out of the cold

The narrow strips of coastal land that are not permanently covered by ice are home to settlements of Kalaallit people – Greenlandic Inuit – who have lived for generations by scouring the freezing waters in kayaks for whales and fish.

As part of a consultation on behalf of Cairn Energy, the Edinburgh-based oil explorer, and others, the visitors are coming to explain the plans for petroleum exploration in the area. Just like those in the lands to the south over the past few years, these people will have to adjust to the ships, planes and heavy equipment that will soon be encroaching on their wilderness.

For some years, Greenland has been seen as perhaps the jewel in the crown of undiscovered oil reserves. The Arctic in general is seen – to the horror of environmentalists – as containing 13% of all undiscovered reserves, according to the US Geological Survey of 2008.

Edinburgh consultant Wood Mackenzie reckons that maybe one-fifth of that, or 20 billion barrels, might be located in Greenlandic waters. This would be less than a tenth of the resources of Saudi Arabia, but the potential revenues of circa $2.5 trillion (£1.6 trillion) have still been easily enough to prompt a push into the area by explorers over the past five years.

Cairn has led the charge, drilling eight out of the 14 exploration wells to date in areas to the south and west of this super-island. The company has made its name as an explorer that has succeeded by spotting opportunities in places overlooked by the majors and then sticking with them when others would have lost their nerve.

This dogged approach led to phenomenal finds in Rajasthan in northern India in particular, but the waters off Greenland are still largely unknown to oil explorers and cover a huge area. Cairn has itself pointed out that the 102,000sqkm covered by its 11 exploration blocks are equivalent to about 450 blocks in the North Sea.

So far things have not gone particularly well, as the company confirmed with its full-year results last week. It has spent $1.2 billion in the region, including $732 million in 2011 alone, but has nothing more to show for it than promising signs and useful data. As chairman Sir Bill Gammell put it: "Whilst we have to date not established commercial quantities of hydrocarbon, we remain convinced that all of the ingredients for success in Greenland are present."

This is the latest instalment in a difficult period for the company, which had a torrid time while selling off its Indian interests and then endured an embarrassing climb-down earlier this year over executive pay. It bounced out of the FTSE100 several weeks ago after shares dropped 70% in a year.

Greenpeace, which has been trying to turn Cairn into a national hate-figure for threatening the Arctic, blamed the drilling failures in Greenland.

The main reason was actually that the company had returned $3.5bn to shareholders from the proceeds of the India deal, but Greenpeace was not entirely wrong. Most observers agree that the company's £4.8bn valuation is well below what it should be, possibly to the tune of £600m. The reason, in the view of one analyst, is that the markets have for some time been "pricing-in fears" about how much more money will be burned on Arctic exploration. Amid rumours of heavy pressure from nervous shareholders behind the scenes to step back from Greenland, Cairn duly confirmed last week that it would spend little more in the region in the foreseeable future and gave details about a change of strategy.

Cairn's story goes back to the early 1980s, when it was set up by Gammell along with his investment banker father, Jimmy and brother, Pete principally to explore in the US. It listed in 1988 and expanded into other territories, making a slightly quirky name for itself as one of the biggest producers of onshore oil and gas in the UK. In the 1990s, it sold out of the US and grew on the back of gas discoveries in places like Bangladesh and the Gulf of Mexico before becoming the junior partner to Shell's onshore exploration interests in Rajasthan.

By this time the company had acquired as head geologist Mike Watt – now deputy chief executive – who had developed an expertise in the region during his time at the now-defunct Burmah Oil. As a formidable background foil to the more exuberant Gammell, Watt was convinced there were big hydrocarbon reserves in the desert region.

Shell was not so sure, and continually dragged its feet on Cairn's investment propositions. It allowed the Edinburgh company to buy it out of the area for a song in 2002. Only two years later, Cairn made the biggest discovery in India for 25 years in its Mangala field, followed by another significant find in the nearby Bhagyam field soon after. Together with a third field, Aishwariya, they are reckoned to contain about one billion barrels of oil equivalent. With Shell engulfed in its reserves scandal of the time, this was another major bloody nose.

Cairn consequently grew sevenfold in two years to burst into the FTSE100. Gammell, a former Fettes schoolboy, Scotland rugby international and childhood friend of George W Bush, was knighted and hailed as one of the masters of the Scottish business universe. The company floated a minority stake in Cairn India and used the $2bn windfall to reward shareholders and invest for the future.

