Investors in Tullow Oil (LSE: TLW) have had a nightmare before Christmas. A torrid December has seen the share price fall by over 50% meaning the FTSE 250 oil explorer has lost over £1bn from its market value.
What’s behind the fall?
The oil producer, which is African-focused, has recently revealed that its 2019 oil production would fall to 87,000 barrels per day. It had previously indicated it would be producing 89,000.
On top of that lowering of forecasts, even worse is the news that next year’s production is predicted to average between 70,000 and 80,000 barrels of oil per day (bopd), while over the next three years it expects an average of 70,000 bopd.
To compound investors’ misery, at the beginning of the year, management believed production could hit 100,000 barrels a day in the second half of 2019.
It has been a tough couple of months as these downgrades are not isolated. Only back in November the firm had problems with its Ghana drilling operations, which led to a reduction in output. This was made worse by the discovery of heavy crudes at a significant discovery off the coast of Guyana.
Heavy crudes are often priced at a discount due to the extra refining costs that are required to treat them.
Analysts have questioned whether Tullow can generate enough cash now to cover its short-term liabilities. The fact that it is being questioned and the risk it poses to the company’s survival, explains the dramatic share price fall. The change in circumstances is also likely to push up borrowing costs for the company.
A longer-term view
Assuming Tullow does survive in the short term, what could the longer term hold? It’s hard to know exactly – the shares are now obviously much cheaper, but the significant operational problems at the company alongside a reliance on the oil price, makes it very risky to me, even if it does make it.
The group is very indebted, which perhaps isn’t unusual for an ambitious oil producer, but it does make life more difficult when things go wrong. And remember it is in an industry where the company has little control over pricing – the price of oil is determined by global supply and demand.
As my colleague Kevin Godbold pointed out, “the balance sheet in last July’s half-year results report disclosed net debt of around $3bn, yet annual operating profit has been running close to just $600m.”
So investors need to consider what the future looks like for oil. Demand for the product isn’t going away any time soon, but with environmental concerns creeping up the political agenda and consumers turning against single-use plastics – which require oil to produce – it’s not hard to see a future where oil is in less demand.
With the FTSE 100 oil producers trying to move into other areas of energy production, I think that’s the way forward. Tullow Oil looks like even if it does survive, it could face too many issues to make it a good investment.
Andy Ross has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019