IN 1966, Sergio Leone directed Clint Eastwood in The Good the Bad and the Ugly. In recent months, three FTSE100 listed E&P companies have re-written the script, issuing drilling updates which have been received in the market as “the good, the bad and the indifferent”.
Tullow’s success last month with the Zaedyus well in French Guiana has been hailed as a “game changer” for the company. As operator and 27.5% stakeholder, Tullow backed its belief that the area would have similar geology to its massive Jubilee field in Ghana, given the fact that way back at the dawn of time, the northern part of South America was linked to Western Africa as a connected land mass.
Zaedyus is the most expensive well ever drilled by Tullow, costing more than $200million, and whilst Tullow expects to significantly reduce the cost of subsequent wells, this underlines the high-stakes nature of the game. High risk can mean high reward, however, and whilst the find has yet to be fully appraised, early estimates stand at around 700million barrels.
The 15% jump in share price on the back of this news casts Tullow very much as the “good” character in our E&P spaghetti-western. The “bad” (at least for now) is being played by Cairn, which announced news of a further dry well in Greenland just days after Tullow popped the champagne corks.
Cairn is currently exploring an area off Greenland’s coast, twice the size of the UK North Sea. So far, five wells have been drilled with each failing to strike any commercial quantity of oil. As the weather window for effective exploration begins to close, this most recent disappointment pushed the shares down almost 10%.
A rough tot-up of Cairn’s assets shows that around £3.4billion is comprised of cash coming from the sale of a 40% stake in Cairn India to Vedanta – much of which will be returned to shareholders – whilst the 20% stake in the Indian venture to be retained by Cairn adds a further £1.7billion in assets.
Given that the company’s market cap is currently around £4billion, it is clear that the market is now heavily discounting Cairn’s exploration risk. Based on forward earnings, Cairn’s share price now trades on a multiple of less than seven times (versus a fairly full multiple of 27 times for Tullow).
In these febrile markets, bad news is swiftly punished, whilst good news can deliver a sharply positive price reaction. Sometimes, however, markets appear to react with almost complete indifference.
One of BG’s most exciting assets is its exposure to the Santos basin, in deep water off the coast of Brazil.
Back in June, the company announced that the five fields where they are involved were likely to hold double the amount of recoverable oil than had previously been thought, putting BG’s estimated share up from 3billion barrels to 6billion barrels.
Analysts estimated that the incremental value of these additional reserves was in the range of 250p to 350p. In this context, the share price jump of only 60-odd pence in response to the announcement felt like a bit of an anti-climax.
Such apparent indifference may simply be a factor of the considerable execution risk in such ambitious and complex drilling projects. The Santos Basin deposits are 2,000m under the sea, sitting below a dense salt crust, and the market is only too well aware of the difficulties which can plague deep water exploration.
Further risks centre on how the Brazilian Government will tax future offshore production. One would hope that they do not take a leaf out of George Osborne’s book but in these fiscally-constrained times, who could be sure?
As it becomes more and more difficult to replace reserves, operators are being forced into ever more hostile territory in their quest for hydrocarbons.
The technological achievements in doing so are amazing, the locations far-flung, and the stakes incredibly high. E&P companies live and die by their drilling programmes and whilst failure can mean calamitous expense, success can undoubtedly deliver “a fistful of dollars”.
David Barclay is a divisional director at investment management and financial planning specialist Brewin Dolphin.
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