Harbour Energy Investment Case
August 25, 2023
Ticker: HBR LN
Price: £2.34
Mkt Cap: £1,872mn
EV: £2,072mn
Price: £2.34
Mkt Cap: £1,872mn
EV: £2,072mn
The Business
Harbour Energy is the largest independent UK offshore E&P company with c. 190kboe/d production and 2P reserves of 410mn boe (+455mn boe of 2C resources). Its production is roughly equally split between gas and oil. The company has a reasonable cost structure with lifting costs at $16/boe and less than $30/boe total costs, including development and decommissioning capex (excluding exploration).
The company was founded by private equity firm EIG Global Energy Partners in 2014 with a strategy to acquire conventional, cash-generative, producing assets outside of North America. In 2017, Harbour made its first acquisition backing Chrysaor Holdings to acquire a package of UK North Sea assets from Shell for $3.0 billion and, in 2019, acquired ConocoPhillips UK North Sea for $2.7 billion.
Chrysaor was founded in 2007 with the purpose of applying development and commercial skills to oil and gas assets.
In 2021, through a reverse takeover, Chrysaor merged with Premier Oil (a well-known UK-listed E&P) to create Harbour Energy.
The company was founded by private equity firm EIG Global Energy Partners in 2014 with a strategy to acquire conventional, cash-generative, producing assets outside of North America. In 2017, Harbour made its first acquisition backing Chrysaor Holdings to acquire a package of UK North Sea assets from Shell for $3.0 billion and, in 2019, acquired ConocoPhillips UK North Sea for $2.7 billion.
Chrysaor was founded in 2007 with the purpose of applying development and commercial skills to oil and gas assets.
In 2021, through a reverse takeover, Chrysaor merged with Premier Oil (a well-known UK-listed E&P) to create Harbour Energy.
What makes it so interesting
Harbour Energy remains highly cash-generative with a clear and consistent framework for returning cash to shareholders. Due to concerns over the higher tax burden for petroleum producers in the UK and falling gas prices, the shares have dropped 55% from their April 2022 highs, and the business is now available at a 40% FCF yield (!).
The company has generated $2.1bn of FCF in 2022, of which $553mn was distributed to shareholders via dividends ($200mn) and buyback ($333mn). The rest of FCF was used to reduce net debt to $0.8bn by December 2022 (from $2.3bn a year before). This is almost a 100% FCF yield.
For the current year (2023), management expects $1bn FCF at $85/bl oil price and 150 pence/therm gas price. Having done an additional analysis, I am confident in the company’s ability to generate this amount of FCF with even some upside potential.
The company remains committed to shareholder distributions with a $200mn annual dividend (9% yield) and a similar $200mn buyback programme. The shareholders should earn a combined cash return of 18% this year.
Since the start of the year, the company has repurchased 64mn shares (£166mn), reducing the share count by 7.4%. It has returned $1bn to shareholders in the past 18 months (dividends + buyback) in addition to a $2.9bn reduction of net debt.
The company has strong insider ownership, with strategic investors (EIG and Potomac View Investments) holding 16.8% interest, while management and Board members own 1.7%.
Harbour is currently a 1.5% position in my portfolio.
The company has generated $2.1bn of FCF in 2022, of which $553mn was distributed to shareholders via dividends ($200mn) and buyback ($333mn). The rest of FCF was used to reduce net debt to $0.8bn by December 2022 (from $2.3bn a year before). This is almost a 100% FCF yield.
For the current year (2023), management expects $1bn FCF at $85/bl oil price and 150 pence/therm gas price. Having done an additional analysis, I am confident in the company’s ability to generate this amount of FCF with even some upside potential.
The company remains committed to shareholder distributions with a $200mn annual dividend (9% yield) and a similar $200mn buyback programme. The shareholders should earn a combined cash return of 18% this year.
Since the start of the year, the company has repurchased 64mn shares (£166mn), reducing the share count by 7.4%. It has returned $1bn to shareholders in the past 18 months (dividends + buyback) in addition to a $2.9bn reduction of net debt.
The company has strong insider ownership, with strategic investors (EIG and Potomac View Investments) holding 16.8% interest, while management and Board members own 1.7%.
Harbour is currently a 1.5% position in my portfolio.
Key risks
Fiscal risks
Fiscal risks are the most critical item, at least based on market views. Following tax hikes introduced by the UK government last year, the effective tax rate for the sector has increased to 75% (from 40%). This windfall tax is scheduled for five years (until March 2028).
In my view, these risks are exaggerated.
Even at a 75% tax rate, I estimate the company should generate FCF of $14/boe (assuming $1bn annual capex).
Fiscal risks are the most critical item, at least based on market views. Following tax hikes introduced by the UK government last year, the effective tax rate for the sector has increased to 75% (from 40%). This windfall tax is scheduled for five years (until March 2028).
