The Shoeshine Column: Plenty of pitfalls for Peak's Plan B

Friday 9th March 2001

Still, there will soon be a fair few patriotically minded investors with cash jingling in their pockets after Shell pays out. And as the People's Bank shows, there are always those who are happy to lose their money in a patriotic cause.

Blackmail is such an ugly word. Shoeshine prefers "negotiating leverage" the term coined by a Russell McVeagh partner during the winebox inquiry.

That must have been what Peak Petroleum's Mark Dunphy was after when he met Shell representatives on February 11.

According to submissions made to the Court of Appeal on Tuesday by Shell's counsel, Jim Farmer QC, Dunphy told Shell he wanted by midnight an unconditional binding undertaking to sell to Peak those Fletcher Energy New Zealand oil and gas assets Shell has to get rid of to keep its deal with the Commerce Commission. Otherwise he would put difficulties in the way of Shell's Energy bid.

Shell showed him the door and Dunphy kept his promise with a bid for the whole division.

The unsavoury incident does nothing to dispel the cloud of suspicion that overhangs the intentions of Peak and its backers.

Dunphy has made no secret of the fact Peak is interested only in Energy's New Zealand assets. His 10-minute address at Tuesday's meeting was loaded with appeals to shareholders' patriotism but his delivery was so leaden and hammy it would have made the most populist politician cringe.

Within minutes of defeat he was back in the ring, saying Peak would stand in line with other bidders for Shell's excess baggage when it went on the block. If it got it he intended to sell shares and list Peak on the Stock Exchange.

He is no doubt relying on the same perceived-patriotic, New Zealand-for-New Zealanders fervour he played on throughout the Energy sale saga. But before investors get too excited they should give Peak's plans a thorough reality check.

First, Plan B doesn't have the same "value proposition," as Dunphy likes to say, as Plan A did.

According to Peak, Shell's winning $US3.55 a share (cash component) offer undervalued Energy by about $US600 million, or $3.90 a share. But as one switched-on shareholder pointed out, Peak was offering only 30USc (69c) more than Shell.

Dunphy said that wasn't necessarily Peak's final offer. And Energy shareholders would in any case be able to share in any discount to "true value" Peak got by switching into Peak shares.

Maybe so, but the switch offer was only a partial one, so Energy shareholders would have captured only part of the discount - how much was never specified.

The rest would have gone to Peak's backers - GPG, FR Partners, Doug Myers, Arcus, Axa, et al. That's the value proposition they were interested in.

Under Plan B Peak may not get the discount it previously sought for the offcast New Zealand assets. It may even have to pay a premium to see off the competition.

Whether its backers will still be interested remains to be seen. If they aren't Peak won't have the wherewithal to bid for anything.

Even if Peak manages to get backing and buy the New Zealand assets at an economic price there is plenty of room for debate about whether the company will be able to create wealth over time.

Asked last year why Fletcher Challenge didn't just let Energy stand alone, chairman Rod Deane treated reporters to a bare-bones exposition of an exploration industry rule-of-thumb - for every 10 holes you drill, nine are likely to be dry.

That makes life risky for small explorers. If you drill only 10 holes you might get one gusher or two, but you might also get none and therefore no cashflow to service your drilling costs. Even if you get one, unless it's a whopper it won't furnish enough cash to drill another 10.

So a few unlucky years and you're out of business.

But if you drill 1000 holes the probability is you'll get 100 wet ones. Even if you get only 80 you're still in business.

The Grant Samuel report on Shell's bid allows itself to be a bit more sophisticated. It points out the global trend in exploration and production is for consolidation, because the bigger the player, the greater the scale economies and the ability to diversify exploration risk.

Big players can afford to bid for new exploration acreage at prices small companies can't match. And, as this is a resource depletion business, you need to replace the wells you pump dry, or die.

What's more, Grant Samuel says, new drilling technologies have become more expensive as exploration moves into deeper water, again restricting the small guys' ability to bid competitively for new acreage.

Dunphy says he doesn't agree with the FCL board's analysis, at least where New Zealand is concerned. He says Energy has a "natural competitive advantage" here because it's the biggest licence holder, has the major interest in production and has first-class people working for it.

He reckons Peak's bid valued Energy's 10 years of reserves in New Zealand and Brunei at only two-and-a-half years' cash flows. That left seven-and-a-half years' flows to fund exploration.

But his comments were made when Peak was still pursuing Plan A. They now apply to Shell as Energy's new owner.

Smaller New Zealand exploration companies, such as New Zealand Oil & Gas, Max Resources and Spectrum Resources, have never looked like becoming another BP or Exxon/Mobil, or even a Fletcher Energy.

That said, "Peak 2" wouldn't be starting from scratch but would have cash flows from the TAWN and Mangahewa fields, 10% of Maui and 3.7% of Pohokura when Shell cared to put it into production. But they would hardly put it on a level footing with Shell and Todd when it came to bidding for exploration permits.

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