by Matthew Lynn

16-03-05

Where is the best place in the world to look for oil?
Under the Indian Ocean? In some of the remote regions of Africa? Down around some of those countries with long, tricky-to- spell names that used to be part of the Soviet Union?
No. The best place to prospect for oil right now is London.

The London stock market is going through a speculative frenzy over oil exploration stocks. Investors are piling into stocks based on little more than rumours and hope. Shares are being sold on the back of the purported expertise of developers, not business plans.
Is this just another dot-com style bubble? Or is there a real investment opportunity underneath the hoopla and the hype?

For a flavour of oil mania 2005, here are two examples. On March 14, Afren, a new oil and gas company, listed its shares on the London exchange at 20 pence each. By lunchtime, they had jumped to more than 56 pence, almost tripling in just a few hours. The London-based company raised £ 8 mm ($ 15.3 mm) in its initial public offering.
Afren has a starry pedigree. The directors include Rilwanu Lukman, a former president and secretary-general of OPEC. Another director, Egbert Imomoh, used to run the Nigerian operations of Shell. The company clearly has people on its team who know a lot about oil.

Investors in White Nile, however, might regard those gains as relatively paltry. In February, the company soared in value. White Nile is an exploration company set up by the former England cricket star Phil Edmonds. Listed on the London market at the start of February, the shares increased more than 11-fold in a week before being suspended.
The Financial Times reported that the UK Financial Services Authority was investigating the price surge, which came just before an announcement that White Nile had obtained a stake in an oil field in Sudan. The shares are still suspended.

In total, 24 new oil exploration and production companies have been listed in London in the last 12 months, according to research by Al Stanton, an analyst with Bridgewell Securities in London.
"Every day there is a thump on the door, and it's another oil company prospectus landing on the doormat," said Stanton. "Share prices are being pushed up very quickly, with what I suspect are thin volumes and a lot of trading from private investors. The man in the street could well get burned."

The oil exploration frenzy is starting to show some spooky similarities to the dot-com bubble of five years ago. Take companies such as Afren and White Nile. They don't actually own any oil in the ground yet. Afren has an agreement to take part in a field in Nigeria. The rest of the money raised from investors will be used make acquisitions.
Likewise White Nile. Again, no actual oil. At least not yet. According to a company statement, it was created "to identify and acquire projects in the natural resources sector with particular emphasis on oil projects within Africa."

While oil exploration by its nature always has been somewhat of a guessing game and companies jumping into that world may go on to great things, many of the new companies seem to be as much about presentation as future production. There are few better illustrations of that than FirstAfrica Oil. It actually used to be a public relations business called Financial Development Corporation before a reverse takeover at the start of this year. It's now in the oil exploration industry (and had been rewarded with a tripling of its share price).
The prospects for small, nimble companies that are good at finding oil haven't looked better in years. The demand for oil has been rising strongly during the last two years, and so has the price. The oil giants need to replenish their reserves.

It's not necessarily a bad thing that some oil companies are being floated on the backs of personalities. The oil industry depends on contacts as much as anything else. The more difficult the territory, the more important it is to know the right people. That may well be a crucial factor for success.
The trouble is, a genuine investment story is being over-hyped, just as it was in the technology bubble. The market is channelling investment into an industry that needs it. Yet it is also creating unrealistic expectations and a playground for speculators. Very few of the technology companies that surfaced during that bubble actually went on to make any money, and the same will almost certainly be true of London's new wave of oil companies.

Source: Bloomberg