Chief Executive Officer Review
We have a singular objective at Bahamas Petroleum Company - to commence drilling on our exciting, highly prospective licences located in the southern waters of The Bahamas, adjacent to the Cuban border. Your Company believes it has access to what could potentially be a world-class, multi-billion barrel petroleum resource. The first step in realising that potential will be to responsibly and safely drill an off-shore exploration well - the first in The Bahamas in nearly 30 years and thus the first to harness the benefits of modern technology.
This might sound simple, but activity of this type is complex and costly, and, most especially after the Gulf of Mexico tragedy, requires the simultaneous management and coordination of a number of challenging regulatory, operational, commercial and financial factors. The extent of progress towards our objective is not always immediately obvious to shareholders and certainly the pace of progress towards initiating drilling has been slower than management envisioned, or than shareholders expect.
There have been a number of developments, both Company specific and more generally, that have continued to shape efforts to reduce expenditures whilst moving the project forward, as well as further defining the business environment in which the Company operates.
What has changed?
Most importantly, on the project front, the first six months of 2016 saw the final passage of the new Bahamian Petroleum Act which was formally enacted as at 31 March 2016. Subsequently, the attendant Petroleum Regulations were gazetted and implemented, thus fully completing the process of updating the legal and regulatory environment of The Bahamas in anticipation of future exploration activities.
Given the significant future investment in the Bahamian economy that a successful project would entail, a number of potential partners regarded the resolution of perceived “above ground” issues as a necessary precursor to the progress of discussions. The passage of the revised legislative package, following on from renewal of the Company’s exploration licences in 2015, has thus provided impetus for partnership discussions to progress in earnest.
Another significant change in relation to the project is that estimates of the entry level capital requirement have continued to be revised downward as rigs are warm or cold stacked. This has resulted in substantial reductions in global rig-rates which are now at roughly one quarter the original estimates received by the Company in 2012.
In relation to “below ground” issues, additional work has been undertaken to further de-risk various technical aspects of the prospects. This has largely been targeted work in response to multiple assessments by various external parties in the course of ongoing discussions, each of whom bring their own particular area of enquiry and focus to the technical evaluation process and commercial discussions.
As a result of this additional work, the already strong technical case for the world class nature of the Company’s assets has been enhanced. Recently published independent analysis from a leading international petroleum consultant (Wood Mackenzie) has reinforced that view, in that it identified the anticipated BPC well as being ranked in the top 10 “Drilling and Future Wells by Prospect Size” (as measured by their estimate of pre-drill volumes – mmboe). In combination, the reduced estimated drilling cost, along with the potential scale of the project resources, further underpins the upper quartile nature of the finding and development (F&D) costs (measured in $/barrel) the industry typically uses as a key benchmark in determining the relative merits of its ‘frontier’ exploration plays.
On the global front, there has been a modest recovery in the price of petroleum from the lows of $30 per barrel at the beginning of the year to circa $45-$50 per barrel at present. The price has also been relatively stable of late, providing some respite from the extreme volatility experienced by the markets over the last two years. This increased price and sustained stability is beginning to have an impact in respect of the capital markets, where occasional “green shoots” of exploration appetite seem to be appearing, as evidenced by a number of successful farm-outs and fundraisings which have been reported in recent months.
Thus whilst overall conditions remain difficult, the indications are that the industry is now beginning to emerge from the most challenging phase of the commodity cycle (as it has done on many previous occasions), and this trend is expected to continue in the coming 12-18 months.
Nonetheless, the recent volatility in oil prices, coupled with weaker long-term predicted fundamentals for the industry, is resulting in constrained availability of exploration capital particularly for opportunities perceived as “frontier” exploration. Thus we are observing that the industry participants, prioritise those frontier plays that not only have considerable scale, but are also demonstrably executable (modest water depths, existing technology, close to infrastructure, in established regimes etc.). More so than ever, the ability to fully realise a project is a key determinant in attracting investment for frontier exploration prospects. In this context, the relative importance of the discharge of many of the perceived “above ground” issues relating to our project, as referred to recently, cannot be understated.
