x Abu Dhabi, UAESaturday 20 January 2018

Junior oil explorers seek paydirt

Analysis Like the explorers of old, independent oil and gas producers have left the beaten track in their quest for new sources of the commodities to develop.

Gulf Keystone operations in Kurdistan, Iraq
Gulf Keystone operations in Kurdistan, Iraq

While many oil companies have cut back investment during the downturn, a band of feisty, independent producers have persevered with efforts to find and develop oil and gas in corners of the globe that "Big Oil" has shunned.

Several are poised for success in parts of Asia and Africa that have yet to make their marks as major producing regions. But the companies' exploits have not been free of trouble. In the past few months, Iraq's semiautonomous Kurdish region has been the setting for two stunning oil discoveries totalling up to 7 billion barrels of crude in place, of which as much as 5 billion barrels may be recoverable.

In May, Heritage Oil of Canada announced it had struck a deposit that could contain as much as 4 billion barrels of oil in the ground. And just last week, the Bermuda-based Gulf Keystone upgraded its earlier estimate of the size of a recent Kurdish oil discovery to as much as 3 billion barrels. Considering that, by some estimates, worldwide discoveries have been less than 20 billion barrels a year for the past two decades, that is a lot of oil to find in the space of four months in a place the size of Switzerland - especially for a couple of money-losing oil juniors.

The Kurdish oil could turn both companies into sizeable, profitable producers, and there is probably much more oil to be found in a region that was sidelined by the previous Iraqi regime. The trick now for both companies is to attract enough financial backing to fund development and tide them over until the Kurdish regional government and Baghdad, long at loggerheads over oil jurisdiction and revenue sharing, reach an agreement allowing foreign companies exporting oil from Kurdistan to be paid.

In the case of Heritage, help is at hand from Genel Enerji, the oil and gas unit of Cukorova Group, which is one of Turkey's largest industrial and investment conglomerates. But a US$5.5 billion (Dh20.2bn) deal to merge the companies seemed to hit a snag on Friday, when Heritage disclosed that the UK Financial Services Authority was investigating some of Genel's managers. Analysts, however, predicted the investigation would not derail the merger.

"Heritage's own operations management is more than adequately qualified and the rationale for the deal lies in the assets rather than the people," explained Richard Griffith, an analyst at Evolution Securities in London. The company's stock still fell 3.2 per cent, or 17 pence, on Friday to 521 pence on the London Stock Exchange. For Gulf Keystone, the deep pockets most likely to fund further drilling belong to a mysterious Middle East private investment fund called Etamic.

Last month, within weeks of announcing its Kurdish oil discovery, Gulf Keystone issued new shares in its Kurdish subsidiary, giving the fund 50 per cent of the unit's equity in return for a promise to pay half the development costs in Kurdistan. But some of Gulf Keystone's minority shareholders are appalled by the sudden large dilution of their holding in the project, and have been posting lively discussions of the issue on internet message boards.

The timing of the transaction, combined with the company's lack of disclosure about the fund's size and location and the identities of its backers, is stoking suspicions of insider dealing. Gulf Keystone, which also has oil and gas assets in Algeria, says it was founded in 2001 by UAE, Kuwaiti, Saudi and US private equity. Its business development director, Ali al Qabandi, who is Gulf Keystone's biggest individual shareholder, is a former director of the Kuwait National Petroleum Company.

The company did not respond to requests from this newspaper for information about Etamic. It may be worth noting that one of its partners in the recent Kurdish oil discovery is Texas Keystone, a private Pittsburgh-based oil and gas services company that Todd Kozel, the executive chairman of Gulf Keystone, founded in 1988. According to Gulf Keystone, the US company "led the pursuit of opportunities in the Kurdistan region".

Texas Keystone, of which Mr Kozel remains a director, holds a 5 per cent interest in the Sheikh Adi block in Kurdistan, with Gulf Keystone holding 75 per cent and a Kurdish state-owned entity the other 20 per cent. In November 2007, Gulf Keystone agreed to pay the US company's share of expenses before drilling the first well. But investors appeared to overlook the controversy over Etamic last week, when they lifted Gulf Keystone's share price in London by more than 70 per cent on Wednesday, the day the company said its Sheikh Adi test well had found more oil. On Friday, the stock closed at 76.75 pence, down 4 pence.

