Tullow Reports Record Results for 2006
Tullow Oil plc on Wednesday announced its results for the year ended 31 December 2006.
Tullow had an excellent year in 2006. Record operational and financial results were achieved in a favorable oil and gas pricing environment, and each core area continued to deliver strong performances. This outcome underpinned ongoing reinvestment in exploration and development activities together with a material increase in dividends and helped to create the financial platform for the acquisition of Hardman Resources Limited ('Hardman'), which was effective in December 2006 and completed in early January 2007.
--11% increase in average annual production to 64,720 boepd --89% organic reserves replacement; three year average organic reserve replacement of 98% --Total reserves and resources increased by 149 to 506 mmboe --Current production is 76,000 boepd and is expected to reach 85,000 boepd by year-end --Initial commercial reserves booked in Uganda; First production scheduled for early 2009 --Preliminary assessment of gross recoverable reserves in the Albertine Basin of 100 to 250 mmbbls --Three gas discoveries in the UK including the potentially significant K4 discovery in the CMS area --Okume, West Espoir and Bangora developments successfully on stream --Seven new African licenses awarded --Completion of £595 million Hardman acquisition in January 2007
Pat Plunkett, Chairman, said:
"The balance and diversity of Tullow's business allows us to adapt quickly and with flexibility to opportunities as they arise and to tailor our investment plans to the changing circumstances of the industry. Our production assets along with our development and exploration activities, and the Hardman business, leaves Tullow with a high-quality, opportunity-rich portfolio in each of its core areas. Our business is healthy and growing and should remain so for the foreseeable future."
Aidan Heavey, Chief Executive, said:
"Tullow had another remarkable year in 2006. Our assets delivered strong production growth and good organic reserves replacement. Seven out of 12 of our exploration wells were discoveries and we proved a new and significant hydrocarbon province in Uganda which is already having a material impact on reserves. We completed our largest ever acquisition and continued to attract and retain great people and acquire quality new acreage. We have an excellent portfolio managed by a top-class technical, commercial and financial team. Our strategy is clear, our business is growing and we are continuing to drive record performance throughout the business."
For the year ended 31 December 2006
During 2006, we invested close to £1 billion in growing the business, including £332 million on capital expenditure, 70% of which was invested in our production and development assets and £595 million on the acquisition of Hardman. The 30% increase in revenue and the Group's operating cash flow before working capital adjustments of £446.7 million comfortably funded all our capital investment and returns to shareholders.
Record operating and financial results overall
Tullow's 2006 revenue increased by 30% to £578.8 million (2005: £445.2 million) as a result of higher production, and sales prices which were on average some 29% ahead of 2005. This growth was driven by strong increases in European gas production against a background of stable African oil output and significantly higher price realizations. European revenues were 60% ahead of 2005, whilst African revenues increased by 9%.
Underlying cash operating costs were down 2% compared with 2005, despite significant cost pressure within our industry. This strong cost performance reflected efficiencies arising from increased production across all assets, ongoing cost control initiatives in UK assets and the addition of lower-cost Asian production during the year. Operating profit before exploration costs written off grew by 32% to £295.1 million (2005: £224.4 million), reflecting strong growth in production and realised oil and gas prices.
Profit before tax increased by 47% to £263.3 million (2005: £178.6 million) and basic earnings per share amounted to 24.23 pence, an increase of 38% (2005: 17.50 pence).
Excellent environmental performance
In 2006, Tullow had no significant environment, health, safety or security issues. The Lost Time Incident Frequency Ratio was 0.81, well within our target of 1.0, despite a 65% increase to 6.1 million hours worked, both onshore and offshore, during the year. Furthermore, our responsibilities also include working with communities in a sustainable manner and in 2006 Tullow spent US$1.5 million in funding social and community projects within our core areas.
Challenging external environment
Whilst the commodity pricing environment has been strong, leading to increased ability to commercialise our oil and gas assets, it has been countered by a tight and inflationary contractor environment. In 2006, despite significant inflationary pressures on our field operating costs we managed to maintain our cost of production below 2005 levels. This has been achieved by strong cost management, but more importantly through optimal use of our infrastructure by increasing throughput and synergies. This will continue in 2007 where operational synergies, especially in the Espoir and Ceiba/Okume projects, are expected to have a greater impact.
Competition also increased for new assets and licenses during the year and Tullow's entrepreneurial approach combined with our diverse portfolio of assets assists us in managing this challenge. In general we are acquiring the equipment and resources necessary for our major developments and operational programs, although we have seen lead times for future developments significantly increase. To address this industry-wide problem we have had to enhance our skills in medium to long-term operational planning and improve our capacity to share resources across our global asset base.
