Tullow Oil Back to Basics Analyst Meeting, share price correlation, operational delivery and dividends

Transcription

1 WEEKLY 23 October, 2016 Issue 3, Volume 1 Companies Tullow Oil Back to Basics Analyst Meeting, share price correlation, operational delivery and dividends Hurricane Energy Lancaster Delivers, high flow rates but how does it rank versus other discoveries? Markets OPEC & Russia another talk of freezing production but can this realistically be achieved while the Russian Grand Fleet approaches Syria and Aleppo? Drilling Results Njord Field Norway Another discovery helping to extend the life of this field and development. Energy Economics Khazoom Brookes Postulate Energy efficiency does not always lead to less energy demand Angus McPhail Jacobite Research info@jacobiteresearch.com Jacobite Research Ltd (Company registration no: ) is not regulated by the Financial Conduct Authority (FCA). No part of this website or the content therein may be reproduced or quoted without the express permission of Jacobite Research. The information in this research report is not FCA regulated because it does not constitute investment advice (as defined in the Financial Services and Markets Act 2000) and is provided for general information only

2 Companies Back to Basics Analysts have a bad habit of over complicating their analysis sometimes and Tullow Oil is a good example of this. The number of analysts that I have met previously who owned up to getting it wrong ; with Tullow are numerous, and sadly they do not appear to learn from their mistakes! I had the privilege of attending an analyst presentation held last week at their head office in Chiswick, London. Amongst the analyst cohort there appeared to be a preoccupation with what has gone wrong in terms of operational delivery rather than examining the basics which I believe are as follows: 1) Will the share price go up and if so what is the main catalyst on the horizon? 2) What operational targets do they have and how confident are they that these will be achieved? 3) Will a dividend be paid, if so when? On point one, I defy any analyst to successfully model all of Tullow s assets accurately such that any NAV is of any significance given the number of assumptions which have to be incorporated into it. The most simple and accurate measure to use is to correlate the historic share price to the underlying oil price. Tullow share price vs Oil Price US$/bbl (Brent) since September 2014 (daily data) Source: Jacobite Research 2 P A G E

3 In our correlation we have opted to use two years worth of data on a daily basis, as timing discrepancies occur over a longer data set. We can see from the graph below that the correlation is very high with an R factor of Using the equation (y= x ) if we calculate the inferred share price under US$100/bbl (substituting for y) we derive a value of 718 pence per share. This assumes that production remains constant, but we know that its West African production is targeted to increase from 51.8kboepd in 1H 16 to 62-68kboepd for FY 16, and so an additional production variable could be factored into the equation to improve its accuracy, since prices and volumes drive the share price. On point two, operational delivery is on track with the first oil from Tweneboa Enyenra - Ntomme (TEN) project in offshore Ghana achieved on 18 August 2016 and production gradually ramping up thereafter. To date since March 2013 US$4bn capex has been spent. Average annualised production is set to reach 23kboepd in 2016, then increase to 65kboepd by Ghana is currently in a maritime border dispute with neighbouring Cote D Ivoire, and as such no new drilling can be done until this is settled by the International Courts which is anticipated by the end of Even under the unlikely scenario that Ghana lost its case and the border was redrawn thus losing the TEN field, Tullow like any international oil company would simply renegotiate its production sharing contract with the government of Cote d Ivoire. Tullow Offshore Ghana Fields, including the Maritime Border between Ghana and Côte D Ivoire Source: Tullow Oil 3 P A G E

4 Examining other projects in Uganda where it has a very low full cycle cost of US$25/bbl (capex, opex and tariff), FEED is expected to commence in early 2017 with the construction of a pipeline between Hoima in Uganda and Tanga an easterly port in Tanzania. In exploration which remain central to Tullow s longer term growth prospects the Araku prospect (30% stake, operator) offshore Guyana-Suriname with a 500mmboe potential (unrisked, prospective resources) was highlighted as being exciting, with Blocks 54 and 47 having multiple high quality prospects identified for follow up drilling. Other exploration prospects include Kenya, Mauritania, Zambia, and offshore Namibia. On point three, Tullow is forecasting to be FCF positive in 2017 at US$50/bbl even assuming an extra US$250m capex options are deployed. These include Jubilee infill drilling (US$75m), East Africa (US$100m) and exploration (US$100m). The payment of a dividend is not a priority therefore since E&P companies are expected to reinvest cash flows to find more oil at the exploration drill bit, thus increasing shareholder returns that way. If oil prices were to go back to their original levels pre July 2014 of US$100/bbl then it is feasible to see a dividend being paid. Tullow have successfully weathered the oil price weakness in 2016 through existing cash flows from Jubilee (despite production issues there from its turret) but also through its debt facilities. It has 27 banks involved in a syndicate for a US$3.5bn facility which has US$1.3bn headroom including a US$300m convertible bond (issued prior to Brexit in June 2016). Additional refinancing is anticipated in 1H 17, ahead of further commitment amortisations in April Currently interest on debt is costing ~ US$250m based on % + LIBOR. Jacobite Research View: Tullow is basically leveraged to the oil price and as our analysis suggests if oil prices move higher then ceteris paribus growth in its share price could follow. Given the likelihood that oil prices will remain depressed going into 2017 this leverage effect may not happen until Tullow has successfully repositioned itself to be leaner in a lower oil price environment, successfully delivered its second large development project after Jubilee in Ghana (TEN), and continues to explore in Kenya and South America. 4 P A G E

