Description

Kistos is an investment company in the oil and gas sector focusing mainly on the North Sea. Apart from being objectively cheap at current prices, it benefits from high quality management with a proven track record on nimble capital allocation, shareholder friendliness and the availability of high quality/IRR growth capex without external funding requirements.

We see multiple catalysts for a 2-3x return by 2023 as management delivers and the undervaluation becomes apparent.

Track record at Rockrose Energy PLC

Kistos is led by Andrew Austin (‘AA’). He is known for his track record at a previous venture called Rockrose Energy PLC where he generated a 41.7x (no typo) return from inception over 4.5 years. The following slide is a visual summary. 

Source: Panmure Gordon, pre marketing slides for Kistos PLC

There is a lot to study here. One can perhaps summarise it as AA being a much smaller, nimbler and shrewder operator, constantly picking off assets from counterparties with:

1. larger and lazier balance sheets,

2. older technology and seismic information, and / or

3. stale/no knowledge on the latest tax, environmental regulation, the shifting political landscape and the opportunities embedded therein.

Point of note (after a warm up period) is the acquisition at step 3. Firstly, he acquires a company by paying £8m and announces immediately thereafter a cash balance of $127m. Secondly, to exacerbate the absurdity of the situation further at step 5 we see him return £1.50/share taking everyone out at cost - and some at profit - as if it were a casual bridge loan that was required to acquire a $127m cash balance at a discount.

An attempt to explain it: he re-optimised abandonment and environmental liabilities that were kept too stringent and/or stale by the sellers in light of recent regulatory developments. Additional small cost/high IRR infill drilling would allow for these liabilities to be pushed backward and thus lowering their PVs. Also, regulation had changed, e.g. sometimes keeping an existing platform would have become a preferable outcome compared to fully removing it as say marine growth has embedded it ecologically, etcetera. The compounding of the above lead to significant value creation.

We asked him how he won the bidding process for Marathon Oil UK (step 9, at the time owned by US listed MRO) given it was a larger asset attracting more bidding attention. AA said he was not the highest bidder, but he was the only bidder to seriously take on the UK defined benefit pension obligations, which he sharpened his pencil on via consulting with local pension/insurance specialists. He sold the DBOs later for a profit.

There are more twists and turns in Rockrose that reflect positively on Kistos, but hopefully the above provides enough to illustrate the capital allocation skills, execution quality and focus on shareholder returns of AA.

Kistos PLC IPO 

After COVID struck RockRose stock cratered to £5, but AA still managed to sell Rockrose at £18.50/share in July 2020 where he personally grossed £66m (pre-tax). Kistos was conceived immediately thereafter to capitalise on the apparent dislocations within the energy sector.

Kistos IPO’ed as a £32m blank cheque company in November 2020 and the only notable change here compared to Rockrose is an upfront commitment to the ‘Net Zero by 2050’ agenda whilst adhering to the motto “Energy in Transition”. Which means that Kistos will be focusing more on gas production which has better green credentials rather than oil (but not excluding).

Management could buy in at 75p vs the IPO price at 100p. As a result IPO investors were getting 92p of cash for 100p and providing an upfront ‘promote’ to AA and his management team as an incentive. And this is the only incentive management has, i.e. no warrants or incentive packages after this. AA put in around £10m which we estimate as ~ 20% of his post-Rockrose, post-tax wealth. 

Acquisition of Tulip Oil Netherlands

On 12 March 2021 Kistos announced the acquisition of Tulip Oil Netherlands (‘TON’), with an effective date of 1 January 2021. TON has 19.5mmboe of reserves and 102 mmboe of contingent reserves and has been cash generative in 2019 and 2020 via the producing ‘Q10-A’ field, currently at 6.5k boepd. The management team coming over is considered to be the best in class in terms of CAPEX efficient well drilling in the North Sea.

The Q10-A asset is efficient, as its low depth, low cost opex, and only 20km from the Dutch shore. On top of that the platform is self-powered by wind and solar power, remotely operated (limiting offshore visits). Where visits are required they are conducted by boat, avoiding helicopters, improving safety and lowering the carbon footprint even further. 

CAPEX Program

Cash will be spent on more wells and the question is then if AA is able to spend it on high IRR projects so that underlying serial compounding can manifest itself into a price multiple at a future date as catalysts realise and the market catches up. It seems there is a “hopper of opportunities” available on “realistic timelines”, without the need to raise additional external funding. 

Given the delivery of Q10-A by TON ahead of schedule and the track record of AA as prescribed above we see a high probability that the below timeline is indeed realistic. We also note that all these developments are shallow water, close to shore with no novel technologies being deployed. The program sets Kistos up to be a 40k boepd producer within 5 years. Which would bring them into the top 5 of Dutch gas producers within a short time frame. 

