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Cairn’s lucky strike in the oil lottery

The Times: Cairn’s lucky strike in the oil lottery

““Still, it (SHELL) must have some regrets about giving away a winning lottery ticket.”

Indian find is akin to being given a free ticket and winning the lottery, says the exploration company.

Report by Peter Koenig

Posted August 15, 2004

TEN DAYS ago, on the morning of August 6, Bill Gammell and Kevin Hart, chief executive and finance director of the Scottish oil-exploration group Cairn Energy, arrived at their Edinburgh headquarters distracted.

Gammell, 51, who, to his chagrin, is as well known for his childhood friendships with George W Bush and Tony Blair as for his accomplishments as an oilman, was thinking ahead to a week’s holiday in Fife.

Hart, 35, a refugee from a City job at Deutsche Morgan Grenfell, wasn’t even supposed to be at work — he was meant to be taking the day off.

A chart on the wall held their attention. It showed an analysis of mud-cuttings drilled from an exploration well in India only hours earlier. It confirmed what the two Scots, the company’s 400-odd other employees and a growing body of investors suspected — Cairn is the 2004 winner in the global economic and geopolitical oil lottery.

Players in this game line up each time the price of crude rises like a phoenix from its previous crash. Early-round winners announce oil strikes as prices rise. The independent oil company hitting the jackpot is the one making significant oil-strike announcements nearest to the oil-price-cycle peak.

“We waited for further physical evidence to make sure of the analysis,” said Hart.

Investors heard on Tuesday that Cairn had made its fourth oil strike in seven months in the desert of Rajasthan, a province of western India famous for its maharajahs and warriors wearing turbans.

Cairn’s announcement came as the prices of Brent and West Texas crude for delivery in September hit record highs due to a supply squeeze punctuated by fears of terrorist attacks and other threats, including the possibility that Russia’s Yukos might stop its 1.7m barrels-a-day production.

Its share price shot up 7% to £14.10, four times its 52-week low. The value of Gammell’s stake rose to £15m, while fulfilment of two incentive schemes assured him of compensation this year of more than £4m, according to Peter Brown, chairman of Independent Remuneration Solutions. This makes Gammell Britain’s second highest-paid oilman after BP’s Lord Browne.

Cairn’s Indian success conforms with wildcatter folklore. Analysts say it’s the result of courage, persistence, technical skill and, not least, luck. In the face of the City’s sophisticated discounted cashflow analyses, Hart sums up the financial reward from this success simply. “Say we’ve found 200m barrels of recoverable oil,” he said. “Multiply that by $30 a barrel. You get $6 billion.”

News accounts of Cairn’s good fortune have been spiced up by rehashes of Gammell’s peculiar fortunes as a boy. Son of the founder of the legendary Scottish fund manager Ivory & Sime, Gammell spent time with George W Bush at the Bush family compound at Kennebunkport, Maine, after his father helped George Bush Sr to finance a troubled oil venture.

Then Gammell went to Fettes College with Blair. Last November the Queen invited Bush to stay at Buckingham Palace, and Blair and Gammell were asked to come to the reception.

Cairn and Gammell now face the question all lucky winners face. What next? “Management has done very well this year,” said Andrew Whittock, an oil analyst at Numis. “But they’re under pressure to continue to do well.” Cairn’s goal since Gammell established it in 1988 has been to double its value every three years. It has pursued this by shrugging off the caution shown by rivals.

With a market capitalisation of £2.2 billion, Cairn is Britain’s largest independent oil company. Tullow Oil is next with a market cap slightly less than £800m. Cairn operates in three countries, Tullow in 17, including Britain. Tullow’s finance director, Tom Hicks, points to an insurance policy Tullow has against a spell of dry holes or a fall in the oil price that Cairn doesn’t have — producing fields in the North Sea. “If oil goes down to

$12 to $14 a barrel again, companies will suffer,” Hicks said. “But we have ballast in the UK and other industrialised regions.”

