In an industry still reeling from the bloodletting of Shell's executive board, it's not a good time to be financial director of an independent oil company. But Tom Hickey says all is well at Tullow Oil, following some shrewd acquisitions.
Tom Hickey didn’t train as an acrobat, yet juggling has become his latest speciality.
The finance director of Tullow Oil, the quoted independent oil firm, has just wrapped up his biggest deal to date – the $570m (£315m) takeover of rival oil company Energy Africa – and he did it while the world around him was in chaos.
Oil prices have shot up to $40 a barrel, which means great profits in the short term, but potential panic if they start to slide. Darkening the industry, meanwhile, is the deep shadow cast by oil giant Shell, which in January announced that a fifth of its proven oil reserves had been overstated. The company has since staggered from one public relations disaster to the next.
An ex-Andersen accountant, Hickey is aware that oil has its financial rules to abide by – just like any other industry. The key rule is not to waste money when the oil price is high, because the situation will change.
‘There is always a temptation every year to budget for $28-$30 a barrel of oil, but in the long term you want to make sure the business has enough funding to sustain it,’ he says.
Oil may seem like a game of Russian roulette to outsiders – throw some money down a hole and hope you hit oil – and that is down to the bad reputation that lingers over the independent oil sector from past failures.
But the new oil barons are much more careful, and while the bumper oil price and huge profits may make it look an exceptional time to be an oil industry finance chief, Hickey says it is very much business as usual.
It’s about making sure that the exploration projects around the world have enough capital to keep them going.
At Tullow, that means planning future exploration projects on the basis of $20 a barrel. Anything above that is a bonus.
Tullow has three main areas of interest: the UK, west Africa and southeast Asia, and the company could be planning or drilling in all three areas at any one time.
Apart from making sure money is available, Hickey says that part of his job is to guarantee that funds end up in the right place at the right time. This means taking both the market and regional issues into account before allocating capital.
‘As part of our budgeting process, we look not only at our financial resources, but the type of opportunities that our shareholders want us to participate in,’ he says.
When determining which country to operate in, Tullow has to take into account the local geography and the political system – all factors that change the value of producing oil in different countries. Market sentiment can be fickle, and Tullow has to consider shareholders when making any decision, as they want the company to operate where it can sell oil at the best price.
But it’s not just a matter of where the company can make the most money.
The market needs to regularly hear about new discoveries and areas of drilling to sustain interest in the stock. Hickey has to bear this in mind when allocating resources.
The art of juggling certainly comes in useful at budgeting time. ‘On the first of January this year when we did the budget, I was looking at wells in the UK, Bangladesh, Pakistan and Gabon and at a minimum any or all of them could be successful,’ he says.
This is not pin money he’s talking about. The company spends less than $1m for a well and usually pays between $8-$10m for development. Last year, it dedicated £45m for exploration and development. ‘We are probably investing between 15 and 20% of our market capitalisation every year,’ he says. This budget is reviewed every few months, because the business moves so quickly.
Aside from the day-to-day issues involved in running an oil company, Hickey has to be mindful of the many factors influencing the business outside of his control.
One such factor presented itself earlier this year when Energy Africa put itself up for sale. As an exploration and production company operating in one of Tullow’s key areas of interest, it was an opportunity not to be missed.
Yet the company was very large by Tullow’s standards and without cash to back up the deal, it could have been one big a bite to swallow.
‘We said a few years ago that we wanted to have a company producing 50,000 barrels of oil per day and £200m of cashflow and this transaction will be a long way to achieving that goal,’ he says.
It was not all plain sailing. Complying with market rules, Tullow suspended its shares pending a deal. Unfortunately, this meant Hickey could not judge the markets’ reaction as other new developments in the company occurred.
Now the deal has been completed, Tullow is a new force in the sector, and has rocketed up the charts to become the UK’s second-largest independent company behind Cairn.
While the champagne corks at Tullow have been popping, the industry as a whole is still under the black cloud of Shell. Only the most nimble of the independents have continued to perform well while one of the biggest oil firms in the world licks its wounds.
Shell’s problems may be a world away from the issues facing independents, but it has seriously damaged investor confidence, as speculation grows over whether Shell will recover.
January’s downgrade pulled apart the company’s conservative image and led to the ousting of chairman Sir Philip Watts, head of exploration and production Walter van de Vijver, and finance director Judy Boynton.
A subsequent report by US lawyers Davis Polk on the company’s conduct over reserves opened up the possibility that at least some members of management knew about these problems for years, but chose to cover them up.
Several regulatory investigations are still ongoing by regulators including the US Securities and Exchange Commission and Department of Justice, and the UK’s Financial Services Authority.
Shareholders are gearing up to claim their own pound of flesh, particularly in the US, and several class-action lawsuits are pending. All in all, it could be years before Shell fully emerges from the storm.
In the meantime, Hickey has his work cut out bedding down Energy Africa and making sure his budgets still work with the expanded resource base.
But he has a head start. Broker Merrill Lynch reinstated coverage of Tullow with a ‘buy’ recommendation, saying that the acquisition means Tullow ‘now offers investors an opportunity to invest in one of the most active and high-potential exploration programmes in the UK exploration and production sector’. Not a bad start really.
WAR OUTSIDE AND WITHIN
Events in Iraq have recently raised real concerns over oil prices, writes Gavin Hinks.
In a shock development, the price shot to $40 (£22.50) for a barrel of crude – a price that hadn’t been seen since Iraq invaded Kuwait in 1990, when it rose to $41.15.
The rises seem to have been triggered by concerns for the stability of the middle east, prompted by the conflict in Iraq that might affect the supply of crude. The result was increased stockpiling – creating huge demand for existing supplies.
Prices appeared to settle when OPEC, the cartel of oil producing countries, made it clear that production would increase to improve supply. However, this was not before speculation began that prices could rise as high as $50, which would have a major detrimental effect on the world economy. The price has stabilised in recent weeks at just over $40 a barrel.
This was not the only shock to recently hit the industry. The whole question of managing oil reserves and how to account for them was pushed into the public eye by the furore that accompanied Shell’s restatement of its oil and gas reserves.
In January, Shell announced it was to cut 20% from its estimated oil and gas reserves. and the company’s position was worsened when it was forced to cut another 470 million barrels in March. Chief financial officer Judy Boynton resigned shortly after publication of an internal review, which said that she had taken ‘virtually no action’ to enquire into the basic facts relating to the oil reserves bookings.
Even Shell’s exploration CEO Walter van de Vijver told Sir Sir Philip Watts, former chairman and CEO, that he was ‘tired of lying’ about the extent of the reserves. Last week, Shell produced another restatement, raising the total removed from its reserves from 4.35 to 4.47 billion barrels.
Problems in accounting for assets in the oil and minerals industry has long been acknowledged, and in January the International Accounting Standard Board launched a consultation on how to value exploration assets. Finding a consensus might prove difficult, and the IASB has already ruled out producing a standard for the 2005 deadline.
However, there is real concern. Accounting for exploration assets varies from one country to another and there is also disagreement over what line an international standard should take. In the meantime, the IASB has demanded that oil companies actually reveal their accounting policies used for exploration expenditure.
