Kosmos Energy Ltd. (KOS) Earnings Call Transcript & Summary

Good morning. I'm James Hosie, part of the Barclays European oil and gas team. I'm delighted to once again welcome Andy Inglis, CEO of Kosmos Energy to present at this year's conference. In the past, frontier explorer would have been one of the phrases used to describe causes of E&P operations in the Atlantic margin. But this morning, the company's announced to sale its frontier exploration portfolio for up to $200 million. So it's an ideal time to hear how the transaction fits into the company's evolving strategy. So with that, I'll pass over to Andy to talk through his presentation before introducing Q&A. Thank you, Andy.

Thanks, James, and thanks to Barclays for the invitation. It's a pleasure to join you this morning. As James mentioned, we announced a transaction with shell this morning. The slides that go alongside that transaction and today's presentation can be found on our website. So I'd like to spend a few minutes talking about the future of the company and how this deal fits within our broader strategy before Q&A. Turning to Slide 1, which looks at the company we're building at Kosmos. Kosmos has a portfolio of world-class conventional oil and gas assets focused on deepwater exploration, development, production along the Atlantic margin. We have 3 oil-producing hubs in Ghana, the Gulf of Mexico, and Equatorial Guinea, as well as a world-scale LNG development operated by BP, book FID in late 2018, with the first phase now over 40% complete. Those advantaged assets have low decline rates, brands or HLS price benchmarks and overall carbon intensity that is significantly lower than the industry average. Given the low-cost nature of these fields and low decline rates, these assets produce significant free cash flow even at lower oil prices. We have a corporate free cash flow breakeven of approximately $35 per barrel, which allows us to maintain production plan. After a challenging second quarter for the company and the industry, we have reached cash flow inflection point and expect to generate free cash flow in the second half of the year and into 2021. On the gas side, the phase along the Tortue LNG project with first gas planned in 2023, is expected to generate a self-funded, long-term free cash flow stream to complement the cash-generative oil assets. On exploration, we're continuing to high-grade the exploration portfolio with a focus on returns. Our acquisitions in Equatorial Guinea and the Gulf of Mexico targeted opportunities that created value through optimizing the existing production base and also by growing the exploration portfolios around the existing infrastructure in these proven basins. We've now built a hopper of exploration opportunities. Around the existing -- we've now built a hopper of exploration opportunities across Kosmos that we need to high grade. Success in exploration comes from having quality through choice. This means prioritizing proven basins where we have a deep technical understanding, a large resource portfolio and can leverage infrastructure. Some people in the past have misconstrued our ESG agenda as a move away from oil exploration. However, that couldn't be further from the truth. We are, however, focusing on lower cost and lower carbon barrels, which have a better risk profile and are aligned with the energy transition. I'll talk more about this in a moment. And finally, we have a solid balance sheet to execute our plans. We had over $600 million of liquidity at the end of 2Q, no near-term maturities, and we expect debt to reduce rapidly as free cash flow continues to improve. Turning to Slide 2. Exploration has always been a major part of Kosmos' strategy. Our approach has evolved in line with the energy transition, which means going forward, exploration will be defined by 3 things: first, a high-graded program drilling lower risk wells in proven basins where we have material acreage positions differentiated technical expertise and strong relationships above ground. Second, exploration will focus on growing production through ILX with hub scale potential. Here, we intend to leverage existing infrastructure to bring down cycle times, lower cost and maximize returns. And third, the ILX portfolio is complemented by play extensions in these proven basins, where large-scale stand-alone prospects of up to 1 billion barrels exist, and the development cycle time can be reduced through our existing infrastructure, operations and relationships. Turning to Slide 3, which looks at the makeup of our portfolio post the transaction with Shell announced today. As I remarked earlier, with the EG and GoM acquisitions and subsequent participation in license rounds and the acquisition of data, we have significantly grown our exploration portfolio and needed to high grade. Shell presented us with an opportunity to monetize some of our longer cycle frontier assets at an attractive valuation, which allows us to focus on the high-graded portfolio in our proven basins. Across the 3 basins in the U.S. GoM, EG and Sao Tome in Ghana, the characteristics of the opportunities are the same. Deep experience of the geology underpinned by large-scale modern seismic data, leading acreage positions, lower cost and shorter cycle developments, strong government and stakeholder relationships and scale. Our current ILX hopper is over 2 billion barrels of total prospect inventory with over 4 billion barrels identified across various play extensions in the basins. Contrast this the assets were farming out as part of today's transaction. Basins with limited industry infrastructure driving longer cycle developments, major capital funding requirements and longer payback periods, limited ability to control the pace. These opportunities fit much better with a super majors portfolio. For Kosmos, we need to direct our discretionary cash flow to only a few high-graded exploration wells, which deliver scale and value. So turning to Slide 4, which looks at the Shell transaction in more detail. As we've communicated several times over the last few months, our intention has been to reduce our interest in our frontier exploration assets. As part of that process, we were