5 Lancaster Delivers Last week Hurricane made two important announcements. Firstly the well flow rate from a-7Z horizontal side track well at Lancaster achieving a flow rate of 14,500bpd. Back in the 1970 s when Forties was discovered it achieved initial flow rates of 4,720bpd, so Lancaster s initial flow rates are extremely encouraging. Hurricane has 2C estimates of 207mmboe for Lancaster, with upside to 456mmboe on a 3C basis. In total across all its West of Shetland acreage it has 2C reserves of mmboe, with upside to mmboe on 3C basis, or just shy of 1bnbbls. Hurricane s Acreage West of Shetland Source: Hurricane Energy The company were quick to leverage on this success by announcing a placement and open offer two days later to raise 70m at 34p per share and 4.4m by way of an open offer to existing shareholders. The proceeds are set to be used to drill two wells in the Greater Lancaster Area, including an exploration well on Lincoln and Warwick which have cumulative unrisked prospective resources of 500mmboe. The company plans to commence drilling these wells in November using the same semi-submersible drill rig the Transocean Spitsbergen. Although neither Hurricane nor Transocean have revealed the day rate to drill Lancaster. Day rates have been falling for a number of years a day rate of between US$ k per day looks feasible (see IHS graph below) in November 2016.The company believe drilling in November will help to lock in the lowest price in the services market, and they are determined 5 P A G E

6 to take advantage of this by purchasing long lead items now ahead of any pickup in activity amongst the oilfield service industry. Hurricane also has the enviable position of holding 100% of all its asset base and given the Lancaster discovery and commercial flow rates achieved puts it in a strong position to negotiate with one of the existing larger integrated s such as OMV. BP or Royal Dutch Shell. Jacobite Research View: The challenge for Hurricane will be to prove out the whole basin and then move forward to full field development and production from Lancaster. The next valuation primer will be the value of any farm out achieved and the terms which are likely to act as a benchmark for any fair value on the stock. The company will be aiming to farm out the minimum stake for the maximum possible value. Based on today s market value of 400m, stripping out the cash value of 70m leads to a value of 330m. If we assume Lancaster alone accounts for 100% of the value of the company then that equates to a value of US$1.91/bbl of 2C reserves (using an FX rate of US$1.20/ ). Assuming that an early production system along with two wells would cost $200m, then this equates to a 50% farm out being the most likely scenario with a further farm out needed to pursue full field development. 6 P A G E

7 Market Update OPEC and Russia Oil prices edged lower this week from US$52.02/bbl to US$51.77/bbl, but still above the important psychological US$50/bbl level that many oil companies have used for budgetary purposes in Oil has been trading firmly at above US$50/bbl, on market hopes Russia and OPEC would reach an agreement over the weekend to support initiatives to keep crude above $50/bbl. This has been tempered by the fact that the US onshore land rig count has been rising steadily since May this year, with shale drillers notably in Texas accounting for over half of this growth. US Land Rig Count (2000 YTD 2016) Source: Baker Hughes Russian Energy Minister Alexander Novak said he would make proposals to Saudi Arabia this weekend on price supportive measures that could include an oil production freeze. Whether this is political posturing by Russia ahead of OPEC s scheduled meeting in November 2016 is difficult to say, however the willingness of quoted Russian oil companies to implement this doesn t appear to be there at this stage. Rosneft s CEO has already stated that he would not be willing to cut production and believes that Russia could easily increase production by 4mmbpd. Also we should not forget that Saudi Arabia like the US are against Russia s position over Syria. In Iraq, Mosul is ready to fall to Iraqi forces with ISIS in retreat towards Raqqa in Syria. A huge show of force in the next week or two by Russia and it grand fleet which is heading across the Mediterranean to attack Aleppo to mark a final decisive victory for Russia. Any agreement with Saudi Arabia at this juncture therefore looks unlikely given that backdrop 7 P A G E

