The Rising Influence of Rising Affluence

[DewDiligence]

E&P Valuations Are Looking Stretched, Says WSJ

[I’m inclined to agree; for instance, APC sports an enterprise value (market cap plus net debt) of more than $40B and insiders have been heavy sellers since the announcement of the Sierra Leone find in Sep 2009.]

http://online.wsj.com/article/SB10001424052748704320104575014822664144494.html

›January 20, 2010
By MATTHEW CURTIN

Tullow Oil and Heritage Oil, two London-listed explorers, have hit the jackpot in Uganda -- the latest in a string of major oil finds by European exploration and development groups that helps explain why the sector has been on a tear. The share prices of Tullow, Heritage and U.K. rival Cairn Energy have more than doubled in the past year. France's Maurel et Prom is up 61%. But the peak may not be far away.

Tullow's decision this week to exercise pre-emption rights over two Heritage-controlled blocks for up to $1.5 billion, subject to Ugandan government approval, will allow it to consolidate its hold over one of Africa's most exciting new oil provinces. Independents like Tullow have benefited from the majors' recent focus on developing existing fields, downstream projects and returning cash to shareholders.

That has enabled the juniors to fill the exploration gap, making big onshore and offshore discoveries from Brazil to India. In the case of the vast Jubilee oil field offshore Ghana thought to hold 1.8 billion barrels of crude, more recent exploration suggests similar fields may exist along a 1,100-kilometer stretch of the West African coast.

But the majors are increasingly under pressure from investors to fire up sluggish share prices with higher-risk exploration given many will battle to average more than 1% annual production growth over the next five years. Shares in BP, the best performing European major, are up 28% in the past year, lagging the FTSE 100, let alone the independents. National oil companies also look increasingly intent on building up their production reserves.

But so far, that's not translated into the anticipated takeovers that have boosted the share prices of explorers. The acquisition of Addax Petroleum by Chinese state-owned oil group Sinopec is the only major deal that's come to pass in Europe. Instead, the majors are regaining their appetite for exploration risk. ExxonMobil has offshore exploration concessions in Guyana alongside Tullow and CGX Resources. Italian energy group Eni dropped a planned bid for Tullow last year and bet instead on the Ugandan government vetoing Tullow's pre-emption of the Heritage blocks. [This plan appears to have worked, according to recent statements from the government of Uganda.]

Meanwhile, barriers to entry are falling as industry deflation is reducing exploration costs from the 2008 average of $17 to $20 a barrel of proven reserves average toward their market value of $10-$15.

In the absence of takeovers, exploration group valuations are starting to look stretched at current oil prices. Tullow's stock is trading at a 2% premium to net asset value while the rest of the sector is trading at a modest 12% discount, based on an oil price of $79 a barrel, according to UBS research.

In such a shifting competitive landscape, further share price rises will depend not only on the independents' ability to maintain recent exploration success rates and control costs, but also much higher oil prices.‹