The merged company, to be called British Borneo Oil and Gas, will be the third biggest player in the sector after Enterprise Oil and Lasmo with commercial reserves of 240m barrels and a portfolio taking in the North Sea, Gulf of Mexico, Australia and Pakistan.
The deal is taking the form of an all-paper offer with British Borneo, Britain's oldest oil company, issuing six new shares for every seven shares in Hardy Oil and Gas.
At last night's closing prices, the offer values the combined group at pounds 790m and Hardy Oil and Gas at pounds 294m. British Borneo shareholders will emerge with 63 per cent of the enlarged group and Hardy Oil and Gas shareholders with 37 per cent.
John Walmsley, chief executive of Hardy Oil and Gas, is quitting with a pay-off expected to be in the region of pounds 600,000.
The chairman and chief executive posts will be filled by Sir Bob Reid and Alan Gaynor, both from British Borneo, while the finance director will be Hardy Oil and Gas' John van der Welle.
The two companies denied that they had been forced together by the low oil price. Mr Gaynor maintained that the alliance was "an ideal fit in terms of strategy, assets and cash flow".
But the market greeted the deal by marking down British Borneo's shares by 13 per cent and analysts did not rule out the possibility of a cash bid for Hardy from one of the oil majors. Hardy shares closed up 15p at 180.5p, compared with the 225p that shares were issued at in July's pounds 86m rights issue.
Alan Marshall, oil analyst with Robert Fleming, said: "It is good for the sector that some consolidation is taking place because there are a lot of small niche players and not much investor enthusiasm for the stocks."
But there were fears that the deal would be dilutive for British Borneo while it would be difficult to gauge whether the merger would pay off for some years, he added.
However, Mr Gaynor said the merger would combine British Borneo's strong cash flow from the Gulf of Mexico with Hardy's longer-term production profile while balancing up the portfolio between oil and gas. Combined output is forecast to rise from 27,000 barrels a day now to more than 100,000 barrels from 2000 onwards.
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