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Junior oil shares: risky, but the returns can be enormous

Experienced investor David Kempton explains what junior oil companies he is investing in and why. There are dangers, but careful assessment and following a few obvious rules can mitigate much of the risk, he says.

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by David Kempton on Sep 10, 2010 at 00:01

Junior oil shares: risky, but the returns can be enormous

With small resources investments it is possible to achieve profits that will frequently exceed any other sector of the market. Obviously there are dangers, but careful assessment and following a few obvious rules can mitigate much of the risk. Experienced investor David Kempton explains.

The small oils sector is especially interesting right now. The oil price seems to have stabilised at around $75. This is high enough for oil cartel OPEC to make massive profits. The risk is on the downside; if OPEC nations were to over-supply oil, it could bring the price down and force much of the renewable energy sector out of business. This is a course that OPEC is unlikely to pursue, but it worries me occasionally.

Small oils are potentially much more rewarding than the majors because so much of the world’s oil sources are in relatively small volumes, which when discovered and exploited would have minimal impact on a major, but are of real significance to the smaller market cap company. Even the North Sea, where the big fields have been depleted, are still rich pasture for the minnows, who can move in when the majors have moved on. This effect is enhanced by modern drilling techniques enabling access to new volumes previously neglected.

There are essentials to follow. The management or key individual should be proven. The company must be suitably funded and operating in a politically stable environment, with fair tax treatment and good access to a port, pipeline or refinery.

My principle in such high risk investment is to have multiple holdings. Buy several and if one is right it could create enormous profits. If a company drills a dry well, the price could halve, but if the management is good and the company is still properly funded, it will live on to keep trying. I have a colleague who bought Cairn Energy at 17p and still owns them at 450p. Clearly that is exceptional, but I have some on the way, and such performance does happen, covering others that fall.

I sold EnCore Oil this week having seen it move from 16p to 80p in the last three months following moderate interests in two substantial North Sea finds. But I probably jumped the gun on further gains, and rather regret it.

I visit Dublin four times a year and local colleagues alerted me to Tullow Oil (which shares the name of a town 35 minutes from the capital). It has proved a lucky company, but I thought its luck had changed when it bought Heritage, led by ex mercenary Tony Buckingham, for a near £1 billion, to then get hit immediately with a CGT bill from the Ugandan Government. I deliberated selling but then read the apparent successful intervention of foreign secretary William Hague, which creates new credibility and support, so decided to hang on.

I hold 10 junior oil companies, and have recently increased my holdings in some.

Increased holdings

Last week I bought BowLeven (BLVN LN) which just completed an appraisal well offshore Cameroon in shallow water, whilst tests indicated the presence of deeper oil. The rig has now moved to an adjacent well, where exploration results will be known in some three months. This includes the long shot possibility of a world class discovery, which would certainly double or treble the share price. Speculative obviously, but supported by a fair assessment of the facts.

I doubled my holding in Sterling Resources (TSX-V.SLG), not to be confused with the AIM stock of similar name. In the North Sea the company has appraised the largest gas field for 10 years and last week announced the results of a well, when the vice-president stated ‘these results so far exceed our expectations…will confirm commerciality of the field’. The next phase is to establish how big it is. The four brokers who follow it have a ‘strong buy’ note whilst the stock is rising with big volumes. Additionally the company has the third largest gas discovery in Romania and has interests in the Paris Basin and Holland.

I hold Ithaca (IAE-LSE or IAE-TSX) which continues to look interesting. Its North Sea Beatrice Field came back on line and elsewhere performance exceeded expectations. The Company has raised cash facilitating early development of more North Sea interests and the purchase of local production and exploration interests from GDF-Suez. Last month three of the directors bought significant stock and the company still looks to have much upside.

David Kempton is an experienced investor, proprietor of Kempton Holdings and a non-executive director of a number of quoted and private companies.

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28 comments so far. Why not have your say?

I totally agree with DK's observations on this area of the sector and the need to have a wide portfolio of such investments to mitigate the risks.

An alternative to trading individual oil company shares is to invest in a Trust/Fund that specialises in this area. I use the CF (Capita Finance) Junior Oils Trust investing on a monthly basis to take advantage of falls. Using a discount broker (in my case Hargreaves Lansdown) charges are minimised.

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I have also followed this Policy it has paid off handsomely with Tullow Rockhopper Falklands Soco etc. I am doing the same with small US Gas stocks

ie Range.

Small mining stocks are another area where multiple small investments pay off

but its more risky.

The downside is the spread on the price which can often be excessive making dealing expenses high.

The Golden rule is many stocks with smallish investments in each

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The Junior Oils Trust and the Junior Mining Trust, means I can sleep at night.

