Northern Petroleum (NOP) owns a tiny share in an oil project in the previously untried waters off the French Guiana coast. In all they have a claim to 1.25% of a licence they share with Tullow Oil, Shell and Total.
It doesn’t sound like a significant prospect does it? Northern certainly has much bigger and more advanced interests in the Netherlands and Italy, so this gamble on a drilling programme off the coast of South America looked nothing more than a corporate extravagance.
But last Friday the gamble paid off handsomely when Tullow struck oil. It added £20m to Northern Petroleum’s stock market value. This little South American afterthought could turn out to a company maker. And the discovery could yet have far wider implications – signalling the prospect of huge returns for investors in penny oil stocks.
Tullow may have discovered a major new oil region
Tullow Oil (TLW) is the operator of the licence – it owns 27.5% of the Guyane Maritime licence, while Shell (RDSA) owns 45% and the French giant Total (FP) has 25%. Drilling at Zaedyus began in March, so it has taken some time, but Tullow has discovered a 72-metre band of oil bearing sands.
Pre-drilling estimates suggest that Zaedyus could hold 700 million barrels of oil, worth some $80bn at today’s prices. But the discovery has wider implications. It suggests that the area off the north-eastern coast of South America could become a major new oil region.
This is the first well that Tullow has drilled here, but the total size of its licence area is a massive 26,340km² – much larger than any of its previously successful licences and second only in its portfolio to its Omo licence in Ethiopia. So Tullow now has a huge canvas upon which to work, and is no doubt already planning the best way to proceed.
The find also confirms a theory. The reason that Tullow chose the north-east coast of South America is because it had previous success off the west coast of Africa. Since the continents of South America and Africa were joined together billions of years of ago, there is good reason to think that the geology off the coast of west Africa is similar to the north-east coast of South America. Since oil has been found at the former, it should be present at the latter. Oil discoveries off the Brazilian coast have already supported the theory, and this provides more confirmation.
A vital message for you as an investor
There is a message here that will not be lost upon the oil industry. But there is also a message for investors. If you want the chance to get some real bang for your buck, you need to invest in small companies.
Shareholders in Tullow were rewarded with a 15% gain on Friday, and those in Northern Petroleum – a much smaller company – benefitted to the tune of 30%. But for the real extremes consider Shell and Wessex (WSX).
Shell is a £73bn monster. So even 45% of what could be the most significant oil find of the year has had no more impact than a fly on an elephant. Shareholders in Shell had nothing to celebrate whatsoever. Overwhelmed by the broader trend on what was a gloomy day for the stock market, its share price actually fell by 2%. But Wessex is valued at just £35m. So even though it only holds a tiny 1.25% interest, its shares raced up by 53%.
Penny stocks can grow quickly in a falling market
The contrast could hardly be starker. Shell is so big and so diverse that any one single event makes little difference. From day to day its share price is driven by macro-driven stock market sentiment and not by its own efforts. For Wessex, on the other hand, whose only other interests are in Hampshire, Dorset and the Isle of Wight, its share price is driven by company-specific events. And a tiny share of an oil discovery was enough to send its value sky high.
That is why, despite the risks being higher than investing in blue chips, I like small companies and penny shares. If the business does well the shares will perform, regardless of the market context. It is of course important that you maintain a diversified portfolio in order to spread your risk, but if you think that stock market sentiment is going to remain gloomy for a while – and plenty currently do – I see no point whatever in buying into giants such as Shell that will not be able to buck the trend. But if you get into the right small companies you will make real money, regardless of what is going on elsewhere. Nowhere is this more true than in the oil sector.
• This article is taken from Tom Bulford’s free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.
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