Tullow facing funding risk, UBS slashes target price by 30%

“A cyclical downturn in E&P asset markets has thwarted Tullow's execution of a key leg of its strategy – the early monetisation of discoveries and recycle of capital. This means until completion of the Tweneboa-Enyenra-Ntomme (TEN) [project in Ghana] in mid-2016 leverage will remain elevated,” UBS said.

While the $2.4bn of headroom on its loans should be enough to see Tullow through to first oil at TEN even at oil prices at $50 per barrel (bbl), UBS said the “availability of facilities faces by covenant and redetermination risk”.

The headroom lies within a $3.5bn reserve-based lending (RBL) and $750m corporate debt facility, both of which carry a covenant of 3.5 times net debt-to-operating profits.

“At our $70/bbl oil price forecast for 2015 this metric reaches 4.1x or, sensitised at $50/bbl, 5.2x. Funding availability will therefore be dependent on how Tullow's banking consortia reacts to lower oil prices,” the bank said.

“Logic suggests getting TEN to production is in all stakeholders' interests (i.e. a credit positive event), but logic, risk tolerance and fear are difficult things to predict.”

UBS said Tullow is “heavily reliant” on its RBL facility as it is a cheap source of funding. So if the facility reduces due to the recent collapse in oil prices - in turn lowering the value of the portfolio - the company’s headroom could also shrink, meaning that it will not have the cash required to develop TEN.

“There is risk, therefore, in our view, capital may be required at a punitive point in the cycle.”

UBS kept a ‘neutral’ recommendation on the stock, which was up 0.8% at 367.6p by 11:42 on Monday.