The headline numbers for Tullow Oil (LSE: TLW) over the past year weren’t pretty and the group’s annual report is splattered with red ink. However, the City’s reaction thus far seems to encourage the view that management has done all within its power to react to lower oil prices.
While an operating loss of roughly $1.1bn is a worrying number, it’s a massive 44% improvement over last year’s $2bn loss. Management will point to this improvement as a sign of better days to come, but I remain leery. Although strong hedging and vicious cost-cutting narrowed yearly losses significantly, the company still added $900m of debt to the balance sheet last year.
Leverage has truly proven to be a double-edged sword for Tullow. When oil prices were above $100/bbl the company was an investor darling as debt was piled on to fund rapid expansion and share prices rose as high as £15.66. But, now that crude prices have plummeted, the company’s staggering $4bn of debt has sent shares careening down to £1.50. Tullow’s position as a pure exploration & production company means it lacks the downstream refining assets of a BP or Shell, which would allow it to ride out low oil prices without adding significant debt. Therefore, Tullow can cut costs as much as it likes, but if crude prices don’t rebound significantly it will continue to harm future growth prospects.
Low-cost assets
Debt aside, major restructuring and cost-cutting have made underlying operations very appealing. The company has the Ghanaian TEN Field coming on-line in mid-July, which will increase overall production numbers by 15%. With targeted operating costs per barrel a mere $8, TEN will be substantially cash flow positive for Tullow. This nearly-$5bn project finally getting off the ground will also significantly reduce the need for debt going forward. Tullow does have a very good base of low cost assets, with all West African projects estimated by analysts to be break-even in the $38-$45/bbl range. If crude prices rebound to this level or above, the massive mountain of debt may finally begin to be whittled away.
Long term though, I remain skeptical that Tullow is a bargain purchase even at today’s prices. Despite significant low-cost assets, the company’s highly leveraged position worries me. At $4bn, net debt is a massive four times the record earnings posted in 2012, when a barrel of crude fetched three times what it does today. Even if oil prices rise significantly, shareholders will find that the majority of profits will be flowing to debt holders. Investors will also find the dismal balance sheet a major hindrance to Tullow’s ability to expand. Given these issues, I believe there are better bargains to be had elsewhere in the industry, particularly Petrofac and Premier Oil.