Exploration capital can be defined as capital deployed in high risk – high reward natural resources exploration projects, undertaken by private entities.
It does not really fit the definition of venture capital or private equity. Venture capital is investing in projects that aim to bring product innovation to the market, and while risk exists, they are less capital-intensive than undertaking an initial geological prospecting program. On the other hand, private equity says that “it invests in well established businesses”, which require several years of being active on the market, have proven revenue stream, good expansion prospects, etc. While PE firms command significantly more capital than VC counterparts, an extensive market research would show that in the sphere of energy (oil&gas) there are very few active, and they are active in the growth capital and buyout segments of PE.
That leaves us with the questions: “Who invests in exploration?”, and “How to motivate people and institutions to become investors?”.
Resources are limited, yet potential to discover new ones still exists, but will require ever more sophisticated techniques and know-how. The easy oil, for example, is gone. If investors were accustomed to making investments in local businesses (the case of North America) where technical aspects were easy (onshore, vertical wells, shallow depths, etc.) and political stability was guaranteed, exploration in the 21st century will have to take into account aspects such as:

• International and cross-border capital intensive projects
• Operating in highly regulated environments
• Dealing with political and security risks on a permanent basis
• Undertaking projects in very remote areas with harsh conditions
• Targets at greater depths, sometimes in need of employing sophisticated drilling techniques and wellbore technology
• Optimization of production economics
• Longer supply and distribution chains
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  In general IOCs and NOCs have the budgets and expertise to undertake and finance this kind of projects.
  But we do see some advantages that exploration capital can offer.

Observing how North American firms active in the oil sector were created, we can derive conclusions that will help us make our investment thesis.
It is a sum of factors that will yield success for exploration capital investments.

1. Ramification

What the general public doesn’t know is that a significant amount of hydrocarbons is pumped out of the subsurface by privately-held firms (in North America). This is unique to North America given its strong capital markets and easiness of acquiring mineral rights. Most firms were created in the 20th century when there was no talk about energy transition and oil&gas developments were quite common. However, as reserves inevitably deplete, many (or most) tend to get sold to larger firms, and in general publicly-traded companies, in a process called “consolidation”.
Ramification is the opposite of consolidation where a central entity (like an investment fund) creates many small entities. The fund acts as a coordinator for its firms, providing them with bespoke capital financing solutions and technical consultancy (especially geoscience and reservoir engineering), while maintaining partial ownership in them, with the rest being held by the local entrepreneurs who will take care of the business.
The listing of oil&gas firms on public markets is clearly no longer a solution, given the fact that society does not appreciate this particular sector, which has resulted in undervaluations.

2. Many small assets instead of a few very large ones

An example from the former Soviet Union states: after its breakup, the top US firms (and some European) went to invest there and got participations in very high-profile projects, unquestionably world-class assets (like Arkutun-Dagi – Chaivo – Odoptu fields, Tengiz, Kashagan, and many others). While these have major reserves, it is possible to create the same monetary value by adding many smaller assets to a company’s (or a fund’s) portfolio. In general, the largest firms have thresholds below which they will not proceed with the development of an oil&gas accumulation. This represents a niche opportunity, especially when facing a rapid depletion of global reserves.

3. Relationship with host governments and inter-government cooperation

This is a delicate subject, since no business can happen without the approval of the rulers in the jurisdiction where we intend to carry out exploration.
It is paramount that we maintain good relationships with governments and present them with satisfactory plans that will address:

• The extent of expected exploration (the more the better)
• Bespoke financing options and establishing fast capital access channels to international partners
• No shady business clauses

In a simplified statement, exploration capital firms can and will arrange the financing of projects (and will keep those financing channels open) as long as the host governments abide by the contract rules and don’t hinder operations. Capital is always deployed in steps and not all at once. To make money in the oil&gas sector one has to either export the extracted products (in exchange of foreign currency), or use the extracted products to develop the internal economy (which, again, requires foreign trade). Exploration capital funds should not invest in countries unwilling to participate in foreign exchanges, since this is viewed as a kind of lack of collateral (whereby the collateral is the development of the national economy).

4. Privacy, flexibility, reduced costs and quick deployment of capital

As opposed to publicly-listed explorers, private firms follow minimal rules. They can speed up project implementation and have the right of discretionary contract awarding. They don’t need to waste time with needless reporting and a very high level of secrecy regarding internal funds will be kept at all times. From a legal point of view, investment funds (and their portfolio companies) have an obligation to pay royalties and taxes on what they produce and deliver returns to shareholders. Anything in between is classified and auditing will be prohibited, unless explicitly required by law.

5. Outstanding financial metrics

Unknown to the general public is that exploration projects have some of the highest IRR/ROI/MOIC indicators, as well as the fastest payback/breakeven time. An exploration project usually takes 1-2 years, with the selling process (exit) included that would be 2-3 years maximum, which is the fastest scheme. Almost all funds are closed-ended and they take up to 10-15 years to disburse their profits to shareholders.

Exploration is risky and those involved should be rewarded generously, in case of success. As an investment fund we will try to negotiate, on behalf of our limited partners, preferential treatment of the companies we invest in. An entitlement we will bring forward is the right of explorers (and eventually producers) of paying much less taxes that other sectors, with the condition of undertaking even more exploration.