Introduction to Kistos PLC
Kistos is an investment company targeting opportunities in the transition energy market. It made its IPO in November 2020, raising £31.75 MM. Its strategy is to take advantage of companies looking for the sale of interesting assets due to a variety of reasons (ESG pressure, non-core assets, new regulations, etc,..) to pay low prices and extend their useful lives by techniques like infill drilling, etc
In April 2021, Kistos raised capital again to fund the acquisition of Tulip Oil for €223MM (comprising €140MM plus an €87MM bond refinancing and other adjustments). It was a privately held exploration and production operator (oil & gas) with assets in the Northern sea and Germany.
Later, in January 2022, Kistos acquired a 20% interest in the Greater Laggan Area in the UK. The price was $125MM and thanks to high natural gas prices & deal structure, it has been self-paid in less than a year. Total (the seller) still has 40% of the GLA stake and is the operator.
These two acquisitions are producing around 12kboepd (6+6) net to Kistos. It has no hedges in place and low Opex (mainly in the Netherlands) with average unit costs of around€5/MWh, Furthermore, Kistos’ asset portfolio provides significant organic upside. It could produce 25 kboed by 2025.
However, to understand Kistos, it is necessary to talk about Rockrose Energy and Andrew Austin (Kistos’ executive chairman). RockRose Energy was an energy company that operated in the North Sea. And Andrew was the CEO of Rockrose from 2016 to 2020. During these four years, Austin delivered a 42x return for Rockrose shareholders pursuing a similar strategy that he is trying to do in Kistos, and again in the North Sea. Although Kistos was created to replicate the success of RockRose, the main difference is that RR was focused on old legacy assets producing oil and Kistos is focused on assets producing natural gas.
Kistos Investment Thesis
Our investment thesis is based on two pillars:
- The structural deficit of natural gas in Europe (increased as a consequence of the sanctions on Russia) will maintain natural gas prices high in Europe for the foreseeable future. From our perspective, Europe took the wrong approach to the green transition. They criminalise investment in energy (other than renewable) and forced majors to diminish their investments in fossil fuels. It would be fantastic if we had the required infrastructure developed enough. But we have not and it is not going to happen soon (batteries, network,..) .Consequently, natural gas production in Europe halved in less than 10 years and as renewable energies are intermittent we are vulnerable and need to import energy from other countries. Then, Russia invaded Ukraine, Europe shoot itself sanctioning Russia and the rest is history… The consequence of all this is Europe is very vulnerable and it needs to pay higher prices than the rest of the world to bring energy (LNG). At the same time, if the energy (LNG) goes to Europe, it is not going to its traditional destination (which cannot afford to pay such high prices). It entails energy problems in the developing world and tough competition with Asia for the marginal natural gas unit, which maintains the price high.
- Superlative management team, with experience in the North Sea, an outstanding M&A track record and strong shareholder alignment with around 20% stake in the company. The fact that oil & gas majors need to focus on renewable energy instead of traditional fossil fuels, means that they also need to disinvest in Oil&Gas assets as they are quite capital intensive. It creates good opportunities for small players like Kistos who can acquire interesting assets at a significant discount. Nevertheless, the most distinguishing characteristic that Kistos have compared to any other peer is Andrew Austin (Executive Chairman) and his team. They have enormous experience doing the same business in the North Sea with unbelievable results. The first months of Kistos have been much better than planned thanks to the high natural gas prices (starting just after the acquisition in the Netherlands) and Kistos have a lot of liquidity to accelerate its initial business plan. Furthermore, we believe that the mess that governments (EU & UK) are doing with taxes will force some majors to exit these jurisdictions, inviting Kistos to carry out some of its fantastic deals.
