It’s been a wild week for the Premier Oil (LSE: PMO) share price. Shares in the North Sea oiler have plunged from a high of 31p on Monday to close at 13p on Thursday.
As I write on Friday morning, the stock has now whipsawed back up 60% to trade at 20p. This move has followed an update from the firm which suggests it can survive the year with oil at $35.
What’s happening?
Saudi Arabia and Russia triggered an oil price crash on Monday when the pair failed to agree on new plans to cut oil production. In response, the Saudis announced that they would increase production by more than 20%, flooding the market with cheap crude.
With demand already weakening due to the coronavirus, oil prices crashed. The black stuff is now trading at $35, down from around $54 one month ago.
There’s an interesting backstory to this situation, but what we need to remember is that an oil price crash is seriously bad news for Premier. Seriously. Bad. News.
Why so worried?
Premier has two problems. Firstly, although it can ‘survive’ lower prives, it needs an oil price of nearly $50 per barrel to break even, on a cash flow basis. With oil prices under $40, the firm will be losing cash on each barrel it pumps.
For a well-funded company with cash in the bank and minimal debt, this would be sustainable for a while. But Premier isn’t that company.
The firm reported net debt of $1.99bn at the end of 2019. That’s a multiple of 2.3x EBITDAX (cash profits), which is above my comfort level of 2x.
Premier’s lenders may be uncomfortable too. Lower oil prices mean falling profits. I think it’s likely that the firm’s leverage could soon move beyond the limits agreed with its lenders. That could trigger refinancing and further losses for shareholders.
Why the Premier share price is rising
In today’s update, Premier says that it should be able to achieve neutral cash flow in 2020, even if oil stays at $35 per barrel. This will be achieved by cutting $100m from planned spending.
Alongside this, the company is still hoping to generate extra cash flow from planned acquisitions in the North Sea. But this deal may not go ahead.
An $871m deal in the North Sea
Premier is currently in dispute with its largest lender over plans to spend up to $871m acquiring additional North Sea oil fields.
Boss Tony Durrant says these acquisitions will boost the group’s cash generation and speed up debt repayments. But this deal will also require $300m of new debt, an extension of the group’s existing loans and a $500m equity fundraising.
There are a lot of moving parts here. I think it’s a fairly risky deal, although it might work out well if oil prices bounce back quickly.
Why I’d avoid PMO shares
In my view, anyone buying Premier Oil shares today is betting that the price of oil will recover quickly.
If oil doesn’t recover over the next few months, I don’t see much value in the firm’s shares. Indeed, I suspect the group could suffer a repeat of its previous debt problems.
In my view, there’s a real chance the Premier share price could go to zero pence. For that reason, I see this as a stock to avoid.
