Sinking oil price has torpedoed Premier Oil plc and Tullow Oil plc

Whither the oil price rally? The rush of excitement following January's $27 a barrel lows has now abated, with crude slipping well below $50 again. As US oil inventories hold firm, consumption dips and disrupted supplies come back on-stream, some analysts are even forecasting that oil could fall to $40 again.

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Troubled waters

The oil supply glut could take time to clear and that spells bad news for explorers Premier Oil(LSE: PMO) and Tullow Oil(LSE: TLW). Both stocks were hit hard by the oil price meltdown, as they built up large piles of debt on the assumption that oil would trade at more than double today's lowly price, but recovered strongly when oil rallied. The rally has faltered and the longer the price stays low, the more onerous those debts will become.

Premier's latest trading update shows net debt of $2.6bn, flat over the quarter but up from $2.2bn at the end of last year, leaving its gearing ratio (total debt/total capital) at a worrying 78.59%. Yet it's under no immediate pressure to pay that debt and has positive news to report, producing 61,000 barrels of oil equivalent per day, and full-year output set for the upper end of its guidance of 65,000 to 70,000 barrels. It has achieved first oil from Solan, fully integrated its E.ON acquisition and hit key milestones on its Catcher project.

Sterling investments

Premier has also taken nifty advantage of the pound's slump against the dollar to lock in £110m of forward expenditure at $1.31. A chunk of its debt is also in sterling, which helps, while it has cash and undrawn facilities of around $800m, and it hopes to bolster its balance sheet by generating free cash flow later this year. Premier looks solid for now and markets appear unconcerned by the oil price dip as its share price holds firm at 70p, well above its January low of 19p.

Tullow Oil's net gearing is only slightly less alarming at 68.89%, but that's up from 58% at the end of 2015. Its net debt has risen from $4.2bn to $4.7bn over the same period, offset by around $1bn of unused debt capacity and free cash. Lower production at its Jubilee project in West Africa earlier this year hit production, which fell to 51,000 barrels a day, below guidance. But Jubilee was pumping a healthy 90,000 barrels a day in June.

Holed but not sunk

Tullow's TEN Project is expected to deliver first oil within the next three-to-six weeks, after three years of work, but you have to offset this against the fact total half-year revenues are expected to be 37.5% lower year-on-year at $0.5bn, with gross profit down 33% to $0.2bn. Lower production is partly to blame but mostly it's down to the bank that it's getting $10 less a barrel, with an average selling price of $61, helped by hedging.

Tullow is supported by $1.35bn cash from operating activities and has of course enjoyed success in drilling and exploration, the problem is that this will be difficult to monetise if the oil prices hits the skids again. Like Premier, Tullow's share price has shrugged off the oil price hiatus for now, let's hope it doesn't sink any further.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.