Source: Kistos

Core Area

There is an immediate plan to upgrade the current, old technology, cost-shared, third-party export route (‘P-15’) of the Q-blocks to land via a new, shorter, fully owned pipe that will be more robust and cost efficient at a cost of ~ EUR 39m (the ‘Re-route’). It will lower future OPEX and provide low cost optionaility for future gas fields in the vicinity. It can also provide for third party tariff income, but we leave this out of our valuation exercise for now.

The immediate beneficiaries will be the adjacent gas discoveries to Q10-A that are fully owned by Kistos:

• Q10-B: 3.7MMboe which is similar in structure to Q10-A

• Q11-B: 19.2MMboe substantial discovery

These 2 discoveries are considered low risk opportunities and will be the near term focus as the re-route is finishing up.

There is also proven light oil in the core-area which goes by the name of ‘Vlieland Oil’, being a naturally fractured formation. An appraisal and flow test drill in 2021. Vlieland is part of the “contingent assets”, meaning that additional payments of up to EUR 82.5m are due, subject to development milestones. Given the substantial size of the resource at 42.9MMboe it could be a source of material value creation.

Q10-Gamma is a mirror image of Q10-A and a high ranking drilling prospect. A contingent payment of EUR 10m is due upon a final investment decision. The planned drill will be quite key in defining the viability of this prospect and other unnamed prospects that are present in the Q block (ca. 20).

Non-Core Area

The non-core area consists of the M10a and M11 gas field discoveries sitting 9km outside the Dutch Wadden Islands. It is substantial at 55.6MMboe which could be source of material upside. However, given the proximity of the fields to the Natura 2000 protected area we will assume a low probability in our valuation for this development to move forward. A maximum contingent payment of EUR 70.5m is due, subject to development milestones.

Valuation Perspective 1: Current cash flows of Q10-A, the producing asset

Firstly, an ‘out of the box’ cash flow calculation of the currently producing asset (Q10-A) alone. We arrive at FCF yields of 31% - assuming that the avg realised gas price YTD (EUR 19.967 / MWh) is the flat forward.

Valuation Perspective 2: SotP and IRRs

Obviously, Q10-A is a depleting asset and debt of EUR 150m needs to be paid back. We account for this, economically by overlaying a linearly amortising debt profile over 10 years and assuming the well depletion profile as provided in the competent person’s report (‘CPR’, source: prospectus). We also: 

• load the CAPEX of the planned IJmuiden Re-route to Q10-A, even though this has positive external effects to the other known discoveries in the vicinity (Q10-B and Q11-B) and the potential for earning third party tariffs,

• assume that EUR 5m of holdco costs are inherited from TON, and

• assume the same chance of development (‘CoD’ in the table) as per the CPR report, however lower the chances of the M10/M11 field to 25% given the ‘social license’ risks surrounding it.

Two pricing scenarios are presented: one as per the CPR and one where the average YTD gas/oil price is assumed to be the starting point of the CPR curve profile.

Discussion of Value, Risks and Mitigating Factors

Undervaluation and Upside: We find it easy to argue that Kistos is mispriced at the current levels as we have to push our discount rate to 15% on low risk assets and developments to get close to the current share price. We have seen third party research that confirms that there is also undervaluation on a EV/(2P+2C) basis when compared to UK listed North Sea peers, providing further proof of cheapness. Lastly, we note that the current reference gas price is much higher than the price scenarios above at +EUR 25/MWh, but given the potential temporary nature of this spike, we shall not take this into further consideration. However, we do see a material upside to the cash balance if the current situation persists.

CPR Price Scenario is Fundamental Floor: Gas prices can go down and we would prefer not to be forced to take a view, but having a cursory look at a long term gas future price graph, we observe that dipping below the CPR assumed spot price of EUR 14.04/MWh has been an infrequent occurrence typically followed by a strong recovery (and we see similarly on the oil price assumption). In fact, we conclude that the CPR price scenario can be a fundamental floor to the stock price, providing a good margin of safety at current entry levels.

Source: Bloomberg, TZT1 Comdty. Dotted line is CPR scenario assumed spot price.

Regulatory and Development Risks are Mitigated: The sole JV partner in all licenses is Energie Beheer Nederland (100% Dutch government) with a 40% stake, which will minimise regulatory and licensing risk to some extent on the development assets. All planned developments are low risk as indicated earlier and we have the teams of both Kistos and TON with stellar track records at hand.

Green Credentials Upside: There is further potential unquantifiable upside due to the active positioning of Kistos as currently having a negligible carbon emission footprint (being one of the lowest in the world). We won’t explore this further but we note the uniqueness of this feature within the O&G sector and hence the shares could see demand from ESG capital.

Catalyst

 See CAPEX schedule in write up for project activity milestones.