x Abu Dhabi, UAETuesday 25 July 2017

Fictional facts can cloud outlook on small oil companies

Shares in Gulf Keystone plunged 9 per cent after Spencer Freeman pretended via Twitter the company was going to issue new shares at a discount. Though his tweets were fictional, the episode is an ironic comment on the volatile world of small oil companies.

Investing in small oil companies is a risky if potentially rewarding activity.Peter Macdiarmid / Getty Images
Investing in small oil companies is a risky if potentially rewarding activity.Peter Macdiarmid / Getty Images

'Twenty-eight years old, with spiky gelled hair, orange tan and a donkey jacket'. As reported by The Wall Street Journal's James Herron, this is Spencer Freeman, taken to court last Thursday over rumours he circulated about the oil company Gulf Keystone.

Mr Freeman earned the wrath of the oil company for pretending in his Twitter account to have access to inside information from Gulf Keystone and directors at ExxonMobil, whom he alleged were planning to purchase the company. He had a devoted following, and when he claimed recently that the company was planning to issue new shares at a discount, the share price dropped by 9 per cent.

He admitted that his tweets were "fictional facts … not related to the real world of reality" and promised to desist. But this episode is an ironic comment on the volatile world of small oil companies.

Many are listed on the UK's AIM market, a less-regulated option than the main market. Canada and Australia are also popular homes - all areas with the right ecosystem of grizzled oil prospectors and a mix of institutional and private investors comfortable with backing frontier wildcatters.

Each one hopes to emulate Cairn or Tullow, small explorers that blossomed into multibillion-dollar companies on the back of big finds in India and Africa, respectively. Today's hot areas now include the Falkland Islands, the Kurdistan region of Iraq and some of the less-touched African countries such as Mozambique, Puntland, Somaliland and Namibia.

Yet the world of small exploration and production (E&P) companies is a volatile one. In recent years, two AIM companies, Regal and Cadogan, raised large amounts of money only to reveal, respectively, that an oil discovery in Greece was not commercial, and that licences in Ukraine were under legal challenge.

The technical language of the industry can be confusing. What is the distinction between "undiscovered resources" (oil that may or may not exist) and "reserves" (known oil that can be commercially produced)? Is it good to find "heavy oil" or "tight oil"? (It depends.) If a company finds gas in the remote waters of the South Atlantic, Greenland or Mozambique, is it likely to be able to do anything with it? (These days, probably yes, if the find is large.)

One of the golden rules of investing is never to fall in love with a stock. Yet certain E&P firms somehow acquire a devoted following. Although social media has created communities of like-minded investors who can help each other clear up some of the technical puzzles, it has also sped up the pace at which rumours circulate.

When Dubai's Emirates National Oil Company offered in 2009 to buy out minority interests in Dragon Oil, which was developing Soviet-era fields in Turkmenistan, small shareholders launched a campaign to oppose the bid. Coordinating via investment discussion sites, they launched a website to "Save the Dragon". However, it was ultimately the hard-headed calculations of fund managers that voted down the offer.

Not that share movements necessarily make sense, whether led by small-time enthusiasts or big institutions. When Horn Petroleum found traces of oil in Puntland last week, and Borders and Southern discovered gas off the Falklands last month, their shares plunged. Investors worried whether the finds were commercial - yet logically, any signs of petroleum in a new region are good news. Either the shares were hugely overvalued before the find, or undervalued afterwards, or quite possibly both.

For small investors and big institutions alike, investing in small oil companies is a risky if potentially rewarding activity. Given the technical and commercial uncertainties, projections of vast discoveries or big acquisitions, while strictly within the law, may also turn out to be no more than fictional facts.

Robin Mills is the head of consulting at Manaar Energy, and the author of The Myth of the Oil Crisis and Capturing Carbon

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