Uganda move has potential to transform Tullow

ANALYSIS:Tullow's $1.5bn bid the first step towards exploiting lucrative African oil field

IF HERITAGE Oil shareholders approve the company’s deal to sell its interests in Uganda to its partner Tullow, it will give the Irish company temporary dominance over one of Africa’s most lucrative oil concessions.

Heritage shareholders are due to meet on Monday to approve its agreement to sell 50 per cent of two exploration prospects in the Lake Albert rift basin blocks to Tullow Oil for a total of $1.5 billion. The blocks are essentially areas where the Ugandan government has granted licences to explore for – and exploit – oil and gas. Tullow owns block two, but shares ownership of blocks one and 3a with Heritage on a 50/50 basis.

As is normal in these arrangements, Tullow had pre-emption rights if Heritage ever wanted to sell. This meant that if a third party offered its partner cash, the Irish company had the right to buy its stake, once it was prepared to pay the same amount. Late last year, Italian giant, Eni, offered Heritage $1.35 billion up front and a deferred payment of $150 million for its stake in the Ugandan blocks, triggering Tullow’s pre-emption right.

Tullow exercised the right this week, offering the same terms. The company is essentially paying to take full control of a series of wells running the length of Lake Albert that have been proven to contain 700 million barrels of oil and potentially a further 1.5 billion barrels, a possible total of 2.2 billion barrels.

Tullow’s control of all this, however, will be temporary. The Ugandan government is a key player in any outcome. It hands out the licences and determines policy.

Tullow chief executive Aidan Heavey points out it does not want one company in a dominant position in the country’s oil industry. Uganda’s energy minister, Hillary Onek, stressed this yesterday, saying the administration supports any process provided it “does not create a monopoly, enhances early production and value addition”.

Tullow will have to bring in at least one partner to develop the resource. This suits the company. Heavey says that Tullow specialises in finding oil and getting it out of the ground, not refining it and getting it to the market.

Those downstream activities – as they are called – are the areas on which the major multinational oil companies focus. There was speculation earlier this week that a number of such companies, including Exxon and Total, were lining up as possible suitors.

Tullow’s statement announcing the agreement to buy out Heritage said that it had attracted a significant amount of interest from international and national oil companies, but it is unlikely to shed any more light on this until a deal is done and there is a formal announcement. That is set to happen next month.

Heavey does acknowledge that a big company will have to be involved, but he also points out that, along with the majors, there are many less high profile oil services operations which specialise in building the industry’s infrastructure.

In Uganda’s case, that infrastructure is going to be extensive. Heavey says getting the oil to where it can be sold will involve building pipelines, refineries, power plants, communications, roads and railways. Some estimates say it will cost around $5 billion.

“It involves an enormous amount of work,” Heavey adds, “but it’s the end of the business that really suits the major oil companies and not us.”

The company’s own calculations are that the field is viable with 300 million to 400 million barrels. On that basis, the proven reserves are more than enough to guarantee a return.

The borrowings that the company will take on to buy out Heritage will leave its debts 20 per cent ahead of its assets. However, this is likely to be resolved once the new partner or partners come on board.

Three things have to happen to get the project to the next stage. Heritage shareholders have to vote yes, a deal has to be done with a partner or partners, and the Ugandan government has to give its approval. If this goes to plan, production could begin in a small way in around two years.

“We’ll probably present the whole thing as a package to the government,” Heavey explains.

He’s not predicting either way what the government will say, but the company is used to dealing with national oil companies and authorities across the continent.

Tullow is the biggest explorer in Africa. Its licences to explore for oil stretch from the Kalahari in the south along the west of the continent to Mauritania and across central Africa.

There are two reasons for this. The first is its purchase of Africa Energy in 2004, which gave it a substantial foothold on the continent. The second is geology. Most of Tullow’s exploration properties are in rift valleys, which are formed by a rift between two tectonic plates (the plates that form the Earth’s crust).

Heavey points out that Lake Albert, the North Sea, its interests along West Africa and their blocks in South America – which “mirror” the West African margin, all share this characteristic.

“When we acquired Africa Energy, they had a very good exploration team,” Heavey says.

“We looked at the successes they had and we started building on where they had been successful, and that’s how it came about.”

So far it looks like it has been very successful. Yesterday, Tullow announced that it has encountered a further oil field off Ghana’s coast, where it began drilling in December. It already has stakes in connected blocks there in covering both deep and shallow water. By the end of last year, it estimated that these interests could ultimately hold reserves of 1.8 billion barrels.

While what’s happening in Uganda will continue to generate headlines, Ghana could well be the focus of attention as the year wears on. Tullow is operating there in partnership with the country’s national petroleum company and is on schedule to begin production in the final three months of 2010.

Yesterday’s news prompted Job Langbroek, Caren Crowley and James McCullough, analysts with stockbroking firm Davy, to increase their valuation of Tullow by 35 pence sterling a share (it has its main listing in London), meaning the brokers now believe the company is worth £14.90 a share. It was about £13.25 early yesterday. That would value the company at £11.97 billion, compared with its current stock market worth of £10.65 billion.

Tullow has mapped out exploration and drilling campaigns for the rest of the year. That, allied to the likelihood that it is planning to begin production from one of its bigger prospects in the last quarter, means that this was just the first of what promises to be plenty of busy weeks for the company over the next 12 months.