or a sustained period where the oil price stays at current levels for a number of years, but any recovery isn’t going to happen overnight.

Following the latest update, I wouldn’t expect the final results to include anything to really give the share price a big boost, and how much the market will like the exact terms of the refinancing deal remains to be seen. So currently I see more risk here than reward, and I would avoid the shares at this level based on the current fundamentals, as there are other producers out there that look to be in a stronger position for the coming year.

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