Going Off The Deep End For Oil

China and Italy fuel a frenzy in Angola

Just how wild is the bidding for good oil acreage these days? Over-the-top wild, to judge by a late May auction of tracts in the Congo Basin, off the coast of Angola. To land the licenses needed to explore three deepwater zones, oil companies from Italy, China, and elsewhere offered to pay an astronomical $3.1 billion in up-front fees (known in the industry as signature bonuses), plus $240 million to build schools and other social projects for the impoverished African country. To give a sense of the price inflation involved, in 1999, Angolan tracts in even deeper water brought in up to $350 million. The May bids were "the highest ever offered for exploration acreage anywhere in the world," says Catriona O'Rourke, an analyst at Edinburgh consultants Wood Mackenzie, which has published an analysis of data provided by the Angolans.

The Angola bidding war shows how governments and companies are adjusting to the new high-price oil environment. Governments with rich oil acreage are trying to cash in while prices are high, and companies -- many of them hungry for crude -- are bidding up properties to previously unimagined levels. Adding to the intensity of the competition is the recent participation of national oil companies from China, Brazil, and elsewhere. These national producers just don't have the same profit motive as the private oil majors. In fact, some of the big players such as Exxon Mobil (XOM ) and BP (BP ) are either submitting token bids in these auctions or staying out until things cool down. Oil projects have long lead times, and many of the majors figure prices will come back to the $40 per barrel range or lower.

The Angola bidding is the latest in a number of auctions over the past year or so in which the prices ballooned. They include bids in the deepwater portion of the Gulf of Mexico, Libya, and Nigeria, where a tract recently went to a Korean state oil company for a pricey $310 million. What makes the Angola deal all the more remarkable is that the huge bids were for tracts that had already been cherry-picked by other international oil companies. ExxonMobil, Total, and BP had earlier exploration rights to these vast tracts, and they think they know how much oil is really there. One industry insider termed the bids "insane," adding: "I can't figure out how anyone is going to make money."

Italian oil major Eni (E ) kicked off the frenzy with an eye-popping $902 million bid for one block. But the most lavish bidder in the Angola round was a consortium led by China's Sinopec (SNP ), which has a joint venture with Sonangol, the national Angolan petroleum company. It bid a combined $2.2 billion for the two other tracts. In contrast, ExxonMobil and BP, the operators of existing projects in these areas, bid only $120 million and $15 million, respectively, in the new round. Industry sources say Sinopec is willing to pay just about anything to become a major player in Angola. Sinopec officials declined to comment, but the Chinese are lending billions to the Angolan government and planning massive infrastructure projects for their new African partner.

A BET ON A BILLION

Angola recently has been one of the great success stories in the oil business, and the values of the country's tracts have risen enormously. But this time the numbers could turn ugly. Having made such huge initial payments before even finding oil -- let alone producing it -- Sinopec and the other successful bidders will find it tough to secure the 15% or so rate of return that commercially minded oil companies ordinarily seek for projects whose outcomes are uncertain. In a study, Deutsche Bank (DB ) reckons the new "winners" will have to make finds in the range of a billion barrels -- a very large discovery -- to make good money.

What works against the likelihood of such massive finds is that ExxonMobil, BP, and others have already done extensive seismic work on each of the blocks and drilled what they thought were the choicest prospects. As a result, Deutsche Bank (DB ) reckons that 12% returns would be a "high-side case" for the Eni-led group with the new license, assuming oil fetches around $40 a barrel when it starts pumping. Much lower returns are possible. If this keeps up, top bidders in the world's oil auctions may soon suffer buyer's remorse.

By Stanley Reed

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