Tullow Oil's H1 trading statement and purchase approval by the Ugandan government

Tullow Oil Plc (LON:TLW), the mainly Africa focused oil and gas E&P giant, has released their trading statement showing all is on track.  One of the main factors that investors were hoping to hear news upon was the Ugandan government approval for the purchase of Heritage’s stake in Tullow’s Ugandan assets, and the expected approval of the farm out of their Ugandan acreage to Total and CNOOC once the purchase was completed.  Fortunately investors got what they wanted as it was stated that approval for the purchase of Heritage’s Ugandan assets was 'imminent'.  Though this was not the news that was hoped for (they wanted to hear the much delayed – in investor eyes – approval had been given), it still was good news. And the wait turned out to be very short lived as today, Tullow has released confirmation of the approval of the purchase of Heritage’s Ugandan assets and the subsequent expected farm out, with the following being stated:

‘Tullow Oil plc (“Tullow”) announces that  the Government of Uganda has approved the sale by Heritage Oil & Gas Limited (“HOGL”) of its 50% interest in Blocks 1 and 3A in Uganda to Tullow’s subsidiary, Tullow Uganda Limited (“Tullow Uganda”), subject to conditions outlined in a Heritage Oil Plc release issued today and reproduced below. Separately, Tullow Uganda has also received approval from the Government for its farmdown to CNOOC and Total, subject to certain routine conditions that Tullow intends to discuss with the Government in due course.’

The purchase and farm out approval

The deal, it is stated, is expected to be completed in five working days following finalisation with the government of a mechanism, including arbitration, for dealing with any taxes lawfully payable from the disposal of the Assets. This tax issue has been the factor behind why the deal has taken so long to go through, and may again possibly cause further delays with Heritage stating that after advice they believe that they owe no tax to the Ugandan government from the sale.  But in response to this the following has been stated:

'In a separate letter Mr. Kabagambe-Kaliisa, Permanent Secretary to the Ministry of Energy & Mineral Development, advised that if HOGL was to resolve the tax matter by arbitration in London, then such arbitration would be on the basis that HOGL deposit approximately US$121.5 million, representing 30% of the disputed amount of US$404,925,000 with the Uganda Revenue Authority and provide a bank guarantee for the balance. As announced on 17 June 2010 Heritage previously proposed to Government the option of arbitration in London.'

On this, Heritage has commented as follows:

‘Heritage’s position, based on comprehensive advice from leading tax experts in Uganda, the United Kingdom and North America, is that the disposal of the Assets is not taxable in Uganda.  Heritage is considering Government’s response and will update the market in due course.’

What this means is that for Tullow’s $1.5bn purchase ($1.35bn upfront with a deferred $150m) is that, although the approval has been given, without the finalisation of this tax issue, more delays may be on the cards, depending on Heritage’s response to Mr. Kabagambe-Kaliisa’s wish.

In terms of what the actual terms of the expected farm out deal are, the exact figures are not yet known but Tullow has stated the following in their trading statement:

Following completion, Tullow plans to enter into transactions with CNOOC and Total to farm down two thirds of its interests in Blocks 1, 2 and 3A in the Lake Albert Rift Basin.

They state that this will result in a unified partnership. In terms of the price that CNOOC and Total will pay for this farm in and how much they will carry Tullow in the $5bn development, at this point it is impossible to say.  Though it has been rumoured that they will carry Tullow through to production, but until the deal is signed, the exact terms will not be known.

Tullow’s H1 Trading and Operational Update

Tullow has provided another strong showing via their H1 trading and operational update, stating that on a working interest basis, production was in line with expectations at 55,800 boepd.  Though it should be noted that they only had a sales volume of 42,600 boepd with the reasoning for this given as:

‘This is due to variations in lifting schedules and because a portion of the production is delivered to host governments under the terms of Production Sharing Contracts.’

In terms of how this will translate to revenue, thanks to an increase in the realised oil price, revenue for H1 is expected to be $495m, up from $438m in the previous year (just to note they now report in USD and not Sterling after finally making the much wished for and expected move of changing their reporting currency).  In terms of how this will translate to likely net profits, considering that they expect to take a hit of $7m through impairment charges, $45m from exploration write-offs caused by unsuccessful exploration activities (something Tullow is not used to) and a $20m credit to cost of sales caused by stock movements, chances are if a net profit is reported it will not be much of one.  But as the latter costs are non-cash charges, cash flow from Tullow’s producing assets should be very strong considering the high oil price.

