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Interview

with Stewart Gibson, CEO, Sterling Resources

04.11.2008 / Energyboardroom

Sterling started in the UK offshore in 2003, and in addition to the UKCS also has interests in Romania and France, although is a Canada-listed company. You personally have a long experience in the oil and gas industry, but what was the vision behind Sterling’s entry into the UKCS?

Sterling’s vision was to grow through international exploration, with international in this context being non-North American. Although listed in Canada, the company does not have assets there, and this was by choice; when Sterling started, it was very much on a blank sheet, meaning no assets and no money. Although building a company was going to be a great challenge, part of it had to be for enjoyment, and some of it has been, but Sterling was founded above all else with the firm intent to grow.
Sterling believes the best way to add value is to find new reserves, and the only way to do that is by exploration. When Sterling started, the company had to be quite selective where to operate, because there were only two of us. We picked the UK and Romania mainly because we knew both areas geologically, given our past careers working in the North Sea and Romania. Furthermore, Sterling entered areas with proven hydrocarbons, so it wasn’t high risk exploration, but rather exploration within proven parameters. The second factor was that both partners had also worked with the governments previously, and thought that was an important element. The third selection criterion was attractive contractual and fiscal terms; Sterling did not want to find oil and gas, only to be faced with poor terms in these regards. The final criteria was picking up acreage where we were able to, given our small size.
With these criteria in mind, as a small company, we initially started onshore UK. The aim was to secure work commitments with quite low liability, in order to manage the company’s financial situation. Everything apart from the recent purchase of offshore assets from Talisman has been through license round applications.
In terms of assets, Sterling at one time had eight onshore UK licenses, and still has seven, in addition to three small discoveries. Sterling has a gas discovery in Yorkshire, and two small oil discoveries in the South of England, all of which will likely come on production in the next year. The opening that changed the company was in 2003 when the UK government introduced the Promote License initiative, which allowed small companies like Sterling to assume offshore blocks, but with low liability and exposure. The Promote system allows a small company to take a license for two years and really do the technical work to try and mature any prospects available, and work them through until ready to be drilled. At the point of drilling, Sterling then looks for an industry partner to share both financial and technical risk, through a process called farming down. Normally, Sterling would go in and operate with 100% working interest, but at the point of drilling brings in a partner, who may pay 100% of well to earn 50% for example, and if successful we are both happy to proceed with 50% working interest. By doing that, Sterling gets wells drilled for low cost. This approach worked well for a while, and at present the company has farmed out a total of 12 wells. As a company, we’ve drilled 22 and of those, 14 found hydrocarbon in some form, representing quite a high level of success.
Sterling has progressed from its early vision, although still considers itself an exploration and drilling company, and recognizes the importance of growing the company by having new licenses continually coming in to progress. The company changed at the end of 2007 or early 2008, when drilling its first operated wells offshore in the UK and Romania, and both were successful. There was the Breagh discovery in the Southern North Sea, and the Doina sets of discoveries offshore Romania. Because of those discoveries, Sterling now finds itself more in the appraisal and development mode of those two discoveries, and that has changed the company. Based on that, Sterling was able to seek funding and financing to complete the appraisal activity in offshore Romania, drilling two wells in the last couple of months in the Black Sea, and both were successful. In the UK, Sterling has successfully tested East Breagh, and is now drilling in West Breagh, so that development planning can commence early 2009 for both those projects.
Sterling is still exploring and has a rig just finished another location in the Northern North Sea, having drilled a successful exploration well at Cladhan. In sum, these activities are what Sterling hoped to do when the company started, and we have progressed successfully against them since inception.

How would you rate the UK in terms of creating the type of environment necessary to encourage companies like Sterling to engage in the activities you mention?

Contractual and fiscal terms are still attractive. One big help was the Promote Initiative, brought in by the government to allow smaller companies to perform technical work and farm out the wells. Along with high product price has come high operating cost for rigs and drilling wells. If I want to drill a well costing £5 million, I could possibly get it farmed out fairly easily. But if that same well is now costing £15 million or £20 million, it’s more difficult. Sterling is fortunate in that most of the company’s discoveries were drilled before prices really started to take off, but high product price has been a negative in terms of the small North Sea exploration players because there is often high associated cost. But that will change, and we’ve been through cycles before.

In regard to Sterling’s shift toward appraisal and development and the subsequent financing that necessitates, how has the company managed its relationships?

Sterling has grown thus far with private placements, with private shareholders in Canada and a couple in the UK. Sterling got funding in place to complete the active appraisal programs, and when they are finished, the next phase is full development plan approval, and after that the financial backing sought is completely different.
Sterling is transitioning from the exploration equity funding into more of a project financial backing, a process going on over the next few months.

Other than purely financial partnerships, can you speak to the importance of your other ties to companies established in the UK?

Sterling has established partnerships mainly by others farming into wells, acquiring a group of partners who are keen to help us drill the first Breagh well. In doing so, Sterling ended up with quite a few partners, including Faroe Petroleum, EnCore, Stratic, Regenersys, a small startup called Petro Ventures, and ADTI with whom Sterling maintains a turnkey drilling contract. They are all slightly different, Encore Faroe and Stratic are possibly peers to Sterling, and are quite small with some success and funding. Petro Ventures is a brand new Australian outfit funded by mining and bank funds, while Regenersys is a new fund set up to discover and develop infrastructure. In offshore Romania, Sterling has a different group, but again based on the fact of looking for companies to farm into the first two drilled wells. Current partners include Gas Plus, an Italian company, alongside Petro Ventures.
Aberdonian companies know each other very well, and thus partner selection is very important because you tend to be with each other for many years. The difference with small companies is that they’re seen as engaging in a true partnership, with three or four small companies all sharing the demands of a given well. This is in contrast to the situation where one of the majors is the operator and in this situation the small partner gets much less of a say. Whereas with a group of smaller companies they tend to share ideas more, doing technical work to compare and contrast, and it actually works quite well.

