Usually at end of a quarter we write a series of Quick Updates, but that will have to wait until next month as we look at the newest, biggest player in the North Sea, a company which combines tax innovation with aged platforms, and decommissioning liabilities with the latest oil industry schemes to reduce carbon dioxide emissions.
On April Fool's Day this year, Harbour Energy shares began trading on the London Stock Exchange, following the merger of privately held Chrysaor Energy with heavily-indebted Premier Oil. Premier's shareholders got just five per cent of the merged company, and the deal came with what analysts described as "substantial tax synergies," since the combined Harbour has around US$4.1 billion worth of British tax losses to utilise going forward.
Don't expect the UK Treasury to be seeing much benefit from Harbour for a long while. The presentation advised lucky investors that "as a result of historic investment in the UK Central Sector, Harbour expects to generate sufficient profit to fully utilise those losses by around 2026."
I think we'd all like to pay next to no tax for five years, and Harbour has found a perfectly legal way to do just that.
Funded by a dream team of American private equity company EIG Global Energy Partners, scandal-ridden Asian trading house the Noble Group (here), and Barclays Bank's private equity division, Chrysaor had made its business buying up old fields from ConocoPhillips and Shell. It followed the Perenco model of squeezing down costs and squeezing out extra production from mature fields (here). For a business backed by Noble, famed for its profligate management and spectacular unravelling, Chysaor was surprisingly successful.
Premier oil was attempting a similar transformation as Chrysaor by making a proposal to buy much of BP's North Sea production for US$625 million, and announcing a US$246 million deal to buy 25 per cent more of the Tolmount gas discovery from Dana Petroleum in early 2020 (Herald coverage here). Premier operated the project, which the company expects will produce first gas later this year.
These ambitious plans were ill-timed, coming just before the Covid crisis led to Brent crude prices falling to below US$30 per barrel. Premier axed its plans to buy more of Tolmount in June 2020, but tenaciously held on to its BP asset acquisition plans in the North Sea, even as its share price fell from 100 pence (US$1.37) to below 20 pence (US$0.27), meaning that its efforts to raise new capital for the deal would have led to existing shareholders being diluted, and the balance sheet taking on eye-popping levels of debt. We predicted that the Premier plan was unlikely to succeed (here).
The Premier existing shareholders were furious with the BP plan, and some creditors tried to take Premier to court to block the plan. At the end of 2020, Premier had net debt of around US$2 billion, and bled money last year – a net cash outflow of US$90 million.
Battered by the crisis, Chrysaor offered a lifeline to Premier – a merger that would also give Chysaor's shareholders the chance to trade their private-held, illiquid stakes for shares in a London Stock Exchange listed company, and to take advantage of Premier's massive tax losses. So, Premier walked away from its plans to buy BP's assets and embraced Chysaor to become Harbour Energy. Even better, many of Premier's creditors swapped their debts for shares in Harbour, helping the latter's balance sheet at its creation.
Harbour Energy is now the UK North Sea's biggest oil and gas producer, with over 200,000 barrels a day equivalent oil production, and it also holds Premier's legacy portfolio of offshore assets, including offshore production in Vietnam and Indonesia. Harbour is the main piped gas supplier to Singapore from its Natuna Sea fields, and its market capitalisation is now about as large as its tax losses – around US$4 billion as well.
With the UK facing an extreme shortage of gas, and sky-rocketing prices (BBC coverage here), Harbour CEO Linda Cook's acquisition of Tolmount's new gas production through the merger looks especially lucrative, if the field can be brought on line at the end of this year, after months of delays.
No sooner than the half year results for the company were released (here) with boasts of over US$300 million of free cash flow generation, than Harbour showed the world what a stranded asset looks like. Harbour set out its investment strategy with a bold statement that it would not "undertake high-risk, multi-billion dollar, long lead time projects."
It then demonstrated what this meant in practice, when it announced it was walking away from the development of the Sea Lion oil field off the Falkland Islands in the South Atlantic. Harbour is a 60 per cent shareholder in the project, which is estimated to contain around 500 million barrels of recoverable oil.