Tullow prioritizes financial and operating flexibility and undertakes a structured and rigorous project and prospect evaluation process to ensure effective allocation of funds at any point in the cycle. For 2007, this means we will be concentrating funding and resources mainly in Africa and Asia, until the anticipated improvement in pricing and the contractor environment occurs in the UK gas market.
Focused growth strategy
Tullow focuses on the long-term resourcing, growth and health of the business and invests accordingly. During 2006, £595 million was invested in the acquisition of Hardman. Hardman represents an outstanding strategic opportunity for Tullow, enabling us to establish a material and influential footprint in Mauritania, assume control of the prime block in the Albertine Rift Basin in Uganda and acquire highly prospective exploration interests in South America. The transaction is a clear demonstration of the substantial financial and operational capability of Tullow's business and team. The Hardman business has now been fully integrated and encouraging operational progress has already been made in Mauritania and Uganda.
Strong positive outlook
Tullow's strong cash flow and rigorous approach to the management of financial risk allows us to continue to implement our growth plans with confidence whilst maintaining and servicing debt of approximately £450 million. During 2007 our focus will be on continuing to increase production to a targeted level of 85,000 boepd by year-end, and drilling over 40 exploration wells, including major campaigns in Uganda, Namibia and India. The oil and gas industry is as dynamic as ever and the combination of excellent knowledge of our core areas, financial and operating flexibility and continued investment in our people means the outlook for Tullow is both positive and exciting.
Each of our core areas demonstrated substantial progress in 2006.
Record UK production and gas price realizations
Tullow's interests in Europe are centered on gas and infrastructure in the Southern North Sea. Over the last six years Tullow has established a dominant position in the Thames-Hewett and Caister Murdoch System (CMS) infrastructure hubs through a combination of acquisitions, an active development and exploration program and participation in licensing rounds.
Our most significant activity during the year was on the Schooner and Ketch fields, where effective operational management increased average uptime to 98% and achieved maximum production of over 100 mmscfd. However, the overall outcome of the work program, which included the non-commercial Schooner NW development well, was below expectations, leading to a 45 bcf downgrade in commercial reserves attributed to the Schooner and Ketch assets at 31 December 2006. Elsewhere, the CMS and Thames-Hewett area fields continued to perform strongly driving average UK production to 172 mmscfd, a 32% increase over 2005 levels and allowing Tullow to take maximum advantage of record gas prices, particularly in the first half of the year.
In parallel to growing production, Tullow also participated in four successful exploration wells, including the potentially significant K4 discovery in the CMS Area. These discoveries, along with the Thurne, Kelvin and Wissey projects already in progress, form the basis of future development and there are a further six exploration wells planned in 2007. In February 2007 Tullow was awarded six exploration blocks spread across the Thames-Hewett and CMS Areas in the 24th offshore Licensing Round. The Group plans to acquire seismic data as part of a full evaluation of the potential of this acreage and anticipates that exploration wells on this acreage will form part of the 2008 drilling program.
Following unprecedented gas pricing in early 2006, the recent much-needed increase in pipeline capacity and the impact of a comparatively mild winter have combined to drive gas prices for the first quarter of this year down to 2003 levels. Looking forward, however, the overall underlying supply and demand fundamentals, allied to the gradual convergence of UK and European gas markets, mean that the long-term outlook for the UK gas business remains positive.
Key objectives delivered in Africa
2006 was an outstanding year for Tullow's African assets. Production commenced from two major development projects, a significant new hydrocarbon province was discovered in Uganda and the portfolio was enhanced through the award of licenses in Angola, Madagascar, Ghana, Congo (DRC) and Gabon. Since year end, Tullow has also acquired interests in two licenses in Cote d'Ivoire. In January 2007, Tullow completed the acquisition of Hardman which added materially to the Group's assets in Mauritania, enabled Tullow to take operational control of Block 2 in Uganda and further high impact exploration acreage in Africa. During 2006, we had a number of key objectives in Africa:
- Ongoing infill drilling on producing assets;
- Major developments to deliver first oil in Equatorial Guinea and Côte d'Ivoire; and
- Significant exploration programs in Gabon and Uganda.
Our principal production objectives were achieved. The response to infill drilling was positive across all fields, and our Gabon output was in line with expectations. On the development front, both West Espoir and Okume came on stream as anticipated. In exploration, while the outcome of the Gabon program was disappointing, results to date from Uganda have exceeded our most optimistic expectations and point to the potential for a world-class new hydrocarbon province to be delivered by the 2007 and 2008 exploration and appraisal programs. Development work on existing discoveries is under way with a view to producing first oil in early 2009. Based on the wells drilled to date, Tullow's preliminary assessment of the gross recoverable reserves in the Albertine Basin is in the range of 100 to 250 million barrels.
