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From the heat of Barmer to the cool of Greenland: Cairn shifts its bet

In a surprise move the Edinburg-based parent of Cairn India sold out its stake to Anil Agarwal’s Vedanta Group. Vedanta Group will take a majority stake in the Cairn India for up to $9.6 billion, leaving Cairn Energy with up to 10 per cent stake. That the deal had been critical for Cairn Energy was illustrated by the CEO of Cairn Sir Bill Gammel rushing in to India to meet the government officials.

Interestingly the announcement of the deal came at a time when Cairn India had been waiting for a nod from Senior Political Leaders of the nation to fly down to Barmer and inaugurate what was being touted as the world’s longest heated pipeline.

Also intriguing is the choice of the buyer. Vedanta is a bauxite and iron ore mining company, embroiled in several controversies from time to time.

The Group has no interest in oil and is involved in non-ferrous metals only. But what is curious is the group’s sharp rise to prominence in less than two decades and now in effect emerging as a major player in India's hydrocarbon sector.

With this deal Vedanta will acquire between 51 per cent and 60 per cent of Cairn India, with up to 51 per cent coming from Cairn Energy. The price per share of `405 includes `50 a share for a non-compete clause. That is Cairn Energy pledged not to pursue licences in India, Pakistan, Bhutan and Sri Lanka. The price paid is at 32 per cent premium to Cairn India’s average closing price for the 90 days before the deal.
Quite a hefty profit indeed for Cairn Energy to feel tempted.

In addition it has got rid of certain nagging headaches in the form of regulatory issues relating to payment of royalty on crude. The company was also concerned over the recent Supreme Court judgment on Natural Gas price where the government right to decide was accepted by the Apex Court. In fact Cairn Energy’s chief of Corporate Affairs was spotted in Delhi on the day of the judgment.

Cairn Energy has been under pressure in the Arctic Ocean region also. Global NGOs including Greenpeace have been asking for a halt in exploration for oil in the Arctic. Cairn Energy gained licences covering 72,000 square km off the west coast of Greenland. Cairn described Greenland as ‘a true frontier country’. Not satisfied with a licence covering an area half the size of England. Cairn Energy has suggested that these are just the beginning and that it hopes to expand further.

The US Geological Survey has estimated that over 16 billion barrels of oil and gas could lie off Greenland’s coast. As it is Arctic exploration is high cost with return expected in the long term. The cost is certain to multiply after the BP Oil spill in the Gulf of Mexico.

Predictably Cairn Energy felt it prudent to cash the Indian asset and build up a war chest for its Arctic adventure. The company knows well enough that once crude prices breach the three digit mark the opposition to Arctic exploration will be pushed to the back.

In one stroke Cairn Energy managed to apply a balm to its headache called India and positioned itself for yet another kill in the future.

At present however the Arctic scenario is not very encouraging for Cairn Energy. A slide within Cairn’s presentations on Arctic oil exploration shows the melting Arctic ice. Reduced heavy sea ice makes exploration work easier around Cairn’s two most “promising” licences, off Disko Island — an area frequently visited by those inspecting the impacts of climate change first hand.

What Cairn Energy views as an opportunity, Greenland’s Inuit population consider a threat to their very survival and are increasingly vocal about the impacts which climate change is already having on them.

Cairn Energy stated that there would be a lot of wells drilled before the company would be successful. How much the US $9 billion or so collected from the sale of Indian assets will support the company in winning the race for oil in the Arctic remains to be seen.

The deal illustrates clearly the adventurous nature of the company set up by Sir Bill Gammel, a former rugby player. Cairn Energy is an exploring company; not keen on managing production.

According to Cairn Energy — the transaction highlights are: Cairn to sell a maximum of 51 per cent of Cairn India to Vedanta at a consideration of up to US $8,480m (INR 396,561m), based on US $8.66 (INR 405) per Cairn India share.
This is a premium of approximately 32 per cent to the Cairn India average closing price for 90 days prior to 14 August 2010. There are put and call options, exercisable after July 2012 and July 2013, to ensure a majority interest in Cairn India can be sold (exercisable at US $8.66 (INR 405). Cairn has the intention to return a substantial proportion of the proceeds from the transaction to Cairn shareholders. Reportedly a big beneficiary will be Gammel himself.

