The case for nuance perhaps falls on deaf ears, nonetheless, latest Guyana well results from Tullow Oil PLC (LON:TLW) may provide encouragement for patient investors and the company's exploration partner Eco Atlantic Oil & Gas Plc (LON:ECO).
Tullow owns 37.5% of Carapa-1, a Repsol-operated well in the Kanuka licence, which has unearthed ‘light sweet’ crude in a new discovery.
That Tullow and Eco’s shares both weakened on Thursday belies what is an important and positive result.
Typically fickle speculators have quickly latched onto the negative that, at only 4 metres, the Carapa well’s net pay was way below pre-drill prognosis (indicated that the well was possibly drilled in a sub-optimal location).
But, confirmation that the premium and prolific cretaceous oil play is present in the Kanuka block has much broader and potentially more significant implications for Tullow and its partners – which include Eco, Total and Repsol.
2019 well disappointments
The not-insignificant knock to Tullow’s 2019 discoveries offshore Guyana was that they comprised lower value heavy crude, with higher than normal levels of sulphur.
It was a weighty blow for Tullow exacerbated by timing, coming alongside a major production downgrade for its West African business and the departure of its long-serving senior management team.
Plainly, market sentiments are skewed to the downside for Tullow – not least given the seasonally low level of participation in London, before trading rooms return to normal capacities next week.
Tullow’s shares fell as much as 20% at one point this morning to trade as low as 50.7p, though, at 60.3p they had recovered some lost ground, now down some 6%.
It ain’t heavy
Prior to 2019’s drilling, Tullow was positioned as a ‘second mover’ or ‘first follower’ in what appears to be a prolific new oil frontier.
Exxon has led the way with the adjacent Strabroek project area where it made fourteen discoveries comprising over 6bn barrels of crude resources.
Strabroek’s most advanced project, the Liza field, is on-track for first oil in the coming months (Q1 2020) before a ramp up to 120,000 bopd in Phase 1 and a Phase 2 development will seek to unlock some 750,000 bopd of production within five years.
Exxon’s Cretaceous age crude discoveries were previously, in summer 2018, indicated to extend into the Tullow’s Orinduik block – via analysis of the Hammerhead discovery, located 7kms from the Orinduik boundary.
Hammerhead, at the time Exxon’s ninth consecutive Guyana discovery, was said to have “materially de-risked one of many similar channel systems in our Orinduik Block.”
Subsequently Tullow’s own wells, drilled in 2019, confirmed two new discoveries Joe and Jethro but both were made in Tertiary age systems, not Cretaceous.
These discoveries were initially welcomed with fanfare, described as ‘significant’ and ‘high quality’ results.
The initial success literally and figuratively soured. Analysis of samples in the lab revealed that Joe and Jethro contained entirely different crude than unearthed by Exxon at Strabroek.
Rather than light sweet crude, a premium product in the market, the oil was instead found to be heavy and sour (containing higher levels of sulphur) which means it will receive a lower market price and may potential require costly additional engineering or processing.
It now remains to be seen what will become of Joe and Jethro’s economic proposition, not least given that Tullow’s recent management changes have triggered a reassessment of all project and priorities.
Immediately after the first well results, Joe and Jethro were believed to host around 295mln to 370mln barrels of potential crude resources – so, if the economics stack up, there’s still a possibly very sizable project there.
Repsol’s Carapa well was the first to be drilled in the Kanuka licence block – which is larger than Orinduik. It is located to the south east of Orinduik and it also shares a boundary directly with Exxon’s Strabroek acreage.
Carapa targeted and found oil in the Cretaceous and, significantly, that crude was confirmed as being light and sweet (with sulphur below 1%).
This ‘high quality’ result is closer to Exxon’s successes, albeit, the well encountered only a thin 4 metre reservoir section.
Value potential remains intact
Stockbroker Peel Hunt described the Cretaceous success as being “materially de-risking” for Tullow’s exploration prospects in both the Kanuku and Orinduik.
