The Motley Fool

Tullow Oil plc And Gulf Keystone Petroleum Limited Are Attractive Low-Cost Oil Producers

Shares in Tullow Oil (LSE: TLW) and Gulf Keystone Petroleum (LSE: GKP) have fallen by 58% and 60%, respectively. Both are regionally focused low-cost producers, but because they lack sizeable downstream operations, their earnings are much more affected by swings in the oil price than those of the oil majors. Tullow focuses on oil production in Africa, whereas Gulf Keystone focuses on the Kurdistan Region of Iraq.

Attractive acquisition targets?

Their low costs of production and their moderately higher level of leverage makes them attractive takeover targets for larger oil and gas producers. So far, there has been relatively little M&A activity since the decline in the oil price; with notable exceptions being BG Group and Dragon Oil.

Claim your FREE copy of The Motley Fool’s Bear Market Survival Guide.

Global stock markets may be reeling from the coronavirus, but you don’t have to face this down market alone. Help yourself to a FREE copy of The Motley Fool’s Bear Market Survival Guide and discover the five steps you can take right now to try and bolster your portfolio… including how you can aim to turn today’s market uncertainty to your advantage. Click here to claim your FREE copy now!

But, with the attractive valuations of some low-cost operators, attractive opportunities remain. Large oil finds are become increasingly difficult and exploration costs are becoming more expensive; and these factors should make producers already operating in low-cost regions with substantial expansion opportunities particularly attractive for larger producers.

Low cash cost of production

Situated in low-cost oil locations, these two oil producers generate substantial cash flows even with low oil prices. The cash operating costs of Tullow and Gulf Keystone are $18.6 and $11.8 per barrel of oil equivalent (boe), respectively.

But, these figures excludes capital expenditure costs for developing wells and royalty expenses, which are costs that producers need to eventually recover to remain profitable. In addition, the break-even price of extraction typically rises with the age of the well, as the easiest oil to extract is usually produced first.

Although these two oil producers are not able to continue their pace of new developments without raising debt, at current oil prices, their levels of indebtedness are reasonable and farm-outs should enable them to broadly meet their medium term production targets.

Hedging and asset sales

Hedging of the oil price has lessened the impact of falling oil prices on the earnings of Tullow and Gulf Keystone in recent quarters, but the proportion of production hedged going forward is much reduced. Tullow still has some 60% of its share of oil sales in 2015 hedged with an average floor price of around $86 per barrel. But, only 40% and 20% of production in 2016 and 2017, respectively, is being hedged.

Gulf Keystone is in talks with prospective buyers with regards to asset sales or the sale of entire company. The Shaikan field, which is the company’s key producing asset, is suffering from working capital shortfalls because of delays in export payments from the Kurdistan Regional Government; and this is unlikely to resolve itself soon. But, once the uncertainty eventually settles down, production could be ramped up from 40,000 barrels of oil production per day (bopd) to 70,000 bopd.

No dividends

Tullow and Gulf Keystone don’t currently pay any dividends, but their impressive production growth makes them attractive in the long term, even without any anticipated takeover offers. Their share prices do not seem to reflect much of a recovery in the oil price, yet their low cost assets should mean they will steer clear of any financial trouble.

Prefer dividend paying shares?

If you are looking for reliable income-generating opportunities, you probably need to look beyond the oil and gas sector. The Motley Fool has a free special report that lists alternatives more aligned with your investing strategy: “The Fool's Five Shares To Retire On”. These five large-cap shares have been selected for their income and growth prospects. The 5 companies generate stable cash flows; as they benefit from their dominant market positions and broad global exposure.

The special report is free and there's no further obligation. Click here to get your free copy.

Jack Tang 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.