Tullow Oil: Cash strapped
The recent merger bid with Capricorn may suggest that Tullow's capex and financing requirements exceed its assets ability to fund them
*Please read the disclaimers at the base of this report. The author has a short position in Tullow. Does not constitute a recommendation to buy or sell the securities mentioned herein. Do your own due diligence.
Tullow’s 2021 results were not full of surprises, unless you count the fact that while net debt fell some $245m or just under 10%, production fell by 15,700 barrels a day from 74,900 a day in 2020 to 59,200 in 2021 or 21% lower and 3,800 bopd lower than its January 2021 forecast. Tullow’s 2022 guidance has a midpoint of 58,000 bopd or a further 2% lower, while production numbers in Ghana already suggest that production at TEN (which was major disappointment in 2021) has already fallen below the average guidance for the year. Clearly assets appear to be shrinking at a greater rate than liabilities, a trend that will need to be reversed swiftly unless additional access to cash resources can be secured. How convenient then that Capricorn management, a company with over 700 million dollars of cash and a newly acquired Egyptian asset are seemingly prepared to come riding to the rescue.
Overly cynical? Perhaps, but then lets consider Tullow’s sources and uses of cash going forward.
This coming year Tullow faces $90m of decommissioning cost, and the benefit of the Uganda FID payment of $75m has been wiped out by the legal settlement in Norway.
Unfortunately in 2022 Tullow will not have much exposure to currently high oil prices as 42,500 barrels a day of its production (approx 3/4 of its 2022 guidance, a bit less post pre-emption of the Oxy stake) is capped at $78 a barrel (floor $51), with over 50% hedge cover in 2023 (higher if production continues to fall). Unfortunately for Tullow hedge losses in the UK cannot be offset against Ghana based tax.
Moreover the currently assessed outstanding tax bill from Ghana stands at $440m the bulk of which has been requested for ICC arbitration (branch profits remittance tax assessment). This issue has been bubbling under the surface for some time and it is hard not to imagine that Tullow’s pre-emption of Kosmos acquisition of Occidental’s Ghana assets is being linked to this issue by the Ghana Revenue Authority.
In the 2021 report the question of Tullow’s gas reserves in Ghana again emerged in the small print, with a significant write down of commercial reserves (approx 20%), presumably because the commercialisation question remains unanswered. Oil reserves also fell after production from 228 to 207mmbls or approx 10% due to disposals and production. Notably the TEN field saw a 16mmboe decrease in reserves due to “poorer than expected Ntomme field performance…” Ntomme is the sub-field in TEN with the highest oil ratio, so this is not good. Elsewhere in the report it states “production decline within this core area has been faster than expected….the overall view of ultimate recovery from these fields has reduced”.
So far this year, it appears that Tullow have been unable to halt the decline at TEN with last reported monthly production (June 2022) at 23,000 barrels a day down 30% from the same period a year ago. While Jubilee production has recovered to approx 87,000 bod, Tullow’s greater ownership share in TEN means its net production has been more impacted by the fall at TEN than the rise at Jubilee. This is accentuated by the fact that the fixed cost profile of the TEN field is considerably higher than Jubilee, owing to the cost of leasing the FPSO at TEN (over $100m a year net to Tullow) vs Jubilee’s FPSO which is owned by the joint venture partners.
Overall for Tullow, the fall in reserves about the same as the fall in debt ($2.5bn at the interim stage, with presumably around a $350m cash balance - inferred from the recent trading update), while organic reserve replacement was 36%, underpinning that shrinking feeling. Tullow has more debt leverage on its production than before (ie per unit of production), and the same debt leverage on its oil reserves. Ex that, any gearing deleveraging is simply a function of the rise in oil prices, currently somewhat limited by Tullow’s significant hedge position. Given the hedge and debt service constraints on Tullow’s cashflows, and its urgent demand to drill more wells to prop up production, a deal rationale with a cash heavy E&P like Capricorn starts to make sense.