Kistos Investment thesis Date: 27th Nov 2022
Kistos Capital Structure
| 1 | Common Shares | £377MM |
| 2 | Preferred Shares | 0 |
| 3 | Debt | €83.3MM |
Main Shareholders
Earning Metrics
| €MM | 2020 | 2021 | 1H22 |
| Revenue | N/A | 89.6 | 285.1** |
| EBITDA | N/A | 78.8 | 261** |
| EPS | N/A | -0.68* | 0.63 |
* Q11B impairment (€121MM), 59MM share average in 2021
**Pro-forma (Including GLA)
Stock Information
| 82.8 | nº shares |
| 525k | 3mth avg vol |
| 1.5 | Beta |
| 318-665p | 52 Week Range |
Assets
Netherlands (ex Tulip)
The acquisition of Tulip Oil brought 2P reserves of 19.7 MMboe plus 2C resources of 99.1 MMboe. Kistos has a 60% Working Interest in the assets acquired. Being the Dutch government the owner of the other 40%. Assets include several natural gas fields: Q10A, Q10B and Q11B, plus the option to acquire M10A, M10B and Q10A-Vlieland Oil paying an agreed amount (around $75MM for both Ms and around $75MM for the oil – depending on the oil found). At this moment, there is only one producing field (10Q-A). Kistos is the operator of the field. which is located 20km offshore of the Netherlands, straddling production licenses Q07/Q10 all licenses expiring in 2042.
Q10A: It is the only producing asset in the Netherlands. It currently produces around 6000 boepd net to Kistos and production costs are only around €3/MWh. It is one of the offshore fields that have less CO2 emission produces in the world as it is powered by wind turbines installed in the platform. The gas produced in the platform is transported by a 42km pipeline to the P15D compressor to send it onshore. This P15D was initially designed for oil, so it needs some days of work around the year apart from the 4 weeks maintenance period (it is the pain point of Kistos)
Q10A is composed of 6 wells. In the 4Q22, Kistos is working to increase production from Q10-A and take advantage of current spot prices. Specifically, Kistos is going to install a velocity string in wells A05 y A06, a sidetrack in the A01 and stimulate the A04 well. It is expected a boost in production for the first 6-8 weeks (estimations are around 2000 boepd) and then it will establish at a lower level.
Q10B: It is a very small field (1.8MMBoe – 2C reserves). Kistos will drill the appraisal wells at the same time as Q10-Gamma. We understand that the idea is to couple them to the Q10A platform.
Q11B: This was the field appraised at the beginning of 2022. The results were not what Kistos expected and they stopped further development. Currently, the most probable option is to extract natural gas from the Q10A platform (a quick and economic solution). It is expected to produce around 2000 boepd. However, we understand that any decision about Q11B will be taken after developing Q10B.
M10A & M10B: These are two big natural gas fields located north of the Q10s. However, they are close to an environmentally protected area and Kistos has not been able to obtain the permissions.
Q10A Vlieland Oil renamed Q10-Orion: Kistos made the appraisals in 2021 and determined that the field was commercially viable. They have the intention to develop the infrastructure and produce from that field. However, the tax situation in the Netherlands has made this asset not a priority now and it is not expected to produce before 2025. There are assessing two different designs. Develop a bridge-linked platform or couple it into the Q10A platform and use the same P15D compressor to extract the oil. The field has 42.9 MMboe 2P reserves. Development Capex could be around €200MM. Initial production could be expected to be 8000-10000 boepd.
Greater Laggan Area (UK)
Kistos acquired a 20% stake in GLA in January this year from Total which is the operator and holds 40% of the asset. GLA is located in the UK, approximately 125km towards the northwest of the Shetland Islands.
GLA consists of four producing fields (Laggan, Tormore, Edradour and Glenlivet), and two organic growth options (Glendronach and Benriach). Current production is slightly over 6000boepd (net to Kistos). This acquisition also includes the Shetland Gas Plant which processes the gas from natural gas fields in the area prior to export to the St Fergus terminal in Scotland. This terminal was designed to process up to 500 MMscf/d. Currently, it is underutilised, but it is not only designed for GLA but also to receive natural gas from other fields in the area. It would diminish the Opex cost for Kistos and be a source of income. We estimate current Opex to be around €8/MWh and reserves 5MM boe (2P reserves)
The structure of the deal was something pretty common in the industry (i.e. Jadestone use it all time) but maybe not so common in other. Kistos agreed on 1st January 2022 as the date that economic interest started (announced the deal on 31st January). It means that the benefit that GLA produced from 1st January until the deal was closed was discounted to the agreed sale price ($125MM + $40MM based on natural gas price in 2022). This type of deal benefits considerably to the acquirer as it reduces the amount of cash/debt they need to finance the acquisition.
