Oil firms becalmed in the North Sea

IN THE Upper Magdalena foothills of the Colombian Andes, Emerald Energy is drilling for oil. And Peter Winton, Emerald's managing director, is enthusiastic. "We hope to prove significant low-cost reserves," he says.

Compared to the oil majors, Emerald is tiny to the point of insignificance. Its Colombian exploration programme will cost some pounds 10m. Yet its optimism, even when crude costs just $11 a barrel, is high. Emerald has to "confirm a giant field at Apulo" in the Andes to reward its investors.

"We expect to make $8 on every barrel we sell at the well-head," says Mr Winton.

But in the oil industry in general, times are tough. Last week, oil giant Shell reported a 53 per cent fall in its fourth- quarter profits, its worst quarterly report ever. Small independent oil companies which operate in the North Sea have it even tougher. According to Crine, an oil industry body, North Sea crude costs $13 a barrel to produce. David Owen, general manager of Crine, says this means "there can be no long- term future for the UK as an oil province".

This grim message is taking its toll. Because many small, independent exploration companies depend almost entirely on their findings in the North Sea, their share prices have followed the plunge of crude, dropping 70 per cent since early last year.

Several explorers now have stock market valuations lower than the value of their assets. According to Caroline Cook of BT Alex Brown, these stocks include British Borneo, Cairn, Monument and Saga. Nick Davies at JP Morgan estimates that both Lasmo and Enterprise - the two "big name" UK independents - are trading at a 35 per cent discount to net assets. In normal times, the shares would be a steal and deals would proliferate. These are, however, not normal times.

One industry executive says: "If this situation continues for several years, the structure of the entire industry will be different. There will be very little non-Opec production left."

Although such a meltdown is some way off, many explorers face losses, cash-flow problems and unpaid dividends. Both Lasmo and Enterprise are expected to suffer losses in 1998. In the meantime, the industry is striving to cut costs and praying that the crude price will recover. Enterprise has just slashed a quarter of its workforce.

Crine believes that cutting North Sea costs can only be achieved by a mixture of pooling resources, improved work practices, better engineering, and the use of new technology. This will take an immense effort and at least three years to achieve, but could reduce the break-even point for North Sea crude from $13 to $8 a barrel.

Successful consolidations are proving elusive. Few explorers have followed BP and Amoco, Exxon and Mobil, Total and PetroFina, which have merged with an eye to cutting costs at the refining and petrol station level.

The City has been distinctly lukewarm about the possibilities of mergers. British Borneo has merged with Hardy, but its share price has halved. News that Lasmo and Enterprise were in exploratory talks failed to set their shares alight.

One analyst explains: "The rationale for any bid would primarily be defensive. It would only work if they could convince the market that the deal would add value."

And this would be difficult. The opportunities for further cost savings are limited. There is little overlap between the two companies, outside the North Sea. There are fresh rumours, however, that Enterprise's chief executive, Pierre Jungels, might be more interested in Monument. Previous talks between the two companies have broken down over price.

Still, the assets of the exploration companies do look remarkably cheap, especially if you believe that crude will rise to $15. Ms Cook at BT Alex Brown says: "All precedents suggest that the oil price will recover and there will be a huge amount of mergers and acquisitions business."

Second-rank players such as Elf, Statoil or BG are watching and waiting for an opportunity to pounce. Confidence in the industry has to rise to spur on the deals, but nobody foresees much change to the crude price in the short term. Julian Lee, at the Centre for Global Energy Studies, predicts: "I think that the outlook for this year is $10 to $12 for Brent."

The Opec meeting scheduled for 23 March is expected to propose cutting production by 1 million barrels a day. Few expect any such agreement to stick, but many think it could herald an upturn.

Mr Davies at JP Morgan, who expects to see crude recover during the next 12 to 18 months to around $15, says: "Exploration and production companies are unlikely to trade on fundamentals until there is a sign of recovery. We do not believe this is the time to buy exploration and production stocks."

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