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AFTER years in the doldrums oil exploration and production is all the rage

Posted on: Monday, 11 July 2005, 06:00 CDT

AFTER years in the doldrums oil exploration and production is all the rage. It's not difficult to see why: surging oil prices and exploration successes have combined to highlight the attractions of the smaller oil stocks to risk-aware investors. The re-weighting of Royal Dutch Shell in the UK benchmark indices is also attracting funds into oil sector stocks.

Premier Oil offers an attractive risk/reward opportunity. The portfolio of assets was restructured in late 2003, re-weighting away from producing assets and increasing leverage to exploration results. Yet the company still has a stable core to its portfolio with established producing assets in Pakistan and Indonesia, providing the cashflow to fund exploration efforts and underpinning the downside that can exist in all stocks in this sector.

Premier's producing fields are generating funds from operations of $120m a year. This is funding the drilling of 12-18 wells per annum. The results worth watching are those from efforts in Mauritania, Guinea and India. To date the field in Mauritania underwent a successful flow test earlier in the year with a new campaign starting this month.

Despite the drilling efforts Premier is un-geared due to the existing cashflows and is conducting a Pounds 10m share buy-back. With valuation, Premier's leverage to the oil price is more modest than some of its peers. Nevertheless, net asset values in the region of 750p a share are reasonable in this oil price environment.

It is one of the few companies not to have been given an "exploration premium" by the market. In part this is justified as exploration results previously have been at best mixed. But this works both ways: the quality of the existing asset base producing cashflow ensures the valuation is not as vulnerable to downside risk from any exploration failure or marked setback in oil prices. At the same time investors have exposure to the large number of opportunities to be explored over the next year.

Premier must be seen within the context of a sector that is generating prodigious amounts of cash. Shell, with its changing corporate culture, has indicated willingness to acquire assets up to Pounds 4.9bn in value. Other majors are likely to participate in consolidation.

Premier may or may not be involved in this process but it may appeal on two counts: the existing asset base and cash-flow may appeal to its peers if the exploration proves unsuccessful; if exploration succeeds, its larger competitors may be attracted to the potential of the new portfolio.

Richard Prew is senior

equities fund manager at

Axa Investment Managers

Source: Sunday Business; London (UK)

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