Encouraging progress was also achieved on the Kudu project in 2006. The Group has focussed on the gas sales negotiations for the gas to power project, the preparation for two appraisal wells in 2007 to test the significant upside potential of this asset and the start of negotiations to bring a partner into the project to reduce the Group's working interest to 70%. Tullow is currently in exclusive negotiations with a potential partner in respect of this interest and expects to conclude arrangements in advance of the commencement of the 2007 appraisal program in April 2007.
In 2007, the Group expects to continue with very significant levels of exploration, development and production activity in Africa. Exploration activity will involve drilling at least six exploration wells with a focus on the two key campaigns in Uganda and Namibia and the high impact Mahogany well in Ghana, in addition to ongoing development projects in Gabon, Congo (Brazzaville), Cote d'Ivoire and Equatorial Guinea.
Significant progress made in South Asia
2006 was a very successful year for Tullow in South Asia, with significant progress made across the exploration and development portfolio. The regeneration of the Group's Asian assets continues apace and the foundations are now in place for an exciting 2007 program.
In Bangladesh, Tullow produced first gas from its Bangora project in May and, following a successful appraisal drilling program, made a declaration of commerciality in December and recorded a material upgrade to reserves at year end. In Pakistan, two development wells were drilled on the Chachar field and, with the installation of the gas plant complete, first gas will be produced in May. On the exploration front, following a seismic program during 2006, a two-well program on the potentially significant Kohat Block will spud late this year.
Perhaps most encouraging, however, has been India, where seismic undertaken during 2005 and 2006 has led to the delineation of a number of distinct targets in the CB-ON/1 Block in the Cambay Basin, which will be the subject of a multi-well drilling campaign in 2007.
The growth challenge
The recent announcement of first production from the Okume field was a major milestone for Tullow. For the Group, bringing Okume on-stream means that over 95% of our commercial reserves at the end of 2006 are now successfully producing. While this is a positive achievement, it also creates a challenge to access and create the next generation of development projects. Based on our annual production rate, Tullow needs to find over 30 million barrels of oil per year to maintain reserves and still keep growing. We believe our portfolio is more than capable of achieving this objective and our exploration, development and new ventures activities are geared towards exceeding it.
Tullow has grown into a versatile and balanced oil and gas Exploration and Production Group and our strategic, financial and operational objective is to run a balanced international business with a long-term perspective on performance and growth.
Within the Group we have defined a number of business units based on geography and activity type. Each business unit is responsible for the execution of a development strategy and achievement of short-term performance targets. These targets are based on and support the Group's strategic objectives and Key Performance Indicators, which are used to assess the ongoing positioning of the business. During 2006, Tullow achieved extremely strong performance across all its key indicators and this enables us to continue to invest with confidence.
Higher production and better pricing
Working interest production averaged 64,720 boepd, 11% ahead of 2005. Sales volumes averaged 57,300 boepd, representing an increase of 7%. Production increased most notably in Europe, which rose 21% or 5,000 boepd, and Asia which rose 330% or 1,400 boepd. Oil production from Africa was in line with 2005, driven by strong performance in Equatorial Guinea and Côte d'Ivoire offset by a modest decline in Gabon.
Prices realised for both oil and gas during 2006 showed material increases over 2005. In the UK, extreme shortness in gas supply during the first half of the year led to record prices and was the principal factor driving Tullow's realized prices to 46.2p/therm, a 36% increase over 2005. The Group also recorded tariff income of £16.6 million (2005: £14.7 million) from its UK infrastructure interests. Increases in world oil prices during the first half were also a key influence on realisations from Tullow's African business which rose by 21% to $52.2/bbl (2005: $43.1/bbl). Tullow's oil production sold at an average discount of 5% to Brent during the year, reflecting improved competitiveness in the West African oil trading environment and revised blending and marketing arrangements in respect of the M'Boundi field.
As a result of higher production and prices, 2006 revenue amounted to £578.8 million, an increase of 30% over 2005. The mix of production also changed slightly, with UK production increasing from 41% of 2005 production to 45% of the 2006 total; with increased production from Asia, this meant that the Group's production was relatively evenly balanced between oil and gas.
