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The search for big oil

Joe Castaldo
April 09, 2007

Two years ago, the Transitional Federal Government of Somalia announced to the world it was essentially open for business. Prime Minister Ali Mohamed Gedi told reporters the country was prepared to offer oil, gas and mineral concessions to foreign companies, although this invitation came with a warning: all firms were to do business only with his government and not some clan jostling for power. "Any violation of this statement will result in negative consequences," he warned, adding that the "culprits will take the responsibilities on their shoulders."

Issuing a threat along with a call for business may be unorthodox, but this is Somalia, after all, and one should expect unorthodoxies when doing business in a country that has existed without a strong, functioning government for 15 years. Despite the prime minister's ominous warning, and the violence and instability that have ravaged the East African country for years, a few oil and gas firms have dipped their toes into Somalia, while Vancouver-based Canmex Minerals Corp. has plunged headfirst.

The company signed a partnership with Australian exploration junior Range Resources Ltd. in late January to explore for oil and gas in northern Somalia, marking one of the first extensive exploration efforts since civil war broke out in 1991. Canmex (TSXV: CXM) will spend $50 million on two basins in which it will acquire an 80% operating interest from Range should commercial production begin.

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Somalia has long been thought to contain petroleum reserves (oil exploration dates back to at least the 1950s) and many companies have tried to profit from whatever lies beneath the surface, including ConocoPhillips, Amoco and Total. But conditions have never permitted a successful drilling operation to be implemented.

"It's a very good place to look for giant oilfields, and there aren't many places like that left in the world," says Canmex CEO Rick Schmitt, who is quick to dismiss the notion the Muslim country's fragile political situation could prevent the company from making any progress. This is despite the fact that some of the worst fighting in years broke out in March, with media reports estimating more than 100 people have been killed so far. "We don't have any concerns. Otherwise we wouldn't be working there," says Schmitt. Canmex acknowledges in its filings, however, that "the risk of war, terrorism…or nullification of existing or future concessions" could derail exploration efforts.

So why is it worth the risk? According to Schmitt, a preliminary resource report indicates the potential for at least two billion barrels of oil on just one of the Canmex properties. (The other property has yet to undergo a similar assessment.) Canmex hopes to score in Somalia where the major oil companies failed, and it's connected with the successful Lundin family, who are accustomed to operating businesses in some of the world's most dangerous places.

Swedish brothers Lukas and Ian Lundin oversee a portfolio of mining, oil and gas companies based in Europe and Vancouver, and have delved into Sudan and the Democratic Republic of Congo. The brothers got into the business thanks to their father, Adolf, a petroleum-engineer-turned-entrepreneur who made a number of oil and gas discoveries in Africa and South America. (Adolf died last September at the age of 73.)

Canmex shares directors with other Lundin firms, and one of the family's private holding companies, Abalone Capital, is the largest shareholder. Canmex was founded in 1993 and languished in the Lundin portfolio for years as a shell company. That changed when Keith Hill, board member of a number of Lundin firms, learned Range Resources was looking to farm out oil exploration in Somalia. Range had signed concessions in 2005 with the state of Puntland, a semi-autonomous region in the northeast that, unlike the rest of the country, has a relatively stable local government. The concessions gave Range a 50.1% interest in all mineral, oil and gas development in Puntland, which is approximately 212,000 square kilometres in size. Hill contacted Schmitt about the project, who was then employed as a consultant to Lundin companies Pearl Exploration and Valkyries Petroleum, and who ultimately negotiated the farm-out deal and joined Canmex as CEO.

Initially, the deal did not go over well with Prime Minister Gedi in the capital, Mogadishu. He wrote a letter to the Australian Securities Exchange arguing the concessions were not valid because only his government had the power to authorize them. But Gedi later expressed his full support for the venture. How Range was able to negotiate such a deal is a bit of a mystery even to Schmitt. "It's difficult to say how they got in there, but they've made a very successful job of it," he says.

Somalia has been on the radar of oil companies for quite some time. The country was seen as a promising oil prospect since its geology is similar to that of Yemen, a country with nearly four billion barrels of proven reserves. Yemen's oil structures are thought to extend all the way down into Somalia. In 1991, the World Bank and the United Nations conducted a study of the oil prospects of African countries and identified Somalia as a prospective play.

The political situation in the country fell apart that same year, however. President Siad Barre, who signed the concessions with western oil firms, fled in January. That led to a vicious power struggle among warlords, followed by U.S. intervention in 1992 on "humanitarian grounds." Troops were pulled out by 1994, after several dozen U.S. soldiers and hundreds of civilians had been killed. Oil companies had long ceased all exploration efforts by then.

The oil potential of Somalia has largely remained a question mark ever since, while exploration in other African nations has taken off in part due to energy-hungry China. That country has invested more than US$4 billion in Sudan over the past 10 years, and spent US$2.2 billion in 2006 for exploration rights in Nigeria. While most oil exploration is concentrated in western African, the east is now getting more attention. "It's a frontier zone for the most part, but it's fast opening up," says Duncan Clarke, chairman and CEO of Global Pacific & Partners, a London-based oil and gas advisory firm. Clarke stresses that work in Somalia is still in its early stages. Canmex has yet to drill an exploratory well, and until it does, the project's viability is unclear.

As interest has picked up, so has the competition for concessions. Schmitt notes there is at least one seismic crew working offshore, and industry trade publication Upstream has reported Taiwanese, Austrian, Malaysian and Australian companies have all been eager to get at Somalia's reserves. "There's a lot of falsification of documents, and it's hard for us to check out a company's credentials," Somaliland mineral resources minister Mohamoud Abdi Farah told Upstream in 2001. The article went on to report that some firms returned under different names after having been denied concessions.

Aside from Canmex, a project by South African company Ophir Energy and its partner Rova Energy is the only other significant onshore exploration effort, though prospects for Canmex and Ophir are quite different. Ophir is exploring for oil in a region known as Somaliland, a breakaway province that declared independence in 1991. The central government in Mogadishu, and indeed the rest of the world, does not recognize Somaliland's independence. The commercial production of oil in Somaliland and the inevitable battle over who owns those resources — Somaliland or Mogadishu — could further destabilize an already tenuous relationship, especially when the area around Mogadishu in southern Somalia is considered less promising for oil. "Somaliland has no desire to share anything with Somalia," says David Shinn, professor of international affairs at George Washington University and former U.S. director for east African affairs. "The only thing that would change that would be military activity by the Somali government, but at this point, they hardly have the capability to do that."

Canmex, on the other hand, has a slight political advantage since the central government's approval of its concession should avoid a fight over resources down the road. Puntland, where Canmex's concessions are located, was also spared the violence last December when U.S.-backed Ethiopian troops routed the Union of Islamic Courts, which had controlled much of the country since 2006, and was thought by the U.S. to have been harbouring terrorists. "Puntland is generally calm," Shinn says, although he cautions further conflict can never be ruled out, even in the short term. "Somalia," he says, "is an inherently unstable country."

Indeed, Canmex's exploration properties extend into two provinces over which both Somaliland and Puntland claim ownership. Schmitt says that, should tensions arise, the company will cease exploration in the disputed region, which makes up only a small portion of the area granted under the concession.

"We're going as fast as we can," Schmitt says. Canmex plans to have an office in Somalia within a month, and has spoken to Asian drilling companies interested in mobilizing a rig once the most promising sites for wells have been identified. The company has raised the $25 million needed for its first exploration phase and is committed to spending another $25 million over the next six years for exploration of its two blocks.

And with that, the question of Somalia's oil potential could be answered once and for all.

Source: Canadian Business, April 09, 2007



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