Wildcats making a comeback

Nov. 12, 2007
You don’t encounter “wildcat” much anymore.

You don’t encounter “wildcat” much anymore.

The word appears hardly at all in reports from oil and gas companies, especially the small producers that once loved it.

And “rank wildcat”? Forget about it.

Producers still have to explore for oil and gas, of course. But when they drill wells out where the wildcats prowl they call the holes they make “exploratory wells.”

So an activity that the oil and gas industry once enshrined with jargon it now hides behind euphemism.

The reason for this retreat from decoration is, of course, risk. Everyone knows exploration is risky. It also requires money in large amounts.

Big companies supply their own drilling capital. Small and medium-size companies, however, must raise capital from outsiders, many of whom find delicious comfort in an aphorism popular since, oh, the oil-price collapse of 1986: The best place to find oil is in an oil field. Investors entranced by this view treat self-proclaimed wildcatters as reckless throwbacks.

Financial metrics

On balance, the industry is surely better for this change. It’s oriented more than before to essential financial metrics calibrated to risk and less to finding hydrocarbons every fifth hole or so. Alas, the financial metrics have for many years drawn capital toward acquisitions and development plays at some expense to exploration.

The money migration has solidified the upstream petroleum business financially but deprived it of a certain zest. Without its wildcats and wildcatters, the oil and gas industry lacks something, like a barbeque platter without jalepeno peppers.

Spice, though, might be returning to the menu.

At least one investment analyst sees exploration as-gasp!-emergent opportunity for small producers and their investors.

Edison Investment Research, London, even uses the word “wildcat” in an October report calling exploration “where the upside is today.”

Especially in the late 1990s, the firm says, success for small independent producers “was built on acquiring small-sized, low-risk assets in mature areas (generally from majors seeking larger discoveries in frontier regions), developing those assets efficiently, and subsequently benefiting from the increasing oil price.”

Uncertain oil prices in that period justified low asset valuations at high discount rates. Investors could buy producing assets and hope for growth without incurring disproportionate risk. Rising oil prices have especially rewarded production-oriented investments in the past 3 years.

But Edison Investment doubts oil prices will rise much more.

“The current stable, high-oil-price environment has made this [production-focused] model difficult to emulate,” it says. “Furthermore, the current environment warrants a change in strategy towards companies which instead focus on organic growth via capital-efficient, well-informed, high-reward exploration.”

The firm identifies three types of plays able to generate “material returns” in a price regime it sees as dulling the allure of production investments.

One is niche plays, such as heavy oil and revitalization of abandoned fields-relatively low-risk ventures on which companies can profit from special expertise. There’s not much exploratory romance here, but Edison Research sees these ventures as something beyond what it calls “pure vanilla E&P plays.”

The firm’s second appealing play is “high-impact, wildcat frontier exploration.” Now they’re talking. This area, Edison Research says, “is where we believe the greatest potential for value creation and high returns exists.”

The third play on Edison Research’s list encompasses high-impact opportunities in mature areas, the type of strategy that yielded EnCana Corp.’s 2001 discovery of 500 million boe Buzzard oil and gas field now on production in the UK North Sea.

The firm favors the “upside” provided by exploration in contrast to the producing and development investments that probably have reached peak value.

“We instead believe that a high oil price environment and the associated potential for high reward have created the ideal environment for investment in high risk-high reward exploration,” it says.

Edison Research likes producers that not only orient themselves to exploration but that also understand the subsurface, use capital efficiently, balance risk and reward, and focus on drilling.

Managing risk

In Edison Research’s view, then, successful producers not only take but also manage risk. They do so by employing skillful geoscientists and engineers, working through partnerships, keeping exposure to the cost of failure below rewards available from success, and staying busy.

Edison Research calls all this “derisking.” Some might call it sensible caution, a trait common to wildcatters who’ve been in business long enough to reminisce about the good old days.