Greater Laggan Area has four operating fields Laggan, Tormore, Edradour and Glenlivet. Laggan is the more productive of all. Its production peak is bigger than the sum of the rest. GLA production has surpassed expectations since Kistos acquired it. in 1H22 its production was about 6300 boepd. The decline of the fields is well-defined as shown in the picture below (“no further action”). Take into account that the picture represents gross production (Kistos owns 20% of it)
Apart from the producing assets, Kistos has important organic growth options to pursue in the coming years. Specifically Glendronach and Benriach
Glendronach: The Glendronach discovery was made in 2018 and appraised by Total. FID is expected to be taken in 2022 and the first gas would arrive in 2024. The project is to develop the field through a single tieback well to the Edradour manifold. The development of Glendronach is expected to increase the life of GLA at least by one year.
Benriach: It is the biggest upside that Kistos has as a consequence of the GLA acquisition. Kistos has 25% ownership in the asset and it could add 28.4 MMboe of net reserves. It is close to the existing pipeline and infrastructure which would diminish the required Capex. It is partially de-risked thanks to Glendronach. The exploration wells are expected to be drilled in the summer of 2023 (this type of work in the North Sea is usually done in the summertime due to the water temperature). If there is commercial viability, Kistos will pay $1.45/boe of net 2P reserves after the first gas.
Taxes
Netherlands
Netherlands is set to apply two different tax schedules. One for 2022 and another one for 2023 & 2024 aligned with the EU.
In 2022, it will apply a 33% tax for this year’s benefits exceeding the average benefits obtained in the last four years. As Kistos was not operative then, we assume that the Tulip production will be taken into account (for 2019 and 2020 as in 2018 was 0).
To the best of our understanding and being not an expert in Dutch legislation, it would be calculated like this:
In 2023 & 2024, the royalties will be increased to 65% for all benefits generated from natural gas sales above €45/MWh (this royalty was 0% for O&G companies with operations offshore). We are still waiting for the definitive approval of this law.
UK
The UK has recently published an updated version of its Energy Profits Levy where it raises the surcharge from 25% to 35%. It means that in addition to the standard 40% tax, there is an extra 35%, making the total taxes 75%. However, there are new investment incentives that every pound invested in the UK can result in an overall tax saving of up to 91.40 pence.
Debt
The company debt is made up of two bonds for a total of €150MM
- €90MM at 8.75% interest maturing November 2024. However, Kistos has been repurchasing this bond. Currently, it has already repurchased €66.7MM. Consequently, there are €23.3MM outstanding
- €60M at 9.15% interest maturing May 2026
The total outstanding debt is €83.3MM (following the latest bond repurchased news from 11th October 2022)We are aware that Kistos is trying to buyback the entire €90MM. It would be an important step to allow the company to repurchase stock as the bond does not allow Kistos to do it (well… it is subject to specific conditions). This bond has call options starting on May-23
Corporate
M&A deals: Kistos reason to be is the M&A activity. They tried to buy Serica this summer and we strongly believe that they are very close to announcing a new deal in the coming months. Mr Austin has declared in some interviews that shareholders should expect a similar pace of acquisition as when he managed RockRose. We all know that with new legislation and natural price volatility 2022 has been a difficult year. However, Shell has already announced that it is exiting the UK and we are sure that UK & EU new taxes will force several companies to exit these jurisdictions, creating opportunities for Kistos. We mainly expect acquisitions in the UK & Norway, and maybe not in the EU as retroactive taxes in the Netherland is to cross a red line…
Share buybacks/tender offer: One of the main characteristics of Mr Austin and his team is the strong compromise for value creation for their shareholders. As it happened in RockRose, we are sure that if there are not attractive M&A opportunities, they will do a tender offer/buyback as soon as possible (read bond covenants)
New structure: This week Kistos has announced a new structure, where it creates a Finance company. To our best interpretation of it, among other things, it will allow Kistos to sell the NBP natural gas at TTF prices. This would allow Kistos to pay taxes for the difference (TTF-NBP) as a financial product and not as natural gas. Specifically, if Kistos does that with a certain amount of NBP production, it would pay the EPL in the UK at the NBP price and the difference (TTF-NBP) as a financial product (no extra taxes for energy production). And we repeat, this is only our best interpretation of the report they published this week. We are not experts in this type of law.
