Gamble of the week: A play on oil shares

The big oil companies, such as Shell and BP, are seen as pretty dull investments. They are good sources of dividend income, but are unlikely to give you big capital gains. Those looking to make big money from oil shares prefer to chance their arms with the smaller exploration and-production (E&P) companies.

For these firms, big oil discoveries can result in massive share-price gains – but dry wells (where you drill for oil and come up with nothing but an empty hole) can lead to equally big losses.

This oil stock has been one of the sector’s great success stories for much of the last ten years. It has become one of Europe’s biggest independent oil exploration companies. Tullow Oil’s (LSE: TLW) discovery of large quantities of oil in Uganda, Ghana, Kenya and French Guiana has propelled it into the FTSE 100 index.

Up until recently, its strategy of finding oil, selling it and using the cash received to look for and find more oil has worked wonders. But a series of dry wells has seen the company forced to write off more than $700m of money spent, which has raised concerns about its ability to keep growing the value of the business.

This, when combined with its failure to ramp up oil production as much as expected in Ghana and elsewhere, has seen its shares lose favour with lots of investors – they are down by a third in the last 12 months and are now trading at close to their 52-week low.

Tullow Oil share price chartHowever, despite these setbacks, Tullow Oil looks to be in good health. The problems in Ghana look like they will be sorted out. The firm has just made a further big oil discovery in Kenya and is hopeful of finding more oil there, as well as in Ethiopia and Uganda.

With other opportunities in locations such as Norway and Mauritania, the company is confident that it will keep on growing its reserves of oil and gas at a healthy rate. What it clearly needs to do is concentrate on producing more oil and getting it to market, or else investors will continue to lose patience.

Tullow’s share price has been sustained by the hope that it will keep on finding lots of oil, but more importantly that it will start generating more cash from it. However, this probably won’t happen in the coming year, and longer term it’s dependent on things like the building of a pipeline from Kenya to the Indian Ocean, which would give Tullow Oil’s prospects a big leg up.

Tullow Oil is well financed and is in no danger of going bust, but it must deliver. The shares still have a high speculative element to them and are based on a ‘jam tomorrow’ story. But it has proved itself a good bet in the past and the shares may now have fallen sufficiently to make them worth a punt for the patient.

Verdict: risky buy

Merryn

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