Kosmos Energy Ltd. quarterly report, Q2 FY2014

Kosmos Energy Ltd. — Q2 2014 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2014. Unaudited results. Kosmos is an independent oil and gas exploration and production company focused on the Atlantic Margin; substantially all current production and product sales came from the Jubilee Field offshore Ghana.

Financial results and liquidity

Metric	Q2 2014	Q2 2013	Six months 2014	Six months 2013
Oil and gas revenue	$328.3 million	$193.4 million	$541.2 million	$421.5 million
Net income (loss)	$56.5 million	$(70.8) million	$131.5 million	$(50.7) million
Cash provided by operating activities	Not presented by quarter	$286.1 million	$276.9 million
Capital spending on oil and gas assets	Not presented by quarter	$186.5 million	$166.6 million

Q2 oil sales were 2.916 million barrels at an average realized price of $112.58 per barrel, compared with 1.944 million barrels at $99.51 a year earlier. First-half sales were 4.853 million barrels at $111.50 per barrel, versus 3.935 million barrels at $107.11.
Oil production costs plus depletion were $30.90 per barrel in Q2 and $31.00 for the first half, down from $40.71 and $40.69, respectively, in 2013. The filing attributes the decline mainly to lower depletion rates and fewer workover costs.
First-half cash flow from operations rose modestly despite a negative working-capital effect, including a $135.6 million increase in receivables. Investing cash outflow was $130.9 million, including $58.3 million in asset-sale proceeds; financing cash outflow was $131.6 million, including $100 million of debt repayments.
At June 30, cash and cash equivalents were $621.6 million and restricted cash was $54.8 million. Debt under the commercial Facility was $800 million; reported net debt, deducting cash and restricted cash, was $123.6 million. The Facility had $700 million undrawn and the Corporate Revolver had $300 million undrawn. Current assets were $905.5 million and current liabilities $326.9 million.
In August, Kosmos issued $300 million of 7.875% senior notes due 2021, receiving $292.5 million net. Proceeds were expected to repay part of Facility borrowings and fund general corporate purposes. The filing states available borrowings plus cash would increase to approximately $1.9 billion after issuance.

Changes, unusual items, and operating developments

First-half revenue increased $119.7 million year over year, reflecting higher sales volumes, one additional lifting, and a higher realized price. Q2 sales included three liftings versus two in Q2 2013.
First-half net income improved by $182.2 million from the prior-year loss. Lower exploration expense was a major factor: 2013 included unsuccessful Cameroon Sipo-1 and Ghana Sapele-1 well costs. First-half 2014 also included a $23.8 million gain on the BP Morocco farm-outs.
Derivatives were a material earnings headwind: the company recorded net derivative losses of $21.6 million in Q2 and $19.5 million for the first half, versus gains of $12.7 million and $7.2 million in the comparable 2013 periods. The filing links the changes to movements in oil-price forward curves.
Q2 included $11.8 million of restructuring charges for severance and related benefits, including $5.0 million of accelerated non-cash LTIP expense. First-half results also included a $2.9 million debt-extinguishment loss related to the March refinancing. The amended Facility reduced interest expense, including a $4.5 million adjustment to deferred interest.
Income tax expense was $80.8 million in Q2 and $131.6 million for the first half; reported effective tax rates were 59% and 50%. Management notes that losses in certain jurisdictions do not generate tax benefits, while higher Ghanaian pretax income increased tax expense.
In Ghana, partners’ share of costs for GNPC’s 5% TEN development interest was estimated at $4.9 billion gross; Kosmos’s portion was estimated at $49 million, with repayment plus interest expected from GNPC’s share of TEN production revenues. The company expected to begin paying its share in Q3 2014.
The government and Ghanaian environmental regulator approved flaring up to 500 MMcf of Jubilee gas per month through October 2014, intended to help maintain production until Jubilee gas-export infrastructure is operational. Management warned that unresolved associated-gas removal issues and resulting production restraints could adversely affect operating cash flow.

Outlook, commitments, and risks

The estimated 2014 capital program was $575 million: approximately $400 million for Ghana development and $175 million for exploration and appraisal, including new ventures. Actual spending could vary with market conditions and exploration results.
TEN development was expected to involve up to 24 wells, with first oil anticipated in the second half of 2016. Commerciality decisions for several Ghana discoveries, including Mahogany, Teak, and Akasa, were expected in early 2015; Wawa’s decision was expected in 2015.
The Atwood Achiever rig was expected to begin operations in the second half of 2014. The three-year contract commitment was estimated at $562.9 million, after a rig-sharing arrangement; this is a substantial multiyear obligation.
As of June 30, the company reported $35.4 million of derivative liabilities, mainly commodity derivatives. A hypothetical 10% increase in oil-price futures curves would reduce future pretax earnings by about $52.4 million; a 10% decrease would increase them by about $40.5 million. These are sensitivities, not forecasts.
The Facility matures March 31, 2021, is subject to borrowing-base constraints and customary covenants, and was reported in covenant compliance at the latest assessment date, March 31, 2014. Litigation and administrative matters were described as ordinary-course matters not expected by management to materially affect financial position, although an unfavorable outcome could materially affect a period’s results.
Other key risks include exploration and development uncertainty, oil-price volatility, financing and refinancing needs, government or regulatory action in operating jurisdictions, operational and environmental hazards, infrastructure constraints, and cyber incidents. The filing added cyber risk as a risk factor; it reported no significant cyber-attacks to date.

Important facts for investors to verify

Whether Jubilee gas-export infrastructure and gas-removal arrangements progress on schedule, and whether production restraints affect sales and cash generation.
Actual 2014 capital spending, TEN development costs and timing, and whether the estimated $49 million Kosmos share of GNPC’s costs is reimbursed as expected.
Commerciality decisions and reserve treatment for Ghana discoveries with $422.4 million of suspended exploratory well costs at June 30.
Use of the senior-note proceeds, resulting debt mix and interest burden, and continued compliance with Facility borrowing-base and covenant requirements.
How lifting timing, realized oil prices, derivative settlements and working-capital changes affect reported earnings and operating cash flow; first-half earnings also included a farm-out gain and material derivative losses.
Execution and cost exposure under the Atwood Achiever contract and other exploration, development, and jurisdictional commitments.