In the not-too-distant past, independent
oil and gas producers who ventured into the international arena
to search for hydrocarbons were a rarity. Today? There's nary a
raised eyebrow when even the smallest of players announces an overseas
International exploration likely will become increasingly
alluring for explorers of all sizes, given the unrelenting political
and public opposition to domestic drilling.
Consider, for instance, that the Bush administration
recently bowed to pressure from the opposition regarding the planned
Lease Sale 181 in the eastern Gulf of Mexico -- and reduced the
sale area by a whopping 75 percent, and, the Gulf sale is still
not a certainty. At the same time, the U.S. House of Representatives
voted to block exploration in national monument areas and under
the Great Lakes.
No matter how attractive an overseas drilling venture
might appear, however, it's a whole different world from the domestic
scene. Sharing "war stories" can be an important first step for
With this in mind, all current and wannabe international
explorers should mark their PDAs -- a calendar will suffice -- to
attend "international night" at the upcoming
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August 27-29 in Houston.
Besides a talk by Alfredo Guzman, exploration manager
for Pemex, the Tuesday, August 28, evening international event will
feature three independent geologists who will discuss their experiences
in making the transition from domestic to international exploration.
The three are AAPG President Robbie Gries, Priority
Oil and Gas; Jim Allen, Sovereign Oil and Gas; and G. Warfield "Skip"
Hobbs, Ammonite Resources.
The scope of international E&P is best defined
"The 163 public companies included in the 2000 Arthur
Andersen Global E&P Trends survey spent $19.7 billion in capital
expenditures in 1999 in Latin America, Africa, the Middle East and
the Asia Pacific," said Dan Foley, senior vice-president of corporate
finance at Mission Resources Corp.
"That's over three times the level spent in 1995."
Foley authored a paper focused on international exploration,
development and production financing, which is included in last
year's AAPG special publication, International Oil and Gas Ventures:
A Business Perspective.
There are a number of unique aspects indigenous to
international projects that impact the amount of financing required,
how easy it is to obtain and the types of financing that are available:
- Projects may be in remote, frontier or generally unattractive
- There may be a high degree of political risk.
- A different approach to environmental, regulatory and political
issues may be required.
- Infrastructure investment may be necessary for pipelines, roads,
storage facilities and such.
- Lag time between discovery and production can be extensive.
- Projects may have to be sufficiently large to justify a company's
entry into a new country and to provide economies of scale.
While a prospect may be technically appealing, it
still may not satisfy the financial criteria needed to raise or
It's highly advisable to plan the financing for a
project and to become familiar with potential sources of financing
early on when preparing an exploration or development program, Foley
said. In fact, evaluation of the project's financing requirements
should be done simultaneously with the overall technical planning.
The best preparation for financing the program, he
added, is to talk to corporate finance professionals active in the
market. These include financial services firms, investment bankers,
commercial banks, multilateral organizations -- such as the World
Bank and other development banks -- and specialized financial consultants.
Financial consultants and investors will examine
a number of aspects of the planned drilling program. The primary
focus, however, will be the relationship between risk and return.
The project developer is cautioned to keep two primary
rules in mind:
- The required rate of return on an investment is a direct function
of the perceived risk of the investment, i.e. the risk of loss
or substandard return on the investment as perceived by the market
of potential investors.
- The perceived risk of the investment will tend to be reduced
as project sponsors reduce uncertainty by providing information.
It's important for the E&P entity to educate
potential financial partners to the maximum possible extent. Because
these partners likely do not have technical expertise, the developer
must assess their experience in reviewing these types of projects
and their comprehension of the technical information in order to
adequately target material for their review.
Risks cover the spectrum of possibilities, from loss
of the entire investment to reductions on the realized rate of return,
and investors will be concerned with various broad categories of
- Physical environment: geology, reservoir characteristics, surface
conditions, hurricanes, earthquakes and such.
- Economic factors: commodity prices at the wellhead, product
demand, taxes, production sharing terms, costs, currency exchange
- Political environment: government regulations, political turmoil,
- Specific project: accuracy of projections, potential operator
or partner nonconformance, etc.
Foley advises full, realistic disclosure and discussion
of risk and risk mitigation in dealing with potential financial
partners. This will tend to reduce the cost of financing and reduce
the probability of future problems.
Financial partners will want to review a wide array
of information. Work done by independent consultants, such as reserves
reports, field studies, and geologic and geophysical information,
will be essential. Technical evaluations, environmental reviews,
feasibility and cost studies, and financial projections also are
And equally important are agreements providing legal
and regulatory underpinnings for the project, such as production
sharing contracts, joint operating agreements, and oil and gas sales
Different types of financing have markedly different
characteristics, suited in varying proportions for different types
of companies and projects -- and even for different stages of a
Debt is the cheapest form of capital available, when
viewed as an individual element of a capital structure. However,
for reasons related to allocation of risk among the elements of
capital, debt can be much more expensive than it appears on a stand-alone
Project financing and production loans are specialized
types of debt financing generally tied to specific projects. Foley
noted that project financing, particularly, can be a powerful tool
in international development, because it can be designed to partially
transfer certain types of risk from operators to investors -- including
currency and price risk and risk of expropriation.
Care must be taken not to let the capital markets
dictate the type of capital raised or the timing. Consider, for
example, a company that over-leveraged by issuing high-yield subordinated
debt when the market was relatively cheap for that type of security
and, as a result, had a tough time servicing that debt during an
Given the volatility of commodity prices, the significant
operating risks involved in oil and gas E&P and the capital-intensive
nature of the business, the degree to which an individual company
moderates the leverage in its capital structure can be the primary
factor that allows it to survive those not-uncommon down cycles
in the industry.