Africa oil favourites of Junior Oils Trust

Jeremy Naylor talks to Angelos Damaskos, CEO of Sector Investment Managers and Fund Manage of the Junior Oils Trust, about the opportunities in the African oil space.

Jeremy:  We have heard a lot about oil opportunities for investors in Africa.  Particularly recently, of course, we have had ongoing interest in Cove Energy.  But also smaller companies like Simba, just releasing a CPR.  The stock has risen on the back of the recent discovery in Kenya, from Tullow Oil.  But a lot of interest surrounding the likes of Simba Energy on such reports, as this Competent Person’s Report that it’s received.

Can you give an overview of the, first of all your Fund performance and your African exposure.  And commentary on what you believe to be the African oil story?

Angelos: Thank you Jeremy.  First of all, interest in the East African oil space as increased greatly recently, on the back of the amazing discovery by Cove Energy of huge volumes of gas offshore Mozambique.  That supported the takeover of this company, which is still to be finalised.  It seems that Shell is on poll position, but it is still not concluded.  And subsequently by the very large, the very good drilling results, as you say, by the first drill by Tullow and African Oil, African Oil, in a joint venture in Kenya.  This indicates potential resources of a very large size indeed.  And according to words of Tullow, they are the best results they have seen in their African operations.  So it is extremely promising.

So there has been a lot of activity by smaller companies, securing neighbouring license areas and acreage that could be equally prospective.  Of course, most of them argue that they are on trend with existing discoveries and therefore very likely to find oil.

Now, investors have to be very careful in backing companies, smaller companies that claim the valuation of their shares is very high, in the back of Competent Person’s Reports.  Because even though the technical assessments on 2D seismic and partial 3D seismic may show very large targets indeed, it is very easy for a smaller company to drill in the wrong place.  And have a very disappointing result for its investors.

Jeremy:  And then, presumably, run out of money?

Angelos: Yes.  For a small company, these wells are very expensive.  There are proportionally, proportionally to the size of the company’s balance sheet, they could have a very, very negative impact.  And that will make it much more difficult for the company to raise further capital and continue its operations.

Jeremy:   So do you think we will see more of what has happened or is happening to Cove?  Do you think we will see a lot of M & A in this area for the smaller oil companies and the explorers being taken out?

Angelos: There could be, but I think the season operators, the likes of Tullow etc, will wait for the first drilling results.  They will wait to see what is it that they have actually found, in order to make a reasonable and realistic assessment of the potential resources before they take over a smaller company.

The exploration game is always stacked against the explorer, typically in an eight to one ratio.  So it is much more likely there is a disappointing result than a successful one.  And at this stage, the early stage of assessing 2D and 3D seismic data is the most dangerous part because no one really knows which is the precise point to drill.  And that’s how the industry operates.

So there would be, there will be, undoubtedly, further takeover activity in the area because the indications are that the resources are potentially vast.  But only in companies, it will focus, primarily on companies that have achieved successful well results, such as Cove, for example.

Jeremy:   Right.  What about the political risk, especially in Kenya with the borders it has?

Angelos: Yes, the political risk is one of the main reasons we have so far avoided the East African space in our Fund, into Junior Oils.  And we have only focused on very, very small selective investments, but should become, should the very negative news would not adversely affect the performance of our portfolio.

But having said that, there is this increasing interest by operators to drill in that space, even at the very large prizes that are potentially available.  Now, of course, Kenya borders with Somalia, we all know about the piracy activities, we all know the instability of the region.  And there is instability in the north eastern parts of Kenya where they border with Somalia.  But generally speaking, Kenya is a much more secure, much more stable economic environment, much more stable government.  And therefore it is much more attractive in terms of investment for large operators such as Tullow and Africa Oil.  And therefore, thereby their success and their interest go into the territory, smaller companies that are at the early stage of the cycle.

Jeremy:   So what about your exposure as the Fund Manager of the Junior Oils Trust at Sector Investment Managers?  What about your exposure, your favoured stocks? 

Angelos: Well, we have certain small holdings in companies that operate in the territory.  In Kenya in particular, we favour a company called First Australian Resources.

Jeremy:   This is an Australian listed company?

