Serica Energy plc (SQZ) Earnings Call Transcript & Summary

Good morning, and welcome to the Serica Energy plc investor presentation. [Operator Instructions]. Before we begin, I'd like to submit the following poll. I'd now like to hand you over to CEO, Chris Cox. Good morning to you sir.

Good morning, and welcome. I'm Chris Cox, CEO of Serica Energy, and I'm joined, as usual, by Martin Copeland, our CFO; and Andrew Benbow, our Group Investor Relations Manager. We're here today to discuss the transaction with Prax Upstream, which we announced this morning. Before we get started, I'd just like to offer a quick update on progress on Triton because I know there's a lot of interest in that. Two weeks ago today, we said that we expected the A compressor running in about a week. That's exactly what happened. So the compressor started up a week ago today as anticipated, and the B compressor should also be available to us soon. So I know people are questioning what's going on with Triton. I just wanted to get that out of the way. That's the last time I will mention Triton on this call today. Not planning on taking any questions on it either. This is really about the transaction we just announced. So we have a fairly short presentation to try and explain what was in the release we put out. As already mentioned, you can submit questions as we go, and we will get through as many of those questions as we can at the end. So moving on to the first slide here. The deal we've announced today, we think, is positive for a number of reasons. It increases our reserves. It diversifies our portfolio. It enhances near-term cash flow at what we think is a very attractive valuation. And as well as the immediate boost to production reserves and cash, we're really excited about the potential, particularly in the West of Shetland Basin, where we see a lot of subsurface opportunities to add to the portfolio. And we've done this by acquiring Prax Upstream, which includes 100% of the Lancaster field and operatorship, along with the associated tax losses within Prax Upstream. Now Prax also has signed agreements in place for 2 separate transactions. These are with TotalEnergies related to the Greater Laggan area and ONE-Dyas for the stakes in Catcher and the Golden Eagle area fields. Now getting this done illustrates our ability to move quickly, utilizing our strong balance sheet and skill sets that we have in the company to get the deal over the line. I'm sure many of you will appreciate that M&A is tough. We've been working on a number of things pretty much since I joined the company a little over a year ago. And it's not straightforward to get deals over the line. There's lots of mine fields and bear traps along the way. But we think on this occasion, we've achieved a great acquisition at a great price by being opportunistic, flexible and diligent. And I'd like to explain a bit more about that. So this schematic shows how the transaction complements our existing portfolio with 2 additional producing assets in the Central North Sea and a new operated hub West of Shetland. It's worth saying upfront that this is just another step in our growth strategy, and it's aligned with that strategy of obtaining mid- to late-life assets where we believe we can add value. Indeed, this addition will support us in delivering further M&A, enhancing our potential to be competitive on future acquisitions and hence, delivering even more value to shareholders. It is completely aligned with our strategy. In addition to being value accretive and diversifying our production base, we see great upside in the geology of the assets we're acquiring, and I'll speak more about that later. Next slide, please. So just to be clear, because it's quite a complex transaction about what we are acquiring, and it was set out in the RNS, but I know it's not easy to digest. Firstly, the entirety of Prax upstream, which includes 100% of Lancaster and operatorship of the field and the 2 existing SPAs with Total for 40% interest in the Greater Laggan area, which includes the Shetland gas plant, and with ONE-Dyas for 10% of Catcher and 5.21% of the Golden Eagle area development. We think we've achieved this on very attractive terms, and I'll hand to Martin briefly to explain further the terms.

