In January 2002 the UK DTI awarded licenses to restart production from the UK's oldest offshore oilfield, Argyll, to two relative newcomers to the market - Tuscan Energy and Acorn Oil and Gas. The deal is one of the flagships of the UK government's fallow fields initiative and the newcomers' success is symptomatic of the development of small, niche, oil and gas exploration/extraction start-ups spawned by mega-mergers at the oil majors in recent years.

The face of the oil and gas business has changed. The oil and gas acquistions market has been frenetic over the past few years. Typical of the movement is ENI acquiring Lasmo who in turn acquired Monument. The combination of market consolidation, restructuring, advances in extraction technology and the political will to extract from what were fallow fields in areas like the North Sea and stranded reserves, have spawned some relative newcomers.

Acorn, Ramco. Tuscan, Eclipse Energy, Venture - all have been founded by ex-oil/gas major staff. Acorn, for example, is run by Mark McAllister, formerly of Lasmo and Monument. Similarly Tuscan is the brainchild of an ex-Atlantic Power crew - Dave Workman, Doug Elsby, Ken McHattie, Paul Schofield and Joanne Harris -  which was bought by Petroleum Goe Services in 1998 for £63 million.

All the newcomers are niche. All are pushing the boundaries in terms of technological innovation. All are run by management/owners with a long track record in oil and gas at the majors. And all are looking for innovative funding.

Although some banks like JP Morgan Chase have pulled out of minor oil and gas, the sector is still popular with many niche lenders including Royal Bank of Scotland, Bank of Scotland, Bayerische Landesbank, CIBC and WestLB. "Historically this has been a secure sector to lend into," says James Pope, director of structured project finance at Credit Agricole Indosuez. And despite the fact that, according to according to Dave Fassom, director at portfolio broker HWA, "the last four months have seen a real surge of interest from investment houses in the US, Canada and the UK in North Sea trade," structured funding techniques outside portfolio trades for the majors remain limited.

In simple terms many of the niche deals are too small to involve the cost of heavily structured financial engineering. Future flow securitization structures, although they have been tried, are not an option because "as oil and gas reserves deplete over time the asset life is falling," says Pope. "And anyway cash from oil and gas flows has a natural seasonal volatility."

Funding innovation

Brian Wilson UK Energy Minister, has reservations about the banking response to North Sea change. "The North Sea is no stranger to innovation [technological]...but I do not think the same degree of innovation has been applied to our investment and finance models. Nevertheless, the investment models and relationships being developed by Tuscan and Acorn on Argyll are breaking new ground and will hopefully provide lessons for the future."

Production on the Argyll Field stopped 10 years ago - after producing 100 million barrels - and is forecast to restart in 2003. The Argyll Field was originally owned by BP. Acorn Oil and Gas has taken a 35% stake, Tuscan Energy - the field operator - 65%.

Despite being start-ups, the new license holders have both managed to secure funding. In February 2002 Tuscan Energy (with KPMG acting as financial advisor) obtained a £10 million private equity investment from Aberdeen Murray Johnstone (AMJPE) - the biggest investment yet in Scotland by AMJPE. And in October Credit Agricole Indosuez provided a $20 million senior debt facility to Acorn Oil and Gas to fund its commitments on Argyll.

Further similar North Sea redevleopment deals look likely. Royal Bank of Scotland is already looking at funding First Oil Expro's redevelopment of the Don field on behalf of current owners BP and Conoco. And the fallow field policy is high on the DTI's agenda. Last year the DTI sent a delegation to look at US operations like ATP and Newfield which have been at the cutting edge of fallow field development in the Gulf Of Mexico.

However, and despite attempts by the DTI to promote the sector, according to a recent report by global energy consultancy Wood Mackenzie, the value of North Sea asset trade deals - a global thermometer for niche field development - has fallen to a four-year low. The oil majors are hanging on to assets in an attempt to play down production growth targets. The bottom 80% of assets owned by the majors account for as little as 16% to 29% of total company value. The conclusion is that less productive fields are not being run or made available to the niche players with the economics of scale to maximise returns.

