LONDON -- SOCO International (LSE: SIA.L) is an oil exploration and production company with a market capitalisation of 1.1 billion pounds. For around 10 years, SOCO has been one of the most popular companies among our readers. Many Fools have made significant profits from owning shares in SOCO, with aggregate profits totaling millions of pounds.
I met recently with SOCO's deputy chief executive and chief financial officer, Roger Cagle. Raised near the oil fields of southeast Oklahoma, Mr. Cagle is one half of the key duo behind SOCO's success. His working relationship with SOCO chief executive Ed Story began more than 35 years ago. I spoke to Mr. Cagle to learn how SOCO has been so successful and what its example teaches Fools about investing in the sector.
1. Management with "skin in the game"
Super-investor Warren Buffett likes to back companies where management owns a substantial amount of stock themselves. Buffett calls this having "skin in the game." There is hardly a listed oil explorer of similar size where management has greater exposure to the company's success than at SOCO. Between them, Roger Cagle and Ed Story own 5.4% of the company they started. When management owns a significant stake, their financial interests are aligned with shareholders'. The investment logic is that such managers will make better decisions.
Mr. Cagle explains the SOCO approach thus:
We are not driven by our share price; we are driven by creating value. In this industry, those two things are very different. We treat this business like it is our own money because a lot of it is. We have never taken a penny off the table. None of the management have taken any money off the table for personal profit. We have a business model that has worked several times before. If you are successful in implementing an E&P model, you will eventually become a producer, generating cash flow.
SOCO's model of "Recognising opportunity. Capturing potential. Realising value" has been demonstrated by its actions of recent years, including asset transactions and production increases.
2. Drill where there is already oil
The exploration and production sector can be divided in two: There are companies that are engaged in frontier exploration and companies sticking to safer plays. Investors (particularly private investors) are often drawn to junior oil companies offering the prospect of massive gains. These firms are frequently exploring in areas where oil has not previously been discovered in commercial quantities. Though payoffs can be spectacular if such exploration is successful, it often ends in disappointment. Many investors make the first mistakes in their investing career buying shares in speculative oil explorers.
SOCO is an entirely different proposition. The company does not get involved in such "Monte Carlo or bust" exploration. SOCO's portfolio combines both exploration assets in the Democratic Republic of Congo and producing assets in Vietnam. Mr. Cagle explains how SOCO's approach is distinct:
We are not going to drill anywhere there is not a known oil basin. Exploratory wells are vastly expensive. SOCO seeks to reduce its investment cost. Part of this is done by going to the expense of generating our own seismic analysis of exploration prospects. We can then use this to attract other industry partners. This reduces risk.
3. Have a stomach for risk
You don't need to be a longtime investor to have seen an oil explorer disappoint its investors. Oil exploration involves the management of a number of risks. Some firms structure their business such that their survival may depend on their next well hitting paydirt. Others have been caught off guard by political developments, resulting in huge costs to shareholders. During our meeting, Roger Cagle spoke extensively about SOCO's attitude to risk and how this affects the company's management of its portfolio. He explained SOCO's philosophy like this:
Oil exploration is a risky business. Not even the largest companies take 100% of the risk on a well. In my experience, the chance of success from a given exploration well is 10%. Our capital requirements are based on every well we drill being a dry hole. We don't go to a geography to drill just one well. We want several different chances of something working.
These "different chances" mean drilling different geological features in the same area.
4. Do your own research
If you are serious about investing in the E&P sector, you want access to the best research available. Fortunately, we have some of the top analytical brains right here on The Motley Fool's discussion boards. There is a general sector investment discussion board here, and the SOCO board is here. Don't just take my word for it -- the reputation of the Fool user community is well-known. Roger Cagle knows all about some of the excellent analysis posted on our boards and has his own theory on why it is so good. He says: "Many of the guys on the Fool's boards are producing top-quality analysis. Why? Primarily because it is their own money at stake."
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