Tullow told investors that tests of its Mputa-4 oil field in the Kaiso-Tonya region of Uganda had indicated some depletion over the period. That decline in pressure suggests a lower reserve quality than investors had been anticipating.
The stock lost as much as 60.5p at 589.5p in reaction, touching a three-week low, before rallying to stand around 3% lower at around midday.
Before appraising the Kaiso-Tonya region, Tullow had booked 35m barrels of oil equivalent from the site. That was widely considered to be a conservative estimate, however, with the company's own mid-case estimate totalling 100m barrels and its best estimate reaching 200m.
"The Mputa-4 test will suggest that the 200m-barrel expectation is certainly a stretch and the 100m-barrel mid case questionable, although further interpretation is still necessary," said Merrill Lynch, which is Tullow’s joint house broker.
Merrill's net asset value of 623p per Tullow share had included a carrying value of 18p for the Kaiso-Tonya prospect, based the recovery of 60m barrels equivalent. That value may need to be adjusted down by 9p a share, it told clients.
The Wall Street bank's team also argued that, before today, investors had been leaving little room for disappointment. "Tullow shares have held up well, given the high oil price, busy drilling schedule, and possibly high expectation for Mputa and Ngassa," its team said, referring to another of the group’s Ugandan prospects which is due to be drilled in February.
However, Merrill said today’s setback cab be seen as an isolated event that may offer a buying opportunity. "The Kaiso-Tonya are shallower reservoirs, and we believe this test has no read across for the deeper reservoirs in Uganda to be appraised (and) explored next year," it said.
Other analysts stressed that the report, while disappointing, had to be seen as only one part of a wider study. "This is just one zone in one well and a final analysis will require the full integration of 3D seismic ahead of the expected early production system sanction in the first quarter of 2008," said Job Langbroek at Davy Research.
Hemscott's verdict: It's inevitable that oil exploration will be hit and miss. There's no way to guarantee what's below ground, so the best a company can do is communicate its progress clearly and keep investor expectations realistic. On both counts, it's arguable whether Tullow has been doing a good job.
Booking only 35m barrels of oil equivalent from the Kaiso Tonya site may have been pragmatic, but it was a best-case estimate of 200m barrels that drove investor optimism. Today's setback has made management's target unrealistic, and appears to have removed one significant source of potential earnings upgrades for the group. Readers can judge for themselves whether Tullow's statement made that clear.
But with shares rallying from their initial drop, investors appear to be concentrating on potential success at Ngassa and Kingfisher, Tullow's larger prospects in the same area, rather than dwell on today's disappointment. That optimism may well prove justified, but a share price of nearly 15 times 2009 earnings forecasts will look to some like a triumph of hope over experience.
