Oil sector dealmaking does not herald a North Sea revival

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The UK’s decision to slap oil and gas producers with a windfall tax in 2022 prompted warnings that the North Sea faced being taxed “to death”. Share prices plummeted; companies cancelled or froze projects in the basin. Harbour Energy, one of the UK’s top producers, responded by diversifying overseas.

There is more than one way to handle this moribund patient. UK-focused Ithaca Energy wants to increase its domestic exposure through a proposed deal with Italian oil major Eni. This could unlock growth in the challenged UK market. But make no mistake, it will not stop the trend of companies trying to reduce their reliance on UK production.

The UK windfall levy should, in theory, provide an incentive to companies to invest in the North Sea given that it includes deductions that enable companies to reduce their tax bill if they press ahead with projects.

In reality, companies have still scaled back capital expenditure. Several changes to the windfall tax since its introduction have led to a reluctance to spend or take on more debt when companies cannot reliably predict future earnings. Worse, banks have cut specialised loans to oil and gas companies as a direct result of the tax.

Line chart of Forward enterprise value/ebitda multiple showing Vår Energi trades at a higher multiple than Eni

Ithaca owns stakes in many of the UK North Sea’s biggest potential developments, including Rosebank, Cambo and Fotla. Yet just as its capital expenditure requirements are increasing, production and cash flows are projected to fall. Ithaca has guided to production of 56,000 to 61,000 barrels of oil equivalent a day this year, versus 70,200/day in 2023.

A deal would simply be trading assets around a troubled basin. Ithaca could acquire all of Eni’s UK upstream oil and gas assets in exchange for new Ithaca stock. Eni would hold 38 to 39 per cent of the enlarged group under the limited details released so far. The combination would raise Ithaca’s production to above 100,000 barrels/day.

The Italian major, meanwhile, has a strategy of spinning off assets into satellite businesses when it thinks it can create more value. It spun out its Norwegian assets into Vår Energi in 2018, which it later floated. Vår now trades on a forward enterprise value/ebitda multiple of 3.2 times forward earnings, nearly double Eni’s multiple.

Ithaca says it is still looking at potential overseas acquisitions. Finding attractive targets is easier said than done. Capricorn Energy had to scrap two proposals following shareholder objections to its proposed targets.

In the meantime, the Eni deal would at least be a way of funding some growth back home.


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