Forgive me for asking this but why is Soco's strategy to develop and sell off assets rather than produce and sell the oil? Just seems a bit at right angles to most other E&P's.

Apologies if this is obvious and stated clearly somewhere, I'm still relatively new to a lot of these companies. Even though I hold shares in many of them!

thx
lfc

why is Soco's strategy to develop and sell off assets rather than produce and sell the oil?

The difference between the two is huge, prospecting as opposed to plumbing.
Soco concentrate on what they are good at [and prefer doing].

Forgive me for asking this but why is Soco's strategy to develop and sell off assets rather than produce and sell the oil? Just seems a bit at right angles to most other E&P's.

It's exactly what >90% of E&P's are trying to do!! Certainly the ones that have any gumption about them, although some like Premier have a ragbag portfolio of bitty assets that noone in their right mind would want to buy. :-))) You deliver most value to shareholders for the least cost at the exploration stage - after that you have huge amounts of capex to deliver lesser amounts of value, after that you have the tedious and risky business of actually producing stuff (qv Chinguetti) and then being liable for the environmental cleanup afterwards. Who in their right minds would want to do that when they could be playing elephant polo having made a mint?

There's a bit of survivorship bias - you may forget the likes of Edinburgh and Burren who were bought out, whereas we are still lumbered with the likes of Premier. But the classic E&P model is to have a bit of cashflow from some production somewhere, that funds the exploration. The likes of Aminex, Sterling and Elixir are classic examples, having the ultimate in "dull" production in the US, funding exploration of potential elephants in "exciting" places in Africa (and also the NS in Elixir's case). SOCO's just a bit unusual in staying closer to the "small" E&P model, just with bigger prospects, rather than something more akin to say Dana who have retained quite a lot of production. And they've retained the same nameplate on the door by selling off individual assets rather than selling the whole company and starting again - but then Cairn have effectively done that as well with their return of capital.

But no, selling up assets is very much what E&Ps do, and that's generally the way that shareholders make most money - you should be somewhat suspicious of directors who appear to actually want to run an oil company. :-))

some like Premier have a ragbag portfolio of bitty assets that noone in their right mind would want to buy. :-)))

Quite!...nonetheless, they are I think the oldest independent E&P on the London market, commencing business pre WWII IIRC, so they are born survivors....to date anyway! And their sp has traded in a range of about 1 to 10 for the last decade, which just goes to show that the opportunity is there to make good money out of them even if they are relatively poor explorers with bitty assets!

Not that I'm recommending them for a moment but survival, courtesy of cashflow, does have its merits...allowing one to make a bob or two ;-)

after that you have the tedious and risky business of actually producing stuff (qv Chinguetti) and then being liable for the environmental cleanup afterwards. Who in their right minds would want to do that when they could be playing elephant polo having made a mint?

Presumably anyone believing they can pick up a bargain and grab assets that will be worth a lot more in the future when the PoO rises? Why would anyone, anyone with reasonable nounce that is, pay more for assets than they can make from them? The only reason I can see for selling stuff on is WM's point about specialisation within an area of expertise. The profitability argument only works in the 'greater fool' scenario. Which I admit doesn't rule it out....

lfc

Presumably anyone believing they can pick up a bargain and grab assets that will be worth a lot more in the future when the PoO rises?

Interesting use of the word "when". :-) I'm sure that was the logic Sinochem used when buying Yemen at $70-75 equivalent.... Most oil companies try not to make huge calls on the POO, in fact they try to reduce its influence by hedging - they just don't feel that it's really their job to play POO, although individual directors may have very strong views on the subject....

The only reason I can see for selling stuff on is WM's point about specialisation within an area of expertise.

Think about housebuilding - do Wimpey and Barratt have large portfolios of tenanted property? No - they see their business as capturing the capital gain of development, rather than the steady drip of rents paid by tenants? On the other hand a REIT or the PMT crowd may be at the very opposite end of that spectrum. Not to say that both can't make money, it's just that they have different amounts of capital available, different risk profiles, and different needs for capital versus income. Same with the oil business - the big boys have huge amounts of capital to deploy on the right project, but they are relatively risk averse. So they're quite happy to outsource the risky business of exploration to smaller companies, and are happy to wait until the project has been substantially derisked. They may pay what seems like a premium price to get those magic 1P/2P reserves onto their books, but it suits their requirements. Or you have the likes of the Chinese who are willing to pay generously for strategic reasons. But at the end of the day if the seller thinks they're getting a good price, and the buyer is happy with the price they're paying - then you have a deal. That's business.

