Oil : Where Now is the Tipping Point?

News that Shell is to halt development of its vast Canadian tar sands project is a sign of changing times in the oil industry – and one that will not be well received at the AIM-listed provider of data to the oil industry, GETECH. This is a pity because last week’s annual results statement revealed a share that looked extremely cheap and prompted an 80% rise in its price from 16p to 30p.

The question that affects a great many more companies than just GETECH is whether Shell’s decision is a one-off, reflecting its unusually complex and expensive project in Alberta or is an indication that the oil industry, which has loosened the purse strings in a big way in the last few years, is now ready to tighten them again.

But it was not the tumble of the oil price from $140 to $60 per barrel that was cited by Shell’s chief executive Jeroen van der Veer. ‘We will wait for costs to cool down before any new investment decisions,’ he said, and it is true that the dramatic ratcheting up of exploration budgets has seen an even more dramatic rise in the cost of drilling rigs, seismic surveys, qualified geologists and all the other ingredients of exploration.

The tipping point for the oil price?

But still for the future of oil exploration the oil price is obviously hugely important, and a few assumptions are now being revisited. Only three months ago, in its research note on GETECH, broker W H Ireland said that ‘Even factoring in a worldwide economic slowdown, few commentators are currently forecasting the price of oil to fall below $100, let alone $70.’ How quickly can such forecasts be overtaken by events!

This matters to GETECH because ultimately its addressable market is determined by the size of exploration budgets in the oil industry. Not surprisingly GETECH has been enjoying something of a boom of late, but when I spoke to chief executive Raymond Wolfson he admitted that GETECH had felt a downturn in the late 1990s when the oil price fell. Then it hit a low point of $16 causing most big oil companies to radically cut back on exploration.

Where now is the tipping point? At what price will oil companies decide that it no longer makes sense to throw huge sums at exploration projects – knowing of course that much of that money will never produce any return? This is a complicated issue that depends amongst other things on the profitability of existing oil production, the complexity of new projects (that is tending to rise as the frontiers of exploration are pushed back) and those costs of the necessary equipment and other resources.

According to GETECH this tipping point lies at about $70, so it will not perhaps have been surprised to see Shell’s decision. But it is probably now wondering what this sudden retraction of the oil price means for its own future.

At the frontier of exploration

GETECH was founded by Dr Derek Fairhead of the University of Leeds, who thought it would be a good idea to produce a comprehensive gravity survey for the African continent and persuaded eight large oil companies not only to contribute their own data but also some money. The Africa Gravity Project was begun in 1986 and was the first in what has become a series of such studies that give oil companies the basic location and structural architecture of sedimentary basins that could contain oil.

Today GETECH has one of the largest and most extensive libraries of magnetic, gravity and topographic data covering almost every country in the world and it is soon to launch five new studies each of which covers a specific geographical region. These are East Africa, the South Atlantic, the Taoudenni basin of Mauritania, South East China and the Arctic.

The latter is of special interest as the Russian Arctic is considered to be one of the last frontier areas for exploration and, as proof that GETECH is a company with international respect, it is building databases in partnership with various Russian scientific organisations.

Profits on a rising trend

GETECH typically has these studies part-sponsored before commencement and subsequently licenses them to additional clients. It sells them for several thousand pounds and, as well as the US Government, its principal customers are big oil companies such as Shell, BP and ExxonMobil.

Having cut back exploration departments in the last downturn these giants are wary of rebuilding them and anyway cannot see much point in trying to create their own databases when GETECH has built a comprehensive database from information gathered from all sources.

Building upon strong relationships with its customers GETECH launched its Petroleum Systems Evaluation Group in 2004. Going one step beyond provision of raw data the aim of this group is to provide a more detailed insight of where oil and gas might be found within the sedimentary basins, and offers interpretation of regional tectonics, earth system modelling and palaeodrainage analysis.

The result of this is a rather unusual business with a strong customer base and a minimal requirement for capital investment. Profits have been on a rising trend, reaching £0.9m in the latest financial year and from earnings per share of 2.17p GETECH paid an attractive dividend of 1.3p. GETEC has net cash of £1.6m and owns its Leeds headquarters which is valued in the balance sheet at £2.7m.

So today’s stock market valuation of £8m is well backed by assets as well as by earnings and the dividend but while the immediate concern rests with the future of the oil price, perhaps a bigger issue for shareholders lies with GETECH’s avowed ambition to make acquisitions. So far in the three year of its AIM listing it has been unable to strike a deal and unless it can find one, and a good one at that, it may be destined to remain some way below the radar of institutional investors.

Regards,

Tom Bulford
for The Penny Sleuth

P.S. If you want to follow the tales of a small company investor, and uncover the hidden gems of the stock market, then sign up for the Penny Sleuth e-letter. It won’t cost you a penny…

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Oil : Where Now is the Tipping Point?

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Oil : Where Now is the Tipping Point?