Dividend policy: It is not their first or second option. However, we believe that in the medium term, they will implement a dividend policy as they did with RockRose
Kistos Valuation
We have valued Kistos taking into account the current assets in production plus the pipeline (including the Oil). We are not considering any additional acquisition or the potential upside from Benriach.
We use a discount rate of 12%. We reach that number by taking into account the cost of debt, the current interest rates (risk-free) and a premium for illiquidity (as we usually do with companies in the AIM London)
We assume that the taxes are going to remain as detailed in the previous section for the foreseeable future (we believe that temporary tax means forever, so we are modelling based on it)
Natural gas prices are by far the most sensitive variable to value Kistos. We have assumed what we think that it is a conservative forecast (much lower than the current futures curve). Particularly, €80MWh in 2023, €60MWh in 2024, €40MWh in 2025 and €25MWh from 2026 and beyond. We also have assumed a 15% discount in NBP prices compared to TTF.
We are considering a Brent price of $70 from 2025 (assumption of first oil) onwards, which we also believe is very conservative.
We assume a unit Opex for natural gas of €5MWh and we are not including any increment in the Shetland plant which would diminish this amount (it would be beneficial for the Opex of GLA assets)
The exchange GBP/EUR to remain at 1.16
We also assume that there will be no more hedges. We know that if there is an important amount of money compromised for Capex / M&A, but we are not including it on the model due to the volatility, it would be bold to model the hedge price accurately.
We obtain a target price of 741p, which offers a 62% upside from this Friday’s close price. This target price has been severely impacted by the new taxes. However, and at least personally, we are not invested in Kistos only for tangible things. We have invested in the best deal-maker team that we know, and we expect that they continue increasing this target price using all the tools at their disposal (M&A, Buybacks, Tender offers,…)
Risks of investing in Kistos
- Production problems: Kistos has only a few producing assets. Consequently, the impact of one of them having problems would be important (50% production in four fields in GLA, 50% Q10A)
- Weather: A mild winter in Europe would avoid inventory depletion and the natural gas prices would not be as high as expected in 2023
- Natural gas supply: It seems unlikely by now (not until 2025) but an increase in LNG / natural gas to Europe would diminish TTF & NBP prices.
- Hedges: we do not expect hedges. However, if Kistos enters in a big M&A operation, maybe it needs to secure some cash flows and hedge some port of its production (also depends on the structure of the contract, if it is like GLA, it does not make sense). In such a volatile market, good luck is also an important factor with hedges
- Regulation: The situation in the UK and Europe regarding taxes is bleak. There is more legal certainty in any West African energy-producing country than in Europe. It seems that the decision is already made. However, if there is a political change in the UK or if the winter is tough and next year TTF & NBP prices are on the roof, we cannot discard more interventions.
Conclusion about Kistos
Kistos, despite being a small company created only 2 years ago, is producing >12000boepd and practically in a net cash position (we estimate around €25MM net debt). Furthermore, its management team is experienced in the North Sea and has an outstanding track record in M&A and a strong shareholder alignment. To all of that, we should add that we are in the most possible bullish environment for natural gas prices in Europe, which we expect to remain normally high for several years.
Kistos and the rest of its peers’ share prices trade depressed due to all the new taxes that the governments made up this year. And we believe that it is a double-edged sword as it disincentives production and will make natural gas prices remain high for more time. In addition, we have a scenario where a considerable amount of players are going to be tempted to exit these jurisdictions and sell their assets. And there is where it comes to the best deal-maker team in the North Sea.
Looking at numbers, we strongly believe that Kistos is well-undervalued. We also think that the worst of political uncertainty has fallen behind and winter temperatures are already here, which will allow Kistos to print a lot of money. Nevertheless, as we stated before, we think that in addition to all the other aspects, there is an intangible component that is not included in the target price, and it is the management team, which we believe will manage to achieve outstanding deals, tender offers/buybacks / whatever to increase the value to their shareholders as they did in RockRose.
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