Is the sun setting on Tullow’s East African misadventure?

KAMPALA, JANUARY16 – While news of the erosion of Tullow Oil’s Ugandan stake in favour of French major Total E&P may have surprised many, industry watchers were anticipating that development as early as two years ago. With word that even its Kenya holdings are on the chopping board, the repositioning may well be a harbinger of Tullow’s complete sunset.

Total secured tentative approval for the $900 million acquisition which reduces Tullow’s stake in Uganda’s upstream oil sector to 11.73 percent, firmly putting Total in the driver’s seat with its 54.9 percent majority.

The development while assigning clear leadership to Uganda’s long delayed oil program, reflects Tullow’s checkered history of missteps in the region and elsewhere which now threaten its very existence. For one, the politically inclined explorer chalked up high program costs and acquired rivals at prices that are no longer supported by the current market environment. Barring a new findings and a new cycle of high global energy prices, its Kenyan fields, with just over 600 million barrels, cannot support viable production program without leaning on joint commercial programs with either Uganda or South Sudan. The former option flew out of the window when Uganda changed the routing of its export pipeline to Tanzania while the latter remains years away depending on how South Sudan settles its political mess.

For Tullow, the near term threat is that in a run of bad luck for the company, its future was heavily premised on its holdings in East Africa. But illiquid and stretched, Tullow could no longer match capital calls for the next stage of development of the Ugandan fields, culminating in a forced sale to Total. The company already owes $4.8 billion and cannot borrow any more.

Indications of what was unfolding became clear last June when Tullow released a trading statement and operational update that projected below par performance of its West African assets

To observers, it was no longer a question of if but when Tullow would throw in the towel. Commentators then argued that its stakes in East Africa’s fields were some of the most promising assets in its portfolio. It now emerges that the only reason it took this long to close the deal was the low appetite for risk in the oil industry at the time and yet its share of Ugandan reserves by volume was high. Were Tullow to sell last year, it would have got just about a third of the $900 million it managed to wring out of this deal. Even this is a loss given that the company has spent more than $4 billion in acquisitions and exploration costs since it first entered Uganda through a $1 billion buyout of Australian wildcat operator Hardman Resources in the middle of the last decade.

Ghana continues to be difficult for Tullow, production from its Jubilee field was projected to average 74,000 bopd with a net of 26,300 bopd for the company in 2016. The only positive news came from Europe where gas production for the first half of 2016 was above expectations averaging 6,800 boepd.

Though he put a brave face to it, Tullow ceo Aidan Heavey’s guidance last June contained cryptic hints of its dilleman. “In East Africa, the Governments’ agreement that there will be separate pipelines to develop resources in Uganda and Kenya brings greater clarity to both projects. In addition in Kenya, a new programme of exploration wells focusing on growing resources is due to start in the fourth quarter. The New Ventures team remains focused on high grading and replenishing the exploration portfolio with a new licence signed in Zambia and ongoing portfolio management and seismic survey activity in South America,” he said back then.

“During the first half of 2016, production in the company’s West Africa working interest averaged 51,900 bopd. “This is below previous guidance due to lower production from the Jubilee field in Ghana, following issues with the FPSO turret identified in February. This resulted in an extended shut down period in April while new off-take procedures were implemented to enable the Jubilee field to restart in early May. Production has gradually been ramped up since then, with gross production in June averaging around 90,000 bopd.

“The Group expects to continue producing from Jubilee at similar levels through the remainder of 2016 with the exception of short periods of reduced production to commence work on the long-term turret solution. As a result, Jubilee gross average production in the second half of 2016 is expected to be around 85,000 bopd (net: 30,200 bopd). Tullow therefore expects average gross production for the Jubilee field in 2016 to be around 74,000 bopd (net: 26,300 bopd). As a consequence, Tullow’s West Africa oil production guidance range is revised to 62-68,000 bopd net. Tullow however has a comprehensive package of insurances in place which includes Business Interruption insurance which covers consequent loss of production and revenue from Jubilee,” Heavey explained in the update.

But that belied deeper problems. The company was seeking approval from the Ghanaian government to spend $100-150 million on a programme to resolve the technical issues at Jubilee during 2017.  Exploration activities in Ghana were also suspended pending resolution of a border dispute between the Côte d’Ivoire and Ghana.

With such a configuration of circumstances, It would be a tall order for Tullow to meet new capital calls for investment in Uganda’s upstream development and the crude export pipeline. Tullow’s debt at the time was $4.7 billion including $1 billion in available credit.

The winners in this case are Uganda which gets to collect a handsome $135 million in capital gains tax and Total which finally gets absolute control over a program that was in the past dogged by shady deals and protracted international litigation.