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Aittch,

I have had handsome results too with CF Junior Oils after investing a lump sum in February 2009 folowed by monthly investments through HL.

Not as good as the profits in Cairn Energy in the article but still very happy, paid my fuel bills for the next few years anyway!

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For those of you who haven't already read it, David Kempton also recently wrote about his investments in junior gold shares:

http://www.citywire.co.uk/money/why-im-backing-gold-mining-shares-through-the-global-turmoil/a415834

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I also have a portfolio of mainly junior oilers, but am surprised that neither Gulf Keystone Petroleum nor Chariot Oil and Gas have been mentioned in David Kempton's article. They have both reistered substantial percentage gains over the last year or so and show no signs of flagging, but, of course, readers must do their own research.

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Yes, junior shares and start ups in general are very risky, but exciting; it's a young man's sport. A good spread of stocks is essential to cover the risk involved, thus, from my own admittedly limited experience in AIM stocks, the nett profit is always average - you can always boast about the good ones of course - so I've learnt to stick with the big fellas. Nonetheless, the temptation remains - slap my wrist!

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I have premier oil plc... from the time they were

37p.... now over £16.00

time to go!!! before I miss the boat..

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I meant to add, it is necessary and good that we should invest in such stocks; after all, where would we be without the entrepreneur.

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The Falkland Islands may be the next potentially profitable investment in the small oils sector. I'm heavily invested in Desire and Rockhopper (who have already found oil).

Very much a gamble, but at the moment a lucrative one!

Time will tell.

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Your could also try Faroe Petroleum big upside to come in the near term IMHO

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Any ideas on Dominion petroleum??

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Thought Heritage Oil only sold their Ugandan assets to Tullow ...... !

A more accurate article would be better .

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I've got Junior Oils Trust, I believe there are opportunities in the sector but it's an area where I don't think I can do better than fund managers.

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You missed out Exillion Energy(EXI:Aim), but you are not alone, as it under the radar of most oil analysts. On the 20 September 2010 it is entering the FTSE All Share Index and the FTSE Small Cap Index. It forecasts to more than double its current 6,500bpd of top grade oil to 14,000bpd by Q2 2011. . Today it announced a $50m loan facility which will reinforce its plans to embark on a drilling programme of 100 wells, over the next 5 years.

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Following the fund managers is less risky but the satisfaction of finding one yourself beats all. I'm relying on Desire & Falklands O & G.

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mcphil - agreed, I own some of small cap miner Herencia and it's having a good day. Might not last but I'm having a celebratory tipple anyway. I just feel less confident about picking oil companies.

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Risky? Suppose I should have stayed with flat/underperforming bluechips!

Since I took control of investment decisions via a SIPP I have consistently beaten the market. It just needs time/research. I have just over 20 holdings in my SIPP with a focus on junior commodity shares.

I agree with an earlier poster who expressed surprise that GKP and CHAR hadn't been mentioned (my 2 largest holdings followed by RKH). Todays action at HER just confirms that there is still value out there if you look for it.

The internet is the best thing that ever happened to Private Investors. Used correctly it enables PI's to stay ahead of the city.

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Gulfkeystones massive find in Kurdistan should have been given a mention.

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Ruth Karp, you forgot to mention that Premier Oil have consolidated their share price by 10 to one so your price paid of 37p should read £3.70p

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AlJolson.. yes of course.. but they are still over £16 now..

from £3.70 !!!! no dividend.. we used to get one in ten free.

presume you hold them as well.. ruth

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Is this the time to sell all the Premier Oil shares..???

highest price ever.. over £16 each...

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Ruth,

I paid 18p (consolidated price 1.80) If my memory serves me right they reached over £2 per share in circa 1980 when the only shares to hold were golds and oils not disimilar from the present time. Premier is a better company today than it was back in 1980 and I will continue to hold them.

I was out of Premier for many years after the 1980 high, they will probably get taken over in the not too distant future, if you are worried then have a stop loss of say 10% below the market.

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What thoughts on Range Resources!

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I do not have any of those shares Christopher, sorry..

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Does anyone have a good word to say about Heritage Oil? I bought a year ago, they did nothing then sent me £1 a share which was then lopped off the share price.!

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Tony

Heritage is a good company and over the long term has performed well.

Regarding the £1 special dividend payment this was paid because the company was so cash rich after selling their African interests to Tullow. Surely you appreciate that if £1 per share is paid out from the assets of the company then the share price has to adjust in line with the depreciation of the assets,

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ruth karp

Sep 15, 2010 at 16:04

Aljolson... tony, sorry I know nothing about the heritage shares.

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