Hunting for oil in the world's six most promising frontiers

As smaller oil explorers head into promising new fields, some are bound to strike lucky: back the right minnow and you could land tomorrow's oil major today. Tom Bulford looks at the small-cap exploration companies leading the search for new oil reserves.

As smaller oil explorers head into promising new fields, some are bound to strike lucky: back the right minnow and you could land tomorrow's oil major today, says Tom Bulford.

Nothing kick-starts a share price like a major oil find. Last August investors in Gulf Keystone Petroleum (Aim: GKP) saw the value of their shares soar by 592% in just 20 days. Last month, investors in Rockhopper Exploration (Aim: RKH) had the same thrill ride, as the share price raced from 37p to 220p in less than a week. Each had struck black gold Gulf Keystone in the northern Iraq region of Kurdistan; Rockhopper in the south Atlantic, close to the Falkland Islands.

Exploiting these new oil finds will be far from easy, no one doubts that. Due to a long-running spat with the Baghdad government, oil firms operating in the semi-autonomous Kurdistan region haven't had a means of payment for their production. And Rockhopper has no definite plan to extract the oil it's found. It'll need to raise hundreds of millions of pounds to do so, its customers are thousands of miles away, and issues over Argentinean sovereignty of the Falkland Islands are ongoing.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free
https://cdn.mos.cms.futurecdn.net/flexiimages/mw70aro6gl1676370748.jpg

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

Yet despite all this, Gulf Keystone, which has net recoverable oil reserves of perhaps one billion barrels, is valued at £520m. Rockhopper, whose Sea Lion discovery is estimated to hold net recoverable reserves of 230 million barrels, is valued at £470m. While the exact value placed on 'oil in the ground' varies between territories according to factors such as accessibility and the fiscal regime, the message is clear. Find oil, and investors will pile in.

See also:

Fortunes can be made in other natural resource ventures, but it takes time. Mining is a long, arduous process.

The evidence is pieced together bit by bit and the shares move gradually. With oil, one lucky strike and a firm can be transformed overnight. Take Cairn Energy (LSE: CNE). This Edinburgh-based explorer was just another hopeful before it discovered the Sangu gas field off Bangladesh in 1996. The share price took off. It's never looked back. By reinvesting the profits of that first success, Cairn has built a business with a stockmarket value of more than $4bn.

What do these firms have in common? They each made their discoveries by focusing all their energies on looking for oil in regions with great geological promise. They worried about all other factors, such as political risk, later.

As John Teeling of Petrel Resources (Aim: PET), which is looking for oil in Iraq, explains: "Politicians come and go, but the oil lasts forever."

Who'll hit pay dirt next?

The big question for investors is where the next lucky strike will be made. Geology narrows the field. Of the world's hydrocarbon reserves, 40% are contained in 932 giant oil and gas fields, says Paul Mann of the University of Texas's Jackson School of Geosciences. These cluster in just 27 regions, covering

about 30% of the earth's land surface. The largest concentrations are in the Persian Gulf and the West Siberian Basin.

As these regions have been explored more thoroughly there has been an upturn in discoveries of giant fields. In fact, in terms of new finds the past decade has been the third best in the 150-year history of modern oil and gas exploration. Yet the most promising tectonic formations are far from fully explored. Mann reckons new discoveries of giant fields (known in the industry as 'elephants') will continue to be made in these regions, especially in deepwater basins.

With that in mind, oil analyst Helen Campbell, author of the report Top Frontier Oil Countries, has identified the best areas for new exploration. The Gulf of Mexico remains important (regardless of the BP spill), but the costs involved mean this is only really feasible for oil majors. But there are lots of other regions suited to smaller explorers.

Six of the most promising oil exploration regions

West Africa

"Every company I know of is active in West Africa," says analyst Fadel Gheit of Oppenheimer & Co. No wonder it has oil in abundance. Nigeria and Angola, both members of oil cartel Opec, each produce about two million barrels a day. They are major suppliers to America and China. A quarter of total US energy imports are forecast to come from the Gulf of Guinea by 2020.

Now other countries want to get in on the act. Sierra Leone and the Ivory Coast each see oil revenues as a means of financing recoveries from recent civil wars.

The International Monetary Fund (IMF) estimates that Ghana could earn about $1bn a year from its oil production, which is expected to start at the end of this year. BP, Chevron, Total and ExxonMobil all have off-shore oil projects in Angola, while further south the Russian gas producer Sintezneftegaz has made a giant discovery off the coast of Namibia.

Image removed.

Claim your special FREE report: 10 simple rules for maximising your penny share profits

  • Receive the stock market wisdom of a top-level penny share expert
  • Your essential guide to playing the small caps market

The region has one particular attraction. Offshore rigs are out of reach of on-shore terrorists. As Philippe de Pontet of political-risk advisers Eurasia puts it, such projects allow energy firms to "avoid the civil wars and ethnic violence that have plagued [Africa], often fuelled by unequal distribution of resource wealth". The oil can then be shipped to eager foreign customers without ever touching dry land.

