Filling the void: Private equity capital for new exploration companies

Aug. 1, 2007
Big oil no longer replaces its depleting reserves with the drill bit. According to research by investment banking firm Bear Stearns, the oil majors’ reserve replacement ratio was only 91% in 2006 and 92% in 2005 and represents the third consecutive year in which the reserve replacement ratio for the industry fell below 100%.

Big oil no longer replaces its depleting reserves with the drill bit. According to research by investment banking firm Bear Stearns, the oil majors’ reserve replacement ratio was only 91% in 2006 and 92% in 2005 and represents the third consecutive year in which the reserve replacement ratio for the industry fell below 100%. With global oil demand now exceeding 30 Bbbl annually and the high cost associated with finding and developing reserves, the challenge increases every year.

Indeed, many oil companies are “prospect short,” lacking the commercial opportunities to find more oil reserves even at present prices. Although the major oil companies now devote a higher percentage of their cash flows to expanding their exploration programs, the results remain disappointing. According to Lehman Brothers, while exploration spend began to increase in 2005, the increase largely tracks the rate of inflation in that time period.

Has big oil become so large and risk averse that it no longer seeks new plays that promise less than multibillion barrel opportunities, or is the world’s geology telling us that we have to try harder? This question is compounded by “successful efforts” accounting that requires writing off unsuccessful exploration, thus bringing down near term accounting returns.

Fortunately, smaller companies, including start-up E&P ventures, can help fill this void by finding new reserves. As funding is more plentiful than ever, the lack of capital and technology which used to put them at a disadvantage is no longer an issue. Even before counting the billions of dollars that have been invested outside of the US for numerous international transactions and within the US for new E&P companies, most of which fall outside of the “venture capital” domain. VentureExpert data shows that approximately 140 energy companies, ranging from exploration, technology, development, and production companies to industry service suppliers, have received start-up funding from US venture capital funds of $2.1 billion over the past 10 years. Furthermore, market experts agree that there is tremendous liquidity available today to back energy ventures, as interest in E&P investing is a newer and fast-growing trend. In the US and Europe, tens of billions of dollars of fresh capital has flowed into the coffers of private equity investors over the last several years, earmarked for new energy companies. A booming stock market in Oslo and London’s AIM also provide further capital for young E&P companies.

With financial backing from private equity firms, talented, entrepreneurial management teams are starting new E&P companies focused on finding significant quantities of hydrocarbons. These teams leave large exploration companies because they recognize that the primary resources for success - capital, technology and management skills - are attainable outside the environment of a super major or large independent. They also realize that they can establish corporate cultures that foster efficiency and timely decision-making, all while generating substantially improved financial rewards for all stakeholders. Examples of successful private equity funded exploration start-ups include Spinnaker Exploration and Gryphon Exploration focused in the Gulf of Mexico, as well as Revus Energy in the Norwegian North Sea, and PEARL Energy focused in Southeast Asia.

Some of these young companies target onshore basins in the US, while others devote their resources to finance offshore exploration in places such as the North Sea, West Africa, the Gulf of Mexico and Southeast Asia. Although not all of these new companies will succeed, many will license the blocks, develop the ideas and drill commercial discoveries that will form the foundation for a new crop of independents while helping to bridge the gap between increasing demand and struggling exploration efficiency.

A tremendous opportunity exists today to start, build, and grow new E&P ventures where modern exploration tools and emerging new technologies provide the appropriate risk-reward for knowledgeable investors. The world needs these entrepreneurial and innovative companies to bridge the growing supply-demand gap. Now is an ideal time to harness the billions of dollars of start-up equity and new technological tools available at affordable prices to start new exploration companies.

Jeffrey A. Harris
Managing Director
Warburg Pincus

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