Turning to Tullow’s very large capital expenditures:

‘Capital expenditure for the first half of 2010 amounted to US$600 million and based on current estimates and work programmes, total capital expenditure for 2010 is forecast to be US$1,500 million. Approximately 60% of this investment will be allocated to production and development activities and the remainder to exploration and appraisal. Tullow's activities in Ghana and Uganda will comprise approximately 65% of the anticipated 2010 capital outlay.’

The current net debt position of $200m is likely to increase further over the year, though as they have $670m in unutilised debt available to them their large capital expenditures should not be an issue.  Also with the farm out of their Ugandan assets the fact that their net debt will likely rise this year should not be a worry in terms of future constraints to capital expenditures as with CNOOC and Total likely carrying the costs of the Ugandan capex, added to Tullow’s increased cash flow from the Jubilee field which is coming on line this year. Tullow should have no issues in term of cash constraints.  Moving onto their operational plans:

Africa

Starting with the Ghana located Jubilee field, Tullow has stated that all is on track still with first production of 60,000 bopd still expected to commence in November or December this year.  Also it is still expected that it will only take about 3-6 months for the field to reach its target production level of 120,000 bopd.  Though one slightly sour note is rather than as hoped, the costs of phase 1 at Jubilee are now put at $3.35bn, which is $200m more than the original target of $3.15bn.  In terms of their future plans for Jubilee, the following is stated:

‘Work is well advanced on further development phases which will extend the field production plateau and ensure optimisation of field reserves. Following the initial Phase 1 development, Phase 1a will involve 5 to 8 infill wells tied into existing infrastructure. Phase 1b may involve up to 20 additional wells and is likely to require expansion of the subsea infrastructure. The timing of these additional development phases will depend on the performance of the Phase 1 wells and the FPSO vessel but sanction is likely within the next one to two years.’ 

They also state that this latest work reaffirms their view of the size of Jubilee, with the last guidance given being that the Jubilee Unit Area contains 500 (P90) - 700 (P50) - 1,000 (P10) mmbbls (just to note, P90 means 1P or Proven, P50 means 2P or probable and P10 means 3P or possible – the numbers are basically percentage terms i.e. 90% chance, 50% chance and a 10% chance).

In terms of their plans for their Ugandan assets, once the farm out is agreed it has been stated that the new partners will prepare an accelerated basin-wide development plan, with the results of this plan expected to deliver a production target of in excess of 200,000 bopd by around 2014/15.

In terms of their other African assets, which are of much smaller scale than the ones mentioned, and most of which most are in production (near 40,000 boepd comes from Afrcia), all seems on track.  The only real issue and point worth noting comes from their exploration acreage in the Democratic Republic of Congo, with the following being stated:

‘Tullow was awarded two Congo (DRC) licences adjacent to its Ugandan acreage on Lake Albert in 2006 through a transparent process in which a signature bonus of US$0.5 million was paid. Tullow have been awaiting ratification from the President ever since, however on 24 June 2010, it appears that the government awarded the licences via Presidential decree to two British Virgin Islands-registered companies. Tullow is currently considering its options with regard to the legality of this transaction.’ 

It was hoped that these field could be substantial in size but with the troubles surrounding these fields now, it seemsunlikely that any work will be done of them any time soon, or in fact ever if the DRC government gets their way.

Rest of the World

Production from the rest of the world, namely the North Sea continues to dwindle with production now at just 12,300 boepd.  This decline is expected to continue with Tullow likely to eventually leave the UK, which is the place that really allowed Tullow to become the company that it is today.  In terms of exploration, Tullow’s main focus in terms of the rest of world is South America where they are hoping to repeat their African success, with their best prospect to date being in French Guiana, where they state the following:

‘In the Guyana Martime block (Tullow 39%), a number of Jubilee-type leads have been identified in the south-eastern part of the block and acquisition of a large 3D seismic programme (2,500 sq km) was completed in early February 2010. Processing and interpretation of this data set is ongoing and well planning for the first well in the Block is continuing with a target spud around year-end 2010 on the Zaedyus prospect.’

Conclusion

To conclude, everything still seems to be going broadly to plan with this year’s production guidance still on track at 56-57,000 bopd. Jubilee is still on track to be producing over 120,000 bopd by this time next year (Tullow’s ownership of the Jubilee field is as follows: 49.95% of the Deep Water Tano and 22.896% of the West Cape Three Points). The only stumbling block that Tullow has at the moment being that the tax issue between Uganda and Heritage.  Tullow is still predominantly an exploration company, hence they still carry substantial risks, but, considering the massive potential that Tullow has to offer, they still warrant a place in the growth section of ‘Grays Stocks to Watch’.

Disclosure of Interest: The Author has no interest in Tullow.