With oil prices starting off 2016 exactly where they left off last year, many investors have begun to prepare themselves for a long period of depressed prices. While it?s a fool?s game (lower case ?f?) to predict the timing of oil price movements, it’s certainly highly unlikely that prices will remain in the $35 per barrel range for years to come. For investors with a long time horizon, 2016 may well be an opportune time to start exploring shares of oil and gas producers.
However, quality will be key as highly-leveraged minor players such as Tullow Oil Plc (LSE:TLW) will…
With oil prices starting off 2016 exactly where they left off last year, many investors have begun to prepare themselves for a long period of depressed prices. While it’s a fool’s game (lower case ‘f’) to predict the timing of oil price movements, it’s certainly highly unlikely that prices will remain in the $35 per barrel range for years to come. For investors with a long time horizon, 2016 may well be an opportune time to start exploring shares of oil and gas producers.
However, quality will be key as highly-leveraged minor players such as Tullow Oil Plc (LSE:TLW) will find it difficult, if not impossible, to survive several more years of depressed crude prices. Tullow has an enviable array of productive oil fields in West Africa and potential fields in East Africa, but has piled on some $4.2bn of debt to reach this position. These West African fields have produced the lion’s share of Tullow’s revenue and will become even more important once the Ghanaian TEN Field comes online in mid-2016 to increase total production by roughly 50%.
With around 40% of expected 2016 production hedged at an average price of $75 and the revenue from the new TEN field, Tullow appears to some as a bargain. Yet, for the first half of 2015 the company took in 52% more cash from credit lines than it did actually selling oil. It has a mere $1.7bn in net cash and undrawn credit lines available to it as of the end of 2015. This is particularly significant as a further $1bn in capex is necessary just to begin pumping oil from the TEN Field and $2.6bn of debt is due to be amortised over the next three years.
If crude prices remain below Tullow’s estimated $38 to $45 breakeven cost for a significant amount of time, there will be problems. Even the additional revenue from the TEN Field will make it impossible for Tullow to continue without piling on even more debt, or resorting to divestments or a rights issue.
Bagging a bargain
Investors looking to bag a bargain bin oil producer would do much better to consider BP plc (LSE:BP). BP’s sheer size means it has been able to diversify revenue among oil production, natural gas extraction, and downstream refining operations. These refining operations provided BP with $2.3bn in underlying profits for the third quarter of 2015 and have allowed BP’s dividend to hold steady, yielding investors a FTSE-beating 7.6%.
Year-to-date the company has registered a $3bn loss, however this is due to a $9.8bn second quarter charge related to the Gulf of Mexico spill. The $55bn BP has paid out so far led it to divest $75bn worth of assets since 2010 and cut costs across the board. That was even before the dramatic drop in oil prices in 2014 – putting it ahead of other oil majors in rebalancing operations for lower oil prices.
Management is determined to maintain dividend payouts and with a gearing ratio of 20%, has the ability to draw on credit to maintain payouts if oil doesn’t rebound to breakeven prices of $60 p/b range for some time. I view BP’s diversified revenue streams, healthy balance sheet and a possible light at the end of the tunnel for oil spill-related payouts as a reason long-term investors should consider adding it to their portfolio in 2016.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has recommended Tullow Oil. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.