With Tullow Oil successfully securing its stake in Ugandan firm Heritage Oil, Nick Wadhams looks at how the company will finance its rapid expansion.

In January of this year, the British energy superstar Tullow Oil seemed to suffer a major setback in Uganda, home to some of its most promising prospects.

The government indicated it would allow Tullow’s partner in Uganda, Heritage Oil, to sell its stake there to Italy’s Eni despite Tullow’s vow to pre-empt the deal and buy the stake itself.

Tullow’s stock price dropped from 1,365 pence to 1,148 pence as Uganda’s energy minister, Hilary Onek casually dismissed the company’s legal right to pre-empt the Eni deal. He said the country didn’t want Tullow to have a monopoly over Uganda’s untapped oil reserves.

But then, after days of negotiation, Tullow got its way. President Yoweri Museveni made Onek eat his words, and Eni withdrew its bid.
Tullow would soon own three blocks with an estimated 2 billion barrels of oil, a figure that some analysts say could actually quadruple with further tests. And it has its pick of suitors among the oil majors looking for a piece of the Uganda action.

That victory capped a stunning run for Tullow, whose share price has doubled in three years, partly on the major oil discoveries it made in Uganda and Ghana, where the offshore Jubilee field may have up to 1.8 billion barrels by itself.

Its balance sheet looks good too: Tullow has a market capitalisation of more than US$10bn, outstanding debt of US$720mn and an underutilised debt capacity of more than US$600mn. The company has also had phenomenal success with its test wells. In 2009, only two of its 15 test wells failed – an industry-leading success rate of 87%. Another two test wells in 2010 in Uganda and Ghana also hit hydrocarbons.

“They’ve clearly shown an ability to nose out at the frontier, which is where I think a lot of the remaining discoveries are,” said Aly-Khan Satchu, who runs Rich Management in Nairobi. “All of a sudden they have got a lot of cash on their balance sheet, they are playing with the big boys, they are playing on their own terms, they are not playing as a supplicant.”

Tullow’s borrowing strategy

The next 12 months will show whether Tullow can maintain that rapid pace of growth. It spent some US$500mn on exploration in 2009 and plans to drill at least 12 test wells in 2010, says Peter Hitchens, an analyst at Panmure Gordon & Co. Some of those drill sites sit on the fringes of its major finds in Ghana and Uganda. Other test areas include Sierra Leone, Liberia, and French Guiana.

Tullow won’t provide details yet about its financing plans for 2010.

According to Phil Corbett, a London-based analyst at the RBS, “the company has said that it is looking to diversify its funding sources by looking to issue high-yield debt at some point in the future”.

Analysts believe Tullow would not have much trouble if it sought more financing.

They point to its past success, including a reserves-based lending facility for US$2bn in March 2009. Thirteen banks helped with that deal, which financed its Jubilee field development.

One banker close to the deal, who didn’t want to be named, told GTR that the paperwork included 204 separate legal documents, 54 spreadsheets in the cashflow model alone, and a waiver request for Uganda that required 27 legal documents on its own.

The complexity of the deal, and the fact that Tullow pinned it down at a time when oil prices were less than half what they had been six months earlier, testified to the company’s financing skills, said the banker.

“It was such a glorious piece of work,” the banker said.

Tullow secured a revolving credit facility for US$250mn in late 2009 and placed US$1.5bn worth of shares on the London stock exchange in early 2010. Some analysts criticised that move because they feared it would dilute the value of existing Tullow shares. So far, the company’s stock price has not suffered.

Analysts saw the share placement as a cautious move as it looks ahead toward more exploration. Tullow has spent US$500mn without a penny of return in Uganda so far, and is spending US$1.5bn to buy Heritage’s 50% stakes in Blocks 1 and 3A in the Lake Albert basin. It needed to get the money from somewhere.

Now, however, Tullow may find itself with a cash surplus.

Recent news reports suggest it will sell at least a 50% stake of its Uganda holdings to France’s Total SA and the Chinese National Offshore Oil Company, Cnooc, for US$2.5bn.

Given the financing deal, the stock sale and the move to sell stakes of its blocks in Uganda, some analysts believe that Tullow has too much finance and may not need to raise any more money in the short term. Adding to its cashflow, Tullow believes the Jubilee field in Ghana will come online by the end of the year, with 120,000 barrels a day of output expected by 2012.