Effective operational cost control
Underlying cash operating costs, which exclude depletion and amortisation and movements on under/over lift, amounted to £112.0 million (£4.74/boe). These costs were 2% below 2005 levels, despite higher underlying oil and gas pricing, which had a direct impact on reported operating costs due to royalties in respect of Gabonese production. Reported operating costs before depletion and amortisation for the year of £114.7 million (2005: £123.5 million) were also impacted by the inclusion at market value of £2.7 million associated with overlifted volumes at 31 December 2006, principally relating to the Group's interests in Gabon and Equatorial Guinea.
Enlarged business, more activity and investment
Depreciation, depletion and amortisation for the year amounted to £144.9 million (£6.13/boe). This represents a 21% increase over 2005, principally as a result of a higher depreciation charge on UK assets. The increased charge was driven by material investment in the Schooner and Ketch assets combined with a reduction of 45 bcf in commercial reserves attributed to the fields. The reduction in reserves followed an evaluation of the results of the 2006 redevelopment program and the drilling of the unsuccessful Schooner NW well.
Tullow invested significantly in people during 2006. Average staff numbers increased 20% to 209 people, adding strong resources to our technical, commercial and senior managerial teams. As a result, underlying general and administrative costs have increased by 48% to £18.3 million. The total general and administrative costs charge of £22.5 million also includes a charge of £4.2 million in respect of the Group's share-based incentive schemes (2005: £1.4 million).
Exploration costs written-off were £32.5 million (2005: £25.8 million), in accordance with the Group's 'successful efforts' accounting policy, which requires that all costs associated with unsuccessful exploration are written-off to the Income Statement. The principal write-downs during 2006 related to Angola, Gabon, UK exploration and new ventures/pre-license costs. The Group drilled 12 exploration wells in 2006 and made seven discoveries, and is planning to drill over 40 wells during 2007.
Operating profit increased 32%
Operating profit before exploration activities amounted to £295.1 million (2005: £224.4 million), an increase of 32%, reflecting the strong growth in Group production and realized oil and gas prices, somewhat offset by increased depreciation charges on a per barrel basis.
More effective hedging
At 31 December 2006 the Group's derivative instruments had a negative mark to market value of £21.0 million (2005: £147.8 million). Of this, £72.7 million relates to a negative mark to market on oil contracts, of which £74.0 million relates to hedges acquired as part of the acquisition of Energy Africa in 2004, which is largely offset by a positive mark to market on gas contracts of £45.6 million. The Group's position also includes a positive mark to market of £5.9 million in respect of foreign exchange derivative instruments entered into in respect of the Hardman transaction and the balance relates to interest rate derivatives.
While the oil and gas arrangements all qualify for hedge accounting, the variations in crude oil discounts and gas production patterns for Tullow do cause a degree of hedge ineffectiveness. During 2006, however, the steady reduction in average discount attributable to Tullow's oil production, combined with lower year- end commodity prices, has resulted in an improvement in overall cumulative hedge ineffectiveness at 31 December 2006. Consequently, a credit of £9.8 million has been recognised in the Income Statement for the year in respect of oil and gas contracts. In addition a credit of £5.9 million is reflected in the Income Statement in respect of foreign exchange derivative instruments as they do not qualify for hedge accounting under IAS 39.
Tullow continues to undertake hedging activities as part of the ongoing management of its business risk and to protect the availability of cash flow for reinvestment across its asset portfolio. Hedges in respect of 2007 provide downside protection on revenue of over £280 million, representing over 75% of 2007 budgeted capital investment.
Financing costs and interest cover
Tullow's growth during 2006, and in particular the Hardman acquisition, was greatly facilitated by the support of the Group's banking syndicate and the balance and diversity of our portfolio. Prudent use of debt is a core element of the Group's overall strategy and Tullow has a flexible financing facility which allows non-OECD activities to be funded at an overall financing cost of circa 8%.
The net interest charge for the year was £15.0 million (2005: £19.8 million) and reflects reduced levels of net debt during 2006. At 31 December 2006, Tullow had net debt of £122.1 million, including £46.5 million of net cash attributable to Hardman. Since year-end this has increased to £450 million as a result of the Hardman transaction, involving payment of AS$819.5 million (£329.9 million) of cash consideration on 10 January 2007. Interest cover is very healthy at over 24.0 times (2005: 15.5 times).
No increase in effective tax rate
The tax charge of £105.9 million (2005: £65.4 million) relates to the Group's North Sea and Gabonese activities and represents 40% of the Group's profit before tax (2005: 37%). After adjusting for non deductible exploration costs, hedge ineffectiveness charges and non-recurring items the Group's underlying effective tax rate remained unchanged at 35%, despite the introduction of an additional 10% supplementary Corporation Tax by the UK Government on 1 January 2006.
