$50 oil will give Premier Oil PLC and Tullow Oil plc even more to celebrate

A rising oil price doesn’t necessarily lift all boats, but it has certainly floated oil explorers Premier Oil (LSE: PMO) and Tullow Oil (LSE: TLW). Their share prices are up 33% and 24% over the last month alone. Oil at $50 a barrel is almost within touching distance and if it passes that landmark price, investors might really start believing the rally is on.

Golden years

In the longer run, oil has to recover. The demand is still there, renewables can’t replace it yet. Crucially, the plunging oil price has forced producers to slash spending on exploration and development, leading to a sharp fall in global drilling activity, and setting up a future supply shock. Some oil companies will benefit because others have gone out of business. Those that survive are sitting on a pot of black gold. Judging by recent performance, investors believe Premier Oil and Tullow Oil slot into the latter category.

Over three months, Premier’s performance has been blistering. It’s up 135% in that time. It was helped by Wednesday’s trading and operations update, which showed the company on track to match or beat upper-end full-year guidance of 65,000 to 70,000 barrels of oil equivalent. The Solan field started production on 12 April with the first well pumping rates of over 14,000 barrels, while its Catcher project remains on schedule and below budget. Premier also completed the acquisition of E.ON’s UK North Sea assets on 28 April.

Rising production meets a rising oil price, what’s not to like? Chief executive Tony Durrant even boasts “significant liquidity with cash and undrawn bank facilities of circa $750m“, but there are still risks as it could breach its financial covenants unless oil powers higher. This has prompted managers to hold talks with lenders to secure a waiver if required, which doesn’t seem to worry investors right now but remains something to bear it in mind.

Marks out of TEN

Tullow Oil is up 70% over three months, so investors appear to have bought into this recovery story as well. Its latest update showed the company making progress against the tough backdrop for oil stocks. Oil from its TEN project is expected to start flowing in July or August. Its South Lokichar programme in Kenya may hold up to 750m barrels and possibly even 1bn.

The company has also managed to extend and increase its borrowing facilities and remains well-funded. Net debt is an estimated $4.5bn with unused debt capacity and free cash of approximately $1.3bn, but it sorely needs oil to rise higher still to get its balance sheet back in order.

Tullow will feel more unfairly punished by the falling oil price than most, given that it had borrowed heavily to develop new oil finds just as the price plunged. Maybe its luck has turned, with the price rising just as TEN is set to add 10,000 barrels a day to production. Forecast pre-tax profits of £58.78 this year are predicted to be £208.42 in 2017, an increase in earnings per share of a whopping 208%.

Premier and Tullow are both at the mercy of what they can’t control: the oil price. If it slips, their debts will prove a growing burden. Even if oil rises higher, it may not rise fast enough. My other concern is that if you’re buying now, rather than three months ago, you’ve missed out on a chunk of the potential upside.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.