Falling Prices, Credit Woes Threaten Small Oil Firms: world economy’s outlook darkens: Shell shares down by 25% since July

THE WALL STREET JOURNAL

As Reserves Lose Value, Bigger Rivals Target Independent Companies for Acquisition; Waiting for a ‘Big Shakeout’

By GUY CHAZAN

The stress in global credit markets is forcing some smaller European oil companies to sell assets and renegotiate debt, while turning the weakest into acquisition targets for bigger rivals.

Most at risk are small outfits focused on exploration and production that urgently need cash to keep drilling. Even a few months ago, these companies had no trouble borrowing money and selling stock to finance operations, based solely on the value of their reserves. But with access to capital drying up, their funding opportunities are dwindling rapidly.

“Smaller oil companies will feel the crunch,” said Aidan Heavey, head of Tullow Oil PLC, a midsize oil company based in London. “There’s going to be a big shakeout.”

The squeeze comes amid a broad selloff of shares in global oil companies as the world economy’s outlook darkens. A steep fall in oil prices is driving the decline. Since peaking at $145 a barrel in July, U.S. benchmark crude has fallen 39% to $87.81 Monday. European integrated oil majors, such as Royal Dutch Shell PLC and Total SA, have seen their share prices fall an average of 25% over that time.

But at least the majors, with strong revenues from operations and significant amounts of cash on their balance sheets, are more or less immune to the chaos in capital markets. Highly leveraged independents are much more vulnerable — especially heavily-indebted ones that have tended to outspend their cash flow — and have seen a much steeper selloff in their shares. Over the past three months, shares of exploration and production companies trading on the AIM, the U.K. market for small or high-risk companies, have tumbled 50%.

There are already signs that this could lead to consolidation as small competitors are gobbled up, often by state-run companies from Asia. ONGC Videsh Ltd. of India is buying London-listed Imperial Energy Corp., whose assets are in Russia. China Petroleum & Chemical Corp, better known as Sinopec, is acquiring Tanganyika Oil Ltd., which operates in Syria.

Smaller companies also are bulking up. Last week, London-based Salamander Energy PLC proposed a takeover of Serica Energy PLC, which is focused on Western Europe and South East Asia. And last month Victoria Oil & Gas PLC, London, said it was in discussions to acquire Bramlin Ltd., which operates in Indonesia, Africa and South America.

Not all small and midsize oil companies are experiencing financial difficulties. “It’s a case of haves and have-nots,” says Simon Lockett, chief executive of London-based Premier Oil PLC. He says Premier has most of the cash and financing in place for its exploration and production needs over the next three years. But other companies that raised money on the AIM “were undercapitalized and will have problems over the next couple of years,” he says.

Tullow’s Mr. Heavey says his company also isn’t affected by the credit crunch. Last year it tidied up its balance sheet, selling off some assets for $1.2 billion and clearing all the company’s debt. Tullow is finalizing a $2 billion long-term credit facility but is “in a position where we can carry out all our major projects without banks,” Mr. Heavey said. “We have good strong cash flow and no debt.”

But those in a weaker position are having to sell assets or find partners for their most promising projects to get the cash infusions they need. That will create opportunities for majors that want to rebalance their portfolios by entering new countries. “Companies will sell down and that’s good news for the asset market,” says Premier’s Mr. Lockett. “The caveat is that the industry has really struggled to get deals done because of the volatility of the oil price.”

Among those divesting is London-based Sterling Energy PLC, which recently was forced to raise funds to meet bank requirements by placing new shares and farming out a slice of its oil field in Iraqi Kurdistan to rival Addax. It also entered into an agreement to sell its U.S. assets.

Urals Energy OOO, a heavily indebted Russian oil producer, confirmed last week that it was looking for a partner for its Siberian production unit, after a Russian newspaper said it was in talks with Shell on selling a stake. Shell denied the report.

Oilexco Inc., a small oil-and-gas company that operates in the North Sea, lowered its 2008 production targets and said it was having difficulty raising its credit lines to $1 billion from $700 million, citing the “unprecedented liquidity and volatility issues facing the credit markets.”

Others have been forced to reduce their exploration budgets and shelve expansion plans.Connacher Oil & Gas Ltd., based in Calgary, Alberta, said it was postponing plans to expand capacity at its refinery in Great Falls, Mont., citing uncertainty in the capital and credit markets.

Write to Guy Chazan at [email protected]

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