Thanks, Chris. Next slide. All of our M&A activity is based around value creation for shareholders, and that starts with the price we paid. The transaction we're announcing will add almost 11 million 2P barrels to our portfolio for a consideration of $25.6 million. This translates to a very attractive acquisition price of $2.3 per barrel of oil equivalent, very low for the North Sea. And also if you compare it to a roughly $8 a barrel of oil equivalent on which Serica currently trades or I should say, traded yesterday. Obviously, we're up a bit this morning. So I think it's -- that demonstrates it's really a very attractive price that we've secured these assets at. And of course, this valuation reference is based only on the 2P reserves, which are virtually all current production, which means that we're clearly not paying for any of the upside in the assets or the optionality on which Chris will be giving more detail in a short while. Upon completion, due to the economic dates of the underlying transactions being in the past and for the deals with TotalEnergies and ONE-Dyas back as far as the 1st of January 2024, as well, of course, as paying the consideration out, we also expect to receive in payments amounting in aggregate for the 3 combined transactions to around $100 million when the deal is complete. These expected cash payments relate to the after-tax cash flows generated by the assets between the economic dates and the expected dates of completion, which we estimate to be year-end 2025 for Prax Upstream and the end of Q1 2026 for the TotalEnergies and ONE-Dyas deals. The increased production added to our portfolio also means that we'll benefit from incremental free cash flow next year, which we estimate to be around $50 million, a year that was already set to be highly cash generative for Serica. The acquisitions also take on future decommissioning costs offset by tax related to the associate fields, which we will come to. But the main part of that cost relates to the GLA, and we're confident there's plenty of growth potential and optionality that means substantive costs won't be incurred for another decade or more. I'll hand back to Chris just to say more about the assets.

Yes. So just a bit more detail on the assets we're acquiring. First of all, the Greater Laggan area, where we're acquiring an operated interest in 4 producing fields and a piece of gas infrastructure in an area of great growth potential. Net production is currently around 5,000 barrels a day. And net operating costs for Laggan should be reducing next year due to the start-up of the Shell-operated Victory field, which will share those operating costs. Shetland gas plant is the newest onshore gas processing facility in the U.K. And given its proximity to a prolific and underexplored basin, we would hope to add further throughput volumes and work with our JV partners to extend the life of the facilities. And now we'll turn our attention to some of the significant upside that lies in the greater Laggan area. The most mature of the upside potential is in the Glendronach discovery and a possible infill well on Tormore, both of which are likely to have an investment decision in the near term. The potential infill well at Tormore has been derisked by recent 4D seismic interpretation, which indicates that the target location is in an undrained fault block. Glendronach was discovered in 2018 by Total and has remained undeveloped. The joint venture is currently undertaking a review of potential field development plans for the field. In addition, the exploration and appraisal acreage we are acquiring contains an estimated more than 400 million BOEs of net unrisked prospective resources in the catchment area of the Shetland gas plant. This includes a number of low-risk, high-volume prospects, which our subsurface team are keen to start work on. The map also highlights in the yellow outline those licenses that have already been awarded to others, including Adura, the Shell Equinor joint venture and Ithaca as well as others acquired by other operators in the area. A recent study estimates that there are 1.5 billion barrels of discovered and prospective resources within 50 kilometers of the newly acquired gas infrastructure. So we've got high hopes of attracting further third-party business as well as future developments on our own acreage. Next slide. Moving on to the ONE-Dyas acquisition which also helps to diversify our production through stakes in the Catcher field and the Golden Eagle area development. Now both fields are late life, but both have the potential for further infill drilling to extend that life should the partners agree. And while they're late life, both are high-quality reservoirs with historically predictable production performance. The uptime at Golden Eagle recently has been around about 97%, for example. Now we've said before that we want to broaden our portfolio so that we're less reliant on our 2 key producing hubs so that we can have more predictable production performance. This acquisition is a step, but definitely not the end game towards achieving that goal. And lastly, amongst the assets, the Lancaster field, production is currently coming from a single well, which delivers around about 6,000 barrels a day in the first half of this year. Our expectation is that this well will continue to produce until Q3 next year when the FPSO is expected to leave and be repurposed for the sea Line development in Falklands. Now obviously, we're aware that Lancaster has had a checkered history and there may be some negative sentiment from those who might have invested previously in Hurricane. However, our investment here is purely based on the expected production from the single well between now and 3Q 2026. I'll hand back to Martin.

