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Tullow Oil - Heavy oil weighs down Tullow

Nicholas Hyett | 13 November 2019 | A A A
Tullow Oil - Heavy oil weighs down Tullow

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Tullow Oil plc Ordinary 10p

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Full year production is set to come in slightly below previous guidance, after drilling problems in the Ghanaian TEN oil field. That will have a knock on effect on free cash flow.

Alongside the trading update, Tullow also announced recent discoveries in Guyana contain low quality, heavy, sour oil which has significantly less commercial value.

Tullow shares fell 21.3% in early trading.

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Our View

Tullow has great assets in Ghana, but the TEN and Jubilee fields account for around 70% of production. As a result, the onus is on these fields to produce enough profit to shift the still substantial debts, fund future projects and pay the new dividend.

That makes the news that recent discoveries in Guyana are of low quality a particular blow. It takes time for new wells to come online, so we were always a long way from Guyana being a profit driver and the group remains optimistic about the larger basin. But a secure source of future cash flows would have been welcome.

Fortunately Tullow's no longer living hand to mouth.

A few years ago, Tullow would likely have been compelled to sell its interest in the assets to shift some of its debts. It may still opt to monetise some of the field now, but recent progress on deleveraging means it's under less pressure to do so.

Prices of over $56 a barrel are locked in for a significant portion of its anticipated production in the next two years. Production in the core Ghanaian wells isn't rising as fast as hoped, but it should still be on an upward trend, with operating costs dropping to as little as $10 per barrel.

That should underpin the group's policy of paying $100m per year in dividends, plus special distributions where appropriate. As things stand, that implies a prospective yield of around 3.7%. If Tullow does make substantial finds elsewhere and can successfully bring production online, it can look forward to improved cash flows in the future. That could translate to higher dividends.

Of course, there are still potential trip wires ahead.

While significantly lower than back in 2015/16, leverage is still a little higher than we think is entirely comfortable so the group remains exposed to a reversal in oil prices.

There's also been a few operational hiccups. The pace of production increases has been tempered by technical problems at key sites and an agreement with the Ugandan government on a farm-down deal with French and Chinese partners has stalled.

However, we think Tullow looks in much better health than it has for some time. Further results from other wells in Guyana are expected later in the year, and the group also has early stage projects in Argentina, Cote d'Ivoire and Peru.

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Third quarter results

Tullow now expects its West African assets, including the Jubilee, TEN and non-operated fields, to produce around 87,000 barrels of oil per day (bopd). That's slightly below previous guidance, as activities were suspended at one well on the TEN field.

In East Africa the group completed its first oil shipment from Mombasa, as the Lokichar pilot scheme continues to produce 2,000 bopd. In Uganda the previous farm-down agreement has now lapsed, although conversations with the government are ongoing.

Oil samples from the Jethro-1 and Joe-1 wells in Guyana have proven to be heavy crudes with a high sulphur content. However, the group "remain confident in the broader light oil potential of the Orinduik and Kanuku blocks located in this prolific oil basin".

Full year free cash flow is now expected to be around $350m, negatively impacted by lower production and lower oil prices. Net debt is expected to finish the year at $2.8bn, compared to $3.1bn last year.

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Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research for more information.