Think about housebuilding - do Wimpey and Barratt have large portfolios of tenanted property? No - they see their business as capturing the capital gain of development, rather than the steady drip of rents paid by tenants? On the other hand a REIT or the PMT crowd may be at the very opposite end of that spectrum. Not to say that both can't make money, it's just that they have different amounts of capital available, different risk profiles, and different needs for capital versus income. Same with the oil business - the big boys have huge amounts of capital to deploy on the right project, but they are relatively risk averse. So they're quite happy to outsource the risky business of exploration to smaller companies, and are happy to wait until the project has been substantially derisked. They may pay what seems like a premium price to get those magic 1P/2P reserves onto their books, but it suits their requirements. Or you have the likes of the Chinese who are willing to pay generously for strategic reasons. But at the end of the day if the seller thinks they're getting a good price, and the buyer is happy with the price they're paying - then you have a deal. That's business.

Completely agree with all that. Hence the comment about specialisation. But that's still a bit different from saying one area (explo) is inherently more profiatble than another (production) which was the gist I got from your previous post;

You deliver most value to shareholders for the least cost at the exploration stage - after that you have huge amounts of capex to deliver lesser amounts of value, after that you have the tedious and risky business of actually producing stuff (qv Chinguetti) and then being liable for the environmental cleanup afterwards. Who in their right minds would want to do that when they could be playing elephant polo having made a mint?

Regarding;

Most oil companies try not to make huge calls on the POO, in fact they try to reduce its influence by hedging - they just don't feel that it's really their job to play POO

I was under the impression the majority of companies didn't hedge - is that wrong? I know dana don't but confess I'm not sure about many others. Is there a list somewhere of which companies do or is it a case of going through all the different company sites? Surely companies must take some view on PoO otherwise how would they make a call on which projects are worth progressing? Presumably long-term decisions can't be made on the basis of spot prices alone?

lfc

Most oil companies try not to make huge calls on the POO, in fact they try to reduce its influence by hedging - they just don't feel that it's really their job to play POO

I was under the impression the majority of companies didn't hedge - is that wrong?

Most companies indeed do not hedge, as they reason that their equity investors are content to accept the oil price risk.

The exception is where bank borrowings come with conditions attached that demand hedging in order that interest payments can be secured out of cashflow - or sometimes, as with Tullow it seems, indebted companies go down that route themselves (Tullow have hedged 15,000bopd in 2009).

ee

But that's still a bit different from saying one area (explo) is inherently more profiatble than another (production) which was the gist I got from your previous post;


In terms of return on capital - it is. And if you've not got much capital, you won't be building $1bn pipelines or whatever in any case, but you might afford a share in a $20m exploration well. But that potential for reward comes at the expense of higher risk. E&P's are more prepared to take that risk. Alan Booth usually includes a slide on this kind of stuff in the early pages of Encore presentations, it might help you to look at one - his last Oilbarrel one did and I think his AGM one.

I was under the impression the majority of companies didn't hedge - is that wrong? I know dana don't but confess I'm not sure about many others. Is there a list somewhere of which companies do or is it a case of going through all the different company sites?

The hedging thing is complicated. Traditionally companies emphasised the financial stability that hedging could bring, it was viewed as a thing that made the shares more appealing by derisking the financials. Then British Borneo happened (went bust after production problems meant they couldn't fulfil their hedge obligations) and people went off the idea of hedging to derisk.:-) And during the bull market, it became fashionable to pass off the POO risk to the shareholders "because investors want the POO exposure". I suspect that hedging may become a bit more fashionable in current circumstances - the Mexicans for instance have hedged almost all of this year's Pemex production at $70-100 and now look like geniuses.... :-)))

That said, the bigger E&P's have tended to maintain some hedging even independently of the requirements of their lenders - Tullow have always been somewhat "hedgey" for instance, long before their recent borrowings, and ISTR Premier did as well. In contrast SOCO have taken a more "small E&P" approach of passing that risk on to shareholders, with no hedging. Again it's one of those things that varies with corporate culture. But yes, I'm not aware of any central repository of hedging information, you have to dig individually (usually in the AR) for that kind of stuff.

