Tullow - What a mixture
All,
Please find our updated Tullow model here.
Since exiting our Tullow positions on the back of the proposed merger with Capricorn in June last year we have debated several times when is the right time to re-enter the trade. Although we think Tullow is misunderstood, at current oil prices we are not going to take an active position. We base this on Tullow’s ability to refinance the existing debt on the back of FY24 numbers, and unless oil prices increase from current levels, Tullow will be attempting a refinancing at similar leverage multiples as per the deal in January 2021.
Ultimately, the mixture of Ghana, poor TEN drilling, oil price exposure and potential tax liabilities is a concoction of risks that isn’t compensated, regardless of the yields.
Investment Considerations:
- Tullow is still subject to the volatility of oil prices and are model shows no deleveraging if the oil price remains in the $60-70/bbl range.
- Tullow struggled to raise financing in January 2021, with no clear investor base, falling between Emerging Markets and High Yield. US investors have not traditionally followed Tullow given the large portion of the US HY market in shale operations. This is made more complicated by the impact of the Ghana restructuring. Tullow’s main operations are situated in Ghana. Ghana is currently in negotiations with the IMF for a $3bn credit facility but has not yet made the necessary conditions agreed upon in December to drawdown this facility. The conditions centre on some debt restructuring both at the domestic and external levels which are ongoing.
- Tullow is highly leveraged to the oil price and with hedges rolling off, will continue to be supercharged to oil.
- We expect Tullow to remain a performing credit for FY23 with Tullow focusing on its drilling program to increase production levels. They will hope that improving production levels will enable them to refinance towards the end of FY24.
- Given the shape of production and cashflows in H1 versus H2, we are cautious about taking a long position at this time, but will continue to follow the name closely, paying particular attention to production numbers in H1, and any progress Ghana makes in the restructuring of its external debt.
Recent Results:
- Operationally, Tullow has made progress in reducing its Gross operating costs, with open/bbl reduced to $12/bbl and expected to be $9/bbl in FY23. Uptime across its platforms increased to 99% in H2 22, which coincided with Tullow taking operational responsibility.
- Leverage continues to come down, with the Company quoting leverage (cash gearing) at 1.3x, down from 2.2x in FY21. This is achieved by increasing the realised price (after hedging) to $88/bbl in FY22, versus $63.3/bbl in FY21. Production was relatively static at c.60kboepd.
Drilling success and otherwise:
- However, more important from the recent results is the outcome of drilling activity in FY22.
- In FY22 Tullow drilled four wells in the Jubilee field, which has underpinned the production guidance for FY23. Note, with the normal delay in the onboarding of the new wells, H123 is going to be lighter in production, with H2 outperforming, due to the wells coming on stream.
- On the flip side, the performance of the drilling program at TEN was disappointing. TEN Is split into two regions. Tullow drilled two wells, one producer and one injector, in the Enyenra region in late 2022. They came on stream in the later part of FY22 and will support FY23 production.
- But Enyenra is the smaller of the two regions c.30%. The 70% region, Ntomme basin, had two wells drilled in FY22 but both encountered uneconomical resources. Coupled with the fact that there is no planned drilling in FY23 in any of the TEN fields, Tullow has had to lower its FY23 TEN production target.
Guidance:
- The Company has guided Production to be 58-64k boepd range, with CAPEX of $400m and Decommissioning of $90m. Free cash flow is expected to be $100m at $80/bbl, rising to $200m if the average oil price hits $100/bbl. At $80/bbl, cash gearing reduces to 1.0x by FY24, this is accelerated to the end of FY23 with a $100/bbl price. These metrics are broadly in line with our model.
- The Company has not included any impact of potential payments from the Uganda field, they sold to Total and CNOOC in stages in 2012 and 2022. Tullow will receive payments once oil production commences (likely in FY24) if oil prices are above $62/bbl.
- Tullow has also guided that due to the onboarding of the Jubilee SE wells, H1 production will be lower at c.80,000 boepd, with H2 likely to be both of 110k boepd. This would result in an average production of 95,000 boepd for the year.
- Coupled with the lower production in H1, Tullow’s CAPEX and Decommissioning expenditure are both front-loaded, which will reduce cash in H1, subject to oil price fluctuations.
- Note, starting in FY23, Tullow will be required to pay $20m annually into escrow for future decommissioning of their current production assets in Ghana and parts of their non-operated portfolio.
Tax Liabilities:
- We have summarised the tax issues in our piece, but in summary, there are three outstanding issues with the Ghanian Authorities, c.$700m, with all three in the process of International arbitration. However, the timeframes are long, and in some instances, the first meeting has not been arranged.
- The other two issues can be split between a tax liability in Bangladesh for $118m and $280m which appear to be related to current claims not yet resolved.
- In our assumptions, we have treated them as liabilities, but the timing of any cash flow is highly uncertain. Potentially there is scope for these claims to be dropped.
- However, the impact of the magnitude of tax liabilities is largely irrelevant to recoveries to bondholders except in the narrow $60-70/bbl range. Outside this range, the fate of recoveries is largely dependent on oil prices.
Other Assets:
- We have not spent much time on the potential equity upside from the Kenyan operations.
- Tullow Oil own a 50% interest in three exploration blocks in Kenya (plus 100% of a fourth). Their JV partners are Africa Oil and Total. They had commenced a sales process but this was halted in July 2020 due to the impact of Covid-19, and specifically, the Joint Venture Partners (Total & Africa Oil) called a Force Majeure on the licenses which delayed FID (Final Investment Decision). This was withdrawn in November 2020 and the Government of Kenya extended the licenses (exploration licenses) until December 2021.
- In March 2023, Tullow and its JV partners resubmitted a revised plan (increased the scope and size due to more favourable initial findings), to the relevant authorities. This is under review and no update is available.
- Although Tullow is seeking to farm down its stake, they are unlikely to receive any cash to deleverage its operations. Any proceeds would be used against their CAPEX liability to achieve First Oil from the current position.
- Away from Kenya, Tullow has some upside concerning the Uganda oil fields they sold to Total and CNOOC, the last tranche in 2022. Once First Oil is achieved, Tullow will receive some royalty payments if the oil price is above $62/bbl. First Oil may be achieved in FY24.
Non-operated Assets:
- In 2021, Tullow divested its interest in Equatorial Guinea and a subset of Gabon assets for c. $180m. There were c. 6,000 producing assets with a 2P of 20mmboe. This is broadly half of the current non-operated portfolio, with Tullow having c. 14,000 boepd production and 39mmboe in commercial reserves. The asset sale in January 2021 was during oil prices just recovering from $40/bbl to $50/bbl at the time of the deal.
- There is always the potential for an asset sale, but given the production figures of c. 14,000 boepd (25% of production, and a similar portion of EBITDAX) we suspect Tullow would be unwilling sellers at those multiples.
Happy to discuss this.