The Tullow Oil (LSE: TLW) share price is up 35% at 22p as I write, after the company confirmed that the $575m sale of its Ugandan oil fields will go ahead.
It’s good news for Tullow, but I think shareholders should be careful about getting too carried away. In my view, this stock remains quite a risky way to play oil. Here, I’ll explain why I won’t be adding the stock to my portfolio anytime soon.
Why are the shares rising?
Let’s start with the basics. Today’s share price gain has returned the stock to a level last seen in late August. That’s all. Tullow shares are still down by 60% so far this year, and by 90% over the last 12 months.
It’s also worth remembering that today’s news isn’t a surprise. The deal to sell the Ugandan assets to French group Total was agreed in April as part of a plan to raise $1bn from disposals. It’s just taken a few months to get the approvals needed from the Ugandan authorities.
In my view, today’s share price rally is just a sign of relief that the deal hasn’t fallen through. It certainly isn’t a new beginning for Tullow.
$575m: too cheap?
When the deal was agreed in April, the oil market had just crashed, and Tullow was starting to look desperate. I suspect Total has secured a rather good price.
The Ugandan assets were thought to contain 467m barrels of oil and were valued in Tullow’s 2019 accounts at $992m. The sale price of $575m represents a 42% discount to this valuation and values the oil at just $1.23 per barrel.
Tullow won’t get the whole $575m upfront either. The firm will get $500m from Total when the deal closes, and a further $75m when a final investment decision is made.
Although Tullow will also be entitled to payments linked to the price of oil after production starts, I wouldn’t get too excited about this. Any payout requires an average annual Brent crude price of at least $62 per barrel. Production could also be many years in the future.
Right now, all the money received from Total will be used to help reduce Tullow’s $3bn net debt. The firm’s recent half-year results made it clear its financial situation remains serious.
Tullow Oil share price: bargain or bust?
In my view, today’s news doesn’t change anything for Tullow. I’d guess chief executive Rahul Dhir is continuing to look for deals to meet his target of $1bn in asset sales. However, with the oil price seemingly stuck around $40, market conditions are difficult for sellers.
In my view, Dhir will have no choice but to continue running Tullow’s operations to maximise cash flow and, if possible, maintain current production levels. I expect all the group’s free cash flow will be used to repay debt. Unless oil prices stage a strong recovery, I don’t think there’ll be much opportunity to generate shareholder value.
Indeed, as with Premier Oil, I think the best hope for shareholders is that Tullow Oil can attract a buyer with stronger finances.
I continue to see Tullow shares as risky and with limited upside potential. If I owned the stock, I’d be tempted to sell into today’s rally.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.