It’s been a tough few months for investors in Tullow Oil (LSE: TLW), its share price standing at about a quarter of the value it held in November. In December its shares plummeted 70% after it reduced its production outlook and announced the departure of both its CEO and Head of Exploration.
January has not seen any improvement, kicking the year off with news that drilling results for an offshore well in South America found less crude than expected, making it unlikely to be commercialised. And mid-month, Tullow was forced to downgrade its crude price assumptions and cut its reserves estimates, leading to a $1.5bn write-down.
In numbers we trust
But Tullow has now begun to suffer a problem far worse for its shares than write-downs and changes to production estimates – falling confidence. Investors are reliant on a company’s financial reports to try to gauge its fair value as an investment. When estimates shift by such huge percentages, it raises questions.
At first glance, the major question arising from these kinds of things is “was management overoptimistic?” But of course, it is the nature of estimates, as well as accounting practices, that even when adhering to all standards and realistic beliefs, they rarely prove to be perfect.
The fact is, these kinds of changes to numbers are more of a problem because they show us how the ‘sausage’ is made. Oil companies need to make predictions not just for reporting purposes, but also as an entire base for their businesses. Sometimes these predictions will prove wrong.
Tullow’s $1.5bn write-down was the result of a $10 a barrel reduction in its long-term price forecast, not because the actually price of crude dropped $10. Even the 70% drop in its shares in December was caused by a reduction in its expected production, not what it was currently producing — a technicality I know, but still…
Oil companies are not alone in having to make such forecasts of course, but to a certain extent, one could argue the forecasts themselves will have a more fundamental impact on an oil firm than other industries.
How soon we forget
The good news for investors and oil companies is that human beings soon forget the past, at least selectively. Investors and analysts have no real choice but to use and rely on the financial information that companies provide them with – that’s a key component of how the stock market works (along with technical analysis and market psychology).
I think in the case of Tullow Oil, this means that any scepticism investors have over its estimates in recent months, will fade back to a normal level if the company isn’t forced to make any similar downgrades in the future. Taken in this context, Tullow’s current share price could be seen as a bargain.
Production estimates may have been cut, for example, but this year’s levels are still expected to sit between 70,000 and 80,000 barrels per day. Likewise, its profit expectations may be 35% lower than in 2018, but this is still a staggering £700m. I haven’t been too optimistic on Tullow’s future generally speaking, but I may be starting to see things in a different light.