Another independent oil company with big news last week was Cairn Energy of Scotland. Yesterday, Manmohan Singh, the Indian prime minister, inaugurated the Mangala oilfield in Rajasthan, from which Cairn expects to produce 125,000 barrels per day (bpd) of oil by the middle of next year. By bringing two more fields on stream it hopes to increase production from the northern Indian state to 175,000 bpd the year after, with further increases to follow.

"We continue to make discoveries. The last one, in December last year, was the 25th," said Rahul Dhir, the managing director and chief executive of Cairn's Indian subsidiary. Last year, India pumped 766,000 bpd of crude, just a fraction of its 2.9 million bpd oil consumption. So the start of production from Rajasthan is deemed to be of national importance. "We are dedicating the Mangala field to the nation," Mr Dhir said. "This is a world-class resource."

The production start is also a personal vindication for Sir William Benjamin Bowring Gammell, more commonly known as Bill Gammell, the Scottish sportsman and industrialist who founded Cairn in the 1980s and is still the company's chief executive. In the mid-1990s, Sir Bill moved Cairn out of mature oilfields in the North Sea and the Gulf of Mexico, and into neglected fields in South Asia, where both the risks and potential rewards were much higher.

Investors were not thrilled and punished Cairn by sending its share price to a low of 291 pence in 2002, after a 37 per cent drop in the company's annual profits. But that was before the Mangala exploration prospect, for which Cairn paid Royal Dutch Shell only $7 million, turned out to be a winner, yielding in 2004 what was believed to be India's biggest oil discovery in 20 years. On Friday, the FTSE 100 company's stock closed at 2,507 pence, up 37 pence. That was just two days after Cairn had announced a first-half net loss of $60.9m and said it had spent $450m to develop Mangala.

But yesterday's celebrations in India do not mean that Cairn's future in the country is secure. Continuing risks include running afoul of the country's cumbersome bureaucracy, an increasing threat of militant attacks on Indian energy installations, and war. Even now, permit delays have put the construction of a pipeline for Mangala's oil behind schedule, so the field's early output will have to be moved expensively by lorry.

But Sir Bill believes some of Cairn's political risks in India have been mitigated by spinning off Cairn India as a separate publicly traded company, listed on the Mumbai Stock Exchange. "The secret is to understand you are a guest in a country," he told the Daily Mail newspaper. The best news for investors is that long-term lifting costs for Mangala oil could be as low as $5 a barrel, similar to costs in Kurdistan and less than half as expensive as in the North Sea.

The next oil Cairn hopes to find and develop will be more expensive. Sir Bill has his sights set on oil seeps in the icy waters off Greenland. Another success story last week came from Tullow Oil, the UK independent that is preparing to start oil production from Uganda and Ghana. Both countries are latecomers to the growing club of African oil producers. Ghana began pumping oil two years ago, while Uganda has yet to start commercial production.

Tullow said on Wednesday it had found more oil in Uganda, adding momentum to its African development plans. Oil shows at its Ngassa-2 well, near Lake Alberta in central Africa, may be "associated with significant oil columns", it said. Tullow produces oil and gas from just 7 per cent of its resource base, so the major developments planned for Ghana and Uganda will make a big difference. In Ghana, Tullow is the biggest partner in the Jubilee oilfield, which is due to come onstream in the second half of next year. Discovered last year, the offshore field may contain as much as 1.8 billion barrels of recoverable oil.

In Uganda, Tullow has found about 700,000 barrels of oil in the Lake Alberta Rift Basin, enough for commercial production. Heritage has discovered another 400,000 barrels in the region. But a long export pipeline will be needed to move the oil out of the landlocked country. Tullow is an upstream oil company, specialising in exploration, so it is now seeking partners to develop the transportation and processing infrastructure.

"We will be looking to bring in partners in Uganda. We have been approached by almost all the major companies," said Aidan Heavey, the chief executive of Tullow. Tullow's shares closed at 1,080 pence on the London Stock Exchange on Friday, up 27 pence.