Surely companies must take some view on PoO otherwise how would they make a call on which projects are worth progressing? Presumably long-term decisions can't be made on the basis of spot prices alone?

Hurdle prices are a slightly different argument to hedging. For one thing, small E&P's will generally have much less capital than ways to spend it, which means that in general they're not doing marginal projects where they have to weight these things up carefully (the exception being the "vulture" companies working to extend end-of-life fields), they just keep plugging away on the projects with the best IRRs, on the basis that noone can sensibly forecast the POO in 5-6 years time which is the sort of timescale you might be looking to progress something from explo->production. Obviously you don't get too silly about it, you still need some kind of view on the oil price - but they're not going to spend money hedging against possible production from a prospect that hasn't even been drilled yet.

Presumably anyone believing they can pick up a bargain and grab assets that will be worth a lot more in the future when the PoO rises? Why would anyone, anyone with reasonable nounce that is, pay more for assets than they can make from them?

Because like you they are perhaps being overly optimistic about oil prices? :-))

I don't want to go on about this, but I happened to come across this piece from Kenneth McKellar of Andersen Petroleum Services for the AAPG which I thought was relevant :

http://www.searchanddiscovery.net/documents/abstracts/annual...

A recent study carried out by Andersen analysed fifty historical North Sea oil & gas
investment transactions. The aim of the study was to determine whether the premiums
paid for these assets could be justified. The results of the study showed that on average
a premium of 10% was paid to acquire assets. Further analysis, based on current
knowledge of the assets showed that the market had in fact paid a 29% premium to
acquire the assets in question. In all it was found that 75% of the assets had not justified
the premiums paid and that investors consistently paid too much to acquire assets.

In other words, in hindsight 75% of all transactions involve selling to "greater fools"... :-)))

People might be interested in the rest of that piece, it discusses various ways of valuing assets, real options etc in an equation-free fashion. Bit too handwavey for my taste, but some may find it useful.

In other words, in hindsight 75% of all transactions involve selling to "greater fools"... :-)))

My goodness. Its a giant Ponzi scheme! Run for the hills! Save yourselves!

:)

Ummm this sort of depends doesn't it on how much they underpaid for the other 25% surely. I didn't read it so probably should not post but surely if 25% of the transactions worked out being a spectacular buy which brought home assets worth several times what they paid and the other 75% just failed to break even then the opposite conclusion could be reached.

Since aquisitions value oil in the ground quite often (i.e. a bit of a guess) I would expect this scenario could well happen.

Perhaps a better study might be to look at the total resulting asset values of all the transactions and compare that against what was paid - maybe they did this.

Morning Hal

the study you cite was written in 2001

As you will remember, POO spiked in 1972 and stayed elevated until 85-86

it then moved sideways/downwards until 97 when it hit a low before a bounce which petered out around 99-00

00-01 it fell back again

that was the point at which the Andersen study was undertaken

Seems to me that the study's conclusions amount to no more than saying that POO has been weak over the time period when the historic transactions were measured.

As we all know POO started a spectacular, multi-year rise around the time the study was published.

I would very much doubt that its conclusions would hold true for transactions conducted since 2001.

I think that a very large number of asset acquisitions made since 2001 have proven to be extraordinarily successful.

RG

Should add that my dates are rough and ready approximations

ref www.wtrg.com/oil_graphs/oilprice1947.gif

the study you cite was written in 2001.....

Seems to me that the study's conclusions amount to no more than saying that POO has been weak over the time period when the historic transactions were measured.

As we all know POO started a spectacular, multi-year rise around the time the study was published.

Furthermore, since it relates to the North Sea, I'd suggest further discussion of it (if warranted) doesn't belong on this board!

ee