Little Oil: cash is king

    23 May 2015

    The small oil and gas company sector, consisting chiefly of AIM-quoted companies, has been massacred over the past few years, and in particular since the oil price decline that began last summer. The good have declined as well as the bad, so in theory there must be value to be found — but the key factor in any analysis of this sector is verysimple: cash.

    Most small oil companies have no cash flow, and require continual injections of new equity to sustain their existence. With a majority of small oil stock prices at all-time lows, raising new cash is exceedingly difficult — never mind that existing shareholders are doubly disadvantaged by rarely being invited into heavily discounted private placings. So before getting overexcited by, say, recent news from UK Oil & Gas plc — which announced prospective resources of of ‘up to 100 billion barrels’ at Horse Hill near Gatwick Airport in Sussex — the first question must be: ‘Have these companies got the cash to explore and pay their overheads, or is there another discounted share placing just around the corner?’

    If life’s so hard in the small oil sector, you might expect relatively cheap UK onshore exploration to be a sensible option. However, a wave of largely ill-informed populist ‘nimbyism’ from Lancashire to Hampshire has caused progress in any onshore exploration, whether conventional or shale, to get stuck in a glue of planning applications and reviews. So well-positioned companies such as IGas, Egton and Europa have suffered.

    Against such a depressing background, it is certain there will have to be amalgamations and trade sales in the small company sector. Most small companies have administration expenses ranging from £250,000 to £1 million. Exploration budgets can be cut but overheads must be paid — and raising such amounts has become exceedingly difficult. Few investors are happy to be paying for salaries, listing fees and audits while they wait for better market conditions or a rare exploration success.

    Merging sounds easy and logical — until it becomes clear that only one management team and one set of advisers will survive. Activist investors are desperately needed to rationalise what has become an inefficient sector.

    So where do we look in the small oil company sector for values that are so effectively hidden at the moment? On the following page are five names quoted on AIM that might survive long enough and finally prosper when oil prices recover and sentiment changes.

    In the meantime their shares could rise for reasons not directly connected to their fundamental businesses but because of corporate activity, changes of governments and perhaps even changes of public opinion towards hydrocarbon exploration.


    Five oil and gas minnows ‘that might survive and prosper’

    Egton resources (Market cap £25.5 million at 11.5p) This venture has shown an ability to be both corporately active and geologically astute. The first of those qualities could be the reason to back it. Two years ago, an acquisition of UK shale licences with huge potential, and a joint venture with Total, caused the shares to triple; cash was then raised that should fund onshore UK drilling this year and next. Brokers talk of asset value at least five times existing capitalisation. Egton also holds 38 per cent of the Holmwood prospect — in the same geological play as UK Oil & Gas at Horse Hill.
    Andes Energia (£158m /28.5p) Investment bank Macquarie put a 35p target on this South American venture. What’s not quantified is the potential impact of a more co-operative Argentine government later this year. If this happens, Andes’ massive reserves could be a target for an oil major — while existing production covers overheads and some exploration.
    Rockhopper Exploration (£184m/62p) Other beneficiaries of change in Argentina might be Rockhopper and its co-explorers in Falklands waters. Not that a new regime would withdraw its claim to ‘Las Malvinas’ — but it might try a new diplomatic tack, allowing Argentine involvement in the exploration areas and onshore service facilities. And Rockhopper is more than just its Falklands interest. Having received over $250 million from Premier Oil & Gas and Noble Energy in a farm-out deal, it used some of the cash to buy Mediterranean Oil & Gas, which has interests in Italy, Malta and France.
    Madagascar Oil (£42.4m/6.5p) This company aims to exploit a world-class resource of heavy oil in an African country that has a supportive government. Technology, necessary approvals and a strong management team are in place. So what’s wrong? The fact that only 16 per cent of the shares are freely traded doesn’t help, and a major fundraising could be needed unless new boss Robert Estill succeeds in bringing in major partners, obviating the need for new funding. Meanwhile, the company should still have some of the $20 million raised last November, and 100,000 barrels of oil in storage to sell.
    Infrastrata (£6.5m/4.25p) Something completely different: with the shift from coal and oil to gas and renewables in power generation, reliable gas supplies are even more vital: gas needs to be stored for days when the wind doesn’t blow or the sun doesn’t shine. This tiddler is developing a huge underground gas storage facility at Islandmagee in Co. Antrim, with EU support, and will also be drilling an onshore exploration well — with a minimum target of 40 million barrels, but not until September — when bird nesting activity has finished. Brokers Arden have set a target price of 36p.