Angelos: Which is listed in Australia.  And it has operations not only in Kenya, but also in Senegal and the Guinea Bissau.  So it has a more diversified portfolio, again, it doesn’t only focus in Kenya.  But in Kenya it holds license areas both onshore and offshore that are similar to Simba.  Both existing operations by larger companies and potentially very highly prospective trends that could be very material should they become successful.  FAR is still at the seismic processing stage, so it is very, very early stages, and that’s why we have allocated a very small percentage of the Fund into this play.

And as the seismic processing activities mature, towards the end of the year, they interpret the targets; they are in a much better position to farm out.  And this is the sensible strategy followed by smaller companies like FAR.  So they assess the seismic data, they establish the target, the potential size of the resource, similar to what Simba is saying.  But then they go out to larger companies and present the results and say, “Will you farm in and pay us a certain premium for the work we have done?”  And therefore they get carried for no extra capital at risk.  For the potential, for the drilling which could be positive or negative.

Jeremy:   I notice, actually, in amongst some of the London listed stocks which you hold in the Fund; Serica Energy is one of those?

Angelos: Yes.  Serica Energy again has a diversified portfolio.  It has operations in the North Sea, in the Irish Seas as well as a very large and highly prospective acreage offshore in Namibia.  Now, Namibia is the part of their assets which has attracted us the most in the oil company.  Because there is another company called Chariot Oil and Gas that has been very much in the centre of activity and investors interests on the back of the interpretation of 2D and 3D seismic data offshore Namibia that potentially indicates very large resources.

Now on the back of those results, they farmed out to, first to PetroGas of Brazil, and secondly to BP to Fund the drilling operations.  Now, Serica holds an adjacent block to Chariot, which is probably half the size of Chariot’s acreage.  And again, they have managed to secure farming by BP earlier this year.  So they are fully carried for the cost of the 2D seismic work which is currently being undertaken, as well as for the first two drills.

And on a comparative evaluation basis, if you compare the market cap of Chariot, which is wholly focused in Namibia and that of Serica that has cash and has other assets in the North Sea, Irish Sea and elsewhere, it is a very compelling and evaluation proposal.

Jeremy:   How about Bowleven?  This was in the news recently, I believe, because of a possible bid for the company.

Angelos: That’s right.  Yes.  We like Bowleven.  We have seen, again, it has very material in highly prospective license areas further north offshore **[0:10:13].  It is, we have, and I have to admit that we have traded in and out of Bowleven over the last three or four years, because the way we operate is, we try to acquire companies where we believe that the market organisation significantly undervalued their assets.  And Bowleven, at times, exceeded our target range and therefore was a candidate for cutting back or eliminated from the portfolio.  

But we recently, earlier in the year, have bought back into Bowleven after the very sharp sale, if you like, de-rating in terms of market capitalisation in the markets.  So at roughly where it is now, to about town, we see it is a very, very cheap entry into the license areas which are at a much more advanced stage than the other two I have mentioned earlier.  They have had some successful drilling results.  They have a much better idea of the size of the prospective resources and reserves.  And therefore are in a much better position to market their company and their assets to potential suitors.  

Now there has been an approach, recently, they never disclose who the suitor was, but it seems that it failed to materialise.  They probably failed to agree on a price, and therefore with this potential bid being removed from the table, investors seem to have lost interest again.  And the shares have slid back to the kind of levels.  But we think that these levels, they are extremely cheap and also a great option for a very large and highly prospective basin. 

Jeremy:   I would just like you to comment on one other facet of all of this, underlying all of this, is the price of oil.  What are your thoughts as the price Brent goes below $100 a barrel?

Angelos: Yes.  We believe that, we have long maintained that it is unlikely for Brent crude price to fall significantly below $100 a barrel.  And we have to bear in mind that Brent is at the, here they call it the benchmark for pricing West and East African oil and well as Middle Eastern oil.  So really, it is the most representative price of crude oil for the European, North African and African territory. 

And therefore, on the basis of the statements made by Saudi Arabia principality, which is the most important member of OPEC, we believe that the OPEC members need oil to remain at around $100 per barrel to fund their social programmes.  Saudi Arabia is extremely concerned by the militancy and activity, rebellious activity in North Africa and other countries in the Middle East, such as Syria and Iran.  And they have embarked on a very dynamic and very large social programme to keep their population happy, basically.

And they have said they can maintain, they need oil to stay around $100 a barrel to find these programmes.  So it is unlikely they will let it slip far below that price level without cutting back production.