8 Ahead of OPEC s 171 st meeting in Vienna on 30 November 2016, analysts will be monitoring refinery crude runs in the US, latent demand in China, and any signs of a colder winter (which is currently forecast) in the Northern Hemisphere. On the latter, weaker La Nina conditions, lower sun spot activity, and a more active Quasi-biennial Oscillation creating a polar vortex are being forecast by meterologists all of which adds up to greater demand for oil and oil products in 4Q 16 and 1Q 17. Jacobite Research View: Time is currently on OPEC s side since the next scheduled meeting is not until 30 November We believe some political posturing ahead of the meeting is possible, however the market is keen to see US$60/bbl being achieved before the end of the year which will aid US shale drillers. We believe the probability of this happening is low, with oil continuing to trade in a US$50-55/bbl range until OPEC makes a tangible cut to production. Furthermore we do believe that any offer by Russia to freeze production is sincere or even realistically negotiable given their position in Syria and current military buildup in the Mediterranean. As Eramus said It is easy to start a war but more difficult to end it. The fact that the Syrian war has raged on for nearly six years gives irrefutable proof of this. 8 P A G E

9 Drilling Results Njord Field The Norwegian Sea continues to provide positive drilling results following on from the recent Cara discovery by Enegie (30% stake, operator) two weeks ago. Faroe Petroleum, announced an oil and gas discovery at the Njord North Flank in the Norwegian Sea (Faroe stake 7.5%). Statoil is the operator of the field with a 20% stake. The well and side-track (NF-2 and NF- 3) are located approximately six kilometers to the north of the existing Njord production facility (Faroe stake 7.5%), making a tie back feasible. Based on the data acquired, a preliminary estimate of the size of the NF-2 discovery is between 1.3 and 18.9 mmboe for NF-2 and between 0.6 and 9.4 mmboe for side-track NF-3. Collectively these discoveries are equivalent to a range of 1.9mmboe to 28.3mmboe (0.14mmboe to 2.1mmboe net to Faroe). This new Greater Njord Area discovery builds on Faroe s already significant position in this core area of the Norwegian Sea and has the potential to add further value and reserves to the Njord Future Project, which is scheduled to commence in early The North Flank discovery has also benefited from low rig rates and hence drilling costs, which, coupled with the Norwegian exploration tax rebate, has ensured Faroe s cost exposure was very low and maintains our low finding costs. We look forward to Faroe s continuing exploration programme; next up is the high impact exploration well on the Dazzler prospect (Faroe 20%) located in the Barents Sea. Dazzler will be operated by Eni and is scheduled to spud around year end. Source: Oil & Gas Journal The Njord Future Project is designed to extend the life of the field, which has been in production since 1997, with 200mmboe originally targeted back then, this has now risen to 450mmboe through the redevelopment of the Njord and Hyme fields, combined with the development of the Snilhorn field and potentially further fields in the area, with a final investment decision (FID) expected shortly in 1Q P A G E

10 Production is set to recommence in 2020 at 80,000boepd (gross), with a total capex of 1.3bn, and opex and capex of US$14/bbl and US$10/bbl respectively. The field has been developed with a floating production facility. Oil is transported by tankers and the gas is exported via the Åsgard Transportation pipeline. Åsgard Transport links the field with the Kårstø gas processing plant and the pipelines to the European gas market. Jacobite Research View: Faroe has both organic and inorganic growth options in the UK, Ireland, and Norway. Inorganic growth through its US$70.2m acquisition of DONG Energy s assets, organically through existing production in the UK and Norway including the Schooner and Ketch gas fields, the Blane oil field in the UK and Brage and Ringhorne East fields in Norway. Full year production is targeted to be 16-18,000boepd. The discovery at the Njord North Flank builds on previous discoveries at Snilehorn and Pil which are in close proximity to the Njord and Hyme fields and helps to extend the life of the field. The Norwegian Sea remains a profilic area for explorers like Faroe (see graph above), and this combined with an attractive petroleum taxation regime in Norway which allows the reimbursement of 78% of costs in the subsequent year gives Faroe an edge over its UK centric peers. The full cycle costs of Njord we estimate are US$25-US$30/boe (opex, capex and transport), making the project economics attractive enough to proceed with FID shortly. 10 P A G E

