Regular readers of my Financial Times column might remember that I’ve been quietly extolling the virtues of the Premier Oil retail bonds. When the oil price collapsed these retail friendly bonds plummeted in value, partly because many risk-averse investors sold out at ridiculously low prices. If prices had kept on falling to $20 that panic might have been deserved but we all know what happened next. Prices stabilised and started rising. I suggested buying the retail bonds of both Premier Oil and Enquest – EnQuest went below £50 a bond at one stage while Premier Oil sank even further down. My assessment was that they represented good value, as long as the mountain of debt could be restructured. This then happened and the bond price has headed up steadily since then. Crucially the interest rate on the debt (and duration) was reset. That means that premier Oil now pays out a much higher coupon (6.5%) than the initial rate (5.5%). With confidence fully restored, the bonds have now repriced, and they are currently trading at above £100 a bond. So, bond investors would have doubled their money.
But the restructuring also introduced a new class of synthetic shares which in effect operate as warrants. My broker very helpfully snapped the image below from Bloomberg giving details of the shares which can’t be redeemed until the 31st of May 2022. These warrants were only paid out if Premier couldn’t hit the cash flows required based on an oil price of $65 a barrel (if I remember properly).
Now, these shares – in effect warrants – have an almost non-existent secondary market according to my broker although I have asked him to ferret out liquidity and bid-offer spreads. He also reports that according to some of his colleagues who know about the shares they’d be buyers nearer the 70p level. They currently trade at around 81p.
What interests me here – and I must disclose that I won a very small slug of these warrants – is that in effect you have a highly geared play on the price of oil. Premier Oil’s existing ordinary shares are already highly correlated with the oil price and these warrants simply up the gearing to turbo levels.
Which brings me nicely back to another recent FT column where I reported on a report from a Swiss asset manager, Burggraben. They argued that oil could increase to $100 a barrel. I’m not entirely convinced but I think it more than possible. Anyway, after publishing the column the firm dropped me a line and in ensuing discussion, I asked them if they had any other ways of playing the theme of rising oil prices. They suggested Premier Oil which they reckoned was a nice, clean way of playing rising oil. I agree with them! I’ve also paste din below their executive summary of the investment case.
All of which brings me to my conclusion. If you are long oil, why not buy the Premier Oil warrants as a highly leveraged way of playing the recovery? I’ll report back on secondary market trading as soon as I hear.
Below I’ve pasted in the Burggraben summary – which you won’t be surprised to discover I agree with.
Report entitled – Premier Oil Catch me if you can… 24 April 2018
Investment Case: There are two aspects to our investment thesis, an industry- and a company-specific. At the industry level, Burggraben is convinced that the year 2018 will offer a “generational opportunity” to invest in the E&P sector after four years of distress in the sector. The latter has forced companies, for the first time in a two decades, to embrace capital and cost discipline which we believe will bear fruits in the years ahead in the form of super-profits for the sector. At the company level, Premier Oil offers a rare low-risk, high-return investment profile in the publicly listed E&P space worldwide from the following characteristics:
– Equity Value from De-leveraging: Over the next three years, mandatory debt repayment and asset disposals will more double shareholder equity at $65/bbl Brent. In the valuation section we illustrate our base case intrinsic value assumption for various scenarios. In short, we argue that the fully diluted value per share is well above GBp 300/share at current commodity prices and when assuming a successful development of the existing project pipeline. This compares with a share price of GBp 91.
- Margin of Safety: Premier Oil is a bargain at an oil price deck of $65/bbl. As at 22 January 2018, the company trades at $3.5 EV/Reserves (2P & 2C) and $38,427 EV/production (flowing barrel) 2018E. This is cheap when compared to similar risk profiles in Norway or the US who trade well above $100,000 per flowing barrel while having similar or worse unit costs while Premier Oil offers similar or better long-term growth prospects (Sea Lion & Zama);
- – Low-Risk: Premier Oil’s portfolio must be considered low risk. De-leveraging has zero development risk left as the Catcher field has been brought online in Q4 2017 while the development pipeline has little “above ground” political country and “below ground” geology risk (conventional oil reservoir) attached at $65/bbl;
- New Oil Order: Most forecasts assume Brent oil prices to be anchored around $60/bbl until 2020 from a combination of long term over-supply from fast-cycle U.S. shale supply as soon as oil prices raise above $60, from elevated commercial inventory levels worldwide (when compared to their 5 year average) and/or from a weakening demand outlook long term as the EV revolution is in the making. In our view, such opinions continued suppressing sentiment for oil related investments in financial markets up until today. Burggraben however is convinced that this is about to change!
- Surplus Inventory Eliminated: The 3 major OECD markets are basically balanced in terms of their 5 year commercial inventory average. The 12 months OPEC agreement to continue cutting supply by some 1.8 Mb/d as announced on 1 December 2017 therefore risks to under-estimate the tightness of the market that already exists today. And so OPEC’s desire to further curb inventory will almost certainly tighten inventory levels below their 5-year average and thus will lead spot prices higher in the coming months. At the very least, OPEC will support prices in case of higher than expected US shale supplies.
- Oil Price Outlook: Burggraben is convinced that oil prices will surprise to the upside in the next 18 months as (a) demand will continue surprising to the upside with likely growth of about 1.8 Mb/d in 2018 from a “parallel” economic growth worldwide, thus absorbing any Permian growth barrel; (b) as prices will react more volatile to supply disruptions, unlike in the years between 2015-2017 when average inventory was at record highs; (c) as higher decline rates of maturing fields worldwide will kick-in in the midterm as a result of years of industry underinvestment, creating an unexpected supply gap by 2020; and (d) as long-term shale growth will disappoint from a combination of more sober drilling results as well as labour constraint. Our view is discussed in more detail in the Commodity Price Section. In addition, we have documented our view in more detail in a separate document.
Risk: The main investment risk is a collapse in Brent prices to below $50/bbl before 2020 as this may lead to a breach of financial covenants and thus subsequently to another round of equity dilution, worst case. Some of that risk is mitigated by the company’s hedging strategy. Also, thanks to Catcher likely producing at plateau by May 2018, this risk has become more remote as the company is able to accelerate debt repayment in the coming months. We fully explain the commodity price risk in last section of this presentation and illustrate the financial covenants in the risk section. After 2020, a short term correction in Brent prices will negatively impact share price performance, but will not materially alter the long term value of the company anymore as the company has materially de-leveraged by then.