Thanks. As is common with acquisitions in the North Sea today, we also have to think about the impact in terms of tax as always being part of the story. We already had significant tax losses contained in the Serica portfolio, which makes our production from Triton tax efficient. And this acquisition materially adds to these losses, bringing an additional $600 million of CT losses, $470 million of SCT losses and $225 million of EPL losses. We've shown on this chart what the aggregate position of all of that is as pro forma for the deals completing. Utilizing these has the potential to enhance cash flows going forward. And this includes, of course, sheltering the tax, including EPL from the GLA, Catcher and Golden Eagle area assets that we're acquiring. But in addition, we are confident that with the total corporation tax losses now of over $2 billion after this deal, we'll be well positioned to compete even more effectively in potential M&A in the U.K. North Sea as well, of course, as continuing to make investments in our portfolio, provided that the right regulatory and fiscal backdrop is provided. Next slide. Having set out the terms of this deal and very attractive cash accretion it will deliver and the very low dollars per barrel of which we're making the acquisition, of course, we are also assuming and have valued some normal liabilities, inevitable in our industry like death and taxes that come with that in terms of future decommissioning. Overall, though, we assess that taking on these decom obligations when added to our very low current position will still leave us at the very low end of the range for our North Sea peers. We've given the numbers of how much we expect the decommissioning to cost. These are, of course, estimates and they are also in actual dollars and not the present value of these. As part of the deals we've announced today, we are also acquiring tax history associated with the GLA assets and some of the others, which means we know we will get tax relief when we come to spend that decommissioning. In addition, we will have options within the Serica Group to optimize the overall position from a tax perspective. But the way we look at this, even without the kind of tax offset optimization that we should be able to achieve in just the first 6 months of owning these assets, we will receive in cash the amount of expected decom spend for the remainder of this decade. The GLA decom sitting here today is slated for the early 2030s. But as we've already covered, and you can see from all the photos that we've shown, the Shetland Gas Plant is by North Sea standards, almost brand new. And it's a key piece of infrastructure serving the most prospective basin on the UKCS. We see but have not factored into our numbers for deal terms, multiple opportunities both to optimize the actual cost of the decommissioning as compared to the TotalEnergies estimates and of course, to push out the time when this will occur through our own development within the GLA area, future third-party processing like the Shell Victory field that's about to start up and of course, possibly future use of the gas plant in the field for new energy solutions in the future. All of these will, of course, also be good for the local community in the Shetlands and the people employed at the gas plant. We would therefore expect to work with our future JV partners to work on optimizing, reducing and extending the time frame of this decom spend as much as possible. And I'll hand back to Chris.

Thanks, Martin. So just in closing, the next steps, we expect to complete the acquisition of Prax Upstream before the end of this year and the other 2 transactions in the first half of 2026, but we are not done. We continue to pursue other opportunities to grow shareholder value through M&A alongside our organic growth agenda. And lastly, I should just mention that we are reiterating our most recent production guidance, and we will give further updates on overall performance at our Q3 trading statement. And with that, I'll hand over to Andrew to coordinate Q&A.

Thank you very much, Chris and Martin. First question has come in, which is how easy is it to develop things West of Shetland?

Okay. Shall I go with that one? It's -- look, it's a bit more difficult the north than the North Sea, I'd say, but not significantly so. It's -- the seas are rougher and the winds are stronger, but it's a case of you build your platforms probably a little bit more overengineered. And if you've got an FPSO out there, then your anchor chains are a bit stronger than they need to be in the North Sea, but it's not a huge leap from normal North Sea operations to West of Shetland. And I would just point out that the Greater Laggan area assets are all subsea at the moment. And so we don't worry too much about the sea state out there.

Next, I'll try and merge a couple of questions we've had about Lancaster. Effectively saying, do you have the option to extend the life of Lancaster beyond Q3 if there's still production going on? And when would you expect decommissioning at Lancaster to begin?

So it's not our option to keep the FPSO for longer. It's not owned by us. It's owned by Bluewater, and they operate it, and it's their choice to take it somewhere else. Now if that gets delayed, if the Sea Lion development is delayed, it could potentially stay out there for longer as long as the well is still producing, but it's not our choice. And on decommissioning, there's basically 2 wells to decommission. I think it's about $60 million. I can't say exactly when that will happen because it might well be linked to us doing a drilling program, for example, at Bruce, and we need to see what contracts we have for rigs and when we can slot in the decommissioning. So it's difficult to say exactly, but it's likely to be within 2 or 3 years after ceasing production.

