After a dismal 2015, Brent crude — the global oil benchmark — has become a star performer this year. The price of black gold is already up more than 20% year to date.
And at the time of writing, the Brent is trading at a fresh high for 2015 of $69 per barrel, up around 2.5% on the day.
For producers and explorers like XCITE Energy (LSE: XEL) and Tullow Oil (LSE: TLW), this is great news.
However, investors need to be careful before jumping back into the oil & gas sector. As it’s not yet clear if the rally in oil prices will last. Indeed, the supply/demand fundamentals have not changed much over the past few months, and while US production growth has slowed, it has not fallen dramatically.
Nevertheless, for the time being the pressures off XCITE and Tullow, although these two companies are still facing enormous challenges.
Legal disputes
The biggest challenge currently facing Tullow is the border dispute between Ghana and the Ivory Coast. Specifically, Ghana has been ordered to suspend drilling in waters next to Tullow’s strategically important Ten oil fields until such time as a dispute over maritime boarders is resolved.
Tullow owns just under half of the £3.5bn Ten project, which is spread across several different oil prospects. The company’s project partners include Kosmos Energy, Anadarko Petroleum, Sabre and the Ghana National Petroleum Corporation.
For the time being, Tullow can continue to develop the Ten project, although there is now a certain amount of uncertainty surrounding the project. The company plans to spend around $1bn on Ten this year, and initial production is expected to be somewhere in the region of 80,000/boed, boosting Tullow’s production by around 50% per annum.
However, analysts are now becoming concerned about the overhang these legal issues could have on Tullow’s future.
While the ban on drilling is only temporary, it could last until 2017, or even longer, which would hinder Tullow’s growth. Moreover, this overhang is likely to deter any possible buyers for Tullow. With this being the case, the company’s lofty forward P/E of 50.6 seems unwarranted.
A long way to go
As oil pushes back to $70/bbl, the economics of XCITE’s flagship Bentley oil field will become attractive once again. What’s more, the project’s economics will have received a boost from the changes to the North Sea tax regime introduced this year.
XCITE is set to be one of the key beneficiaries of the changes to the tax regime. Figures from City analysts suggest that the tax bill for new fields in North Sea could now fall to 40%, from the current level, which is closer to 60%.
Additionally, XCITE is set to benefit from an investment allowance set at 62.5% of expenditure, which can be set off against profits subject to the supplementary tax rate.
So overall, if the price of oil continues to rise, the Bentley field’s economics could become more attractive than they have been at any point during the past five years.
This will be a huge boost for XCITE, dramatically increasing the chances of a peer making a bid for the company.
