As an investor you weigh up risks and potential returns, trying to eliminate or limit the unknowns and one of the biggest issues with investing is political risk.
It is a consideration whether you are investing in North America, Asia, Europe or indeed even here in the UK where inconsistent taxation policies towards the oil and gas industry in recent years has made it difficult to create financial models with any sort of certainty.
Africa remains a fascinating prospect for investment, resource rich and full of potential. There is an increasing amount of interest in exploration for oil and gas within and around the African continent and barely a month goes by without a major new oil discovery.
Only five of the continent’s 55 countries are neither producing nor exploring for oil. However, political and economic uncertainties continue to mar the development of Africa’s huge oil and gas reserves.
Changing regimes, shifting price policies, taxation changes and threats from rebel groups are among the major concerns when considering investment.
Sacha Baron Cohen’s latest parody, The Dictator, tells the story of the battle for control of a fictional North African country’s oil reserves, with oil majors lining up to gain control.
This is all done with tongue firmly in cheek, but some of the outrageous behaviour in the film rings true with many reports and anecdotes of real political life in Africa and yet it this does not deter international oil companies.
Of the oil majors, Total, has the greatest proportion of its assets in Africa, representing around one quarter of production, primarily focused in West and North Africa.
ExxonMobil, Shell, Chevron and BP all have sizeable operations, but again they are focused on the traditionally fertile West and North of the continent and do not offer a pure play on the region.
In recent years, a series of hydrocarbon discoveries across Eastern Africa (on- and offshore) has established the region as one of the key emerging areas for fossil fuel development in the world.
The number of finds in the area has increased or matched the previous figure each year during the last five years, with 13 discoveries alone this year up until August.
Lack of infrastructure, including skilled labour, could slow the development but such an impressive rate of discovery is in turn drawing greater upstream investment from oil and gas firms looking to capitalise from East Africa’s massive hydrocarbon potential.
For the investor looking for a more focussed African play, in particular frontier discoveries in the East, and is willing to accept the associated risks, Afren may tick all boxes.
The company is now Africa’s second largest independent oil company.
In addition to quality assets in the Kurdistan region of Iraq, Afren’s Ebok fields offshore Nigeria have surprised many with the speed with which they have been brought onstream and production ramped up.
It is, however, the company’s exposure to East Africa, which is grabbing my attention.
Further seismic data activity has increased the resource potential in the area and of particular interest is the new lower-risk shallow water play in Kenya which it shares with Tullow Oil.
Overall, Afren has now almost tripled its estimate of prospective resources acquired via the Black Marlin purchase in 2010.
The shares have been fairly volatile in recent years reacting negatively when Tanzania decided to review production sharing contracts.
Unfortunately, a combination of this political risk and shareholder fatigue due to management’s preference to use equity to pay for acquisitions has seen the shares fairly lowly rated by the market when compared to peers.
The key advantage the company does have, however, is it is operator of the majority of its licences, thus reducing the operational risks in developing the fields.
Tullow Oil is itself the largest independent oil company operating in Africa. The drilling successes in Uganda and the Equatorial Atlantic region in the past two years have exceeded even the most optimistic expectations.
The farm-down of the Ugandan assets to CNOOC and Exxon at the start of the year proved to be welcome news for the shares as the company will be developing two world-class oil basins over the next four years.
The long-term outlook has also been enhanced by discoveries in French Guyana and, in particular, Kenya where the company reported positive exploration news. Further drilling at the Ngamia-1 well in Kenya has encountered another light oil discovery.
More significant is the increased confidence of further success.
Tullow has raised the number of potential targets in seven nearby basins with each of the basins offering the potential to be larger than the 1billion barrels oil equivalent discovered in Uganda.
However, somewhat coyly, Tullow does not feel comfortable in declaring the find a commercial success yet, given that only one well has been drilled. The situation could change in the fourth quarter when the results of a second well, Papai, are released.
Steve McKay is a divisional director at Brewin Dolphin
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