Oil companies up for grabs but the deals pipeline is blocked

And so it is that Roughneck, who may or may not be Richard Slape at small-cap specialist broker Canaccord, has alighted upon the sort of stat that is making those old-fashioned types who actually buy shares on the stock market sit up and take notice.

"Casting around for things to write," Roughneck blogged the other day, "it occurred to me that I hadn't looked at the collective performance of AIM's oil and gas companies for quite some time.

"When I did so I must confess to being surprised at just how bad things have become. The FTSE Aim oil and gas index is [back] at a level it first reached on a day when Brent crude was trading at $34 per barrel in April 2004.

"The fully-listed companies have given up 15% of their value this year and 26% in the last three months. The relevant figures for the aforementioned Aim index are 33% and 42%.

"Having spent much of the last few years complaining about what I believed to be the ludicrously high valuations of many of the upstream players listed on London's junior market, I now find myself in the curious position of thinking many of them to be chronically undervalued."

There is barely an oil and gas analyst in London who isn't talking up his client list and indicating the sector is about to be engulfed in an Exxon Valdez-like slurry of takeover offers and mergers.

But while many have been pointing out for some time that we are in that part of the industry cycle called consolidation — one-time small independents now maturing toward production and appearing ripe for the plucking — the recent sharp fall in the oil price and the deflated price therefore of many stocks is beginning to highlight what look like raging buys.

In truth, the process of consolidation has already started with £3 billion of deals going through on the London stock market alone in recent weeks and months in Burren Energy, Imperial Energy and First Calgary Petroleum.

"The fact is it is cheaper to buy companies than assets currently," says broker Daniel Stewart's Tim Heeley. "As such, what is everyone waiting for?"

Heeley says he looks for companies with decent proven and probable reserves in the books with small enterprise value-to-cash ratios — that is, companies whose stock-market value is not much more than the cashflow being thrown up. And he can name 10 without breaking sweat.

Answering his own question, it is the "human factor" that is causing the delay. A lot of these companies are run by former folk of the Big Oil supermajors and all have the egos that come with that.

"Many boards and senior management teams believe their companies are the natural consolidators," says Heeley. "The market is mostly occupied by self-purported consolidators."

Stephane Foucaud, analyst at Fox-Davies Capital, prefers to look at larger independents — those who have built up reserves of more than 100 million barrels and which might make some form of difference to an acquisitive company higher up the food chain.

"The recent very significant contraction of oil and gas companies' market caps means that numerous companies trade at a steep discount to their net asset values," he said.

But there are some stand-out reasons why the deals aren't flowing.

A lot of these smaller explorers are working in an industry where costs have soared along with the oil price: the cost of hiring the rigs and the people at this month's prices may soon be well ahead of the price at which the black stuff can be extracted.

And then there is the fear of looking foolish in this unforgiving industry.

With the oil price down 36% in two months, why buy now when the stock prices could be way cheaper next month?

Six that are attracting interest

Soco International — Management that specialises in finding and developing assets and selling them on. Vietnam and African plays suggest it may be bought lock stock and 160 million barrels of reserves.

Venture Petroleum — North Sea driller (exclusively) which enjoys a good record of exploration-to-development-to-production of hitherto abandoned fields. Reserves of 200 million barrels booked.

Faroe Petroleum — Another North Sea driller with respected management. Regarded as both a consolidator and a potential target.

Roc Oil — Australian explorer that got into China through Apache and which is to more than double in size through a merger with Bass Strait producer Anzon.

Oilex — Asia and Indian subcontinent play whose stock price is valuing almost only its cash and not its reserves.

Northern Petroleum — Drilling along in the south coast of England. Reserves are respected but investors are spooked by high-profile sellers of the stock.