Taking AIM at small oil and gas firms

By bne IntelliNews April 14, 2009

Nicholas Watson in Prague -

The financing plight of small, independent oil and gas companies, some of which explore in Central and Eastern Europe, led many to predict at the end of last year a massive wave of M&A. This consolidation began slowly but appears to be picking up pace.

There's no doubt the sector has been struggling to raise the cash necessary to finance ongoing operations due to the credit crunch, accompanying economic downturn and consequent lower oil price - the average Brent crude price in the fourth quarter was $54.86, some 52% lower than the average in the third quarter.

According to Ernst & Young, oil and gas companies listed on London's Alternative Investment Market (AIM) raised just £23.6m in the fourth quarter compared with £229m in the previous quarter and £325m in the year-earlier period. This worrying trend is continuing into 2009, with just £1.19m raised by the sector in January. "This represents the lowest monthly amount since September 2003 and is a stark continuation of the slowdown in capital raising now being witnessed in the sector," says Alec Carstairs, oil and gas partner at E&Y. In October, the consultancy calculated that 65% of the AIM-listed oil and gas companies had less than £10m cash left in the bank to spend on existing opportunities or new projects.

All this has had a devastating effect on the share prices of these companies; Ernst & Young's "oil and gas eye" index, which tracks these firms, ended 2008 about 66% lower and the index is little changed over the first quarter. "We've got assets that in a reasonable market would be good for a share price of a pound [sterling], but here we are at 13 [pence]," sighs Frank Jackson, managing director of the Aim-listed Aurelian Oil and Gas, which has assets in Poland, Slovakia, Bulgaria and Romania.

Industry insiders say that financial institutions are currently looking for four attributes in an oil and gas stock before investing any money: proven reserves; cash to carry through the work programmes; liquidity in the shares; and at least some hydrocarbon production. "If you don't have those things, you're dead in the water," says Jackson.

Weak share prices combined with low levels of cash on balance sheets inevitably opens the door for distressed deals, as many firms simply can't continue to finance their day-to-day operations, and in the last quarter of 2008 some were predicting a massive wave of M&A at the end of last year. E&Y's Carstairs predicts that the number of companies listed on AIM could drop from around 100 to as few as 60 over the next 18 months: "There is a complete lack of liquidity on AIM; the whole market has stopped."

Slow burn

Yet apart from a few opportunistic purchases, this largely failed to materialise at first. According to mergermarket, the volume of European M&A deals in the first quarter dropped 60% from the year-earlier period and was down 35% from the previous quarter. Reflecting the slow burn of the consolidation process, the oil and gas sector did feature prominently: over 80% of the total value of European M&A in the first quarter took place in just two sectors: Energy, Mining & Utilities (58%) and Financial Services (24%), with the former seeing 47 deals worth a total $61.8bn.

One of the problems has been that, like two drunks hanging onto each other, many of these junior oil companies couldn't tie up because they suffered from similar problems. "The problem with consolidation is that if you take two small companies without money and you put them together, you've got a slightly bigger company without money," says Aurelian's Jackson. "If you do a merger, you must be buying someone with cash or someone with assets. To put two portfolios together without the backing doesn't create anything."

However, the shakeout in the industry is working its way through the system and the likely winners in the process who have access to capital are coming to the fore.

Industry experts say the consolidation process really kicked off in February with Dana Petroleum's announcement it had agreed to buy Canada-based Bow Valley Energy for €131.5m, or CAD0.50 per share, significantly lower than the more than CAD6 per share Bow Valley was trading at back in July 2008 when oil prices were at their peak. In March, San Leon Energy announced plans to acquire Gold Point Energy for $1.5m, which just a month earlier said its wholly owned Polish subsidiary, Liesa Investments, had been awarded two concessions for oil and gas exploration in Poland. The two concessions totaling 2,245 square kilometres are located in western Poland. The granting of the two concessions added to Liesa's portfolio in Poland, which already included a farm-in agreement with Gas Plus International.

Experts point to increasing interest in producers with assets in CEE. After yet another spat over unpaid gas bills between Russia and Ukraine left Europe shivering in the cold in January, CEE governments are desperate to develop their own resources, thereby reducing dependence on Russia.

And there are a lot of good assets in the region, as evidenced by the return of the majors to the region. At the end of last year, Exxon Mobil announced it had struck a deal with Petrom, Romania's largest oil and gas company, to explore off the Romanian coast in the Black Sea. This agreement came just days after the US company signed with Turkey's TPAO to explore two offshore blocks in a deal that marked the US firm's entry into the Black Sea region, where oil reserves are estimated to be around 10bn barrels and gas at about 1.5 trillion cm.

Aurelian's Jackson explains that the majors first came into region in early 1990s as communism collapsed, but spent most of the next five or so years trying to get the environment right before drilling, then heading off to potentially greater prizes on offer in the Caspian Sea region and Siberia. "Shell had the block that we've got now in Poland, but they spent first four years negotiating with the government to change the operating environment. Then all the big stuff started to happen in the Caspian and Siberia, so they all dropped everything and ran off to the east chasing the elephants. All us little guys stayed there and filled the void."

Shell has announced its return to the region with the announcement in October that its Ukrainian subsidiary is planning to drill its first well in the country this year, and is looking for further opportunities in the country. Speaking at the Ukrainian Energy Forum earlier this year, Shell Ukraine E&P's general manager, Patrick Van Dael, said the company had started seismic activity at Shebelinka gas field in eastern Ukraine, which will be followed by the 3D survey.

Short of merging with or being acquired by another player, a growing number of firms operating in CEE are getting the necessary finance for projects by farming out their licenses. In November, Aurelian announced it would farm out 40% of its licenses in Poland to Canamens Energy to help finance the development of its Polish gas fields. In return for that 40% interest, the private equity-funded upstream oil and gas company Canamens will bear 80% of the total cost of a defined work programme up to a maximum investment of €40m.

Swiss-based upstream independent Manas Petroleum said January 21 it's in talks with potential farm-in partners for one of its four onshore blocks in Albania in order to drill an exploration prospect this year.

More recently, on March 11, Canadian independent oil and gas firm Sterling Resources announced it had signed a farm-in agreement for two blocks in Romania's territorial waters in the Black Sea with Melrose Resources. Under the terms of the farm-in, Melrose will earn a 32.5% interest in the blocks in return for providing $12m of funding to Sterling. Melrose will also carry Sterling for a proportion of their future development costs ranging between $63m and $78m, depending on the gas price achieved for the development projects.

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