The world is awash with cheap oil, but nobody wants to buy it. The expected surge in demand for cheaper fuel simply isn’t happening.
Instead, it looks increasingly likely that the market will rely on big production cuts to balance supply and demand. This could mean oil prices stay low for some time.
Against this uncertain outlook, are battered oil stocks such as Tullow Oil (LSE: TLW) Xcite Energy (LSE: XEL) and Gulf Keystone Petroleum (LSE: GKP) now cheap enough to buy?
Tullow Oil: Bargain or not?
With the shares down by 65% in just 12 months, Tullow Oil now trades at less than half its last-reported book value. Surely it’s a bargain? I suspect not.
The group’s trading update last week confirmed that net debt is now $4bn. Although Tullow does have a further $1.9bn of borrowing headroom, the group’s debt levels are high relative to earnings. Tullow is expected to report a gross profit (before debt repayments) of just $600m for 2015.
Tullow spent $173m on interest costs in 2014. Similar or higher totals are likely in 2015 and 2016. Until oil prices rise, my view is that Tullow will be unable to do anything to meaningfully reduce its debt.
If oil prices fail to rise significantly over the next year, Tullow’s lenders may start to feel that the group’s board should raise some fresh cash from shareholders. Even if they don’t, servicing Tullow’s debt is likely to absorb any available cash.
I don’t see any reason to buy Tullow shares just yet.
Xcite Energy: Wipeout ahead?
If Tullow has challenges ahead, Xcite is in a far worse position, in my opinion. This small-cap North Sea challenger has spent a long time trying and failing to find a bigger partner to help develop its Bentley field.
At this point, I think that investors need to ask themselves if a project that failed to find a partner at $100 per barrel is likely to succeed when oil is trading for less than $30 per barrel.
Xcite also faces a second, more urgent problem. The group has no revenue but is due to repay $139m of bonds by 30 June 2016. At the end of September, Xcite had a cash balance of just $27.9m. The group has already warned that if it doesn’t find a financing partner for Bentley, it may be unable to meet its obligations as a going concern.
Shareholders could be completely wiped out, in my view.
Gulf Keystone Petroleum: Too much debt
Gulf Keystone does have the benefit of a large, low-cost production asset, but like Xcite, Gulf also has debt problems.
While Gulf is now receiving regular $12m payments from the Kurdistan Regional Government (KRG), these payments are only just enough to cover production costs and the firm’s interest payments.
Gulf is still owed estimated arrears of $283m by the KRG. Unless these arrears are cleared in the next 12 months or so, Gulf seems unlikely to be able to repay the bond debt of $250m bonds that’s due in 2017.
As with Xcite, I believe there’s a real risk that Gulf Keystone shareholders could be wiped out or heavily diluted when these debt repayments become due.
As you’ve probably guessed, I don’t think that Tullow, Gulf Keystone or Xcite are a buy in the current market.
