Cash Cairn

Cairn Energy: Cairn Energy shows that dreams can come true for investors in oil exploration businesses. Its shares have multiplied ten-fold since the beginning of 2004, and it is about to receive most of its current market value in cash from the sale of shares in its Indian subsidiary.

Cairn promises to return “billions of dollars” to shareholders, but the temptation to hang onto more than it needs is strong. Just as a windfall legacy can quite destroy the motive for an individual to work, the danger is that Cairn will pour cash down holes that have little chance of becoming productive. If Cairn’s stake in Cairn India falls to 11 per cent – from 62.4 per cent today – it will receive $8.5 billion in cash. Assuming a 13 percent tax rate, this would be worth about 340 pence per share. Even if Cairn is left with a 22 per cent stake in its subsidiary, its cash pile would still be worth 265 pence per share – more than half its current stock market value.

Cairn has prospered by being careful. Its rigs are currently grinding away in Greenland, a frontier where costs are high and prospects almost completely unknown. It expects to spend $300 million a year for the next three years there, but it already has $700 million in the bank.

Besides, it is spending other people’s money. A canny deal with Petronas, Malaysia’s national oil company, paid for the first year’s costs and secured two rigs, allowing drilling to start this summer rather than next.

In other words, Cairn could pay back all the cash to shareholders and still comfortably fund its Greenland adventure.

The justification for not paying out the lot is Cairn’s track record. It pulled off the oil coup of the decade by buying out Shell’s half share in what turned into the Rajasthan oilfield in 2002 for just $7.25 million. On Cairn’s latest estimate, the field contains 6.5 billion barrels of recoverable reserves.

The company’s philosophy is to make a few big bets, and the stakes in Greenland are rising rapidly. The next licensing round, due shortly, will attract the oil majors. Cairn deserves to keep enough cash to compete with them – provided it eschews any ambition to turn into one.