The news sent shares in the other 40 per cent partner in Sea Lion, Rockhopper Exploration, down 35 per cent in a single day. With a market capitalisation of less than US$40 million, Rockhopper is unlikely to be able to proceed alone with a development that might cost US$1.8 billion. SBM Offshore had been commissioned to perform design studies for the field in 2016, but in 2020 Premier was forced to write off US$200 million of historic costs in the field when the low oil price meant that Sea Lion was deemed unviable.
Premier had sought to de-risk the project by bringing in a partner, but a farm-in to the block by Israeli company Navitas Petroleum now hangs in the balance. Navitas had hoped to acquire half of Harbour/Premier's share in the project. It has until September 30 to decide whether it will proceed.
Rockhopper made the initial Sea Lion oil discovery in 2010, and in 2012 Premier Oil farmed into the block. The field looked a good fit for Premier's track record in the North Sea developing harsh environment fields with FPSOs, but the collapse in the oil price in late 2014 meant that Premier found the economics extremely difficult, especially given its own strained balance sheet, and Rockhopper's lack of money. Rockhopper's public disclosures have suggested that Sea Lion needs oil prices in between US$40 and US$50 per barrel to break even, but lenders would probably require at least US$50 or US$60 a barrel to fund it.
Now, with sentiment turning against new oil and gas investments, the harsh environment, the remote location from any existing oil and gas infrastructure, and the lack of any existing production performance data makes Sea Lion a difficult prospect for a debt raising, once Harbour exits the project.
Financially, the government of the Falkland Islands would love the Sea Lion project to go ahead, offering the prospect of oil revenues to the tiny islands, which have a population of just three thousand people. The Falklands are currently dependent on fishing revenues to sustain the economy. Tourism was hard hit by Covid, and the executive council of the islands has banned large cruise ships from calling there, as the islands' health system cannot manage a large outbreak of Covid.
Argentina, of course, is adamantly opposed to the development of Sea Lion under the auspices of the British, and in 2015 sought to arrest all the vessels involved in oil exploration in the territory's waters, which it claims for itself (here).
So, Harbour's decision would have been warmly greeted in Buenos Aires.
The decision by Harbour not to go ahead with Sea Lion shows us how the publicly-listed oil and gas industry is increasingly risk-averse and is focused on generating short-term cash flows from existing assets, rather than making highly leveraged gambles on new plays in remote locations. ENI has made much of its strategy of simply boosting production offshore Angola by tying back new discoveries like Cuica and Cabaca North to its old infrastructure (here) extending the life of its FPSO Armada Olombendo.
Perhaps investors and lenders have a point. The shut-in of the Apsara oilfield in Cambodia and the bankruptcy of the operator KrisEnergy earlier this year (here) show that bringing new fields to production can lead to disappointment. Harbour has chosen to eschew the opportunity to chase the next potential Stabroek Block off Guyana (here) and focus on its sweating its core North Sea assets. At the same time as announcing it was quitting the Falklands, it said it would also exit its exploration license interests in the Ceará basin off northeast Brazil, and in the Burgos basin offshore Mexico.
"Exploration and appraisal activities are capital intensive and the results are inherently uncertain as there can be no assurance that future exploration expenditure will result in the discovery of commercially producible hydrocarbons," Premier warned investors in the merger prospectus. "Such activities may involve unprofitable efforts, not only by drilling dry wells, but also by drilling wells that discover hydrocarbons but are of insufficient volume or in poor-quality reservoirs that cannot support commercial development. Appraisal and development activities may also be subject to delays in obtaining governmental approvals or consents, lender consents, [and] agreeing development plans with joint venture partners."
Clearly Harbour doesn't want that risk. If Sea Lion is the first obvious candidate to be labelled a "stranded asset," an oil and gas resource that is known but that will never be brought to production, it won't be the last.
ExxonMobil and Total have huge deepwater gas fields off Mozambique which are currently pending the cessation of hostilities in Cabo Delgado province to bring to production via tens of billions in capital investments in LNG plants. Give peace a chance, so the gas can flow. Most of Venezuela's heavy oil resources and Canada's western tar sands may simply prove too polluting to ever produce.