All was well until the company announced in 2010 that it would sell 40% of Cairn India to Indian energy group Vedanta, diluting its own share to 22% and effectively handing over control of the operation. Once again the deal was about shareholder payback and unlocking investment money, but the Indian authorities used the opportunity to extract a pound of flesh.

The negotiations dragged on into 2011, leading many observers to wonder if the deal would collapse. In the end, Cairn swallowed terms that knocked about an eighth off the deal's value. It meant the company's final gain of $4.4bn was around $600m less than it originally would have been.

Meantime, Gammell was elevated to chairman as part of a boardroom reshuffle in June last year that saw commercial director Simon Thomson take over as chief executive. Shareholders were growing restless about Greenland, not to mention the Cairn India, uncertainty but there are no suggestions that Gammell was pushed. They seem to have ground their teeth somewhat as the company announced that Gammell would be getting a £1.4 million payment to help him upstairs, but it was allowed to pass. Yet when the company announced in January that Gammell would also receive a £2.5m windfall for completing the Cairn India deal – over and above his shareholder income from the coming exceptional dividend – institutional owners like Legal and General rebelled. Several weeks later the windfall was scrapped as Gammell admitted Cairn could have handled the situation better by telling shareholders the year before.

Around the same time, to reduce the risks in Greenland, the company said it had brought Norwegian group Statoil on board as a minority partner to help exploit its Pitu concession in Baffin Bay.

The details are sketchy, but analysts believe Statoil will pay the cost of any exploration that will take place, depending on seismic data due back in the coming months. Similar deals will cover the cost of any other exploration in Cairn's other Greenland concessions. The company is committed to spending around $60m this year in the region, but not much more, despite the fact that it still has around $1bn in cash to spare (plus the $2.9bn-valued 22% of Cairn India).

Cairn will still be a big winner if its Greenland concessions come up trumps, but its money looks likely to be spent buying into producing fields elsewhere – rumours have suggested the Falklands – and seeking licences and doing early-stage exploration work in the Spanish Mediterranean, Cyprus and Lebanon.

Richard Slape, an analyst at Canaccord, says there was a "degree of upset" over the Greenland exploration but questions whether it was reasonable. "The company has always pursued projects that relative to its size are quite risky.

"This goes right back to the 1980s ... They drilled 16 wells in Rajasthan and spent $140m before they found Mangala, and remember they were only a $400m company at the time. A good management team has not suddenly become a bad management team."

One analyst who does not want to be named points out that the company always said it would spend $1bn in Greenland, but calls the last couple of years a "somewhat chastening" end to Sir Bill's time in charge. He adds: "Some people wonder why Cairn sold India. It was a cash-generative asset and now they want to buy one. It's slightly counter-intuitive."

Although some say the India deal was logical because it returned value to shareholders and enables Cairn to make higher shareholder returns now that it is slightly smaller, another analyst points to a more sober period ahead for the company. He compares the company to a pools winner that is having to learn to become more conservative again after a splurge.

Whether or not this is reasonable, Simon Thomson has made it clear that by the end of the year Cairn will look very different to the way it looks now.

Shareholders and analysts alike will be watching closely to see how the new chief executive spends what is left in the kitty.

Mission Greenland: $150m per well

Petroleum exploration is famous for taking place in difficult conditions, not least the North Sea, but Greenland comes with more challenges than most. Although Cairn Energy points to advantages such as relatively calm waters, relatively shallow water depths and long hours of daylight in the summertime, there is plenty about the area to give exploration procurement managers nightmares and make exploration much more expensive than in other regions.

Stieg Morten Knutsen, an exploration manager at Greenland national oil company and Cairn partner Nunaoil, who has worked off Greenland, Norway and Canada, says that although it can depend which part of these waters you are talking about, these are some of the toughest conditions for exploration in the world. Sea ice makes the going very difficult, and impossible in the winter time, and has to be managed by the support crews. Fog caused by ice coming up against warmer waters can last for days, sometimes weeks, and prevent any progress by helicopters or planes. Then there are icebergs, particularly to the north.

"They can be huge," says Knutsen. "Sometimes they are so huge that you have to stop drilling and move the rig. There's nothing that can stop them."

Equally challenging are the distances. Only 50,000 people live in the entire country, so manpower and equipment has to come from far away. For instance, Cairn had to pay for three chartered flights for workers every week while it was exploring last year.

"Cairn had 14 support vessels," he says. "Each of them would have a crew of 10 or 15 men. Then the drilling ships had several hundred."