Cairn Energy CFO on exploring opportunities in the oil sector

When James Smith became CFO of Cairn Energy in 2014, he brought a highly entrepreneurial approach to one of the best-known UK oil exploration companies.

But he also needed to be the person in the team responsible for holding to account the more ambitious efforts of the company. In essence he provides a nuanced role in an industry defined by capital intensity and risk-taking.“There are not many other industries like it where the value of the business gets re-invested every year, so we have to balance our risk profile carefully, especially as we invest in interesting and sometimes challenging parts of the world,” he says.

As result, Smith is a key member of the executive team along with CEO Simon Thomson, thinking in an opportunistic way about new opportunities, whilst wearing the hat of the finance chief. The former banker says: “I like to think I have a good balance as historically a deal maker, but my job is also to be the cautious one that reins in some of the wilder thinking.

“It’s really important not to be closed-minded to quite radical ideas, but to make sure that as they mature, there comes a point where you apply the right and appropriate risk assessment to them,” he adds.

Cairn is now poised for growth with a portfolio of assets in Africa and Latin America, as well as the North Sea, that are at various stages of delivering returns. The group made a loss of £338m for the first half of 2018- but its share price has been on the up this year, giving it a market value of just over £1bn.

City Slicker

Smith came to Cairn from a series of investment banking roles focused on the energy sector- particularly the exploration & production (E&P) space of mid-tier players that Cairn operates in.

After studying English at Oxford University, he started at ABN Amro’s oil and gas team at the time of the dotcom boom, in a sector he describes as “deeply unfashionable because everyone wanted to work in the internet economy, but from the beginning I found it completely fascinating”.

He says he received a “ huge education” working for some of the majors including ENI, BP and state oil companies, though he preferred advising smaller, more interesting players. A move to specialist oil and gas advisory firm Harrison Lovegrove raised his technical understanding of the oil and gas industry, before arriving at investment banking powerhouse Merrill Lynch.

Smith came to the Wall Street giant when it was a dominant force in global finance, part of a team undertaking a full range of work including debt financing, capital-raising and M&A advisory for the energy sector.

It was here that he began a relationship with Cairn Energy, helping advise the firm on the IPO of its hugely successful business in India- then the biggest in the country’s history. Smith spent time in the deserts of Rajasthan in north west India. “I saw all the discoveries and where the infrastructure investment was going to be. It was an important time for building a relationship with Cairn because it was a big moment for them,” says Smith.

Whilst building a rapport with Cairn’s management, his boss at Merrill Lynch Rahul Dhir upped sticks to become the CEO of Cairn India. “It was a bit of a surprise. I was working for him advising on the IPO and then it was suddenly announced he was going to be the CEO.”

The relationship with Cairn deepened as the IPO took on a complex set of twists and turns, most notably when responsibility for building a 500km pipeline from the desert to the coast refinery shifted from the Indian government to Cairn. Smith says investment banking is “most fun when you’re completely immersed in all of the kind of corporate complexity  around getting a deal done- and it takes a year or more.”

Although Smith stayed at Merrills after the 2018 financial crisis forced the one-time leviathan into being acquired by Bank of America, he moved to Rothchild soon after. It was another great name, but one focused purely on advisory- rather than full service investment banking so a safer bet in the uncertain world soon after the crash.

“Rothschild had a much more cyclical business model, as it’s an advice-only house so not a provider of capital. It’s a privately-owned business that doesn’t have that kind of quarterly requirement to have results for the stock market, and its longevity as a family-owned business is pretty legendary, so that had an appeal,” says Smith.

Rothschild also boasted a strong relationship with Cairn, which having exited its Indian business was well-placed to deliver a strategy of making new discoveries, bringing these assets to the point of being commercialised, selling them on and then reinvesting in new opportunities. “The IPO in India and subsequent sell-downs, were part of that strategy and as a result Cairn was re-investing elsewhere, so it was a busy M&A client while I was at Rothschild.”

Financially thinking

When the opportunity rose for Smith to join Cairn as CFO, when his predecessor Jann Brown headed to new pastures, he faced the fact he had no formal finance function experience. What did he think about that? “It was a question I asked myself and the chairman of the audit committee asked me that question when I was interviewing for the job,” he says.

But he was not too fazed, given the industry norm. “When I look at E&P CFOs, the number that are qualified accountants and are not is about 50/50. It’s a higher percentage of those that are not than in other sectors.

“I think a key reason is that it is not traditionally a sector where managing the P&L outcome is the principle objective of the CFO, the principle objective very bluntly, in such a capital-intensive industry is not running out of money. The financing and funding background I have from banking is a really important fit for E&P companies,” he says.

Nevertheless, Smith had to ensure he had a competent finance function, especially on the statutory accounting side. “I had very little experience of what that was like in real life, so the critical thing for me was having a strong team in place. The key issue is having a good financial controller, because operational finance in an E&P is quite complex- we tend to run all of our projects as joint ventures, and joint venture accounting is complex,” he says.

He reveals a critical element of his role is ensuring a close relationship between operational finance and the planning team. “As a result of the capital intensity of the industry, it’s the fulcrum between reporting what’s happened and planning what’s going forward that is key. Your working capital at any point is pretty material, so it’s the integration of the operational finance team and your planning and treasury team, and getting that flow of information right,” he says.

Risk business

Given Smith’s role it makes sense that he chairs the group’s risk committee which assesses the multitude of possible issues, including political and other above ground risk, as well as potential issues underground.

He says Cairn’s approach to risk reflects the group’s reliance on its own balance sheet- boosted by the proceeds of the Indian business- to support new projects, rather than tapping equity markets. “In the last 10-12 years we’ve returned $4.5bn of capital to shareholders, and we’ve raised something like $200m, we’ve almost never raised equity,” he says.

The funds from the Rajasthan find are now supporting exploration drilling in the deep water off Senegal, which he says is development ready. At some point soon the Senegal asset will be sold to return capital to shareholders, while fresh projects in Mexico, Surinam, Mauritania and Cote d’Ivoire are developed.

“They all have the potential to be the next Senegal, which was the next Rajasthan, and that was the follow-on from Bangladesh, so those successes are what Cairn’s about, but ultimately it needs to be in a self-funded business plan,” says Smith. They’re offset by North Sea fields Catcher and Kraken where Cairn has minority positions, “that have delivered decent returns.”

All projects are tested against a “$50 Brent” base line for every investment, which came close to being breached when the oil price slipped to $60 a barrel late last year- resulting in Cairn’s share price bottoming out before recovering this year. The possibility of some positive news from the Senegal development and a strong chance of winning a potential $1bn tax dispute in India shortly may also be contributing to the recovery, says Smith.

On risk, Smith says the issue of climate change has been increasing in focus for investors and other stakeholders “that we are expected to address more and more”, he says. “In the 2018 annual report we’re about to publish we had an independent party carry out a resilience testing against various climate change policy scenarios, the baseline being the 2 degree COP 21 objective, and scenarios around that.

“We tested the investments we are making against the policy framework that is in place today and where you might expect it to be,” he says. “But ultimately in most people’s scenarios oil is going to remain a pretty material part of the global energy mix for decades to come and the underlying decline in oil production is pretty sharp, so you need to continue investing, even if growth is slowing,” he adds.

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