Should contrarian investors jump on Gulf Keystone Petroleum Limited and Tullow Oil plc?
It's been a rough few years for all oil companies amid plummeting prices. But times have been tougher for heavily indebted Kurdish producer Gulf Keystone Petroleum (LSE: GKP). Yet with good news on the debt front is now the time to begin considering shares of GKP?
Optimism around the firm stems from creditors' acceptance of a debt-for-equity swap that will see net debt reduced from $600m to $100m. For a company whose market cap is currently hovering around £67m, it's understandable why this was a major relief for shareholders, even if significant dilution is on the cards.
However, investors should be ask whether this agreement is merely a plaster to keep the company solvent for a few more years or if the company's underlying fundamentals have changed for the better.
GKP's primary problem, low oil prices, won't be fixed overnight and there's unfortunately nothing it can do to alter the current supply glut affecting global markets.
The next issue for GKP, the failure of the Kurdish Regional Government to pay the company for oil produced, has been partially ameliorated with payments of $97.5m from the government through the first six months of the year for current and past production. But problems on this front may be beginning anew as the company disclosed in interim results on Thursday that it had yet to receive payment for July and August production.
Third, unbearably expensive debt repayments will be considerably reduced by the deal. We won't know until the next results period what monthly interest to creditors will be, but it will be far lower than the $35.7m spent on financing costs in the first six months of the year.
At the end of the day though, despite low production costs, GKP is still running an operating loss due to high transportation costs and low prices for its lower-quality oil, a problem that won't be going away as its capital-intensive primary Shaikan field requires higher and higher investment to maintain output levels. The debt agreement is a step in the right direction but fundamental problems are still enough to keep me away from shares.
Can Tullow cut its debt?
It's better news for African producer Tullow Oil (LSE: TLW) as its massive new TEN field off the coast of Ghana pumped first oil last month. It couldn't have come at a better time for Tullow as its mountain of debt had clocked in at $4.7bn at the end of June representing a staggering gearing ratio of 62%.
Delivering TEN on time and on budget was quite a coup for this offshore development, but now the company must focus on ensuring expected operating costs of around $8-$9/bbl are achieved. If costs can be wrangled lower and TEN's output is quickly ramped up to its expected 80,000 barrels per day then Tullow should be able to begin whittling down its pile of debt in the coming quarters.
With the company moving back into profitability for the first time in several years, signs are good that Tullow has finally turned the corner. High debt means investors shouldn't be expecting dividends for a long time but low cost of production assets and an end to massive capital outlays means now could be the time for bargain hunters to begin taking a closer look at Tullow.
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Ian Pierce 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.