Equalising the buyer and seller: Shell and Chrysaor's oil price contingent payment structure

After a tumultuous period of oil prices with investment decisions and M&A transactions put on hold, the outlook is beginning to stabilise in 2017. With more comfort on the near term trajectory of oil prices, the corporate mind-set is shifting from balance sheet management to strategic re-focussing and growth.

Nevertheless, buyer-seller price expectation gaps still remain and a way to bridge this gap is the use of oil price contingent payments in a transaction. The last time this mechanism was seen in a major market deal was Seplat’s acquisition of Chevron’s assets in Nigeria in 2015. Today, this novel structure was seen again in Chrysaor’s acquisition of Shell’s North Sea portfolio, with an additional twist.

In the Chrysaor acquisition, the terms were as follows - Chrysaor would make payments to Shell of up to USD600 million split over the 2018-2021 period:

• First payment to be made if Brent rises above USD60/bbl in 2018 and 2019
• Second payment to be made if brent rises above USD70/bbl in 2020 and 2021
• Full payout of the USD600 million is made if Brent reaches USD95/bbl anytime in the 2018-2021 period

However, Chrysaor also managed to secure downside protection on its acquisition should oil prices fall. The transaction allows for Shell to make a payment to Chrysaor of up to USD25 million a year (totaling USD100 million) between 2018-21 should Brent fall in the range of USD47.5–52.5/bbl. Full payout of the USD25 million is made in each year if Brent falls below USD47.5/bbl.

The above structure strikes a balance in providing Shell protection from selling the assets too cheaply in a rising oil price environment and Chrysaor overpaying should oil prices fall. Given the structure of the mechanism, it is clear that the contingent consideration is based on near term rather than long term oil price performance with the size of the payments reflecting the impact on near term production cash flows depending on the direction of the oil price. The long stop date of 2021 is relatively long for an M&A transaction, but suitable for a transaction of this nature where oil prices behavior is exhibited over a longer period of time. While longer periods in which contingent payments are active are normally more beneficial to the seller, the mirroring contingent payment from Shell to Chrysaor in this instance puts both the buyer and seller on equal footing.

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Chrysaor future: Acquisition of Shell North Sea portfolio

On 31st January, Chrysaor announced that it had agreed to acquire a portfolio of North Sea assets from Shell for USD3 billion. The transaction is expected to close in H2 2017 and will transform Chrysaor into one of the largest North Sea focussed E&P companies, who will adopt 400 staff from Shell as part of the deal.

The full-cycle portfolio, which comprises exploration, near-term development and production, produced 115mboepd in 2016 and 350mmboe of 2P reserves. Chrysaor has already identified a number of growth opportunities in the portfolio including incremental recovery to extend field life and intends to implement a programme of near field drilling around key hubs.

The acquisition will be funded by:

• USD1.5 billion bank debt
• USD1 billion investment from Harbour Energy
• USD0.5 billion from existing company and shareholder funds and a financing package provided by Shell

An important component of the deal is that Shell will retain a decommissioning liability of USD1 billion, in a which mirrors EnQuest’s recent acquisition of BP’s North Sea assets. The decommissioning costs associated with the portfolio are currently expected at USD2.9 billion (2016 real terms) and USD3.9 billion in nominal terms. There are no material decommissioning costs in the near term, however, Chrysaor has provided security for its exposure to the liability through letters of credit from part of its bank credit lines (on top of the USD1.5 billion bank debt). (Further discussion in our Siccar Point article).

Harbour Energy is a private equity vehicle backed by EIG Global Energy Partners and led by Linda Cook as CEO. Ms Cook was previously at Shell for 29 years where she was in charge of Shell’s gas and renewables business. She left in 2014 after losing out to Peter Voser for the spot of Chief Executive of Shell. She will now act as Chairwoman of Chrysaor.

The transaction also allows for USD780 million in contingent payments, comprising USD180 million for future exploration success and USD600 million for higher oil prices.