Western Sahara

One of the world's most sparsely populated territories, the focus of attention here is the Boujdour Block, a 27 million-acre area that stretches from the Sahara's cliff-lined shores to depths of more than 10,000 feet in the Atlantic Ocean. This could contain oil and gas in line with the significant quantities found in neighbouring Mauritania, although for the time being nobody knows.

That's because in 1975 Morocco occupied this former Spanish colony. Under pressure from the United Nations, oil companies in Western Sahara, including Total, withdrew. According to explorer Kosmos Energy, which is now trying to bring partners into the region, Boujdour's "large structural closures" offer a "company-making frontier exploration opportunity". But while Morocco is happy to award exploration licences, the dispute over Western Sahara's legal status (the Algerian-backed Polisario Front also lays claim to the territory) is deterring all but the boldest bounty hunters. These include San Leon Energy (Aim: SLE), which I'll discuss further in the box on page 24.

The Falkland Islands

News of Rockhopper's oil strike has confirmed what many geologists, headed by Phil Richards of the British Geological Survey, have believed for years. It proved that these sub-sea sedimentary basins, which were uplifted and folded as the African continent shifted away from the South American continent to leave the Falklands Islands stranded out at sea, contain oil.

Reserves have been estimated at 60 billion barrels. That would be enough to catapult these tiny islands, with their population of just three thousand people, into ninth place on the top-ten list of the world's oil owners, behind Russia, but ahead of Libya. Resources giant BHP Billiton has formed a joint venture with the area's largest licence holder, Falkland Oil & Gas (Aim: FOGL). But the oil majors have so far been deterred by the remote location, the extraction challenges, and the likely reaction of Argentina. However, further finds in the current drilling campaign are likely to tempt the majors into the region.

Uganda

In the 1970s, few would have thought Uganda could become a major oil producer. The murderous rule of Idi Amin was one problem. Then there was its landlocked location and lack of suitable infrastructure. But Uganda lies on the Great Rift Valley that runs from the Red Sea through the eastern side of Africa to Mozambique. Since the 1990s, when Heritage Oil (LSE: HOIL) pioneered exploration of the Albertine Rift (a section of the Valley that stretches from the northern end of Lake Albert to the southern end of Lake Tanganyika), Uganda has become the most exciting new oil and gas play in sub-Saharan Africa.

Since the beginning of 2006, 27 wells have been drilled in the Albert Basin. Only one has come up dry. So far, 700 million barrels of oil have been found. Further exploration could take this to more than two billion barrels, turning Uganda from a country that spends $320m a year on petroleum imports, to one making $2bn a year from oil by 2015.

Heritage Oil now plans to sell its Ugandan assets to Tullow Oil (LSE: TLW) for $1.5bn. Tullow is putting together a $10bn industry development project involving France's Total and the Chinese National Overseas Oil Corporation (CNOOC).

The Bahamas

Cuba, which sits on the North Cuba Fold and Thrust Belt, has estimated its oil reserves at 20 billion barrels. Just north of Cuba, and at a junction between the north and south Atlantic rifts and the Gulf of Mexico rift, lie the Bahamas. Licences have been granted over Bahamian waters since 1945.

But activity has been sporadic, with just five wells drilled over 60 years. The last, in 1986, was drilled by Tenneco. At the time the company identified seven structures holding a maximum of 17 billion barrels of reserves. Plans further to define these reserves were halted by the industry meltdown of the late 1980s. However, in 2008, an independent report by Moyes & Co confirmed the existence of more than 20 leads capable of holding "giant accumulations" (i.e. upward of 500 million barrels).

The Arctic

According to the US Geological Survey, 30% of the world's undiscovered gas and 13% of its oil may be in the Arctic. By international law, countries' rights over coastal waters extend to a limit of only 200 miles. So now ownership of the Arctic is being contested by Russia, the US, Canada, Denmark and Norway. Russian submarines have already placed a titanium container holding the Russian flag under the North Pole.

But while the geopolitical chess game continues, oil firms, encouraged by global warming of the ice-cap, are already edging northwards. Shell, Chevron, and ExxonMobil are all keen to drill in the Arctic Ocean, off the north coast of Alaska. Norway's Statoil is poised to explore the Barents Sea, some 500kms inside the Arctic Circle. And this summerCairn Energy will begin drilling off Disko Island in Greenland's Baffin Bay.

Oil exploration could pay high dividends in any, or all, of these areas. Politics, accessibility, and inadequate drilling and production techniques mean that many have yet to be fully prospected. But, one by one, they're opening up. And as Al Stanton of RBC Capital Markets puts it, "exploration still pays". Gulf Keystone and Rockhopper prove that.

I look at three explorers who could follow suit here: Three small-cap oil plays for the bold

This article was originally published in MoneyWeek magazine issue number 489 on 4 June 2010, and was available exclusively to magazine subscribers. To read more articles like this, ensure you don't miss a thing, and get instant access to all our premium content, subscribe to MoneyWeek magazine now and get your first three issues free.

You can read more from Tom by signing up to his free email, The Penny Sleuth.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.