Strong profit for the period and increased dividend
Profit after tax amounted to £157.4 million, representing a 39% increase over 2005. This profitability has allowed the Group to once again substantially increase its dividend. A final dividend of 3.5 pence per share has been proposed by the Board. This brings the total payout in respect of 2006 to 5.5 pence per share, representing an increase of 38% over 2005. While the Board plans to maintain a progressive dividend policy future increases are unlikely to match those of recent years, due to the significant level of the current reinvestment opportunities the Group has.
Shareholder distribution and total shareholder returns
Since Tullow initiated dividend payments in 2003, cash returned to shareholders has exceeded £80 million.
This is an important component of total shareholder return, which in 2006 exceeded 49%, placing Tullow in the top quartile of its peer group. Over the five year period from 2001 to 2006, Tullow's total shareholder return has been in excess of 400%, while total shares in issue have doubled from 358 million shares to the current level of approximately 717 million shares spread across over 10,000 shareholders.
Strong balance sheet capacity and financial flexibility
The excellent pricing environment, allied to increasing production and effective control of underlying operating costs, led to record operating cash flow before working capital movements of £446.7 million, 44% ahead of 2005. This cash flow, allied to the positive asset performance and strong reserve replacement of recent years meant that the Group had access to substantial financial capacity throughout 2006; facilitating investment of £332 million in production, development and exploration, a 38% increase in the dividend and the acquisition of Hardman.
During 2006 approximately 70% of Group capital expenditure was associated with ongoing development and production enhancement projects in the UK, Gabon, Congo (Brazzaville), Equatorial Guinea and Côte d'Ivoire. The remainder of expenditure was reinvested in exploration and appraisal activities, where the Group drilled 12 wells, recording seven discoveries. The success of these multi-year programs has enabled Tullow to record average organic reserve replacement of 98% for the three-year period 2004 to 2006. During 2007, we plan to invest a further £350 million in our assets, with the objective of achieving average production of approximately 80,000 boepd and delivering three major exploration campaigns in Uganda, Namibia and India.
On 25 September 2006, Tullow announced a proposal to acquire Hardman by way of a Scheme of Arrangement. Following the approval of the acquisition by Hardman shareholders and the Australian Courts, the Scheme became effective on 20 December 2006 and formal completion occurred on 10 January 2007. The acquisition of Hardman was by a cash offer, combined with a partial equity alternative amounting to up to a maximum 65 million Tullow shares, representing approximately 40% of the value of the transaction. The partial equity option was fully exercised by Hardman shareholders and the balance of the acquisition consideration, amounting to £359.1 million, was paid in cash funded by a mixture of existing debt and a new facility provided by Bank of Scotland Corporate. Following the transaction, Tullow has net debt totalling approximately £450 million. During 2007, the Group will seek to repay a portion of this debt and adjust the terms of the remainder to match better the Group's reserve base and long-term growth objectives.
Hardman's business and assets have been consolidated in Tullow's financial statements with effect from 31 December 2006. A preliminary fair value exercise has been undertaken to determine the values attributable to the acquired assets and liabilities within the Group's Balance Sheet as at 31 December 2006. The total fair value attributed to the transaction amounts to £750.0 million, comprising £594.7 million of consideration and associated costs and an additional £155.3 million of deferred tax uplift provided in accordance with the provisions of IAS 12. Based upon this preliminary exercise, Tullow has allocated a total of £86.9 million to Tangible Assets, relating to the Chinguetti field in Mauritania, and a total of £623.6 million to intangible assets reflecting Hardman's interests in a variety of discoveries, potential development projects and exploration across a total of seven countries including Uganda and Mauritania. The balance of the preliminary fair value allocation, amounting to £39.5 million, is accounted for by the other net assets, including cash balances, acquired. Due to the timing of the transaction and the wide range of assets and interests acquired, the fair value allocated at 31 December is preliminary in nature and will be reviewed during 2007 in accordance with the provisions of IFRS 3 relating to Business Combinations.
The reserves attributable to the Hardman assets have also been reflected in Tullow's commercial reserves and contingent resources analysis at 31 December 2006. In particular, Tullow has allocated a total of 9.6 mmboe to its 19% interest in Chinguetti and 17.8 mmboe to Hardman's 50% interest in the Mputa and Nzizi discoveries in Block 2 in Uganda (where Tullow now holds a total interest of 100%) within the commercial reserves category.
Financial Strategy and Outlook
Tullow operates a business that is commercially aggressive but financially conservative. We recognize the financial risks inherent in our operations and mitigate them through portfolio diversity, prudent hedging and close attention to costs.
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