The list of assets acquired are as follows:

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What E&Ps do best: EnQuest acquires North Sea assets from BP for USD85 million

EnQuest has agreed to acquire a package of assets from BP, which includes a 25% operated interest in the Magnus field and various infrastructure interests, adding 15.9mmboe of 2P reserves and 4.2mboepd or production. EnQuest will consolidate its infrastructure interests by acquiring 3% in the Sullom Voe Terminal (currently hold 3%), 9% of the Northern Leg Gas Pipeline (currently hold 5.9%) and 3.8% of the Ninian Pipeline System (currently hold 2.7%).

The transaction makes use of an innovative financing structure in which EnQuest will not have to front any cash for the acquisition. The USD85 million consideration will be funded by deferred consideration payable from the production cash flow of the assets acquired. BP will retain the decommissioning liability in respect of the existing wells and infrastructure on the assets acquired – in exchange, EnQuest will pay 7.5% of BP’s decommissioning cost on the working interest on a post-tax basis.

As part of the deal, EnQuest also has the option to receive USD50 million from BP for undertaking the management of the decommissioning on the Thistle and Deveron fields. EnQuest currently owns 99% of these fields, with BP owning the remaining 1%. BP (and ConocoPhillips) currently retain the decommissioning liability on these fields due to a series of historical transactions, but EnQuest has the opportunity to benefit if it can manage the decommissioning more efficiently and effectively.

EnQuest has the opportunity to upsize in the assets with an option to acquire the remaining 75% of Magnus (from BP) and BP's interest in the associated infrastructure for USD300 million (subject to working capital and other adjsutments). The option is exercisable between 1 July 2018 and 15 January 2019, with EnQuest’s upfront payment limited to USD100 million and the remainder funded by a vendor loan from BP.

This transaction is aligned with EnQuest's reputation for creating value from late life assets with remaining resource potential. Magnus forms part of EnQuest’s hub around the Sullom Voe Terminal and EnQuest has the ability to maximise the potential of the field given its experience in the area and without the overheads of a majors. The relatively late life and small size of Magnus in BP’s global portfolio would have meant it received less attention and ability to obtain capital for investment would have been constrained. EnQuest has already identified synergies on Magnus with its existing assets and opportunities to operate the asset more efficiently.

Magnus overview
Source: EnQuest acquisition presentation

Magnus operational bench-marking
Source: EnQuest acquisition presentation

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Taq Taq Tumble

At the end of October, we raised the prospect of a potential downgrade at Taq Taq following a disappointing production update from Genel.

On 24^th January, Genel provided updated guidance of 24-31mbopd production average for the field in 2017, down from 60.2mbopd in 2016. The declining production from the field has already been well publicised, however the scale of the fall was unexpected.

A new field development plan and reserves estimates are being currently being prepared and expected to be published within the coming months. Capital investment to stem the decline is expected, however given the low level of the FY2017 production guidance, this spend could be some way off.

On a more positive note, production from the DNO-operated Tawke field is budgeted to increase to 115mbopd from 107mbopd (2016).

On the Miran and Bina Bawi gas fields, Genel continues to seek a partner to help develop the resources, but management expect to recognise an impairment charge on this asset in the 2016 year end results.

Despite the issues facing Genel, the company still holds a large resource and remains one of the largest Kurdistan focussed E&Ps. The gas resource provides significant upside with ample demand once local geopolitics allows for its development.

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BP Christmas shopping

BP has announced a series of high profile acquisitions in the past few weeks. The deals are in line with BP's longer term strategy of building in regions where they can gain "scale and materiality", although the company has moved more quickly than expected based on OGInsight's recent conversation with them, where BP said they were in divestment and portfolio rationalisation mode. This potentially signals a view of an improving oil price environment and willingness to move from balance sheet conservatism to growth.

At the end of November, BP acquired a 10% interest in Zohr from Eni. Since then, BP has announced two further acquisitions:

ADCO Concession

BP announced over the weekend that it had secured a 10% stake in the Abu Dhabi’s multi-billion barrel resource ADCO concession. BP previously held 9.5% in the concession prior to the expiry of its licence in January 2014. Other holders of the concession are currently Total (10%), INPEX (5%) and GS Energy (3%).

