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Should You Buy Cairn Energy PLC Following Oil Find?

oil rigShares in Cairn Energy (LSE: CNE) shot up by more than 10% and touched a high of 203p this morning, after the firm announced an oil discovery in its offshore Senegal acreage.

A gusher?

The firm says that the FAN-1 exploration well in the Sangomar Deep block, offshore Senegal, has a mean gross oil-in-place estimate of around 950 million barrels, of which Cairn’s share is 40%.

This could be important for Cairn: commenting on today’s news, chief executive Simon Thomson said that today’s find “materially upgrades the prospectivity of the block” and “may have significant potential as a standalone discovery“.

Too late to buy?

Explorers’ share prices often rise ahead of drilling results, before falling back again afterwards.

That’s not the case with Cairn, however — the firm’s share price has fallen by 28% so far this year, thanks to a run of disappointing results. Even after today’s gains, Cairn shares look relatively cheap: as I write, Cairn’s share price is 195p, but at the end of June, the firm had cash of $1.1bn — equivalent to 190p per share!

Cairn also has a number of other exploration wells due to complete this year, plus it owns stakes in the Catcher and Kraken fields in the North Sea, which are due to start producing oil in 2016/17.

Too good to be true?

Of course, there is a catch. Exploration companies with lots of cash don’t generally return it to shareholders — they keep on spending until they either get lucky, or run out of money.

In Cairn’s case, the size of the company’s cash resources suggests that the firm is more likely to strike oil than run out of cash.

However, although Cairn has $1.6bn in cash and undrawn debt facilities, this money is mostly spoken for: current planned capex on exploration and development is $1.4bn, and the company’s remaining $1bn stake in Cairn India is currently out of bounds, due to a tax dispute with Indian authorities.

Is Cairn a buy?

I don’t believe Cairn is as cheap is it looks, but the firm does offer potential value for investors willing to shoulder exploration risk, and today’s find is very promising.

I’d rate Cairn as a hold, rather than a buy, but braver investors who buy now could reap fat rewards at today’s price, if things go well over the next couple of years. 

Small-cap opportunities?

Cairn's $1.1bn market cap means that any discoveries need to be pretty big to move the needle on the company's share price.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Cairn Energy. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.