Scottish referendum: a spark to trigger North Sea M&A?

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The dramatic narrowing of the polls on the Scottish referendum seems to have been a prime factor in recent share price falls in North Sea oil companies, compounding already low sector valuations.

That raises the possibility that price falls to-date and likely further volatility, following a possible “Yes” vote, may prove to be catalysts for North Sea M&A activity. Analysts, however, caution that the potential elimination of historic tax losses is a major risk for North Sea companies, and the issue would have to be resolved before significant deal flow is seen.

Companies such as Enquest, Ithaca and Xcite Energy have most or all of their assets in the Scottish North Sea and they have all experienced significant share price losses in the last 2-3 months leading up to mid-September.

The Scottish referendum has been a major contributing factor vis-a-vis those share price falls. In the period from July 30 to September 15 (closing prices): Enquest has seen its share price fall 19% whereas Ithaca Energy’s share price drop was a more modest 5% (although it was a more severe 15% from June 30). At the same time, Xcite Energy has seen its already battered share lose a further 14% during the same period (July 30 to September 15). Xcite’s share price has lost about 47% of its value in the year leading up to September 15 2014 mainly due to delays in plans for developing the Bentley field.

Westhouse, in their note dated September 9, stress that “… implementing fiscal changes would not be an overnight process and given the dependency of Scotland on the oil industry, we think radical, unfavourable changes would be unlikely.”

They have decided not to change valuations and ratings on four North Sea oil companies (Enquest, Ithaca, Parkmead and Faroe Petroleum) with assets mostly in Scotland’s part of the North Sea.

According to First Energy Capital’s note dated September 10, any fundamental detrimental changes would appear unlikely as both sides herald the importance of stability.

They note that Alex Salmond was originally opposed to the increase in supplementary tax to 32% from 20% but at the same time the fact that taxation of oil companies in Norway – whose oil fund has been praised by Salmond- at 78% overall is higher than that of the UK at 62%.

First Energy’s sensitivity analysis shows that NAV for Ithaca and Enquest could climb 10-20% if supplementary tax was to go down to 20%. However, elimination of historic tax losses could have a more dramatic impact as it would mean up to 50% NAV loss for Enquest and 80% for Ithaca  (NB. A substantial part of the price paid for the acquisition of Valiant by Ithaca was with respect to tax losses).

In case of Scottish independence going ahead, the exacerbation of such uncertainty may create further short-term trouble for the share price of the aforementioned companies.

If such reaction was not founded on valid concerns, some strategic stakebuilding by recently created PE funds targeting the North Sea or even some of the oil majors cannot be excluded.

Enquest and Ithaca, albeit producers, are both trading below 75% of their full NAVs at 10% (based on a Canaccord sector flash report dated September 2 and price movement since then) and the Enterprise Value of Xcite Energy, expected to be four years from production, is below 25% of the NAV at 10% as assessed by engineering firm AGR TRACS.

Only recently in August the Royal Dutch Shell chief executive was quoted in The Herald saying that he wasn’t concerned about the outcome of the referendum and that his company intended to spend billions on North Sea assets in years to come.

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