approached by Shell to purchase the package of exploration assets for a total consideration of up to $200 million. And the terms of our transaction, Shell will acquire participating interest in Suriname, Sao Tome, Namibia and South Africa for an upfront cash consideration of around $100 million with an additional $50 million payable on each commercial discovery of the first 4 wells across the acreage capped at $100 million. While we're excited about the value creation opportunity from our frontier exploration portfolio, the transaction with Shell allows us to participate with no further capital exposed. In particular, whilst there has been success in Suriname recently, those wells were on a trend with a now proven shelf edge play in a Stabroek Block offshore Ghana. Our block 42 prospects are a different play type and therefore, carry greater risk and significant future spend to delineate. In addition to the upfront consideration, we also expect to save around $125 million in future CapEx and G&A, which would have been required to drill out the defined prospects. These savings will further our objective of maximizing free cash flow over the next several years. We plan to use this future free cash flow to strengthen the balance sheet, selectively invest in proven basin exploration and look to the future return of capital to shareholders. Turning to Slide 5, which looks at our first region of exploration focus, the Gulf of Mexico. We know the Gulf of Mexico well, we're a combination of a team we acquired as part of the Deep Gulf energy transaction in 2018 and Kosmos' management experience in the basin. For a company of Kosmos' size, there's massive opportunity in the basin. Since the DGE acquisition, we've taken advantage of the low competition environment and continue to build a deep hopper of quality opportunities. Today, we have around 25 hub scale prospects in our inventory, totaling over 1 billion barrels of potential resource. These opportunities are being derisked by improving technology and typically have a chance of success of around 50%. We expect that they will have high returns and low breakevens due to their proximity to existing infrastructure. In addition, Gulf of Mexico production is characterized by natural aquifer drive and a gas export infrastructure, which gives each barrel produced a very low carbon intensity compared to global averages. In addition to the ILX opportunities, we've identified several play extensions into the Norphlet and Wilcox, which could be much larger if successful. Turning to Slide 6, which looks at 2 near-term exploration opportunities in the GoM, which are 2 of the best in our portfolio and of hub scale potential. The first is the Monarch prospect, which has been high-graded and is drill ready. It's conventional subsalt, upper miocene prospect that has multiple reservoir targets across 7 blocks, the first of which we expect to drill next quarter. Monarch has attracted predrill economics as it's planned as a subsea tieback, engineered by infrastructure with an estimated full cycle return of greater than 35% potential script. Importantly, in a success case, a discovery derisks over 200 million barrels of gross resource. For Kosmos, this is relatively inexpensive test, which could prove to be material in the success case. Also on the slide is a Zora prospect, it has been high-grade and is drill ready. Again, a conventional miocene prospect in a proven mini basin. This amplitude play has a positive AVO response and a similar pre-drill economics to Monarch. If successful, it de-risks over 100 million barrels gross, and Kosmos will have a 50% working interest. The net cost to drill is expected to be around $20 million. Turning to Slide 9, which looks at the Rio Muni, another proven basin. The basin spans the inboard plays in Equatorial Guinea around the Ceiba and Okume infrastructure. The outboard plays in deeper water, Equatorial Guinea into Sao Tome and Principe, where new seismic has identified several deeper plays for the first time. Similar to the U.S. GoM, we have a spectrum of lower-risk near field targets around existing infrastructure with a total gross inventory of around 1 billion barrels and deeper play extensions with over 4 billion barrels of total prospect inventory. Within the play extensions, there are some very material targets around 1 billion barrels in gross resource potential. Turning to Slide 8. Our focused shorter cycle exploration portfolio is complemented by the longer cycle Tortue LNG development, which is expected to provide a steady long-term source of free cash flow to the company. The project continues to make progress with Phase 1 now over 40% complete. Once online, we expect the first 2 phases to deliver approximately $150 million to $200 million of annual cash flow net to our current working interest. That said, our priority with the asset continues to be the delivery of a self-funded gas business, and we're in active discussions with potential partners. So turning to Slide 9 and to conclude. The world is changing. And in response, Kosmos continues to shape its portfolio for the future, a portfolio that creates value for shareholders today and longer term, ensuring we have a place in the energy transition as a supplier of low-cost, lower carbon barrels. This portfolio is currently made up of 3 production hubs, which are highly cash generative, as we've demonstrated over the last 3 years. After a challenging 2Q, we've reached an inflection point with cash flow used to strengthen the balance sheet, selectively invest in high-return projects and fund shareholder returns when appropriate. The first phase of our Tortue gas development is now over 40% complete. First gas is planned for 2023 and is expected to generate a self-funded, long-term free cash flow stream to complement our cash-generative oil assets. And finally, through the Shell transaction, we're driving quality through choice by high-grading our exploration assets to focus on shorter cycle ILX and more material play extensions in proven basins, which are characterized by high returns, quicker paybacks, lower cost and lower carbon. Thank you. And I'd now like to turn the call back to James for Q&A. James?

