International Deals a Different World

APPEX to Feature Practical Advice

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 project.

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 the novice.

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 APPEX prospect expo 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.

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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 project.

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 the novice.

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 [PFItemLinkShortcode|id:20862|type:standard|anchorText:APPEX prospect expo|cssClass:asshref|title:article - APPEX Provides Efficient Market|PFItemLinkShortcode] 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 by numbers.

"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.

Be Prepared

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 regions.
  • 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 commit capital.

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.

Straight Talk

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 risk, including:

  • 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 rates, etc.
  • Political environment: government regulations, political turmoil, possible expropriation.
  • 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 crucial.

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 agreements.

Financial Matters

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 project.

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 basis.

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 industry downturn.

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.

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