When you focus on one aspect of an investment, it’s easy to underestimate the importance of another, often more important, aspect. I did that with Premier Oil (LSE: PMO) when I bought some shares during the depths of the oil price crash.
It seemed inevitable to me that oil prices would recover, as many of the world’s oil producing nations would effectively be insolvent with oil down around $30 for too long.
While I obviously knew of Premier’s debts, I was largely assuming that recovering oil prices would push debt considerations to the background a little and that Premier Oil could continue as usual.
Obviously that hasn’t happened, Premier’s huge debt pile is at the fore of any discussions about the company, and with the share price at 82p as I write, I’m still down on the 99p I paid in September 2015.
If I’d only waited a few more months, I’d be nicely in profit by now, and I think that illustrates two things – that timing can be critical in a recovery situation, and that I’m as bad at it as I ever was.
New oil success
Speaking of Premier’s usual business, the company’s explorations appear to be progressing well. The firm has just announced a success at its Tolmount East well in the UK Southern Gas Basin, which had been exploring a 50% certainty target of 220 billion cubic feet (BCF) in an undrilled area four kilometres east of the 500 BCF Tolmount gas field.
In the words of the company’s announcement, the well has “penetrated 241 feet of gas bearing high quality Leman sands with a net-to-gross ratio of 71%, porosity of 16% and gas saturation of 82%.” The company added that “The quality and thickness of reservoir sands encountered are at the upper end of expectations and no gas water contact was penetrated,” which speaks of a high quality resource.
CEO Tony Durrant says the result “will add significant value to our UK portfolio,” and as a shareholder, I’m pretty upbeat about the company’s exploration and production prospects.
Mountain to climb
But back to that debt. At the interim stage at 30 June, while improving cash flow was helping to drive debt reduction, net debt still stood at $2.15bn. That was down from $2.33bn at 31 December, and at that rate of reduction it would take six years to completely eliminate.
The big question is what debt level will need to be reached before confidence in the firm’s long-term financial security will return and investors will be prepared to put a higher valuation on the shares. Previous assumptions about a safe level of debt were clearly misplaced, as Premier came very close to going bust under the weight of it.
And with oil having slipped back below $60 per barrel in the presence of an ongoing worldwide glut, the possibility of a new oil slump and a return to those dark days must be real.
I’ll feel a lot more comfortable if I see debt getting down below $1.5bn, and I think we could see a significant share price rise if we get close to that. But for now, Premier looks to be in improving shape. I rate it a buy, and I’m holding my shares.
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Alan Oscroft owns shares of Premier Oil. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.