With operating interests of 40% in Cladhan, and 45% in East Breagh for example, Sterling seems to be taking the brunt of the responsibility. What makes Sterling the partner of choice for these other operators looking for a piece of the action?

To be fair, they’re probably partners in Breagh and Doina because they like the prospects. They saw the potential value there, and whether they were attracted by the prospects, or Sterling, I’m unsure; perhaps a bit of both.

What has been the evolution of Sterling’s human capital?

Sterling has been fortunate and owes a great deal to its small dedicated team of professionals; once we had some assets and funding to get the initial wells drilled, I was able to hire two or three very experienced individuals. Normally, companies our size attract industry veterans because they can see the benefit of success and options, whereas younger individuals look for different things. Once Sterling became more established, management became involved with local consultants and put agreements in place several years ago, so there is the further benefit of longer-term relationships with high-calibre consulting resources. For a small company, it’s the final thing that’s important: get the good assets, some financial backing to drill them, and then ensure a good team of people to drive success. Getting the right people in industry can be difficult today, but so far, Sterling has been fortunate.

What makes Sterling attractive for them to stay?

What drives our people is activity; when drilling exploration wells there’s a buzz, and if you enjoy it, then that’s what you’re here for. If Sterling were doing technical work and no drilling, it would be much harder to keep its people; even the mature ones need to see activity.

In the current financing situation, some people believe that there is an unsustainable overpopulation of independents in the UKCS. What is your opinion on the matter?

Going forward, there will probably be consolidation, but that would likely happen anyway, because as smaller companies go from exploration into development, they enter a different financial environment. Therefore, the kind of merger or consolidation was probably going to happen anyway, but will only be accelerated with the current financial climate. Sterling is not AIM-listed, but instead listed on the Toronto Venture Exchange, and is different from some of the other companies in the area.
Going forward, although Sterling has farmed down its prospects, the goal has always been to maintain a healthy working interest, with 65% in offshore Romania, and 45% in Breagh, which gives us the ability to farm down even more and use that funding on top of any bank funding to create developments, keeping an extra arrow in the bow, in a sense, to get the project done. There’s a lot of interest in both those prospects, so the ability to still come down in interest in both those projects remains quite useful. I’m not saying it’s definitely going to happen, but there’s always the option.

What’s next in terms of geographical diversification for Sterling?

As a small company, the focus has been primarily on two countries, so we could prove we can make it work. It’s very easy to get spread out all over the world and lose focus.
Taking a step back, before Sterling drilled Breagh, it accumulated an interest in 12 surrounding blocks. Sterling has the Doina gas discovery, alongside an additional 1.1 million acres in offshore Romania. Those two areas contain 20 nearby prospects waiting to be drilled. The development of a core area really adds to the economic synergy, because if we have a development with a pipeline, and can start drilling prospects around it and continually add new production to the pipeline, then it makes a lot of sense.
There is still a lot of work to be done in the two core areas, and Sterling is still looking to add more countries, hosting strategy sessions investigating where we might go next, but there are limitations due to a relatively small size. For example, Sterling is too small to enter North Africa or the Middle East, although management does have lots of experience in those countries, and one day we might go back there – but it’s a long way off. The next step for Sterling would be a cautious one, such as to other areas in the Southern North Sea where we understand the geology, or from Romania we can enter Bulgaria, the Ukraine, Hungary, or Poland. If and when the company does decide to take a further step, it will probably be close to where our interests already lie.

In the next five to 10 year time horizon, with these potential areas panning out for Sterling, what is your vision for the company?

The most important achievement will be to have first gas from Breagh at the end of 2010. First gas from offshore Romania will occur at the same time or maybe early 2011. Given Sterling’s current interests, assets could be producing a net 150 mmcfpd of gas, which is huge for a company our size. Armed with that kind of cash flow, we can certainly get all the exploration and drilling around all those prospects completed quite easily, and that would be the time to take the next step to the next country and do more of the same. If you have something successful working, just try to repeat it. Sterling will set the same criteria, going back to the areas where management has geological knowledge, a familiar government, and attractive fiscal terms. Sterling sees itself going from a blank sheet to a producer, and then using the production revenues to harness the expertise of exploring to do more of the same.

What is your final message to OGFJ readers?

It’s possible to go into areas that have been explored for several years and still come up with success. Looking at both Breagh and Doina, they were drilled by majors 10 years ago, and found some gas but weren’t developed for various reasons, such as gas prices, contractual terms, or materiality, whereas a smaller company going into the same area can look at the situation with a different perspective. Sterling has tested Breagh at rates six times those achieved by the previous operator from the same reservoir, and now with changing gas price and current terms, something that had been stranded can be made to work. Exploration and revitalizing stranded assets will be the way Sterling goes forward, and if people watch us and like our success, we encourage potential partners to get in touch.

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