Nostrum Oil reported that the second unsuccessful well in 2019, Well 41, drilled in the North of the company’s only producing asset Chinarevskoye field, did not deliver commercial flow of hydrocarbons. The news comes after Well 42 showed similarly discouraging results.
In simple terms, this means that Nostrum, which is experiencing a 12-15% natural decline in the rate of production annually, has not added new capacity in 2019. The company’s ability to maintain (not to mention increase) production at the current c30,000bopd level depends primarily on the results of reservoir reviews and consequently, on availability of funding to pursue a 2020 drilling programme.
With oil at US$55-60/bbl, Nostrum will generate just about enough cash to keep production flat or slowly increase it. This is not nearly fast enough to utilise GTU3 at full capacity and justify a cU$550mn investment in the state-of-the-art processing facility. If reserves reports invoke optimism, Nostrum will need a cash injection to ramp up production. This brings the debt restructuring question back in the spotlight. We believe, that as time goes by, the bondholder-friendly re-profiling is becoming less likely and a deeply NPV-negative restructuring involving a serious haircut more probable.
NOGLN 22s and 25s mid prices are at c47, according to Bloomberg. Prices could fall further down if reservoir reviews deliver disappointing results. But, even if the reservoir reports are constructive, there will be no positive triggers for the bonds until the debt question is resolved. We reiterate our Sell recommendation.
Below we outline our view on a positive scenario for NOGLN bondholders:
- Schlumberger and PM Lucas confirm that there are sufficient reserves in the producing North-East part of Chinarevskoye. The reports were due in Q3 19, but there are no public disclosures yet.
- Debt restructuring. We estimate that with oil price of U$55-60/bbl and the current capital structure, Nostrum could spare up to US$60mn on expansionary drilling. This is not enough to increase production meaningfully. Without significantly higher oil prices, current production is disproportionately low relative to the debt burden. If the restructuring proposal were announced today, it would have to involve a material haircut, reduction of cash interest, introduction of pay-in-kind interest and, quite possibly, an equity stake offered to bondholders.
- Cash injection to ramp up production. In theory, a company could raise debt, sell equity in the market or to a strategic investor, or partner up with a cash-rich party. In the case of Nostrum, capital markets transactions are out of the question as investor confidence in debt or equity is very low, as evidenced by bond and stock prices. Any strategic investor or partner would seek to ring-fence their investments, rather than bail out bondholders. Since Nostrum’s market cap is US$15mn, it would be difficult to build a value-accretive case for taking an equity stake in the company before the debt situation has been addressed.