Other oil and gas fields off Vietnam sit undeveloped because of China's forceful assertion of its purported rights over them (here). In Yemen, civil war and famine have led to the collapse in oil production, with exports falling to around just 15,000 barrels per day in some months, down from 400,000 per day before the conflict and Saudi military intervention ripped the country apart (here).
Anadarko made deepwater discoveries off Sierra Leone a decade ago, but these have never been brought to production (here) after the oil price fall made deepwater greenfield development too expensive. In Indonesia, the massive but very remote Abadi gas field in the Arafura Sea has been stalled by operator Inpex, and partner Shell is now looking to sell after years of arguments with the Indonesian government over how the field should be developed (Hint: Floating LNG would be fastest and cheapest – here). East Timor's Sunrise offshore gas field also stalled after two decades of wrangling, along with other projects on the North West Shelf of Australia, where minor oilfields and uneconomic gas reservoirs sit like tempting strings of pearls under the seabed – too expensive to develop, but too big to ignore.
Not only is Harbour an excellent vehicle for not paying tax, it also has its hand out to the UK government for subsidies for two carbon capture and storage (CCS) schemes. The V Net Zero project involves CO2 from industrial facilities on the banks of the River Humber in the UK being piped offshore and safely stored in Harbour's old, empty oil and gas reservoirs under the North Sea. Harbour says that the Humber region produces nearly 20 million tonnes of CO2 a year and that the V Net Zero scheme could sequester over half of this pollution. The Acorn CCS project should see CO2 from the St Fergus gas plant sequestered offshore Scotland.
This plan to develop these CCS facilities is part of the company's scheme to be committed to Net Zero for Scope 1 and 2 emissions by 2035, meaning that Harbour itself will not be a net producer of CO2 in its operations, even if its customers, who burn its oil and gas, are still polluting with its products.
The second part of the plan is for Harbour to "purchase independently verified carbon offsets." Bloomberg covers the extremely dubious nature of the US$100 billion carbon offsets market here.
But back to Harbour's CCS plans.
To say that CCS is controversial is an understatement. ExxonMobil and Chevron have championed the technology as a way of continuing to process and produce gas with a much limited carbon footprint. Chevron's CCS scheme at its Gorgon LNG plant in Australia has been, like every part of the Gorgon project to date, "disappointing" (here).
Exxon has said that it will invest with its partners in a US$100 billion plan to decarbonise the Houston Ship Channel area of refineries and chemical plants in Texas (here). But only if there are "government incentives, private sector and government investment [and] new policies and regulations to encourage innovation".
I think we can all read what that means.
Proponents of CCS say that rather than the world converting to wind and solar electricity generation, essentially oil and gas could continue as usual, with the CO2 emissions being safely sequestered deep underground in the same geologically stable reservoirs from whence it came. They highlight that CCS is probably the best way to decarbonise steel and cement production, and other heavy industries.
Critics of CCS claim that the whole concept is a scam, "a complex process whereby fossil fuel companies inject donations into… politicians to delay climate action and let them keeping making the ching-ching."
"CCS entails two key stages: Capture and Storage," Australian satirist Giordano Nani wrote. " In the Capture Stage, also known as state capture, fossil fuel interests infiltrate your government at every level, so that we'll ignore scientists and keep approving new coal and gas projects. In the Storage phase we pay those fossil fuel companies billions of dollars to bury their emissions underground… Those companies store the billions of dollars deep, deep down in their bank accounts."
Do not click on this link setting out the case against CCS here if you are offended by bad language.
Harbour, a company that has stated it intends to pay next to no taxes in the UK until 2026, makes it very clear that the taxpayer is in the hook for a considerable share of the costs for the Acorn CCS project. The company describes the Acorn Project as "an ambitious programme designed to tackle climate change by dealing with industrial CO2 emissions and other 'hard to decarbonise' sectors… This project aims to capture CO2 emissions from the St Fergus Gas Terminal, transporting them offshore for permanent sequestration. Subsequent build-out modules include hydrogen generation. The Acorn CCS Project is part funded by the UK Government and the European Union, and is designated as a European Project of Common Interest."
Harbour goes on to say that it is already lobbying for tax breaks for CCS.
