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Oil and gas juniors enjoy improved market conditions

27 November 2009

News this week that two AIM listed oil and gas explorers working in the Falkland Islands had secured new funding has set the scene for a frenzy of drilling activity in the region early next year.

On Thursday, Borders & Southern Petroleum raised £113.1m and Falkland Oil and Gas raised £50m, with both companies setting out their plans for drilling campaigns. Those deals followed two other share placings by Falklands explorers in the fourth quarter; one for £42m by Desire Petroleum and another for £50m by Rockhopper Exploration.

But while anticipation over a long-touted oil bonanza in the Falklands continues to build, juniors elsewhere in the market are also feeling the positive effects of a cautious recovery in confidence and improved oil prices. However, despite the promising signs, analysts are still divided over whether investors really are keen to dive back in to the market or that they simply feel compelled to protect and back-up their existing investments.

According to the latest review by business advisory firm Ernst & Young, activity across the junior oil and gas sector soared in the third quarter. Not only did the firm’s own index make strong gains of 35% during the three months, but secondary fundraisings topped £333.3 million – the highest quarterly total since the spring of 2006.

It says the majority of companies that managed to secure extra investor cash did so in order to speed up asset development and bring forward revenues.

Matra Petroleum was one such example, which raised £5.35 million in July in order to drill Well-13 on its Sokolovskoe field in Russia. That drilling is now underway but it didn’t stop Matra returning to the market this week to raise another £2.0 million to pay for a production licence and explore new ventures. The company’s shares rocketed by 233% during the third quarter.

Elsewhere, Ascent Resources tapped its equity line of credit with YA Global for £1.3 million in July and took a similar amount in October before this week raising £6.0 million. The latest cash has been earmarked specifically for projects that can produce near term cash flow. Ascent’s managing director, Jeremy Eng, said the money would help the company implement its 2010 development plan, “which is focussed on proving up reserves and increasing production”.

Return of IPOs

Despite the buoyant secondary fundraising environment, the absence of any IPOs on the AIM market during the period – and none now for a year – illustrates the uncertainty still felt by many potential backers towards new entrants and the sector in general. But even here, Ernst & Young thinks there could be signs of optimism, with interest levels in IPOs higher than they have been for some time and a pipeline of candidates actively preparing.

It says that interest has been triggered by increasing market stability and a return of investor risk appetite, manifesting itself in an increase in funds flow to equity funds. The increase in capital market activity, including renewed confidence in the transaction market, is a sign that there could be higher levels of IPO activity through 2010.

Alec Carstairs, an oil and gas partner at Ernst & Young said: “With the pipeline of IPO candidates continuing to build, the competition will be fierce. Investors will be seeking the highest quality candidates who will have a strong growth story, visibility of cash generation, credible management, conservative capital structures and the scale to generate liquidity in the stock. Being able to clearly articulate the ‘equity story’ to investors during IPO road shows will be essential for management.”

M&A activity

The final part of the oil and gas picture in the third quarter was a rise in mergers and acquisitions activity – up by 14 deals that the same period of 2008. That’s despite a general slowdown in global deal values and volumes, as depressed gas prices in the US and the longer-term dip in oil prices put companies off.

According to Ernst & Young, the main M&A players this year have been independent companies as both buyers and sellers, with many sellers being forced to do deals in order to preserve shareholder value. Nevertheless, the firm reckons a glut of distressed assets on the market will not cause cash-rich players to be any less cautious, meaning that deal volumes will remain flat for the foreseeable future.

Jon Clark, an oil and gas director at Ernst & Young said: “Transactions in the short-term are likely to include joint ventures involving small to medium-sized corporates and alliances of a strategic or tactical nature. We do not expect to see a return to the record deal volumes and values of 2006-07 and the first half of 2008.

“Meanwhile, the carve-outs that followed the mega-mergers of the 1990s will continue as larger companies sell non-strategic business. While future deals will be structured in a way to be much less reliant on debt than had become the norm, there is financing available for the stronger oil and gas players to make things happen.”