Thank you, Andy. Let's talk about somewhere about the deal rationale. You're focusing on proven basins in EG and the Gulf, where you've had some success so far, albeit relatively small scale, how confident are you this ILX and play extension strategy can create real value to investors?

Yes. If we look at both acquisitions in Equatorial Guinea and the Gulf of Mexico, it was about getting into proven basins to have the dimensions of production optimization and exploration. So if you look at those deals from a production optimization basis, we know we've done really well in Equatorial Guinea. I think we've taken probably over 1.5, close to 2x our cash out already compared to what we paid for the assets. And it will be over 2. Just on the basis of the 2P reserves that we have in Equatorial Guinea. But the upside was always from the exploration. The -- there'd be no seismic shock for 20 years in EG. It was focused purely on the development of Ceiba and Okume. There's the old outage that you find oil where there is oil. And we went back, shot a modern seismic and have identified significant new plays below in deeper targets around the infrastructure there. And it is not small. It's over 1 billion barrels of prospect activity. And we know the basin well. The original team that opened it up, the Trident team, one of the Kosmos explorers. So this was a basin where we knew the geology well. We have modern seismic now. And we've trended that out on the Rio Muni basin to the deeper water in Equatorial Guinea and same with Sao Tome, and we see some significant large targets there for extension. So what's different? We've spent really 3 years getting the data that allows us to build the prospect inventory. Same in the Gulf of Mexico. We -- over the last 2 years, the DGE team have been taking opportunities in the license round. Data is readily available. And the competition is really low. You can pick up licenses at basically minimal bids. And so we've built that portfolio. And again, around 1 billion barrels. So what's different is, really, it's sort of 3 years in the baking to get to the point now where we have the infrastructure plays that we like with the play extensions, whether they be the Norphlet or the Wilcox or the deeper outboard plays in Sao Tome and EG. So out of all of that, you need to get to the point where you high grade. And we've got more to do than we've got capital. And exploration is about quality through choice. You've got to pick a very few number of things that have the financial characteristics to generate value to shareholders. And that's what the deal is about. It's about high grading, it's about focusing on the things which we believe have the financial characteristics for today and the longer-term ESG credentials for the future. And we're doing it because we have confidence from the last 3 years of work of building the portfolio. So it is an inflection point where we've built the portfolio that allows us to make this decision. We couldn't have done it a couple of years ago.

Okay. And [indiscernible], where a patch in Total's recent success is being made up by rare exploration hotspot for the industry.

Yes. And it's great to see the success in Ghana and the success trend into Suriname. I think it's important to note that our Block 42 acreage is actually down-dip of the well-proven shelf edge play that clearly opened up by Exxon and Hess and then funded across into Suriname, yes. So it's the same play across both countries. Block 42 is down there. So it's a different play time. And as such, it has a different risk profile. And I think it also -- if successful, it will have more capital to delineate because it will require appraisal, a significant appraisal, and it will have a longer cycle time as a result. So I think that's the fundamental decision that we're making. And it's good for Shell. They've got the balance sheet and the time to spend on it. I think for us when you have alternative opportunities that can generate a shorter payback, higher returns, that's where our investors want to see us focus our cap.

Okay. That's fair. And then thinking about your future capital allocation, how much CapEx do you expect to spend on exploration going forward annually? And then how do you balance your capital expenditure against debt reduction in the coming years?

Yes. Look, as we sort of talked about in the material, well, there are 3 main sources, main uses of future cash flow. Clearly, debt paydown is the first priority today. The reinvestment in select high-quality opportunities and then future shareholder returns. It's important that we focus very hard today on the debt paydown, and that is our first priority. In terms of the use of the proceeds, around 1/3, and I think it's up to 1/3 because we have flexibility on the participation interest that we have in Zora it's up to 1/3 of the proceeds will go to the ILX and the GoM. So it's up to $30 million. I would see that number may be growing slightly into '22, but not by much. What we need to do is demonstrate we're free cash flow positive. We're paying down debt, and it will be very selective in terms of the exploration targets. And actually, it's good to have that tension. I'm big believer that quality through choice will ultimately drive the success. Now how do you generate more volume with less capital, you've got to target it to things which are truly high quality. So that tension within the organization is going to be good. So it's going to be very selective. We're being very prudent at the beginning. And you can see that sort of evolve over the next 1 to 2 years.