The other major impact of recent industry conditions has been on timing of investment decisions. In response to recent market conditions, many of the larger industry players have become increasingly risk-averse with stringent cutbacks on spending and huge turnover in or reshuffling of personnel. Assurance, governance and approval processes in relation to new investments have become considerably more onerous and time-consuming. These factors, combined with the unprecedented range of options available in a “buyer” dominated market, have adversely impacted the pace of progress towards the Company goal of securing an industry partner for its project although most importantly, not its ultimate achievement.
The Company’s strategy remains intact: to secure exploration funding from an industry partner, thus enabling the timely discharge of licence obligations. In support of this strategy meaningful discussions with a number of suitably qualified potential partners are ongoing. The positive attributes of our project means we have continued to attract the attention of both major and independent operators, notwithstanding the overall subdued industry environment, although mainly due to the external market factors previously mentioned, the pace of progress has been less that we would desire.
As reported in our most recent Interim Financial Statements to June 2016, the total 6 month operating loss for the Group was $2.159 million, down 8% on the comparative 6-month period and 11% on the 2015 full year result on an annualised basis.
Moreover, on a true cash basis, considerably greater savings have been achieved as a result of measures implemented over the last few years and, in particular, over the 6-month period to June 2016. In particular, as previously announced, the Board elected to increase its fee deferral from 1 April 2016 to 50% of contracted entitlements (up from the 20% deferral implemented in the fourth quarter of 2014). Additionally, I took the decision to increase the deferral of my contracted salary to 90%, also effective 1 April 2016, and similar deferrals were agreed to by other executive employees of the Company. These deferrals are only repayable once a successful farm-out or other financing arrangement has been concluded such that the Company’s forward programme is secured. A considerable portion of these deferrals are repayable in shares (and therefore will represent a non-cash cost to the Company), further aligning Board, Management and shareholders alike.
As a direct result of the above, the Company has saved a total of $678k in cash fees / salary outgoings since the deferrals commenced in 4Q 2014, with about half of these cash savings in the current 6-month period alone.
Finally, as part of the recent agreement to increase ongoing deferrals, I also agreed to waive all of my accumulated deferred salary from the period 1 October 2014 to 31 March 2016, an amount of approximately $300k, in support of the project. However, the provisions of IFRS 2 require that the Company continues to recognise all of these foregone costs under Employee Benefit Expenses, despite the non-cash and contingent nature of the deferrals. Thus the waiver of my accrued entitlements (as at 31 March 2016) did not result in a write back of these amounts, which had already been recognised in the Statement of Comprehensive Income as an expense to the Company. Similarly, the increased salary deferrals, which became effective form 1 April 2016, do not result in any decrease to ongoing Employee Benefit Expense recognised under IFRS 2.
In simple terms what this means is that the reported figure for Employee Benefit Expense for the period includes $335k of non-cash items, and also excludes previously recognised deferred fees “written off” in this period. As a result, the true nature of the ‘cash’ savings in the period and the Company’s ongoing cash “burn” rate, are not entirely transparent in the accounts and therefore detailed comparison of the current period costs with the prior period does not provide for meaningful analysis. By contrast, the cost reductions achieved across “non-employee” categories of expenditure are more immediately visible, with a 27% reduction in Other Expenses compared with the previous 6-month period, and a 29% reduction on the 2015 full year results on an annualised basis.
Going forward, the effect of ongoing cost reduction efforts in their entirety will have substantially more visibility on a cash basis (albeit noting that the ongoing requirements to recognise deferred fees under IFRS 2 will continue to result in the reported Operating Loss figure being relatively larger).As at 30 June 2016 the Company had a total cash balance of approx. $2.5m.
Overall, efforts to secure the finance required for the Company’s initial exploration well via a farm-out or partnership continue to progress encouragingly, but at a slower pace than desired. The low oil price environment means that it is undoubtedly a “buyers” market, with selection criteria and decision making processes for new “frontier” exploration prospects being more onerous and time-consuming than ever. Industry players are focussed on projects of scale with robust economics and which are relatively uncomplicated operationally all of which criteria our project meets: multi-billion barrel potential, competitive metrics, robust profitability even at today’s oil price, and advantaged location adjacent to the largest offshore operating environment and energy market in the world. Consequently, we remain confident that we will conclude a partnership agreement within the required timeframes.
The Board would like to thank all of our shareholders for their continued support and perseverance, and looks forward to reporting further progress to you as we bring the Company into the next phase of its exciting project.
Chief Executive Officer