 TULLOW OIL OPERATIONAL SUMMARY JUNE 30, 2016

East Africa development
On 23 April 2016, the Presidents of Kenya and Uganda agreed to pursue two separate crude oil export pipelines for the development of Kenya’s South Lokichar oil fields and Uganda’s Lake Albert oil fields. The Uganda pipeline route will be through Tanzania from the Ugandan town of Hoima to the Tanzanian port of Tanga. The pipeline development is being led by Total and the Government of Uganda. In Kenya, Tullow and its upstream partners Africa Oil and Maersk Oil, along with the Government of Kenya, are currently negotiating a Joint Development Agreement to implement the Kenya crude oil pipeline which will run from South Lokichar to the port of Lamu. It is anticipated that for both the Kenya and Uganda pipelines, technical, environmental and social studies and tenders required to proceed to FEED will commence in the second half of 2016 with the objective of commencing FEED in 2017.

In addition to progressing the full field development work in Kenya, an Early Oil Pilot Scheme (EOPS) transporting oil from South Lokichar to Mombasa, utilising road or a combination of road and rail, is being assessed to provide reservoir management information to assist in full field development planning. The EOPS would utilise existing upstream wells and oil storage tanks to initially produce approximately 2,000 bopd gross around mid-2017, subject to agreement with National and County Governments.

Kenya Exploration and Appraisal
In the first half of the year, Tullow concluded its first phase of exploration and appraisal in the South Lokichar Basin. The success of this programme and ongoing analysis of the discoveries has led to an upgrade of the South Lokichar resource estimate up to 750 mmbo. Significant upside remains across the South Lokichar Basin with the potential to increase the resource estimate to around 1 billion barrels of oil. The Kenya Joint Venture Partners therefore plan to recommence drilling activities in the fourth quarter of 2016 with an initial programme of four wells in the South Lokichar basin and the potential to extend this by a further four wells. In addition, Tullow is planning an extensive water injection test programme in the fourth quarter of 2016 to collect data to optimise the field development plans.

Exploration activity continued outside of the South Lokichar basin in the first half of 2016, and the Cheptuket-1 well in the Kerio Valley Basin was successfully completed in March 2016. The well encountered good oil shows, seen in cuttings and rotary sidewall cores, across an interval of over 700 metres. Further exploration activities in this basin and Tullow’s remaining unexplored Kenyan acreage, continue to be evaluated.

New ventures
Tullow has continued to actively manage its New Ventures portfolio in the first half of 2016 through both licence acquisitions and farm downs of existing acreage to manage exposure to exploration costs.

In June, Tullow extended its East African rift play acreage through the award of Petroleum Exploration Licence 28, onshore Zambia. The 55,000 sq km block builds on Tullow’s existing low-cost, core East African Tertiary rift basins, giving the Group access to three further unexplored basins. Within the first two years of the licence, Tullow plans to complete initial geological studies, acquire an FTG survey and collect passive seismic data. If the results are positive the Group will then carry out the acquisition of 2D Seismic over the block.

Financial Update
The Group’s 2016 capital expenditure guidance remains at $1.0 billion with further savings being offset by additional capex associated with the Jubilee turret issue ahead of potential insurance payments and the start of a new drilling campaign in Kenya.

At the end of June 2016, net debt is estimated at $4.7 billion and unutilised debt capacity and free cash at approximately $1.0 billion. The Group’s hedging strategy remains unchanged; ensuring a percentage of production entitlement volumes are hedged on a three-year look forward basis. Having temporarily suspended the execution of this strategy in the fourth quarter 2015, it was resumed in April 2016.

In April, Tullow successfully completed its routine six-monthly Reserve Based Lending (RBL) redetermination process, securing available debt capacity of $3.5 billion. The first amortisation of the RBL is scheduled in October 2016, when commitments will reduce to $3.25 billion. The Company currently plans to refinance the RBL before any further amortisation in 2017.

The Group also agreed a twelve month extension to the maturity of the Corporate Facility to April 2018. The Corporate Facility commitments remain at $1 billion until April 2017, when commitments reduce to $800 million with an accordion feature for an additional amount of $200 million. Tullow’s lending banks also agreed a further amendment to the financial leverage covenant of the RBL and the Corporate Facility. This demonstrates the continued support of the Group’s lending banks during this period of low oil prices and the high quality of Tullow’s asset portfolio. Strengthening the balance sheet and debt reduction continue to be key priorities for Tullow this year. Options available include further rationalisation of our cost base, further cuts to discretionary capital expenditure, portfolio management and other funding options.

 

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