US Edition 
Questor share tip: Cairn Energy shares tumble
The frontier oil explorer has been hit hard by an Indian tax investigation but the drilling potential remains, says Questor
Cairn Energy
164.7p-2.2
Questor says BUY
SHARES in oil explorer Cairn Energy have been hit this year by an Indian tax dispute and a dry well off Morocco. However, Questor is keeping faith with the FTSE 250-listed oil explorer as the investment case was always a high risk exploration play.
Cairn focuses on oil and gas exploration in frontier regions and has eschewed a big role in the running of wells once the oil is flowing. The business model for Cairn is that once oil discoveries are made and developed they are then sold off and the cash returned to shareholders.
The Indian tax dispute stems from one of Cairn’s largest ever oil discoveries onshore in India. The company sold a majority stake in Cairn India, to Vedanta resources in 2010, and then returned $3.5bn (£2.1bn) to shareholders last year.
The deal was structured to minimise the tax bill and Cairn also retained a 10pc sake in Cairn India, valued at around $1bn. In January the Indian tax man came calling to discuss income tax assessments for the past seven years.
Cairn isn’t the first British company to be dragged into a tax dispute. Vodafone is being chased for $2.5bn, and the fact these tax disputes come during an election year in India has not gone unnoticed.
That said, Cairn’s 10pc sake in Cairn India is now marooned for the foreseeable future. The company has also put its $300m share buyback programme on hold. The Cairn India stake was worth about 100p to Cairn shareholders, and the shares have fallen by as much since the announcement.
The investment case was always about the potential of new wells. The first a 38pcinterest in Cap Juby Maritime III, offshore Morocco, came up empty. Now attention turns to two much bigger prospects being drilled offshore in Senegalese waters. The first well is due to start drilling within weeks and the second within six months.
Frontier drilling is high risk, though. The odds of discovery are as low as about 1 in 8, says JP Morgan Cazenove. The costs of drilling offshore are also higher, with each well costing up to $80m, compared with about $20m for onshore, according to Cairn.
Questor said this was a high-risk option and expected a bumpy ride with the shares. However, it wouldn’t make sense to realise a loss in advance of the drilling results, for that reason the shares remain a buy.