IT HAS been another interesting week for the UK independent oil and gas sector. Shares in Cairn Energy, the biggest player, leapt on rumours that BP was considering a £2.3 billion bid. Paladin Resources’ price went the other way when Aberforth Partners, its biggest shareholder, sold £43 million of shares. And there was another twist in the saga of Regal Petroleum, forced to admit that Frank Timis, its ousted founder, had secretly signed an option agreement to sell its only profitable asset. There was also the small matter of oil hitting $60 a barrel in New York, a record.

With so many conflicting signals, a decision to invest in the UK independent (that is, ex-BP, Shell and BG) oil and gas sector remains tricky. One may be forgiven for following Aberforth and cutting exposure to the sector, taking profit in expectation that share prices have more downside risk than upside scope. A lesson of the Regal fiasco has been that there is a tendency for investors to talk up shares ahead of real worth. Cairn’s investors found out the hard way last December when its shares crashed 26 per cent on a downgrade to reserve estimates. Cairn, however, stayed one of the biggest oil success stories of recent years, because of significant finds in India that far outweighed the December downgrade.

However, the exuberance with which investors embraced each successful Cairn well drilled rubbed off on other companies in the sector. Failures, in terms of unsuccessful wells, were punished accordingly, as Premier Oil can attest. But it was little wonder that Mr Timis found an attentive audience when he rattled the tin to raise £44.8 million for Regal in April. After all, he had done a marvellous job hyping Regal’s prospects, especially the likelihood that it was sitting on at least a billion barrels of oil off Greece. On a modest 20 per cent recoverability rate, the mooted Kallirachi find would have yielded $12 billion (£6.5 billion) of oil (before costs and at today’s prices) — figures to make even the most conservative investor discard the usual discipline. Alas, Mr Timis was effectively sacked by Regal shareholders when they found out only three weeks after the fundraising that Kallirachi was uncommercial.

There will be more Regals. Indeed, Regal was hardly the first overhyped story in natural resources to be shown up later, and after much shareholder suffering, for lacking the key ingredient: ownership of oil or gas in the ground that can be recovered.

The oil price continues to soar. Traders expect little relief as we head towards the northern hemisphere winter — the peak demand period for oil. The key concern is that demand is gradually outstripping the world’s oil supply. Opec is already being pressed to raise significantly members’ output while industry leaders, such as BP and Chevron, struggle to find new, large oilfields. Add to that political pressures affecting oil-exporting countries, ranging from uncertainties over asset ownership in Russia to civil unrest in Nigeria, and it is easy to understand oil traders’ fears. Merrill Lynch, the bank, has raised price forecast averages for this year by $4 to $49 a barrel, and by a similar sum to $41 in 2006.

Oil’s booming price has done for the UK oil and gas sector what soaring metal prices have done for London-listed miners. Investors have flocked to companies that vow to seek substantial assets, or those with a solid portfolio of producing assets that, at current oil prices, should produce lots of free cash. The high prices have also attracted opportunists to list oil investment vehicles, cashing in on generally upbeat market sentiment. Al Stanton, Bridgewell Securities analyst, says share prices of UK small and mid-tier oil companies are up a fifth year on year, but that the performance is increasingly mixed. In his view, it is a company’s management of underlying assets, rather than the oil price, that has the most material impact on its share price. In that context, a few companies stand out: Paladin and Dana Petroleum have strong-performing production assets. Cairn’s finds in India continue to excite, and Premier will hope to issue more positive drilling news this year, as well as cash in on higher gas prices. At the market’s smaller end, investment becomes more selective, but there is scope for rewards. Gulf Keystone is in Algeria, but only future drilling will confirm its potential. Granby Oil & Gas joined AIM only this month, but its shares are already up more than half. Granby is to give results of its first well drilled in the North Sea on Monday. A positive result will no doubt further fuel Granby shares. A dry well, however, will not go unnoticed.

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