You may strike it rich playing oil explorer roulette

Investment Insider

The oil sector has been brought firmly back into play after BP swung into a full-year profit of £15bn. In 2010 it made a £3bn loss following its Gulf of Mexico catastrophe.

However, the resilience of BP, coupled with its ability to generate cash, has allowed it to not only return to profit but to increase its dividend by 14 per cent.

For many investors, the majors such as BP, Royal Dutch Shell and BG Group will be about as close they want to get to oil and gas. Those that have dabbled have seen their investments deliver market-beating returns over the past decade – about 6 per cent a year in the case of Shell.

However, even those returns are trumped by a trio of explorers, Tullow Oil, Premier Oil and Cairn Energy. They have delivered returns of 2,526 per cent, 1,263 per cent and 1,975 per cent, respectively, since 2000. It just goes to show that investing in relatively unknown oil explorers at an early stage can reap handsome returns.

But how can private investors identify the next Tullow, Premier and Cairn? It is not easy, as oil exploration owes as much to luck as it does to sound geological research.

Leaving luck to one side, a good way of identifying potentially successful explorers is to look for senior people who have left the majors and struck out on their own.

Valuing oil explorers is not an exact science but it is better to be vaguely right than exactly wrong. Your portfolio could include some of the majors and proven oil companies such as Tullow and Cairn. You can then think about sprinkling in more speculative explorers that you have valued, aiming for a good geographical spread.

Using this scattergun approach may feel more like playing "Explorer Roulette" than investing. But with a portfolio of 10 speculative explorers, you should only need one or two to strike it rich for your bet to pay off.

David Kuo is director of the financial advice website www.fool.co.uk