Small oil explorer set to gush

Oil shares are hot. Share prices for "majors" such as Shell and BP are on the march and some of the minnows are soaring ahead. Factors are the strength of oil and gas prices and a global boom in deep-water drilling, helped by technological advances. One of the hottest areas attracting the deep-water explorers is the Gulf of Mexico, which is shaping up as an oil province many times larger than the North Sea. Shell is a huge player here, with an armlock on half the acreage. But one much smaller company, British-Borneo Petroleum Syndicate, at 671p, is becoming a key player.

British-Borneo has a remarkable recent history. In the 1980s, it was little more than a holding company with a portfolio of oil industry investments dominated by holdings in Shell - a name that keeps recurring in the British- Borneo story. In 1989, an energetic new chief executive, Alan Gaynor, was brought in to help the company liquidate its holdings without incurring huge capital gains tax bills. The idea was to invest the proceeds in "safe" oil exploration assets with 100 per cent tax relief.

Blue-blooded stockbrokers Cazenove quickly realised that Mr Gaynor was the right man for a more ambitious programme to transform British-Borneo into a fully-fledged oil exploration company. In 1992, they masterminded a massive three-for-two rights issue to finance the pounds 55m purchase of the North Sea assets of Norway's Norsk Hydro. At the same time, finance director Bill Colvin joined the group, forming an effective team at the heart of the enterprise.

Stage two in the build-up was a programme of acquisitions of mainly relatively low-risk oil and gas exploration and production assets. Initially the group targeted the North Sea, where it has built up an impressive portfolio. But Chancellor Norman Lamont's changes to petroleum revenue tax made exploration overseas more attractive, turning the group's attention to the Gulf of Mexico. A programme of investment and exploration in the low-risk shallow waters of the Gulf gave the company substantial gas reserves just ahead of a sharp rise in the price of gas.

Some idea of the success of the group's efforts can be seen in the spectacular rise in market capitalisation of British-Borneo. When Mr Gaynor arrived it was capitalised at some pounds 20m. Since then, some pounds 110m has been raised in two rights issues, including pounds 54m raised earlier this year from a two- for-five issue at 310p. But the latest market valuation is pounds 424m. The driving force behind this huge leap is a rapidly growing reserve base. When last reported the group had some 37 million barrels of oil and oil equivalent (gas) reserves - compared with zero in 1989.

Industry experts will know that 37 million barrels in the ground are not worth pounds 424m. The company's share price continues to storm ahead because of stage three in the group's progress, an involvement in deep-water drilling in the Gulf of Mexico. In particular, the group has pulled off two spectacular coups. First, it has acquired 100 per cent of a probable 50 million-barrel field with a decision to develop almost certain to be announced later in the year. Secondly it has acquired extensive acreage, much of it in partnership with Texaco in other deep-water prospects in the region. Mr Colvin reckons an up-to-date picture of group reserves is nearer 100 million barrels with further big increases likely.

Readers may wonder how British-Borneo proved the 50 million-barrel Morpeth field so quickly. The answer is that Shell "gave" it to them in return for an undisclosed royalty on profits. Shell did this for several reasons. The oil giant was under pressure to develop the field or lose it, with the lease due to expire next year. It did a deal with British-Borneo because it has two of the world's currently scarce deep-water drilling rigs under contract for the next two to four years.

The small company also has the technology to bring relatively small fields like Morpeth into production economically. It has exclusive rights in the Gulf of Mexico to a low-cost technology using a miniaturised platform (2,000 instead of 50,000 tonnes), which can be used to produce the oil. Shell has bigger fish to play with and would not have bothered to develop a 50 million barrel field. Hence the deal which analysts estimate is worth at least 200p a share to British-Borneo. Mr Colvin hints it may be worth more.

Arguably even all this does not justify the pounds 424m valuation, though clearly a premium to asset backing is warranted for such effective management. Stockbrokers James Capel recently valued group assets around pounds 5 a share, some way short of the latest share price. But the exciting kicker is that oil giants, including Shell, are sitting on more prospects of 75 millino barrels or less in the Gulf of Mexico with leases running out. There is an excellent chance of further Morpeth-type deals. It is also involved in far more drilling activity over the next couple of years than ever before. The shares are somewhat speculative as an oil explorer trading at a premium to assets, but they look an outstanding buy.