CAIRN got involved in southern Asia as a partner with Shell in 1997. Together with the American oil-services company Halliburton, then run by US vice-president Dick Cheney, the two European oil companies developed the Sangu gas field in Bangladesh. Shell had exploration rights in India’s Rajasthan. Hart said: “As we were tying up our Bangladesh joint venture, more or less as a make-weight, we took a 10% interest in Rajasthan.”

Shell’s seven-year exploration licence in Rajasthan expired in 2002. The oil major was frustrated. Its plan to become a leading energy supplier to India’s fast-growing economy had been blocked by Bangladesh’s refusal to allow Sangu gas to go to India. Bangladesh sees Sangu as one of its few natural resources.

Shell then bowed out of exploration in southern Asia. It was the only oil major to be drilling in the area, in any event. It sold its stake in Rajasthan to Cairn for $7.2m. “Shell had good reasons for doing what it did,” said a source knowledgeable about the sale. “Still, it must have some regrets about giving away a winning lottery ticket.”

Cairn knew its Rajasthan acreage had the right geological structure for finding oil. But it could not find a reservoir until January, when it took a flyer and drilled a well 40 miles north of where it made its first tentative discoveries. The Mangla field transformed Cairn in January. Its 120m-200m barrels of recoverable oil makes it larger than the Buzzard field northeast of Aberdeen, the biggest North Sea oil discovery in 20 years — although still a far cry from fields in the Middle East, Gulf of Mexico or Siberia. The NV oilfield Cairn found last week could produce about 60m barrels of oil.

Richard Rose, an oil analyst at Oriel Securities, calculates that Cairn’s Indian oil justifies an £8 to £10 share price. “The fact that the share price is at

£14 means the market is anticipating further discoveries,” he said.

At Numis, Whittock calculates that Cairn must find another 500m barrels of crude to close the gap between its share price and net asset value. “Management must deliver six or seven more discoveries like the one last week,” he said.

Analysts say this is an ambitious but realistic goal. Cairn has five rigs in Rajasthan. They can drill 35 wells between now and next May, when its exploration licence expires. If Cairn is to avoid disappointing investors, it will have to strike oil in up to half the exploration wells it drills, Whittock estimates.

If Cairn passes this test, it must then get the crude to market. The government-controlled Indian Oil Company has contracted to build a pipeline from Cairn’s Rajasthan fields to a refinery 180 miles away.

Analysts say construction may be slow because of Indian red tape. Hart says the government will move fast, because the country needs oil and more than half the revenue generated by selling Rajasthan crude will go to it in taxes and other fees.

Confident of its achievement in India, Cairn is now shifting its sights to a third under- explored Asian country. Last week its exploration director, Mike Watts, signed a contract with the Nepalese government to explore an area five times the size of its Rajasthan fields.

Nepal is practically virgin territory. Only one oil well has ever been drilled there, by Shell in 1988. Hart says Cairn is seeking to repeat its against-the-odds wildcat success in India.

Meanwhile, Hart is preparing for Cairn’s selection to an elite City club — a slot in the FTSE-100 stock index. That is likely to come this autumn when the index managers next convene.

Rose at Oriel said Cairn’s oil price might be high partly for technical reasons. “When the company announced its discovery in January, the share-price rise was exaggerated, because a number of institutions had shorted the company, and had to cover their positions.” Now, as Cairn moved from being a FTSE mid-cap stock to a FTSE-100 stock, it had owners from funds targeting both categories. “This, too, has exaggerated the upward trend,” he said.

Cairn also faces rumours of a takeover engendered by nothing more than its successful strike rate and a high oil price.

In the face of such speculation, Hart laughs. As he sees it, his problems are those of the lottery winner who has to decide what to do with his money — invest it, buy a yacht, or give it to friends. “These are the kinds of problems you like to have,” he said.

Additional reporting: Dan Box

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