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Financial Times: Energy: Banks still have a role to play

By Thomas Catan
Published: May 30 2006 19:15 | Last updated: May 30 2006 19:15

With energy prices at record highs, oil and gas companies are hardly begging for money these days.
ExxonMobil has posted the largest annual profit in corporate history; BP, Royal Dutch Shell and other “supermajors” are struggling to find ways to use their huge infusions of cash.

Collectively, the largest oil companies have returned well over $120bn to shareholders through share buybacks and dividends over the past two years. ExxonMobil alone is returning $2bn to shareholders every month.

Even so, oil companies continue to sit on record levels of profit. ExxonMobil’s cash mountain has reached almost $32bn, behind only Microsoft and Berkshire Hathaway. It is likely to overtake Microsoft this year to become the wealthiest non-financial company in the world.

“In essence, anybody with significant amounts of [oil and gas] production can probably fund their business without recourse to the equity markets,” says Richard Slape, an analyst at Seymour Pierce, the investment bank.

“On the whole, their problem is not knowing what to do with all the money, rather than where to get some more from.”

Most oil companies are able to fund even multi-billion dollar projects from their own balance sheets, with little need to raise more capital. But there are exceptions.

One is liquefied natural gas. LNG developments require vast amounts of capital and often have half-a-dozen equity holders.

“A lot of LNG projects tend to be financed because you have a number of joint venture partners, some weak, some strong,” says Uwa Igiehon, managing director of energy finance at RBC Capital Markets.

In particular, projects that have a state-controlled national oil company as a partner may wish to turn to project financing.

“Mostly, the oil companies are funding their own projects,” explains an official at one of the supermajors. “But if you get involved with a state company that is resource-rich but cash-poor, that’s where things like project financing can come in. They can help partners to get the money.”

Bankers also claim that the due diligence and scrutiny they bring to projects has other benefits. Financed projects, such as BG’s in Egypt, have mostly been completed on schedule and within budget. By contrast, many self-financed projects like Statoil’s Snohvit have been plagued by delays and cost overruns.

Companies may also wish to secure outside financing for a project if it threatens to be controversial.

For its $20bn Sakhalin-2 project in an environmentally-sensitive area off the east coast of Russia, Royal Dutch Shell has sought financing from the European Bank for Reconstruction and Development (EBRD), among others.

The reason: Shell wants the imprimatur of a public sector lender on the project, which protest groups say will threaten the western grey whale and despoil Sakhalin’s pristine environment.

BP’s Baku-Tbilisi-Ceyhan (BTC) pipeline, running from the Caspian Sea to the Mediterranean, was also built with support from a range of public sector lenders, including the World Bank’s International Finance Corporation and the EBRD. Export credit agencies from the UK, Germany, France, Italy, the US and Japan also backed the project, which was the target of environmental activists.

Turning to such public institutions can hugely complicate the process of financing a project, and gives opponents new and visible targets to put pressure on. But many oil companies feel that the public process can give them future cover from any allegations that they did not live up to international standards.

Record energy prices have obviated the need for even the mid-cap oil producers to tap the equity markets for extra funds.

Companies such as Cairn, Burren, Tullow, Premier or Venture, have now grown large enough to access a variety of funding options, says a banker who has worked on several recent deals.

“If they’ve got booked reserves and production, then they can get bank lending facilities secured on reserves. They can look at the convertible market, high yield bond market, or they can look at equity,” he says.

Soco International, for example, raised $250m in an unusual convertible bond issue this month.

It is the very smallest exploration companies, often with no production or booked reserves, that have been the most active in the equity markets.

In particular, there has been a boom in initial public offerings of oil minnows on the Alternative Investment Market (Aim), London’s junior share market.

The oil sector has been the star performer on Aim over the past couple of years, driving valuations of often speculative stocks to very high levels.

But some analysts say the boom in IPOs could be coming to an end.

“Some of it has been highly speculative to say the least,” says Mr Slape.

“As a group, they’ve massively underperformed the more mainstream companies. Investors are starting to wake up to that and perhaps now starting to be a bit more discerning.”

Last year, oil companies listing on Aim raised nearly £500m. In the first quarter of this year, there have been four IPOs raising just £20m between them, according to Seymour Pierce.

“I think it’s becoming a bit tougher for them to raise money,” Mr Slape says.

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