Shares in Tullow Oil (LSE: TLW) have risen by 33% over the last month. The firm’s full-year results on 10 February were well received by the market. Tullow is now one of a small group of oil stocks which have risen since the start of 2016.
Does this mean I was wrong to rule out an investment in Tullow, on the grounds that its $4bn net debt made it too risky for equity investors?
Fully priced
Tullow’s 2015 results were published last week and showed that the firm still has undrawn debt and cash totalling $1.9bn. Operating cash flow was $1.0bn last year. Tullow hopes to cut capital expenditure from a planned level of $1.1bn to $0.9bn for 2016, and then to as little as $0.3bn in 2017, if oil prices don’t start to recover.
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So there doesn’t appear to be any immediate danger of Tullow running out of cash.
One reason for this is Tullow’s strong hedging programme. Unlike many smaller firms, Tullow’s hedging protection will not run out in 2016. The firm has almost 50% of its 2016 forecast production hedged at $75.14 and around 30% of 2017 production hedged at $72.94. There’s even a small amount hedged for 2018.
So is Tullow a recovery buy? By mid-2017, I expect oil prices to have recovered somewhat. But I don’t think prices are likely to rise above $60 for several years, due to the availability of cheap, quick new production from US shale fields.
On this basis I still think Tullow is fully priced. Interest costs alone were $145m last year and are likely to be higher this year. Tullow’s current valuation, including debt, prices its proven and probable reserves at $19.54 per barrel. That’s doesn’t seem like a bargain to me.
Too risky
Xcite Energy (LSE: XEL) is racing against the clock to find a partner prepared to fund the development of Xcite’s Bentley heavy oil field in the North Sea. Unfortunately, there are two problems with this.
Firstly, Xcite couldn’t find a development partner when oil was trading at $100 per barrel. It’s now $33 per barrel.
Secondly, Xcite has $139.05m of bonds which are due for repayment on 30 June 2016. At the end of September, unrestricted cash was only $15m and revenue was zero. Unless Xcite can find a partner for Bentley, the firm looks likely to default on its debt repayments in June.
This would result in the Xcite’s lenders taking control of the firm and would almost certainly mean that existing shares were worth nothing. For this reason, I view Xcite as too risky to buy at any price.
Long haul
Rockhopper Exploration (LSE: RKH) does not have any debt and recently reported a cash balance of around $110m. The firm expects to have $70-$80m of cash left at the end of 2016.
There’s clearly no immediate risk of funding problems, but Rockhopper’s valuation is largely based on the potential value of its stake in the Falkland Island Sea Lion field. Rockhopper has an attractive farm-out deal with Premier Oil to develop Sea Lion. However, while preparatory work is being carried out, the timescale of the field development and eventual production are uncertain.
The latest forecast from Rockhopper suggests oil production could start in 2020. Rockhopper shareholders have a long haul ahead of them.