Cairn Energy accepted the fact that the retained cash would provide it with financial flexibility to pursue an active exploration programme in its leading acreage position in Greenland and future growth opportunities.

Sir Bill Gammell, Chief Executive of Cairn said, “The transaction will ensure we have the financial flexibility to focus on an active multi-year exploration and drilling programme in Greenland and also consider further material growth opportunities.”
The IPO of Cairn India in 2007 provided a return of cash to shareholders and created sufficient financial flexibility to allow the fast-track development of Cairn’s world-class discoveries in Rajasthan.

The completion of the first phase of the Rajasthan development represents a significant milestone for the Cairn Group, with the project now producing approximately 125,000 barrels per day.

The project is now materially derisked and as a result, significant value has been created for Cairn shareholders. The Cairn Board therefore believes that now is an appropriate time to realise further value from its shareholding in Cairn India, whilst at the same time maintaining exposure to the ongoing business through a significant retained shareholding.

Once the transaction is completed Cairn Energy will have its major activity in offshore Greenland, an expected interest of between approximately 10.6 per cent and approximately 21.6 per cent in Cairn India (on a fully-diluted basis at completion) and its Rajasthan development, a position in South Asia comprising operated gas production and exploration upside in Bangladesh and a frontier exploration position in Nepal; as well as exploration licences in the Mediterranean region.

In sum the next bet of Cairn Energy will be in offshore Greenland.
Its statement said: The Arctic regions of Greenland are increasingly recognised as a world-class prospective area. Cairn has built the largest portfolio of exploration assets in Greenland, a frontier exploration area where management sees extensive potential. Cairn’s acreage spans three separate prospective basins offshore South, South-West and West Greenland.

Cairn Energy holds a 62.4 per cent interest in Cairn India. Cairn India was listed on the Bombay Stock Exchange and the National Stock Exchange of India in January 2007.

Cairn India currently has a market capitalisation in excess of US $14 billion and is the fourth largest oil and gas company in India. Cairn India has interests in 11 blocks in India and Sri Lanka.

Cairn India is based in India and has a strong institutional shareholder base both within India and internationally. The company has a 70 per cent operated working interest in development areas totalling 3,111 sq km in the Rajasthan Block. The main Development Area (1,858 sq.km), which includes Mangala, Aishwariya, Raageshwari and Saraswati is shared between Cairn India and ONGC, with Cairn India holding 70 per cent and ONGC having exercised its back in right for 30 per cent.

Further Development Areas (430 sq km), including the Bhagyam and Shakti fields and (822 sq.km) comprising of the Kaameshwari West Development Area, is also shared between Cairn India and ONGC in the same proportion.
Current production is approximately 125,000 barrels a day from the Mangala field. Cairn India also has operated interests in producing fields at Ravva in Block PKGM-1 in the Krishna-Godavari Basin offshore eastern India (a 22.5 per cent working interest) and at Lakshmi and Gauri in Block CB/OS-2 in the Cambay Basin offshore western India (a 40 per cent working interest).

Crude oil and natural gas production from Ravva commenced in 1993. Production of natural gas commenced from Lakshmi in 2002 and from Gauri in 2004. Production of commingled crude oil from Gauri commenced in 2005. The company also has equity interests in eight blocks where there is currently no production or development but which are in various stages of exploration.

The three main basins where the Indian Business is currently actively involved in exploring include the Cambay, Krishna-Godavari and Mannar Basins. As at 31 December 2009, the gross assets in the balance sheet of Cairn India were US $3,073.5m. For the 12 months ended 31 December 2009 the result before tax was US $(29.1)m.

There are some issues which need to be cleared before the transaction can fructify.
The government and more important the state-owned ONGC, partner of Cairn India in Barmer, might not agree to the deal. The production sharing contract signed by Cairn India will be examined minutely to check if the deal violated any condition.
The tax authorities would like to impose capital gains tax, estimated to be US $1 billion upwards. But given the networking muscle Vedanta can bring in, eventually the deal might close rather smoothly. Cairn Energy has chosen its buyer carefully.

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