Recently the company has finalised the pre-emption of Kosmos acquisition of the Anadarko/Occidental Ghana stake for $118m. That will add about 4000bod to production this year. However it is hard to imagine that pre-emption being secured without some sort of understanding with the Ghana Revenue Authority on Ghana’s tax claim against Tullow, which runs to over $400m. I would expect us to hear some news on this in the not too distant future. Indeed, it is surprising that, but for a couple of tanker liftings after the interim period end in June 2022, Tullow would have been FCF negative: is Tullow having to make good on some of its tax liabilities?
In terms of reserve adequacy and Tullow’s cash needs, we are lucky that we have a close listed peer to compare with, Tullow’s JV partner in Ghana, Kosmos. Kosmos gross reserve disclosure on Ghana is quite revealing:
Kosmos 10k Gross reserves ( PDP, PDNP, PUD, 1P).
Looking at these reserves, we have gross field reserves of approximately 340 million barrels for both TEN and Jubilee, a 1P number that is approximately 100m lower than Tullow’s current 2P number for both fields.
If we look at Kosmos financial disclosure we can see an estimate of approx $18/bl opex and some $22/bl capex for developing the undeveloped reserves, a fairly material number given the fact that PUD reserves are infield or nearfield and next to infrastructure. $4bn capex (gross) between the fields) assuming it was within a 5 year period would represent $800m a year and at least $300m net to Tullow per annum, without even thinking about adding in the development cost associated with probable reserves, or indeed the capital required to sustain the non-operated fields elsewhere in West Africa.
Meanwhile, Tullow’s claims around at least one of its core fields, TEN, remain questionable. Production remains down 35% year over year while GOR is now approx 100%.
Simple Log Rate vs Cum analysis continues to point to a total EUR for TEN of approx 120 million barrels of oil assuming a 10,000 barrel a day economic limit; while incremental drilling may extend that, the trend is fairly clear:
On that basic analysis there is as little as 20 million barrels yet to economically produce, while the company report 99 million barrels of gross 2P reserves at TEN
The 2P figure of 99m barrels remaining seems pretty aggressive and dependent on success in new defined projects like the Ntomme Riser Base area, however even more aggressive is the suggested production recovery and growth suggested below:
Mathematically, any shift up of production to approach 50,000 barrels a day would imply a greater resource capture than 99 million barrels: the chart above implies capture of 2C resources into the proven category; highly optimistic in light of recent performance (current monthly production of just over 25,000 bod), and hinting at reserve capture of 150 million barrels.
The delta in 2025 could be as much as 40,000 barrels a day of gross production or at least 20,000 barrels a day net to Tullow: highly material.
Meanwhile we know from Kosmos’s reporting that developing existing undeveloped reserves and resources isn’t cheap, and is likely dearer now given all the cost inflation in the industry. The inference is that the Capricorn deal (and Capricorn’s India cash) is necessary for the company to fulfil its resource development plans just to keep production anywhere near flat for the next few years (and with obvious downside risk at TEN, the Jubilee field has do most of the lifting).
Conclusions
Currently Capricorn is trading well above the inferred offer price from Tullow given the ratio that Tullow is offering, with Capricorn trading at a 12% premium to terms. While CEO of Tullow, Rahul Dhir suggests no tweaks are needed, he may need to offer Capricorn shareholders more red meat for them to accept the offer. After all, from what we can see above, Tullow appears to need this deal (effectively a rights issue in disguise) or else it could well need to raise further capital much more dearly. This is all the more noticeable after post hedging free cashflow in the first half was neutral (indeed negative if we don’t include July lifting proceeds) at an average post hedging realisation of $87/barrel!
As for Capricorn, well its heavy cash balance underpins the valuation while likely higher receipts from its conditional contingent payments from Waldorf going forward (from sale of Catcher and Kraken stakes) should provide a tailwind going forward to raising its NPV value. On that basis it seems that as it stands, Tullow are getting a rights issue without any of the discount (indeed a premium!) you would expect in such a challenged situation.
The author maintains a short position in Tullow and a long position in Capricorn.
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Tullow Oil: Cash strapped
My question is, in case that aquisitions succeds under current or similar terms (which I agree are very strange), what that implies for valuation of Tullow's shares
It is difficult to understand the incentives for Cairn directors to recommend the bid. Not just the terms, which are poor and with an obviously wounded partner, but the strategic rationale of balancing Egyptian assets with ... declining Ghanaian assets with an unsettled row attached !