Executive Insider

Junior firms must drill deep for capital in an uncertain economy

February 16, 2012

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Emerging oil companies require a good deal of upfront capital, unlike many other start-ups which can be started on modest initial expenditures. The oil business is expensive and risky; both in the finding of oil and in the developing it. Very few people have the ability to fund such an endeavor personally, so they must depend upon capital from other sources.

Debt financing, and borrowing from banks and the like, is an option once the company has a guaranteed revenue stream. For start-ups, equity from issuing shares is usually the first step in securing capital. In a buoyant market it can even be an ongoing step. But we are not in a buoyant market right now, and the majority of investors are nervous as to where the world economy is heading. As a result, they have been holding onto their money, and what little they invest often goes to large companies that they perceive have more security.

With even large stable companies trading at well below net asset value in many cases, who can blame them? But this situation really hurts junior oil and gas companies. It has the double effect of limiting capital to small caps and depressing share prices such that further equity can substantially dilute the existing shareholders.

At Terrex Energy, we raised our initial capital of $15 million in 2010 essentially through the usual method of issuing shares and captured our first enhanced oil recovery (EOR) project. Then we raised another $14.7 million through a forward production sale, where we were supplied capital in exchange for supplying the investor with about 20 per cent of the company’s production. This allowed us to acquire a second oil project without issuing more shares, which would have had a dilutive effect on our equity. We are now working on developing these projects fully, and even adding additional ones to our portfolio. We will likely need to be creative in going after capital again.

We are a small company with significant capital requirements and longer lead times to production than many new oil companies. But this is offset by our strengths. We are oil-oriented in a world of strong oil demand and robust pricing. We are also focused on exploitation not exploration. We are concentrating on the use of EOR technology to develop significant new reserves in mature pools. We have three shovel-ready projects that have the potential to yield over four million barrels of oil with the application of in-fill drilling and chemical water-floods.

We may have to explore other options besides debt and equity to fund our work in the future. Some of these options could be financial or industry joint ventures, forward production sales and even consolidations, which offer growth and reduce overall operational costs. Another avenue is a limited partnership or other yield arrangements, which have the potential to provide an investor with a guaranteed return plus advantageous tax treatment. This could be an attractive replacement of the old energy trust model.

A creative company is receptive to investigating conventional and unconventional finance sources to grow shareholder value. Terrex has an immediate use of funds, with clear production growth potential, which should be attractive to many investors. It’s encouraging that the last few weeks have shown signs of growing investor confidence in the stock market and an interest in investing again in the junior oil companies whose shares have been particularly hard hit and are often trading well under their net asset value. It is also reasonable to assume that continued low interest rates will encourage investors to expand their risk tolerance for smaller cap companies and for participating in different financing ventures.

More posts by Kim Davies

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