How to make it big in... oil

Starting a billion-dollar oil empire may not be number one on your to-do list, but for Sam Malin, that's how things worked out. Malin founded a company that grew into a US $1.25bn empire in five years. He raised US $250m in funding before he'd even begun his project. And last November, Total Oil invested multi-billions into his business for a 60% stake.

The actual exploration phase is typically about seven or eight years. You're usually unlikely to be able to find a well and drill oil until three or four years into that.

But this is oil - everything happens in millions and billions. When you start talking about the total worth of the industry, it's in trillions of dollars - although no one knows exactly how much the industry is worth as a whole, as no one can tell how much oil there actually is.

Oil brings with it superyachts and supermodels, but also the power to transform countries' economies, to shape the future. But not far behind, all too often, come corruption, environmental destruction and the kind of capitalism that makes investment bankers look like three-year-olds with abacuses.

Finding oil takes the cooperation of governments - selling it at the right price takes the cooperation of the world's stock markets.

Making it big in oil is not straightforward.

Malin found oil in Madagascar, going on to found Madagascar Oil in 2003, before setting up the Avana Group, which is headquartered in the Seychelles has more diverse interests in terms of where it extracts oil.

He realised that there was oil in Madagascar in 1994, while doing research on historic gas discoveries - he started out as a geophysicist. "Having an engineering or geological degree certainly helps. But people can come in from many different angles - you still find people who didn't complete high-school." He adds, though, "Part of my credibility is that I have a technical grounding."

The Madagascan government knew the oil fields were there - they had given Malin the documentation that revealed their presence. But the oil was heavy oil, which is more difficult to extract and more expensive to produce. The government didn't have the resources.

Before he could do anything more, Malin needed funding. US $250m, to be precise. Even the initial exploration of the field, which itself requires extensive feats of engineering and a drill to be built, would require "millions of dollars". And there was no certainty the appraisal would produce favourable results - the risk being the oil wouldn't be worth extracting.

The foreignness of Madagascar was a deterrent for many potential investors, he explains, combined with the complications of dealing with heavy oil. "In the 90s the timing wasn't right," he adds. "The technologies for heavy oil weren't there and the economy was at a low. Oil prices were only in the twenties per barrel."

It took Malin 10 years to get the full investment he needed. While continuing in his job as a consultant at Standard & Poors and doing consultancy work for European Union, he began by finding investors through business contacts and dinners. They put up single digit millions initially, then venture capitalists and hedge funds bumped the total up to $20m in second round funding.

But it was then being able to hire financial advisors that really brought in the big bucks, and finally made up the total.

And it helped that while Malin had been raising investment, heavy oil techniques had advanced and the price of oil increased.

The initial funding was "for a period of a couple of years to get the project well on its way." Malin founded Madagascar Oil in 2003 and work began.

A ten-year incubating period, though, is not particularly unusual. "The lead time to thinking about looking for oil and actually producing it is years," Malin says. "The actual exploration phase is typically about seven or eight years. You're usually unlikely to be able to find a well and drill oil until three or four years into that.

"Even if you strike oil, it doesn't mean that it's economic - you have to do further drilling to understand if the oil is economic and to find out the best way of getting it out the ground."

But how did Malin have the conviction to persevere throughout all that time? He puts it partly down to "gut feel", and partly because "I'd read about the oil, I saw it with own eyes and it was a heck of a lot of oil. You can see it, it leaks onto the surface. I couldn't be sure that it would be economical but it wasn't impossible. There's people drilling thousands of miles down to find oil so at least here you knew it was there."

Of course, he had to have the Madagascan government well on side - "for support on drilling, on the environmental impact, on the right to export the oil. And, in the case of Madagascar, bringing money in and out of the country as their currency is not liquid."

He explains "even if you strike oil, it doesn't belong to the company. The oil in almost every jurisdiction belongs to the government."

A government makes money from the oil either by allowing the company to keep it and charging taxes, or by giving the company a percentage of the oil to keep as payment for producing it.

"Percentages vary widely from deal to deal - the company's share can go from less than 25% to more than 75%. In most developing countries the percentage is typically negotiated. In higher risk countries, in a less well understood area, the company can negotiate more for itself."

Malin cites Venezuela, Ethiopia, Somalia and Sudan as the riskiest areas - "and I think you could probably say Iraq's pretty risky!"

But financial complications extend far beyond deals with governments.

"Fundamentally, oil prices reflect supply and demand. But the problem is that in modern markets the speculative positions that get taken completely swamp the fundamentals. So that the $140 [per barrel] price that we saw last year didn't reflect demand. The vast majority of that price spike was due to speculative positions. And of course that's fiendishly difficult to plan for."

How does he plan for it?

"The answer is to take a conservative view of prices from an oil explorer and producer view. We assume the US $30 [per barrel] oil price - which is actually much lower than the prices today.
"Of course, there are project promoters who don't do it that way."

And how much profit can be made per barrel? "That's very complex. It depends on the engineering solutions that get put in place - from the pipelines that get put in place to the tanker facilities.

"But if companies are looking for return on investment of anything from 10-30%, they'll tend to look for a higher return in places that are higher risk."

And let's be honest, there's clearly a lot of money to be made in such areas.

But where does that leave social and environmental responsibilities?

Malin says his companies work with environmental pressure groups. The Worldwide Fund for Nature (WWF) is one of his partners on one of his funds for Madagascar.

He points out that "at the moment 86% of energy in Madagascar comes from burning trees - and as people get wealthier they can use other energy sources which don't have the same terrible impact on the forests."

And the gold-rush effect, the problem of infrastructure in these less developed countries being able to keep up with the sudden influx of huge amounts of money? "We are aware of the problems but we can't pretend to know fully how to deal with them. The International Finance Corporation deals with the socioeconomic problems as part of the World Bank. They have an entire department for it for advice, and we work with them."

Not answers that would satisfy everyone, but from a purely financial point of view, if you can find oil and get the money in place to produce it, the rewards speak for themselves.

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