The concession is for 40 years and will add 1.8bnboe of 2P reserves to BP (net). The agreement includes various fields in the country with a total resource base estimated at c.20bnboe and represents a long term, low decline, sizeable resource for BP. The timing of the transaction will allow BP to book the reserves for the year end.

BP will pay a signature bonus of $2.2bn for its 10% stake, in line with the bonuses paid by other participants. However, the key noticeable difference is that BP will be paying in shares and will be issuing 393 million shares at £4.47 or a 9% discount, equating to 2% of its stock. The shares will be held by Mubudala and signals flexibility on the part of Abu Dhabi to secure a deal in a tough environment.

Mauritania and Senegal with Kosmos Energy

On 19^th December, BP announced that it had reached agreement with Kosmos Energy to acquire an operated interest in the Tortue field and surrounding blocks offshore Mauritania and Senegal. This will comprise of a 62% operated interest in C-6, C-8, C-12 and C-13 on the Mauritania side and 32.5% interest in Saint-Louis Profond and Cayar Profond on the Senegal side.

As part of the deal, BP will pay USD162 million upon closing of the transaction, appraisal carry of USD221 million and development carry of USD533 million bring total consideration to USD916 million. BP will also pay a contingent bonus of up to USD2/bbl for up to 1bnbbl of liquids structured as a royalty, should liquids be discovered. Kosmos will continue as exploration operator of the blocks.

The blocks contain the Tortue field, which is estimated to hold 15tcf of gas resources with potential for 1bnbbl of liquids. Project sanction is expected to be in 2018 with the most likely development scenario being a phased near-shore FLNG development.

Greater Tortue Area
Source: Kosmos Energy

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Eni: Bringing in successive partners for Zohr

On 28^th November, Eni announced the divestment a 10% interest in Zohr to BP for USD375 million plus pro-rata reimbursement of past costs (c.USD150 million net), bringing total consideration to USD525 million. BP also has an option to acquire an additional 5% interest on the same terms before the end of 2017.

On 12^th December, Eni announced that it had divested a further 30% interest in Zohr to Rosneft for USD1.125 billion and USD450 million of back costs - i.e. on substantially the same terms as BP. Rosneft also has an option to acquire an additional 5% interest on the same terms.

The transactions reduce Eni's exposure to the Zohr development by 40% from 100% to 60%; this could fall to 50% if BP and Rosneft exercise their options for additional interests. The divestment will also reduce Eni's capex by c.USD900 million in 2017 ahead of first gas at the end of 2017. A similar capex saving is expected to be made in 2018.

Eni has successfully demonstrated its ability to monetise large resource finds. The farm-out significantly derisks the upcoming development and it is promising to see buyers for good quality assets despite the current oil price environment.

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TransGlobe: Branching out...back to roots

This week saw Canadian listed, Egyptian focussed TransGlobe ‎announce an acquisition of producing assets in Western Canada. The company will be paying USD80 million to Bellatrix Exploration for Cardium light oil and Mannville liquid-rich gas acreage in the Harmattan Area. The portfolio comes with 21mmboe of 2P reserves and 3,100boepd of production.

The acquisition is a shift away from the company's ‎historic strategy of being an Egyptian focussed player. However this had been pre-announced with TransGlobe stating earlier this year that it was seeking to diversify its asset base with more exposure to OECD. Although shareholders would have initially invested in TransGlobe for the attractive story at the time of low risk, onshore exploration and production in the Middle East, the company has failed to deliver that story for a variety of reasons and this acquisition appears to be a sensible first step in redefining the company.

Having lost its position in Yemen followed by a series of disappointments in Egypt, TransGlobe has fallen short of its aspirations which would have seen Egyptian production of c.20mbopd today instead of the current c.13mbopd. The Arab Spring which began at the end of 2010 coupled with the more recent spread of Islamic State has deterred investor interest from the Middle East. For TransGlobe specifically, the lack of a stable government in Egypt until the arrival of President Sisi and a ballooning budget deficit hampered TransGlobe's efforts to progress its portfolio in the country as well as being paid for its production by EGPC.

While production cash flow should help strengthen the company's financial position, the mix of Canadian and Egyptian cash flow presents an eclectic mix of assets and it will be interesting to see how TransGlobe will continue to transform over time.

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