Oil and Gas Eye Q3 2012

The stock market volatility characterising the first half of the year persisted into Q3. Markets varied between concerns over global economic growth and anticipation of stimulatory economic measures from central banks. Against this backdrop, the index increased 5% over the quarter. Despite a sharp drop in value in Q2, the index is now 9% higher than at the start of the year.

Junior oil and gas companies outperformed their larger peers in Q3. The FTSE 350 Oil and Gas Producers Index fell 1%, and oil prices moved to a firmer footing in the three months to end September. Recently oil prices have become disconnected from market fundamentals, looking to wider economic developments for direction. Brent crude prices rose 16% over Q3 to average US$109.68 per barrel. Oil and gas companies also slightly outperformed those in other sectors on AIM in Q3. The FTSE AIM All-Share index increased 4%.

The increase in the index's value masks the sharply contrasting fortunes of many small-cap oil and gas companies. Those with cash flow from producing assets and financed near-term development programmes continue to receive investor support, and companies with acreage in highly prospective regions, like East Africa, can still raise capital. However, 43% of those in the AIM oil and gas universe recorded a share price fall in Q3.

Capital is on the agenda of every board in the sector, whether raising it, preserving or optimizing it, or investing available funds.

Four years from the start of the financial crisis, for many junior oil and gas companies fund-raising conditions are no less challenging. At £48.9m, the total raised from further issues by AIM oil and gas companies in Q3 was the lowest quarterly amount since Q1 2009, and over a third of this related to just one company.

Less than 10% of AIM-listed oil and gas companies successfully raised capital in Q3. Funding challenges are affecting some companies' development programmes. Resaca Exploitation, for example, announced it was only able to progress capital initiatives funded through operating cash flow. In the absence of additional funding, Max Petroleum has issued its shares to one of its drilling contractors in return for services in Kazakhstan.

Companies struggling to secure funding, especially those without revenues from producing assets, may have to turn to larger, better capitalized partners or acquirers. Consolidation of the AIM oil and gas universe accelerated in Q3, with the takeovers of three AIM-listed oil and gas companies completing.

Corporate acquisition activity is likely to stay brisk in Q4. Petroceltic International and Melrose Resources announced they have reached terms for a merger, and Lochard Energy and Valiant Petroleum have begun formal sale or option review processes.

Companies looking to maximize shareholder value through a sales process have a diverse range of potential buyers. AIM-listed oil and gas companies have been takeover targets of National Oil Companies (NOCs), majors, larger independents and AIM-listed peers with stronger balance sheets.

Demand for capital continues to outstrip supply, but, amid negative sentiment, there was a significant glimmer of hope with West Africa-focused Eland Oil & Gas raising £118m through the largest AIM IPO in three years. Two other oil and gas companies joined AIM in Q3, albeit without raising funds, reflecting the market's continued attraction.

Performance of the Oil and Gas Eye index since 2008

Performance of the Oil and Gas Eye index over Q3 2012

Source: Ernst & Young, Thomson Datastream

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