11 Energy Economics Khazzoom Brookes Postulate Following the OPEC oil crisises of the 1970 s, two economists Daniel Khazzoom and Leonard Brookes put forward independent ideas about energy consumption in the 1980 s in an effort to see if efforts to reduce the consumption of oil through efficiency measures, would lead to less demand in practice. They found that that increased energy efficiency paradoxically tends to lead to increased energy consumption. In 1992, the US economist Harry Saunders named this hypothesis the Khazzoom Brookes postulate, and showed that it was true under Neo- Classical growth theory over a wide range of assumptions. In broad terms the postulate states that energy efficiency gains obtained at a micro level will lead to changes at a macro level. It remains a postulate as not everyone agrees with its conclusions, notably in the US where some leading energy economists think that the rebound effect in minimal. Dr Larry Dale currently a leading energy and water economist at Lawrence Berkeley National Laboratory in California, agrees that there is some rebound effect from more efficient heating and air conditioning systems, however for a fridge the effect he believes is zero. Regarding efforts to mitigate climate change through increasing energy efficiency is not enough, especially as nations like China and India come online and global energy use continues to rise. Dale went onto say that In the U.S., the rebound may be somewhere between 20% to 30%. In developing countries, it might be 70% to 80%. As developing nations become richer then tend to consume more electricity. Harry Saunders extended the original idea which was known as Jevon s paradox in the mid- 19 th Century. William Jevons one of the founders of Neo Classical economics, observed that England's consumption of coal increased considerably after the Scottish inventor James Watt introduced his improvements to the Newcomen steam engine sporadically between 1763 and Jevons argued that increased efficiency in the use of coal would also tend to increase the demand for coal, and would not reduce the rate at which England's deposits of coal were running out. Jevons Paradox: Elastic Demand (Left) and Inelastic Demand (Right) Source: Wilkipedia 11 P A G E

12 When individuals change behaviour and begin to use methods and devices that are more energy efficient, there are cases where, on a macro-economic level, energy usage actually increases. The effect of higher energy prices, either through taxes or producer induced shortages, initially reduces demand, but in the longer term encourages greater energy efficiency. This efficiency response amounts to a partial accommodation of the price rise and making the reduction in demand a short term phenomena. The end result is a new balance between supply and demand at a higher level of supply and consumption than if there had been no efficiency response. Increased energy efficiency can increase energy consumption by three means. Firstly, increased energy efficiency makes the use of energy relatively cheaper, thus encouraging increased use. Secondly, increased energy efficiency leads to increased economic growth, which pulls up energy use in the whole economy. Thirdly, increased efficiency in any one constrained resource multiplies the use of all the companion technologies, products and services that were being restrained by it. One simple example is that suburban development limited by water use can be doubled if the houses adopt water efficiency measures that cut their water demand in half. That way a small efficiency can have large opposite multiplier effect. Similarly cars that use less fuel are likely to cause matching increases in the number of cars and trips and companion travel activities rather than a decrease in energy demand. It appears that these latent multipliers of opposite effects may be generally greater than the linear result of the original effect.the rebound effect will usually be larger if energy costs make up a large share of the total costs of a given product or its consumption, and will also depend on demand elasticities. 12 P A G E

13 Disclaimer Jacobite Research Ltd, Jacobite Research provides a professional weekly independent research report on the global oil and gas sector. Whilst every reasonable effort has been made to ensure that the information in the research is correct, this cannot be guaranteed. The research reflects the objective views of Angus McPhail. None of the companies mentioned in this report pay the analyst any research or corporate fee other than the subscription fee for the website itself. The research is therefore completely independent. Jacobite Research does not buy or sell shares, either for its own account or for other parties and neither does it undertake investment business. Jacobite Research does not make recommendations. We therefore we do not publish records of our past recommendations. Where a fair value price is given in a research note this is the theoretical result of a study of a range of possible outcomes, and not a forecast of a likely share price. Where a thumbs up or thumbs down symbol is used this does not constitute a recommendation. Nothing in this report should be construed as an offer, or the solicitation of an offer, to buy or sell securities by us. This information is not tailored to your individual situation and the investment(s) covered may not be suitable for you. You should not make any investment decision without consulting a fully qualified financial adviser. This report may not be reproduced in whole or in part without prior permission from Jacobite Research. This report may not be forwarded to other third parties by or otherwise without prior permission from Jacobite Research. Jacobite Research Ltd is registered at Companies House (Company registration no: ) is not regulated by the Financial Conduct Authority (FCA). However, the information in this research report is not FCA regulated because it does not constitute investment advice (as defined in the Financial Services and Markets Act 2000) and is provided for general information only 13 P A G E