After one of the most aggressive oil bear markets in recent history, the oil sector is now rife with takeover speculation. With sector valuations at lows not seen since the financial crisis, it’s widely believed that oil majors will start to buy up smaller peers like Tullow Oil (LSE: TLW) and Enquest (LSE: ENQ) to boost their reserves and production at attractive prices. 

Takeover talk… again

Tullow Oil is no stranger to takeover speculation. City analysts have been touting the company as a takeover target for years based on the company’s attractive asset base, reserves and production profile. Indeed, only a few days ago takeover chatter began again, but after so many rumours that have turned out to be false, the market is now highly sceptical about any takeover talk regarding Tullow. 

And it’s unlikely that a potential bidder will make an offer for Tullow until the company gets its house in order. The group’s debt is the most concerning factor here.

Tullow carries net debt of three-to-four times next year’s forecast earnings before interest, tax, depreciation and amortisation (EBITDA), this figure varying depending on where the price of oil settles this year. However, net debt of more than two times EBITDA is generally considered to be too high for most investors. So unless the price of oil suddenly snaps back to $100/bbl this year, Tullow’s towering debt pile might prove to be too much for potential acquirers.

That said, in October Tullow agreed on fresh terms with its lenders that ensured it would continue to have access to $3.7bn of debt, so the company itself isn’t at risk of bankruptcy any time soon. And Tullow is expecting to bring its Tweneboa, Enyenra and Ntomme (TEN) development — touted as Tullow’s second flagship project after the Jubilee field — on-line during the second quarter of this year, nearly doubling the company’s output. This should help the group start to reduce debt, and may reignite interest among potential bidders. 

Struggling to remain solvent

It’s no secret that Enquest is in dire straits. The company has been hit harder than most by the collapse in the price of oil and even though the company’s market cap has fallen by more than 90% in the space of two years, Enquest is unlikely to become the target of a larger peer any time soon.

Things have become so bad for Enquest that the company is taking drastic measures to increase liquidity. It’s looking to sell stakes in some of its producing assets, which should help fund the development of the group’s other North Sea assets.

The company has launched a process to farm-out a stake in the Heather/Broom field. Enquest currently owns 63% of the field. It’s also been reported that Enquest was seeking to sell up to a quarter of its stake in the Kraken field, and a 10% to 20% share of the Scolty/Crathes fields, in which it has a 50% interest. Enquest has vowed to press ahead with the development of these two new North Sea oil fields next year and management is targeting a 33% year-on-year rise in production in 2016.

If any bidders do emerge for Enquest, it’s likely that they’ll wait for the company to announce that it hit its production target for this year before making an offer. 

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Rupert Hargreaves 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.