In my view, these risks are exaggerated.
Even at a 75% tax rate, I estimate the company should generate FCF of $14/boe (assuming $1bn annual capex).
Besides, Harbour had $1,097mn tax losses and allowances at the end of H1 ’23. This should help the company reduce its near-term tax liability and generate better FCF.
The company also has about 260mn 2C resources outside the UK, primarily in Indonesia and Mexico. They can potentially be brought into production in the medium term, reducing the company’s effective tax rate.
Importantly, actual tax payments can be reduced due to investment allowances. Initially set at 80% (in May 2022), they were later reduced to just 29%. However, decarbonisation expenditure enjoys an 80% investment allowance. So companies, for example, can claim 80% of the costs to modify an oil platform to use wind power.
There was some easing of the tax burden after the government introduced the changes in June 2023. Specifically, the tax rate will return to 40% if both oil and gas prices average $71.4/bl and £0.54/therm for two consecutive quarters.
Short reserves life
With 410mn boe of 2P reserves, Harbour’s reserves life is just 5.9. This is much shorter than the usual 10+ years for a typical E&P – a minimum level that allows to keep production broadly flat. At 5.9, Harbour’s production is just not sustainable and could face a 15-20% annual decline without more development or acquisitions.
I think the company could partially mitigate this issue through the development of its contingent resources (2C), which are almost the same in size as its proved and probable reserves (2P). M&A is another option.
At 190kboe/d daily output (70mn boe annually), Harbour's annual FCF should be $1.1bn. In the worst case, assuming that the company's organic decline is 20%, Harbour would need to replace 14mn boe of reserves every year to keep production flat.
Historically, finding and development costs (F&D) averaged about $10-15/boe, which would require $140-210mn. Even if Harbour spends twice the amount, its capex will rise by a total of $280-420mn, and its FCF should still be at a comfortable $0.7-0.8bn.
Moreover, with many smaller companies trading at about $5/boe reserves multiples, Harbour may find buying existing companies cheaper than drilling for new reserves.
The optimists may also point out international opportunities in Harbour’s portfolio, including 260mn boe of 2C resources in Mexico and Indonesia and almost 10% of existing production outside the UK.
Macro
Lower oil & gas prices represent a usual risk for an E&P company like Harbour. However, the company has been hedging some of its production so it is less sensitive to the declining energy prices. Its relatively low opex provides further cushion for its cash flows.
A $5/bl change in the oil price would lead to a 9% change in FCF, while a 10p/therm change in the gas prices would change its FCF by 5% (based on management’s guidance).
The company also has about 260mn 2C resources outside the UK, primarily in Indonesia and Mexico. They can potentially be brought into production in the medium term, reducing the company’s effective tax rate.
Importantly, actual tax payments can be reduced due to investment allowances. Initially set at 80% (in May 2022), they were later reduced to just 29%. However, decarbonisation expenditure enjoys an 80% investment allowance. So companies, for example, can claim 80% of the costs to modify an oil platform to use wind power.
There was some easing of the tax burden after the government introduced the changes in June 2023. Specifically, the tax rate will return to 40% if both oil and gas prices average $71.4/bl and £0.54/therm for two consecutive quarters.
Short reserves life
With 410mn boe of 2P reserves, Harbour’s reserves life is just 5.9. This is much shorter than the usual 10+ years for a typical E&P – a minimum level that allows to keep production broadly flat. At 5.9, Harbour’s production is just not sustainable and could face a 15-20% annual decline without more development or acquisitions.
I think the company could partially mitigate this issue through the development of its contingent resources (2C), which are almost the same in size as its proved and probable reserves (2P). M&A is another option.
At 190kboe/d daily output (70mn boe annually), Harbour's annual FCF should be $1.1bn. In the worst case, assuming that the company's organic decline is 20%, Harbour would need to replace 14mn boe of reserves every year to keep production flat.
Historically, finding and development costs (F&D) averaged about $10-15/boe, which would require $140-210mn. Even if Harbour spends twice the amount, its capex will rise by a total of $280-420mn, and its FCF should still be at a comfortable $0.7-0.8bn.
Moreover, with many smaller companies trading at about $5/boe reserves multiples, Harbour may find buying existing companies cheaper than drilling for new reserves.
The optimists may also point out international opportunities in Harbour’s portfolio, including 260mn boe of 2C resources in Mexico and Indonesia and almost 10% of existing production outside the UK.
Macro
Lower oil & gas prices represent a usual risk for an E&P company like Harbour. However, the company has been hedging some of its production so it is less sensitive to the declining energy prices. Its relatively low opex provides further cushion for its cash flows.
A $5/bl change in the oil price would lead to a 9% change in FCF, while a 10p/therm change in the gas prices would change its FCF by 5% (based on management’s guidance).
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