"In May, Acorn and a cross-sector group of Scottish industrial CO2 emitters formed the Scottish Cluster as part of a campaign calling on the Scottish and UK Governments to deliver the actions needed so that CCS, hydrogen and other low carbon technologies can enable the decarbonisation of Scottish and UK industry and facilitate a low carbon economy."
The "actions needed" include a slug of funding from the state, with access to a US$1.4 billion "CCS Infrastructure Fund, which will primarily support capital expenditure on CO2 transport and storage networks and industrial carbon capture projects."
Harbour and its partners, which include the Phillips66 refinery, owned by ConocoPhillips, and the Immingham power plant, owned by trading giant Vitol, got their application into the UK government for funding from the UK CCS Infrastructure fund in July. Acorn has also made an application for CCS Infrastructure Fund cash.
It seems Harbour wants British taxpayers to support the schemes of a company that intends to pay no tax in the UK for the next half decade. Strangely, no budgetary indication of the costs of these CCS projects, or estimates of the company's share of the expenses, was mentioned in any of Harbour's public filings. Timeframes for the start of CCS operations were very vague.
For CCS to have credibility, it needs successful projects up and running now. Otherwise, it starts to look like its notorious and much vaunted relative "clean coal."
So, Harbour is important in several many ways. It is now the UK's largest listed independent oil and gas producer. Its low-risk, low-carbon strategy has already created a likely stranded asset in the South Atlantic. It now intends to lobby the UK government for funding for its CCS projects.
The word "tax" appeared 737 times in the merger prospectus between Chrysaor and Premier Oil: ten times more than the word "safety," ten times more than the word "environment," and nearly twice as much as the word "exploration". This tells you a lot about the company's focus.
As the largest oil producer in the UK North Sea, Harbour also has some of the largest decommissioning expenses in future, when it must dismantle and remove dozens of platforms and miles and miles of pipelines.
Premier's prospectus stated that Harbour had US$3.5 billion in decommissioning liabilities, whilst Premier itself had liabilities of over US$1.2 billion reported in its August 2020 results. So, at just under US$5 billion in total, the decommissioning liabilities of the combined Harbour Energy likely actually exceed its market capitalisation, its tax losses, and its net debt.
We have already seen in Australia and New Zealand that decommissioning can carry significant unforeseen costs (here).
Harbour Energy represents one aspect of the future of offshore – it is an entity intent on extending the life of its existing assets as long as it can, of deferring its decommissioning liabilities for as long as possible, and of finding as many advantageous tax schemes and state subsidies from which it can benefit.
Chrysaor in Greek mythology was born of blood and violence (see below). Chrysaor's twenty-first century business offspring, Harbour, was born of private equity, careful tax planning, and the desire to present a cleaner, greener image for the offshore industry.
With the Sea Lion project safely ditched, the Brent oil price trading comfortably above US$75 today and the UK bracing for a winter of natural gas shortages and high prices, Harbour CEO Linda Cook can smile at a job well done so far.
Background reading
Harbour's investor presentation on its launch six months ago as a "new global independent oil and gas company" can be found here.
The prospectus for the merger is here – as ever with a public listed company, picking through the details provides much more information than reading Chrysaor and Harbour's press releases. Pages 109 and 110 set out the UK oil industry tax loss policy, stating that "these losses can be carried forward if the company is still trading or carried back and set off against past profits as far back as 2002 (or indefinitely for PRT purposes). The carry back of losses can generate valuable tax refunds to the extent the company incurring the losses has paid tax historically."
You can download the details of the UK taxpayer subsidies for the "Track 1" CCS projects here.
The Juice Media podcast with Richie Merzian of the Australia Institute on CCS is here.
More politely, Greenpeace's position on CCS is here. The campaigners are opposed to CCS.
Note on Chrysaor's name
In Greek mythology, Chrysaor was the son of sea-god Poseidon, who had raped the Gorgon Medusa. Medusa's hair was made up of snakes, and whomever gazed upon her was turned to stone. When Perseus sliced off Medusa's head, legend says that Chrysaor and the winged horse Pegasus sprang forth from her blood.
Yes, a strange name to choose for a company, especially one with a female leader.
