North Sea consolidation reflects funding challenges among juniors

It seems consolidation is very much on the agenda for North Sea oil firms at the moment.

We’ve already seen a number of significant developments over the past few weeks, most notably Premier Oil’s (LON:PMO) £221 million takeover of EnCore Oil (LON:EO.) which was agreed in October.

Since the turn of the year things have stepped up a gear. 

First, EnQuest took the plunge buying a 20 per cent stake in Nautical Petroleum’s (LON:NPE) Kraken field for US$90 million. 

Then, this morning, EnQuest agreed a US$240 million deal to buy a further 25 per cent of Kraken and take control of the project.

It follows yesterday’s news from Ithaca Energy (LON:IAE), which is hoping to start production from the Athena field later this year, that it was in confidential talks with a potential bidder.

It is something of a perfect storm that’s creating such a favourable environment for M&A.

Operationally, many juniors are performing well, successfully finding, appraising and in some cases, even producing oil, on a shoe-string budget.  

But making it big and completing the transformation into a fully fledged E&P company is becoming more difficult.

The broader economy has played its part. Austere lending practices and economic uncertainty has depressed share prices and as a result many undeveloped oil assets are now quite undervalued. 

This, in most cases, makes large equity based funding too dilutive to be a viable option. On top of that traditional debt project financing is scarce.

As a result, firms have to look at alternative funding options.

For North Sea oil firms in particular, this issue is more acute as the UK’s Department of Energy and Climate Change (DECC) requires that financing is in place before any development plan can be approved.

Meanwhile on the other side larger more established firms, as ever, need to replenish their reserves as their existing oilfields mature and slowly dry up. 

Unlike private investors and the banks, these larger oil firms have both the means and appetite to fund new development projects, particularly when asset values have fallen so low and they can pick up a bargain.

Today’s deal, between EnQuest and Nautical, is a case in point.

The deal has a US$6 a barrel price tag, before factoring in tax considerations, and US$2.4 a barrel afterwards. 

Also that deal is priced on notably better terms than EnQuest’s US$90 million deal for its initial 20 per cent stake.

Combining both deals EnQuest believes it will have increased its contingent oil resources by around 70 per cent. This will be achieved by spending £330 million at most.

That said, the transaction is still good for Nautical as it has now overcome the funding challenge and it can proceed with its flagship project without diluting equity holders or taking on a heavy debt burden.

Numis Securities reckons the deal is positive for both parties. The broker believes that Kraken is a relatively low risk development and with EnQuest at the helm, first oil may be achieved in late 2015 or early 2016, it said.

Analyst Mathew Lambourne says a significant portion of the funding risk has now been removed and as a result the market will have more confidence in Kraken’s commercial success.

“The size of the farmdown is in line with our expectations, and leaves Nautical with a material exposure to Kraken but without a capex liability that is prohibitively expensive,” Lambourne said.

Given that Nautical's share of the phase one capex costs is now estimated to be US$225 million, Lambourne believes that today’s deal is likely to cover Nautical’s entire liability – providing the oil reserves are sufficient to trigger the contingent part of the deal.

Should Nautical need any more cash to cover its liabilities then, Lambourne says, a reserve-backed debt deal or the sale of non-core assets could fund the development.

Meanwhile, there are several significant oilfield development plays that have yet to secure funding, and a number of market experts believe that share prices may continue to underperform, versus asset valuations.

If this is the case more stocks could be seen as attractive takeover targets for their larger cash-rich rivals as they keep looking for cheap oil in the ground. So it seems that at this early stage there could be plenty more consolidation in the months ahead.