How cash flow, debt and oil reserves explain Premier Oil business?

In my last post, I discuss Premier Oil uncontrollable debt growth which played a major role in limiting share price appreciation. It has gotten so large that for every barrel of oil in reserves, $10 goes to debt repayment!

In this post, we will look at cash earnings, capital employed taxes and oil reserves.

 

Oil Producers cash earnings

You would have noticed that Premier oil has achieved positive net cash flow for the past ten years, which is strange because it makes accounting losses. However, this isn’t unfamiliar because Tullow Oil and EnQuest has positive cash margins.

Oil producers net cash margins

The problem comes down to their uncontrollable business model and the nature of the sector.

If you are a growing oil producer this can turn into a vicious cycle. Let me explain to you in three logical points:

Point 1: When oil producers extract oil from reserves, it depletes the oil field and shorten its life cycle.

Point 2: This feeds into management and forcing them to make continuous capital expenditure to sustain their business.

Point 3: As these new oil fields take years to commerce, it requires long-term contracts.

All this is good when oil prices are high. Now, Premier Oil living on borrowed money which has been growing every year!

Unlike BP and Shell, which has a refinery division and a service component, Premier Oil is solely about extracting oil.

As a growing oil producer, it is no coincident that Premier Oil achieved averages net cash flow of £332.8m in the last ten years, but made average capital spending (including acquisitions) of £693.6m.

 

Revenue hasn’t caught up with Asset Value Growth

With average capital spending of £700m per year (Tip: This is greater than the average revenue of £594m.), it means Premier Oil has a lot of assets in their books. This is shown in the continuous growth of their capital employed.

Premier oil asset vs revenue

Premier Oil’s asset turnover (minus the cash) has continued to fall, despite impairments totalling over £2.3bn, which values their tangible’s net book value at 32% of original asset value, down from 67%! It is possible that further impairment charges can happen, but limited because the oil price has stabilised!

Premier Oil asset turnover

Important

Earlier, I mention net cash flow and capital spending. Now, this is displayed in the form of accumulated negative free cash flow. Instead of prudent investors adherence to “cash is king”, which can be misleading they should adhere to “free cash flow is king”!

And Premier Oil has lots of it.

Premier negative free cash flow

That totals over £800m and is two and a half times the size of their market capitalisation.

 

With all this doom and gloom, is there any good news for Premier Oil?

One piece of good news is the accumulation of tax assets.

 

Premier Oil’s Deferred Tax Assets

This occurs when Premier Oil was making investment losses.

Premier Oil tax asset

Right now, it has over £800m in net tax assets sitting on their books. They can only benefit from it if the oil price returns to a stable level that makes Premier Oil operations viable and sustainable.

The other positives are the lack of operating lease and pension deficits.

 

 

Oil Statistic on Premier Oil

Over the past ten years, Premier Oil has increased their production output. But it hasn’t always translated to higher revenue or increase in economies of scale, due to lower oil prices.

 

Annual Production

Premier oil production

The daily output has more than doubled in ten years translating annual oil production from 12m barrels to 26m barrels, but it doesn’t always lead to higher revenue.

Production vs. Revenue

Premier oil production and revenue

Premier Oil was selling oil at an average price of below $50 for the past two years. In fact, revenue per barrel has never gone over $70 per barrel, despite Brent Crude trading over $85 per barrel between 2011 and 2013. This leads to a scramble of cutting costs.

Life of Oil Reserves  

Although Premier Oil has managed to increase (2P) oil reserves from 152m to 353m barrels, you got to look at the life of production at current levels of production.

And the current level of production means Premier Oil has 13.5 years of oil reserves, which is below the average of 14.9 years in the past decade.

Premier Oil life of production

Either Premier Oil needs to reduce oil output which would preserve cash and cause the loss of jobs or they continue to borrow, but the shareholders suffer instead!

Which is why every investor should keep a close eye on operating costs per barrel and capex per barrel every year!

Premier Oil capex and operating costs

Evaluating Premier Oil’s cost of production and sustainability, these facts should interest you: –

-Capex per barrel is two and a half times greater than Opex/barrel;

-Last year, cost of sustainability fell towards $40 per barrel, as capital spending is cut;

-Premier Oil ramped up capital expenditure during 2010-2015, as oil production doubles.

 

I mentioned in my previous post that total borrowings hold claims over Premier Oil. But I didn’t mention that the interest costs act as a royalty payment to lenders.

Interest Royalty to Lenders

Premier Oil royalty payments to lenders

 

$10 per barrel in net interest costs represents 20% of the current oil price. However, an interesting fact is the net interest costs account for 30% of revenue.

 

There you have it, I hope you enjoy this fact manipulating post on Premier Oil. The next time, I will be analysing the oil producer valuation levels.

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