Oil minnows are now on the takeover menu

It's not just the oil price that's tanking, shares in small oil and gas exploration companies have nosedived, too – and there is worse to come. The majors see this as a chance to snap up their struggling smaller rivals, as Jody Clarke explains.

It's not just the oil price that's tanking. Shares in small oil and gas exploration companies have nosedived, too, as speculative buyers exit the market. Falkland Oil & Gas is down 40% this year, Petroneft nearly 70% and Roc Oil, the Australian-based oil and gas player, around 80%. But the 'majors', though heavily down, are coping well by comparison. Exxon has fallen by a more modest 25% since January, virtually tracking the lower oil price. So what's the key difference between the majors and the minnows? In a word cash.

Exxon has the security of a $30bn cash pile built up while the oil price surged. In these times of tight credit, this can be used both to buy back stock and to fund vital exploration and drilling programmes. What's more, falling oil prices don't hurt the majors as badly as some fear. Even when oil prices were surging above $140 a barrel, analysts priced many 'big oil' shares using a relatively conservative $80-$90 a barrel in their revenue forecasts. Why? As MoneyWeek share tipster Paul Hill explains, a number of larger firms have production-sharing deals with the local government in some of the 'frontier' regions in which they operate. The various concessions they win often tax-related allow them to recover their production costs quickly. But this comes at a price if the oil price rises substantially, the host country takes the lion's share of any extra revenue.

For smaller firms, however, all is not so well. Their problem is that they rely on raising debt and equity capital to fund their participation in similar programmes. But fresh lending is now hard to come by, while hedge funds and other speculative investors in small oil stocks have started baling out of the sector hence the battered share prices. And there could be worse to come. "All the companies below $1bn market capitalisation will be swept from the market," Jean Claude Gandur, chief executive of Addax Petroleum, tells the Financial Times.

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Examples of these funding problems abound. London-based Sterling Energy recently sold part of an Iraqi oilfield simply to keep its bank at bay, while Canada-based Connacher Oil & Gas recently announced it was postponing expansion plans at its refinery in Montana in the US Midwest, due to a lack of fresh capital.

But this is all music to the ears of the likes of Royal Dutch Shell and Exxon, who see a chance to gain easy access to previously impenetrable markets, and to boost their reserves cheaply, by snapping up their struggling, smaller rivals. Indeed, as Robin Pagnamenta points out in The Times, the credit crunch is set to unleash a forest fire of consolidation right across the oil industry.

Bids are already piling in. Shares in Soco, the Asia and Africa-focused oil group, surged by 40% in one week as the company confirmed an approach, thought to be from China. China Petroleum & Chemical Corp, or Sinopec, has confirmed it is buying Syrian-focused Tanganyika Oil Ltd, while London-based Salamander Energy is chasing South East Asia-focused oil explorer Serica Energy. We look at a couple of others seen as likely bid targets below.

Junior oil: the best bid targets

According to broker Daniel Stewart, takeover opportunities are now emerging as shares in many small oil companies get seriously cheap. Prime targets include those with sufficient cash and oil reserves to tempt an acquisitive suitor. Stphane Foucaud, an analyst at Fox-Davies Capital, tips larger independents that have built up reserves of more than 100 million barrels. A tumbling equity market "means that numerous companies trade at a steep discount to their net asset values," he told the Evening Standard. As such Oilex (LSE:OEX), which explores for oil and natural gas in India and South East Asia, is a likely target. Its Cambay Field in India alone a joint venture with a local state firm is good for an estimated 49 million barrels of oil and substantial gas reserves. Another joint venture off East Timor has potential reserves of up to 300m barrels of oil. Trading on 8.8 times forward earnings, its stock price is down 63% this year. And that values the company virtually at the value of its cash alone, says the Evening Standard.

Another likely target is Australia-based Roc Oil (LSE:ROC), which although it has made several share-based acquisitions this year, and is set to double in size via a merger with Bass Strait producer Anzon, has now become a target on a pe ratio of just 4.4.

Jody Clarke

Jody studied at the University of Limerick and she has been a senior writer for MoneyWeek for more than 15 years. Jody is experienced in interviewing, for example in her time she has dug into the lives of an ex-M15 agent and quirky business owners who have made millions. Jody’s other areas of expertise include advice on funds, stocks and house prices.