Says James Faulkner of specialist small cap website WatsHot.com

Sterling was a victim of the credit crunch and its survival had been in question. But a large placing has transformed the financial position of the company and should enable it to progress its highly prospective acreage in Kurdistan. Further upside potential could arise from farm-ins and asset sales. The shares are a buy, at 3.575p.
Oil: a nil-brainer?

It is my view that the current economic downturn has provided a great long-term buying opportunity in oil stocks. The recession has created an artificial lull in the oil price before the next surge upwards, which promises to break all records now that the rapidly growing emerging economies account for the lion's share of energy consumption - in 2008, for the first time ever, non-OECD energy consumption outstripped that of the OECD states. If you have any doubts about the outlook for the oil price read The End of Oil by Paul Roberts (click here for the book review).

There has been a spate of M&A activity in the sector recently, concentrating on the lower to mid tier E&P stocks. This in itself is evidence that industry insiders view black gold as cheap, but it also highlights the fact that many of the independent majors are running out of their own acreage to develop and are increasingly having to turn to acquisitions to bolster their reserves.

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Not a sterling story...

Sterling Energy should have been a well rounded E&P play, having some existing production in the US as well as exciting exploration upside in Madagascar and Kurdistan in Iraq. However, its timing was poor: it bought its US assets at the peak of the commodities cycle and the credit crunch triggered huge asset impairments and left it with a funding gap of around $25 million (i.e. it had drawn down $25 million more than its banking agreements stipulated). Despite having repaid $41.4 million of its bank debt during 2008 and the first half of 2009, the group's debt position stood at $112 million at the end of June. The firm managed secure a waiver of repayments from its banks in April, but this only gave it a bit of breathing space in which to tackle the debt issue..

But this could all be about to change...

The key to restoring Sterling's financial stability is asset sales. However, up until recently the credit crunch ensured that takers for its US assets were few and far between. But now that oil prices are once again on the up, the prospects for offloading the US assets are now much more favourable. The company is also looking for potential farm-in partners for its assets in Cameroon and Madagascar.

It has long been anticipated that an equity placing would accompany the sale of the group's US assets, and today (14th August) the company has duly obliged, raising £62.5 million at 1.3p per share. $35 million of this will be used to repay debt and plug the firm's funding gap, while the rest will put to use on the group's Kurdistan assets, to which we now turn.
*The value of investments can go down as well as up. Investing in equities can lose you part or all of your capital. Smaller company shares can be relatively illiquid and thus hard to trade. And that makes such investments more of a high risk than larger company shares. UK-Analyst.com is owned by t1ps.com Ltd which is authorised and regulated by the FSA and can be contacted at 5-11 Worship Street, London EC2A 2BH or on 020 7562 3370.
Sangaw North, Kurdistan

Sterling has a 53.33% interest (40% fully diluted) in the Sangaw North PSC (production sharing contract) where a 325 km 2D seismic programme was completed on the block in late 2008. The company is fully carried for its share of well costs up to the point of testing, Addax Petroleum being the operator with a 20% farm-in, and the first well is due to spud in Q4 this year. Covering an area of 492 square kilometres, the block lies in a highly prospective area for hydrocarbons, with the giant Kirkuk field 50 kilometres to the North West. Sterling estimates recoverable reserves of 212 million barrels, with potential upside as high as 787 million barrels. Broker Canaccord Adams reckons the drilling of the well could be a transformational event for Sterling, possibly increasing NAV to as much as 10p per share. I'm sure I need not mention that Iraqi oil is among the cheapest in the world to extract, and Kurdistan in particular has been attracting significant interest of late due to some exciting discoveries emanating from the region. Most recently, Gulf Keystone (GKP) saw the value of its shares almost triple after it made an oil discovery at its Shaken well, which indicated a flow-rate of 5,000-8,000 barrels/day of oil, and in-place reserves of an estimated 300-500 mumble, or an estimated 75-125 mumble recoverable - and despite it being too soon to tell if this is a commercial discovery!

Recovery play

The stage is now set for a significant re-rating. Alongside the placing, the company announced some pretty significant management changes. Alastair Beardsall was appointed executive chairman and Keith Henry non-executive director. Beardsall has been executive chairman of Emerald Energy (EEN) since 2003, another Middle East operator which is in the process of being taken over by the Chinese. Henry is chairman of Regal Petroleum (RPT). Coupled with executive deputy chairman and co-founder Harry Wilson, who has over 35 years experience including senior posts at BP, this is now a heavyweight management team with the capability to turn the company around. The company can now focus on taking forward its Kurdistan assets, while further upside potential is possible if the firm can secure a buyer for its US assets and/or a farm in partner for its Madagascar/Cameroon assets. Sterling has all the makings of a great recovery play - the stock is climbing on the placing news as I write - and the shares are a buy, at 3.575p. Buy.

Key Data

EPIC: SEY
Market: AIM
Spread: 3.56p - 3.60p (11%)

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