Peel Hunt analyst Werner Riding, in a note, highlighted that Tullow had previously guided that more than 2bn barrels of potential resources may be present across prospects in the two blocks.
Lessons learned and better well positioning can still unlock this value, the analyst noted.
“The thin net pay is disappointing and indicates Kanuku-1 has been drilled off the axis of channel.
“However, subsequent wells (on both Carapa and other cretaceous prospects) should be able to use the new well–seismic tie to allow thicker reservoir to be targeted more effectively.”
In terms of its bigger picture, however, Tullow’s business remains somewhat in flux.
Peel Hunt repeated a ‘hold’ recommendation with a 75p price target.
Tullow could hit reset on its business model
As former chief executive Paul McDade and exploration director Angus McCoss departed in December, Tullow’s interim executive team threw the ‘kitchen-sink’ at the FTSE 350 firm’s guidance.
Tullow warned of a near 60% plunge in cash flow with 2020 guidance of US$200mln from prior guidance that it would generate US$350mln in 2019.
It triggers commensurate axing of Tullow’s capital expenditure budget which shrinks by around US$200mln, to US$350mln in 2020 from around US$540mln this year.
Tullow said its board was disappointed by the performance of Tullow’s business and it would now take time to conduct a thorough review of operations.
It was not clear what this would mean precisely, though it didn’t take much analysis to draw a few quick presumptions.
- Preservation of cash flow will be key, given US$2.9bn debt pile
- Spending on growth and exploration will be de-prioritised
- Asset divestments may be sought to balance the books
The outcome of Tullow’s “thorough reassessment of cost base and future investment plans” may have important implications for expansive and likely expensive projects like those in Guyana.
In December, executive chair Dorothy Thompson told Tullow investors that a further update on the company’s plans will come in February, alongside the full year results for 2019.
In the meantime, the market will be left to speculate.
What does it mean for Eco Atlantic?
Eco’s position was arguably strengthened significantly by the Carapa result.
Whilst Eco doesn’t hold a stake in the Kanuka block, the result provides further validation and ‘de-risking’ of the Cretaceous play – which is now demonstrated in two immediately adjacent areas.
With an eye on new plans for the New Year, hindsight is 2020 and its arguable that not directly testing a Cretaceous target last year was unfortunate and a missed opportunity.
Quite how much Tullow is prepared to spend on its frontier exploration in Guyana now remains to be seen, particularly given that the rapid progress to date means that Orinduik is already secured years ahead of the minimum contracted obligation.
Investors in Eco will be keen for February’s update at Tullow. Hopes will be that interim management will commit to fresh work in Guyana later this year.
Prior to the corporate fireworks through the latter part of 2019, Eco had been prepared for a ramp up of exploration activity in 2020.
Following equity funding earlier in the year, Eco had C$30.7mln of cash at the end of September (H1) and by November it still had some C$27.9mln remaining.
It was envisaged that Eco would be able to cover its 15% share of costs for up to four additional exploration or development wells.
“We are now very strongly funded for a potential development drilling scenario and additional exploration wells on the Orinduik block," chief executive Gil Holzman said alongside an April 2019 share placing.
More recently, on 10 December, Holzman told investors: “We have met and exceeded all of the licence commitments to date and stand ready to further appraise and explore the significant hydrocarbon potential of the Orinduik Block licence, both in the proven discoveries of the Tertiary layer and in the deeper Cretaceous layer, estimated to hold an additional 3.2 bn barrels of oil.”
“As we look to next year, we will continue to work closely with all our stakeholders, including our host governments and the JV partners, to determine the budget and drilling programme for 2020, and we look forward to publishing an updated CPR on Orinduik Block and sharing our upcoming plans on our Namibian and Guyanese licences over the coming months."
In terms of assets and finances, Eco remains in a relatively strong position (compared to many AIM peers) though the pace of progress will likely be driven by Tullow, and its forward strategy.
Questions remain – will Tullow stay committed to exploration? As operator, what will Tullow’s plan be at Orinduik? Will the more passive involvement in Repsol operated Kanuka take precedence?
Answers likely won’t emerge until February.