A question from Martin, I think, which is how easily could you utilize tax losses that have been acquired? Is there any chance of utilizing them beyond the GLA area?

Yes. So first of all, of course, the way, obviously, Prax Upstream before their parent company went into administration was actually pursuing a strategy of looking to monetize those tax losses. So hence, the deals that they had signed with TotalEnergies and with ONE-Dyas were part of that, right? So when those deals complete, they will go into those same companies and the same logic should follow. But there's a lot more losses than can be used just by those assets that are in there. And so extracting the value from those losses is a case of either us acquiring more taxpaying production to go into it or potentially because we've obviously got taxpaying production within our group, we could do some intra group reorganization in due course. And that all of those options are available, and we'll obviously be looking at all of those as we move forward with a mix of M&A and also take into account our own plans for investment for instance in the Bruce asset. So it's worth doing that.

I think, Martin, while you're on a roll, I will ask if you can elaborate on the contingent consideration that could be payable on the GLA assets in terms of their size and what would trigger the payment.

Yes. It's -- look, the only thing that's got any contingent is the GLA transaction, and it's contingent on potential future third-party business coming into the gas plant. And I guess the logic of that, and obviously, we were -- to a certain extent, we inherited a deal that was already negotiated between Prax Upstream and TotalEnergies, but obviously, we've been having our own direct conversations with TotalEnergies as well. But essentially, the logic of it was that, I guess, under the current operator, they've done a lot of the predevelopment work for various things that could come down the pipe, both literally and metaphorically. And so obviously, they wanted to capture some of the potential value for that. It doesn't, for instance, include the Victory field that's already about to start up. So it's things that could come down the pipe in years to come. And I think it actually runs out as far as 2033. But it's quite a complicated formula. But what I can say is that in any circumstance were that to happen, we would be benefiting much more in terms of the value that's added by that production coming on than we would be paying out in any contingent consideration.

A quick follow-up question, which I think I will take, which is who are the other partners in the GLA. So the GLA of the partners all with 20% are Ineos, Kistos and Viaro, I believe. Moving on to a more challenging question. By the time you get around to appraising, let alone developing Glendronach, et cetera, Shetland gas plant operating costs will have the plant running at a loss. Shouldn't the emphasis of the company be on taking over operatorship of Triton where true and immediate value lies.

First of all, I'm not sure I believe that what was a statement rather than a question. But obviously, we'll get into that. And there is potential for a lot more volumes to go through this Shetland gas plant. Yes, look, we've said this before, Triton, we would love to be operating it ourselves. That's not within our gift. [ Gannet ] are the operator and they continue to be so. I guess all I can say is we continue to have conversations with [ Gannet ] about how we jointly improve the operating performance of the FPSO going forward. And you have to understand that even if we were in conversations to take over, I wouldn't be able to say anything specific about that. So you'll just have to leave that with us, I'm afraid.

And maybe just one thing I would add is that again, using a metaphor, we are kind of able to both pat our head and rub our tummy at the same time, right? We do look at multiple things. It's not -- so people shouldn't think about it as just well you're doing this because you're not doing that, right? That's not how it is, and that's not how we work.

I think the next one is one we covered well on the presentation, but should we expect more M&A in the coming months? Or is the focus on digesting the acquisition and investing in the portfolio?

I was making that point. I mean M&A is always about, particularly when you're looking to do a strategy that's involving buying means that you really need to look at multiple things and you need to look at multiple things in parallel. Because, of course, we have -- I think Chris made the point earlier, right? I mean there's a lot of stuff that we can't control in any M&A situation, right? So we need to look at multiple things in parallel, and we are looking at multiple things in parallel. So I can't predict exactly when that will happen. It could become like London buses, but it could be that there's a gap in the bus schedule. So either way, I think suffice it to say that we're looking at a bunch of things.

Too many metaphors we need to handle today Martin.

Yes. And hopefully, this one won't bring others the next question to Martin as well, I think. What percentage of annual free cash flow do you expect to return to shareholders? Or the other easier way of saying that question is another one that came in, I think, which is how will this transaction impact shareholder dividends?