“My thought on financing is they’ve got enough cash as we speak to cover everything they want,” said Hitchens of Panmure. “The only uncertainty is if they make a series of acquisitions which require a huge amount of work drilling appraisal and exploration wells. That’s the only time I can see them starting to require more money.”

Downstream expertise

Tullow officials won’t reveal their potential partners in Uganda, but acknowledge they want to team up with majors that have downstream expertise in building a refinery and a pipeline – both of which Uganda needs. After all, Tullow is still, at heart, an exploration company.

Its stakes produce just 60,000 barrels per day, just 6% of its reserves, though it says it wants to boost that number to 200,000 soon.
The partnering process “should be done very carefully”, Tim O’Hanlon, Tullow’s vice-president for African business, said in December 2009. “Now that we’ve taken the risk and found oil in a place that nobody believed we would, some of the biggest companies in the world are interested.”

“That’s a great thing for Uganda, it means it’s a competitive environment,” O’Hanlon said. “You can choose the best candidate along with us. Why on earth would you or anyone else talk to the first guy who comes through the door?”

Tullow’s gearing ratio has gone down from 70% to a much more conservative 25%. Still, future success faces at least two possible threats: a delay in oil production in Ghana and a drastic fall-off in production and prices for its North Sea gas fields. The company says its overall production was expected to decline in 2009 to 58,000 barrels from 66,000 the year before. Part of that is the result of declines in its North Sea fields.

Disaster doesn’t seem likely at this stage, but both possibilities are a reminder of the oil sector’s unpredictability.

“It has some growth options which require cash but it’s positioned itself to get the funds it needs to do that, provided there’s not a material delay in the cash generation from Jubilee and its existing businesses don’t fall off a cliff,” says Peter Hutton, a London-based analyst for NCB Stockbrokers.

Tullow may get even more money out of the Uganda operation than anticipated.

According to Hitchens of Panmure, the Ugandan government wants Tullow to sell two-thirds of its stakes there, not just 50%. Officials at Tullow and in the Ugandan government would not discuss the company’s plans.

Starting to divest of some of its Uganda holdings may ultimately work in Tullow’s favour. Unlike Ghana’s Jubilee field, which is offshore and gives easy and quick access to oil, Uganda is landlocked, requiring a pipeline to bring it to the Kenyan coast 1,200 kilometres away.

Uganda’s government is insisting on refining the product domestically, meaning that a refinery project will ultimately be in the pipeline.
“A refinery is a given,” said Tullow’s O’Hanlon. “There would also be export of crude oil to maximise the economic value for Uganda.”

Problems and pitfalls

Yet a number of pitfalls wait ahead in Uganda. Tullow’s image as a company that stresses corporate social responsibility cannot escape the fact that some of its most promising finds sit in environmentally sensitive areas including Uganda’s Murchison Falls National Park, one of Africa’s great natural treasures.

Local civil society groups have also promised a fight to make sure the government spends oil money properly. Those demands might slow down the production timeline.

“The levels of corruption that we see now, the patronage networks that have been constructed around regime longevity and regime survival, there is no way you can guarantee that oil revenue can be applied in a manner that is transparent and benefits our people,” says Godber Tumushabe, executive director of Uganda’s Advocates Coalition for Development and Environment.

At the same time, the government wants Tullow to produce first oil as quickly as possible. Tullow now says it will pump small amounts of oil by the end of the year, with thousands of barrels coming online in 2011.

Whether this is a realistic target or not waits to be seen. The Ugandan government says it needs US$8bn to develop the oil industry, and it has a distinct shortage of people who can do the skilled scientific and engineering jobs required by an oil industry.

“In Uganda, we’ve got a big challenge on our hands in getting people trained and qualified,” Tullow’s Uganda country manager, Brian Glover, said in an interview in December 2009.

Glover says Tullow’s focus is on “maintaining strong relationships” wherever it does business. That may sound like typical upbeat pabulum.

But then consider the widely held opinion that Tullow’s relationship with President Museveni played a large role in the Ugandan leader’s decision to let it pre-empt Eni’s purchase of the Heritage assets.

“You cannot discard the first person who came to you,” says Peter Lokeris, Uganda’s minister for mineral development. “We owe a lot to Tullow. When we were just wooing people and engaging in a risky business, when we didn’t know whether there was oil there or not, Tullow was the first that came. Therefore we cannot say that we are unhappy with Tullow.”

“They took a lot of risks, and so did Heritage,” he adds. “We have a lot of respect for them.”