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Oil explorers push boundaries of political, geological risk

When Pete Landau went to Somalia – amid a civil war – to search for oil in early 2006, a local adviser gave the chief executive of Range Resources two choices: either travel with enough security to repel roaming warlords or go pretty much alone so as not to attract attention.

Mr. Landau rode in a 15-car security convoy to view two oil blocks that he later bought. Last month, the Aim-quoted company (Aim is a sub-market of the London Stock Exchange) raised £20-million ($32-million U.S.) in part to help develop its onshore Somali assets, in partnership with Sweden's Lundin, with a total resource estimate of more than 3 billion barrels.

Range's exploits are one example of how oil companies are increasingly prepared to push the boundaries of political and geological risk in frontier exploration.

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According to figures compiled by Wood Mackenzie, frontier basins – or those with no previous discoveries – attracted 6 per cent of the global $330-billion spent by explorers between 2000 and 2009. However, in the same period, they saw the fastest growth in drilling. In 2009, driven by the diminishing prospect of big finds in mature and emerging basins, frontier plays were the only category to register an increase in wells drilled on the year before, from 81 to 115 in places such as offshore São Tomé, Uganda's Lake Albert and Kurdistan in northern Iraq.

"There is more money that's flowing to exploration in general, so people will push the boat out on some of the geographies they deal in," says Andrew Fry, head of Europe, Middle East and Africa oil at Goldman Sachs. "Investors are looking for explorers with a proven record of success going to riskier areas. As a result, the majors are now increasing their exploration as low-hanging fruit runs out. That means a greater risk profile generally."

Such was the case with BP's ill-fated venture with Rosneft, the Russian state-owned oil group. In spite of its well-publicized setback, investors' demands for growth and the Arctic basin's estimated 412 billion barrels of oil equivalent mean that analysts expect other western oil majors to try to team up with Rosneft – and possibly BP to try again.

On the other side of the Arctic frontier, Cairn Energy, in a statement on Thursday, says it has approval from Greenland's government for a $500-million drilling program to target several billion-barrel prospects.

What constitutes frontier risk varies considerably. For Cairn, according to the company, it is the logistical challenge of "managing and provisioning two rigs, at least 12 supply boats and 600-odd people". For Range in Somalia, according to Mr. Landau, it is the "odd chance" of terrorism. Although Somalia remains an outlier – for now – the oil industry regarded Uganda in much the same way until oil was struck in equatorial Lake Albert. Heritage Oil, a Ugandan pioneer, sold its Lake Albert stake for $1.45-billion to Tullow Oil last year. Tullow brought in China's Cnooc and France's Total in a subsequent $2.9-billion deal.

"Today's mature basins were yesterday's frontier basins," says Richard Rose, an analyst at Oriel Securities. "What you've seen over the past five years is the trend of frontier exploration increasing because investors are more willing to provide funding."

Apart from established explorers such as Cairn, Tullow and Premier Oil, it is smaller companies that typically lead the most extreme frontier plays.

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"At the exploration stage, there is not a huge amount of risk capital – and the potential rewards are huge in the event of success," says Keith Morris, an analyst at Evolution Securities.

"Small explorers will look to exit before the big development capex spend comes in. Then countries usually look to change the rules when the cash starts to flow – by which time the small companies are long gone."

Aminex, which has substantial operations in east Africa, has an offshore concession in a highly prospective market considered politically forbidden: North Korea.

"You have to push out to politically and physically difficult places," says Brian Hall, chief executive.

A year ago, Aminex signed a production-sharing contract in the Korean East Sea but western sanctions against the North Korean government mean it has to tread lightly. Aminex is deferring bringing in a partner until the geopolitical situation improves.

"North Korea doesn't sit well with our U.S. assets politically at the moment," says Mr. Hall. "If this acreage were off the coast of Angola or Brazil there would be a rush to go there ... Because of the politics, it may as well be on the moon at the moment."

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Are there any places still out-of-bounds? According to Alex von Sponeck, director of emerging market debt financing at Goldman Sachs, it depends on where companies are based.

"The markets are as supportive as they could be at the moment: if western companies could do business in, for example, Syria or south Sudan or Somalia, there is a strong likelihood that the markets would finance them," he said.

"So I think the real hurdle at present is a regulatory one, not a markets one. You can find a way to attract investors for 'frontier' frontier markets in the ongoing hunt for yield."

Copyright The Financial Times Ltd. All rights reserved.

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