Yes, certainly, I think -- hopefully, you can see with the -- how cash flow accretive and cash generation accretive this is it doesn't do anything to harm our ability to pay a dividend. In fact, it enhances that. We're not going to comment on future dividend policy. That's not a topic for today. It's absolutely a topic for the Board to decide at the right time. But clearly, this is an enhancing rather than anything else in that respect. I'd also say though, we obviously -- and I indicated that we think next year is going to be a strong cash generation year operationally and obviously, actually through these transactions as well. But equally, we've already made the point that we're working on and preparing an exciting investment program on our -- particularly on Bruce. And so we want to make sure that we have the funds to be able to continue to make those investments and continue to pay very healthy shareholder distributions, which remains our strategy.

A good question has come in, which is why these are good assets in perhaps go into administration.

Should I pick that one up? Yes. I mean, look, people may have seen it's been widely covered in the news. It was nothing to do with the upstream assets, the upstream business. The reason that the company went into administration was solely to do with the refinery, the problems of operating the Lindsey refinery, which I got a lot of sympathy for that was operating refineries in the U.K. or in Western Europe is a very, very difficult business today. There's a lot of costs being layered on to them. But frankly, that's nothing to do with what -- we essentially have been able to slightly take advantage of that situation and get a very attractive -- what we consider to be a very attractive acquisition. But yes, so they were left in a position just where the parent got into trouble, but there was nothing wrong with the child. I keep using metaphors, but there you go.

By the way, I've just received a message from a very, very good friend of mine telling me that Victory started up today, good news.

Another question. Given the problems elsewhere in Prax's portfolio, what confidence do you have about how well run these assets are?

Well, I mean, first of all, they had already separated quite clearly different teams doing different things and the people who've been running the Prax upstream business are very well-known, seasoned North Sea operating folks. So we have a lot of time for them. And obviously, we've been -- we will be bringing those people in because we're doing a corporate acquisition. So -- and we see very much how they can be additive to seeing us get the underlying deals completed and obviously helping us as we grow our business. So I don't think there's any sort of read across there.

I think Prax has got a strong team. Lancaster has actually run very efficiently, and that's what they operate today. And they were gearing up to take over the Total assets. And so you already put together a pretty strong team to do that in addition to the Total team that will be coming across. So we feel pretty confident about that.

Yes, there's been a specific question about that, actually asking if any Prax employees are coming across as well.

So yes, as I mentioned, it's a corporate acquisition. And so yes, there are around 30 people that are employed by Prax Upstream, and they will become Serra employees when we complete the transaction. And yes, that's how it's working.

We're start to come to the end of the Q&A. There's quite a few questions you have submitted that are very specific. I'll be very happy to take offline. So if you do, please feel free to e-mail me if you'd like to have any others. We have a couple of questions about liabilities taken on there, including the DCUs from the Prax acquisition of Hurricane Energy. Martin, I'm not sure if that's something you can comment on.

Yes, I can pick that one up very straightforwardly. We're not taking on any of the DCU obligations. Those actually sit in a company above the one that we're acquiring. So actually, the company, Prax E&P plc, which actually they put into administration yesterday. So we're not taking on those liabilities, I guess, is the simple answer on the DCUs.

Perfect. And then apologies to anyone who feels that question hasn't been answered, as I say, please do feel free to reach out to me directly. And with that, I'd say that's the end of the Q&A. So Chris, any final comments?

Just that we're really excited to get this done. It's been quite a slog to get here, and we had to run very fast to get this done before Prax Upstream went into administration. So yes, a big thanks to the internal team as well as all of our advisers and lawyers, et cetera, that have helped us get to this point because it was a struggle, and it's great to get it over the line.

Thanks very much. And with that, we can hand back over to the operator.

That's great. Well, thanks very much for updating investors today. Could I please ask investors not to close the session as you now be automatically redirected to provide your feedback in order the management team can better understand your views and expectations. This will only take a few moments to complete, but I'm sure will be greatly valued by the company. On behalf of the management team of Serica Energy plc, we'd like to thank you for attending today's presentation, and good morning to you all.