Tullow - more drilling please

All,

Please find our unchanged analysis here. We will update our model for the FY21 numbers later this week.

Tullow released their FY21 numbers this morning, which just confirmed the details already released in the January trading statement. The emphasis of the presentation was forward-looking, highlighting the further drilling opportunities in both Ghanian fields and the pathway to First Oil in Kenya.

Historics:

- Tullow had already released preliminary numbers in their trading statement in January, and today’s release confirmed our expectations. Net Debt has reduced to $2.1bn, and with an achieved price of $62.7, leverage has reduced to 2.2x.

- Additionally, Tullow released further information on their cost base, highlighting the reduction in costs at Jubilee and TEN, where Tullow are operators. On drilling costs, Tullow had guided the market to $75 per rig, (we use $80m CAPEX) but outperformed and achieved an average of $52m for the four wells they drilled last year.

Hedging:

- In the current environment, investors are complaining about the hedging program. However, Tullow is committed to increasing the hedge levels for the period May 2021 to May 2024 to 75%, 75% and 50% of planned production. Note: this commitment is excluding the acquisition of Occidental’s stake via the pre-emption rights.

- The headline hedges are roughly 70% hedged for FY22, 50% hedged for FY23 and 16% hedged for FY24 as of December 2021. The remainder of the hedging program was completed in Q1 2022, but Tullow only disclosed that The strong recovery in oil prices allowed them to secure sold calls above $95/bbl.

- A couple of points to note: the hedging requirement under the terms of the bond are for May to May 12 month periods, and not the calendar years Tullow discloses their hedge positions, hence the discrepancy in the level of hedges; there is no requirement to hedge the acquired Occidental stake.

- Finally, due to the previous hedging regime under the RBL Facilities (which were taken out by the Senior Secured Bonds), Tullow has outright puts for FY22. Tullow normally hedges via collars, but for FY22, they have some legacy puts, which account for an extra 15% of upside exposure.

FY22 outlook:

- Given the oil price rally since the beginning of the year, Tullow has achieved an $89/bbl price, after hedging, for January and February. Coupled with the puts mentioned above, Tullow’s hedge position for FY22 gives them downside protection for 75% of production but with 40% exposure to the higher oil prices (60% is capped at c.$78/bbl). If oil prices are $100/bbl, this would equate to an achieved price of $87/bbl for Tullow post hedging.

- Tullow has maintained their $100m of Free cash flow with underlying oil prices of $75/bbl. If oil price reaches $95/bbl for the full year, Free Cashflow doubles to $200m. This is after the $75m receipt from Total re: Uganda and the $76m payment concerning the adverse arbitration decision in January.

Positioning:

- We maintain our 3% long position in the 2025 bonds and 4% long position in the equity. We have enjoyed the recent rally in oil prices which has impacted our equity position. However, we remain puzzled by the underperformance of the debt position, given the deleveraging that is currently taking place, the hedging position (which is a negative to the equity position) and the acquisition of the Occidental stake which further creates value to all stakeholders.

- At 15% yield for the subs and 500bps wide of the Senior Secured notes, we are baffled at the trading levels. There is an additional $1bn of equity cushion beneath the debt.

- Given their hedge position, and even in an extreme case of no further successful drilling over the FY22-25 period, Tullow’s existing wells are likely to produce 50-60,000 boepd in FY25, which equates to c. $2bn revenue and $1bn EBITDAX. We are going to explore this further in our detailed analysis.

- We are not excluding the potential tax liability at Ghana - no further update from the Company on this issue - but even allowing for full potential exposure of $320m, given current oil prices and liquidity at Tullow this is not an insurmountable problem.

Happy to discuss.

Tomás

E: tmannion@sarria.co.uk
T: +44 20 3744 7009

M:+44 7786 705 806
www.sarria.co.uk