Others claim that global portfolio trade figures have been skewed by the mega-mergers. And outside the North Sea business is brisk. In September Lundin closed a $172 million syndicated and bridge loan from Barclays Capital and Bank of Scotland for the assets of French oil and gas group Coparex International. The deal is the largest borrowing base oil portfolio lending transaction to be completed in the UK.

Fallow fields

Nevertheless the slowdown in North Sea portfolio trade is a worry for North Sea fallow field redevelopment. The DTI estimates that there are 4 billion barrels of oil in the North Sea which are potentially recoverable and are not being worked. Some of the pools contain as little as 10 million barrels of oil and are simply not economically viable for the majors.

Furthermore, abandonment obligations mean that there is an economic interest for the majors to keep infrastructure in place without further investment. Minister Wilson is combating the problem head on by changing the licensing system. Under the old system oil companies could hold licences for North Sea blocks for 40 years without investing in them. Under the new rules, which are being introduced by agreement with the industry, acreage is deemed to be fallow if it has no investment for four years.

In addition to licence changes, the UK government has started a number of initiatives to safeguard the future of North Sea income - most notably PILOT. The scheme is a collaboration between industry and government and has launched a Fallow Register under UK LIFT (License Information for Trading) in a move to unlock unexploited oil and gas potential.

But political will aside, the attraction for investors on these deals is clear. AJMPs £10 million gamble on Tuscan is based on a return on equity on a post extraction potential value of 40 million barrels in Block 30/24 which at oil prices at the time represented $300 million in total value (Block 30/24 includes the Argyll, Duncan and Innes fields).

And banks and investors follow very conservative investment criteria. Risk analysis - if a producing asset - is based on the minimum production profile, discounted oil and gas pricing, and a further 8-10% overall discount. Typically banks will lend up to 70% of acquisition price with venture capital putting up the rest.

But the speculative nature of the business can make funding difficult to come by without offtake agreements - despite the relatively small size deals. Scotland-based oil and gas production and exploration company Ramco is typical of the funding hurdles that face small oil operators

Ramco pulled off a coup in the mid-90s when it joined the consortium that found oil in the Caspian Sea offshore Azerbaijan. It sold its 2.1% carried stake to Amerada Hess two years ago for $150 million. This war chest, together with the fact the company has a successful oil services division, has allowed Ramco to keep going and stay profitable.

But earlier in the year concerns about delays in bringing its Celtic Sea Seven Heads gas strike on stream came to light when the company reported its interim results in September. The pre-tax loss for the six months to June 30 2002 was £2.7 million against a profit of £1.9 million for the first six months of 2001.

Now Bank of Scotland is arranging a six-year £60 million project financing for the company. The deal, expected to close in first quarter 2003, will fund development of Seven Heads. Ramco is project operator with 86.5% of Seven Heads production and is in partnership with Island Petroleum (12.5%) and Sunningdale Oils (1%).

An exploration well on the block 48/24-54 tested a maximum flow rate of 15.7 million cubic feet of gas per day. On the basis of this discovery Ramco reaffirmed its assessment that the field could have 500 billion cubic feet of gas in place with 350 billion cubic feet recoverable.

The project - £100 million in total costs - is underpinned by a seven-year gas offtake agreement with UK energy company Innogy, with prices linked to the spot price at the UK balancing point. The gas - 50mmscf-80mmscf per day depending on field performance - will be landed by subsea pipeline at Marathon's Kinsale Head facility. The project includes an option on Innogy's part of extension to the life of the field. Deliveries of gas are expected to start before the end of 2003 at around 50 million cubic feet (500,000 therms) per day and rise to 80 million cubic feet (800,000 therms) depending on field performance.

Whilst the UK fallow fields story to date is Tuscan and Acorn, further niche deal flow and funding innovation is a certainty. US-based ATP has already crossed the atlantic to the Helvellyn Field and is promoting deferred payment structures. Similarly Ramco's relatively small project finance deal is unlikely to be its last.