A vicious truth has emerged in the oil business over the last few months.
The sector is struggling to stay profitable.
Even the world’s largest E&P firms are scrambling to maintain their margins. Just look at some of the recent numbers.
Exxon Mobil Corp. (
NYSE: XOM,
Stock Forum)saw its profits fall by 27% in 2013, as compared to 2012.
And the world’s largest oil company wasn’t alone in seeing financial difficulties.
Royal Dutch Shell’s ADS (
NYSE: RDS.A,
Stock Forum) profits dropped 23% for 2013.
BP Plc (
NYSE: BP,
Stock Forum) was down 20%.
Chevron (
NYSE: CVX,
Stock Forum)fell 18%.
What’s going on with big oil? The answer it seems, comes down to one thing.
Costs.
Digging into the financial statements, the cause of the lower profits is clear: higher capital spending on discovery costs and reserve extension is eating into the bottom line.
The five companies mentioned above spent a total $169 billion on exploration and development in 2013. That’s a startling 20% rise from 2012—equating to over $25 billion in extra spending.
The problem isn’t just affecting the majors. Around the world, E&Ps of all sizes are seeing costs for drilling, facilities and seismic rising significantly.
This is a big challenge for investors—especially those looking at the high-impact junior end of the E&P spectrum. Junior firms live and die by their access to capital. High costs can easily erode corporate treasuries, putting the very survival of these companies at risk—and creating the potential for massive losses to shareholders.
But a new breed of junior firm is seizing this high-spending environment as an opportunity. These groups are using the money being poured out by others to advance their own projects—and gaining big value at little or no cost to themselves.
This strategy is used by some of the most savvy oil industry insiders globally, who go by an old saying in the business, “Never drill a well yourself if someone else will do it for you.”
This of course sounds unbelievable. Why would another company spending millions to drill a well for you?
But actually, it happens all the time.
The latest example of a firm utilizing this strategy is one of the newest junior offshore E&Ps to hit the market.
Gondwana Oil Corp. (
CSE: GO,
Stock Forum), aims to develop over 1,600 square kilometers of prime exploration acreage in the much sought-after West African nation of Ghana.
There are a lot of good things going for Gondwana. The company appears to be on the cusp of grabbing an exploration block in the heart of the rapidly-emerging offshore petroleum province here. The discovery of the 2 billion-barrel Jubilee oil field catapulted this area into the big leagues almost overnight.
Gondwana’s targeted acreage lies less than 30 kilometers from Jubilee. This is a coup in terms of positioning for this start-up firm—considering the big numbers around Jubilee’s production. Individual wells in the field produce 20,000 b/d—with the full development running 120,000 b/d.
But the “let others do it”, cost-beating strategy here springs from another important aspect of Gondwana’s prospective land package. The neighbors.
The offshore Ghana acreage is completely surrounded by some big names in the petroleum space.
Hess Corp. (
NYSE: HES,
Stock Forum) immediately to the west,
Eni Spa (
NYSE: E,
Stock Forum) to the north, and Vanco and
Lukoil Co. (
OTC: LUKOY,
Stock Forum) to the east and south.
These are key exploration holdings for all of these firms, evidenced by a wave of drilling activity over the past year. All told, no less than 10 wells have been drilled around Gondwana’s acreage during the past 12 months.
That’s a lot of money that’s gone into the ground from other firms. All to the benefit of Gondwana.
The thing is, when it comes to an emerging frontier like West Africa, the more drilling the better. Each drill hole sunk into the play creates greater understanding and awareness of the geology—and the discovery potential.
An unbelievable 65% discovery rate in the last 5 years for what is largely a frontier area.
For a company operating on its own, gathering such valuable information about the play might cost tens or even hundreds of millions for drilling. But in Gondwana’s case it doesn’t cost a penny. The company simply watches what happens as other firms pay the way to drill—just a few kilometers away from its license boundaries.
That’s the genius of having a central land position in a high-interest play this like. You can let others—including some of the best technical teams in the world with the majors—do the heavy lifting in taking the lid off the play. Gondwana and the like can soak in the information about play type, risks, and—ultimately—the location of the sweetest spots to finally drill.
In Gondwana’s case, that body of work is already well advanced. The flurry of drilling activity over the past year has yielded 11 new oil and gas discoveries surrounding the Gondwana acreage. This has provided deep insight into the dynamics of the play—and given management lots of data ammunition as it pinpoints its own drill targets.
Perhaps the biggest advantage of the “let someone else drill it” strategy is the potential for big jumps in valuation—based on results throughout the region.
The 2 billion-barrel Jubilee discovery raised the bar a notch for West Africa, with acreage formerly considered moose pasture here suddenly commanding multi-milliondollar signing bonuses.
In fact, recent farm-in deals show just how much value has accrued to acreage here. Last year, ExxonMobil signed a deal to join
Canadian Overseas Petroleum Ltd. (
TSX: V. XOP,
Stock Forum) on a block in nearby offshore Liberia, 1,000 miles away from Jubilee. Exxon is paying a cool $247 million to earn 83% here, hanging a big pricetag on this land holding. Indeed, Canadian Overseas Petroleum itself boasts a ~$120 million dollar market capitalization based on speculation surrounding upcoming drilling, and its carried interest.
These are the kind of deals investors notice, creating a re-rating of companies holding prime positions in these plays.
There could be a lot more such advances coming—with drilling activity along the West
African coast hitting a fever pitch and an estimated 63 wells to be drilled in the next 2 years!! Wells are being sunk nearly monthly in Cote D’Ivoire, Sierra Leone, Ghana, Gambia, etc. Another big discovery here is likely to drop a match into the growing powder keg of speculation around the potential for more billion-barrel finds.
It’s a great thing when a stock can see big gains based on what everyone else is doing—even before the company pays for a kilometer of seismic themselves. And this low-cost approach to exploration may be the perfect thing for surviving and prospering in today’s E&P sector, where rising expenses continue to take their toll, and smart connected management teams can bring majors thirsty for reserves to drill their blocks at no cost to themselves.