Who Really Wants to Own This New U.K. Oil Explorer?

(Bloomberg Opinion) -- Private equity is cleaning up in the North Sea with a takeover of Premier Oil Plc. The deal provides a fresh start for the struggling oil explorer’s shareholders and creditors. And the terms make it easier to understand the approach taken by the longstanding thorn in Premier’s side, hedge fund and lead creditor Asia Research & Capital Management Ltd.

Premier has come a long way in a year. A deal to buy assets from oil major BP Plc was bitterly opposed by ARCM for doubling down on crude despite despite a stretched balance sheet. The acrimony was compounded by the fact that ARCM had a 17% short position in Premier’s equity, raising questions over the fund’s financial motives. A renegotiation of terms with BP in June brought a truce.

Tuesday’s deal with private equity-backed Chrysaor Holdings Ltd. sees the BP asset purchases scrapped altogether. Instead, Premier merges with Chrysaor, giving it a listing. There’s also a new proposal for Premier’s creditors. They get cash, credit notes and equity altogether worth about 75% of the face value of their exposure, analysts at Stifel reckon.

Specialist credit investors who bought the debt at a discount to par may have hoped for a full recovery. Indeed, the outcome shows the value of ARCM’s controversial short position. The firm had around $425 million of the company’s debt. Assume this was acquired at a one-third discount and the holding would have cost around $280 million. Annual coupons since 2017, plus the value of Tuesday’s transaction, would provide an estimated $400 million payback, ignoring the short position. That’s a low-teens internal rate of return, not stellar for this type of investment.

But factor in the estimated gains on the short, and the IRR jumps to the high-teens level that investors expect.

The structure of the deal creates a huge challenge for Linda Cook, the former Royal Dutch Shell Plc executive who will be chief executive officer of the enlarged company. Some 18% of Premier’s register will now comprise creditors who are not natural owners of the stock and will surely want to sell into any share-price strength.

Chrysaor has built a business extracting the last barrels of oil from mature fields that have ceased to make much difference to the performance of the oil majors. Cook says the aim is to create a new independent oil explorer with global relevance. The deal has some financial synergies, by accelerating the use of Premier's approximately $4 billion of U.K. tax losses. It also creates a U.K.-listed peer to the likes of Aker BP ASA and Lundin Energy AB.

Still, finding buyers for the new group’s stock will be tough when institutional investors are already fleeing fossil fuels for environmental reasons, and the weak oil price provides a financial motivation to shun the sector too. Chrysaor of course has targets to reduce its carbon emissions and holds the promise of reliable cash returns. That is the foundation of an investment story – but the overhang looms large here. It’s as if ARCM’s massive short has simply been reborn.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Chris Hughes is a Bloomberg Opinion columnist covering deals. He previously worked for Reuters Breakingviews, as well as the Financial Times and the Independent newspaper.

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