East Africa - The Last Great Frontier in the Hunt for Hydrocarbons (TLW.L, APC, ENI)

Geopolitical concerns have been a major barrier for entry in East Africa and the sole reason that the region has been neglected over the past several decades.

While major oil companies have been drilling in the most politically friendly country in the region, Kenya, for the past decade, few companies have wanted to dedicate resources to search for oil and gas in the region, or risk drilling wells in volatile countries like Ethiopia and Somalia.

But political calming, better technology, lower risk and a continuation of rising oil prices have changed the outlook. East Africa is now experiencing one of the highest levels of investments on the globe and we are only in the initial stages.

Over the past decade, drillers have sunk 20,000 and 14,000 new wells in North Africa and West Africa, respectively.

In East Africa only 500 wells have been built in that time.

That number is growing, and fast.

Large-cap oil companies such as Tullow Oil TLW and Anardarko APC have already stepped into the region with success. Tullow tapped into almost 2 billion bbl of oil in Uganda while Anardarko managed to find a giant reservoir of natural gas of the coast of Mozambique.

Others have followed. Italy's Enersis ENI, China's National Offshore Oil Corporation (CNOOC)and Malaysia's Petronas have all set up camp in East Africa over the past few years.

However none of the major players have attempted to move into Somalia, or more specifically the Puntland region of the country.

The Puntland region is a stable self-governing region in the north part of Somalia that was established in 1998. Only within the past few years have they have geared up to begin exploration within the country and there is two companies that has exclusive drilling rights to the region

The only negative right now is that the Somalian government has challenged the agreement, claiming the Puntland is unable to grant drilling rights to a company without the approval of the central government.

However, the President of Puntland has a different take. He recently stated that the central government of Somalia has no authority in Somalia outside of Mogadishu, the southern, coastal capital city. Puntland has its own elected officials and military.

The Puntland region has basically been untouched when it comes to oil exploration even though the potential is excellent. Numerous civil wars have been a deterrent, but that seems to be a thing of the past. Oil companies are salivating over the prospects that lie underground in Puntland.

Currently, oil reserves in the region are licensed to two companies with the major player receiving 80% of open oil production of any oil discovered. According to Petroconsultants of Geneva the region is expected to contain as much as 10 billion barrels of crude oil.

For the first time in decades, people are talking about producing oil in Somalia as political risk is slowly waning. The reality and the perception of risk are lessening.

Remember, by their very nature exploration companies are riskier than producing companies. You should always resist the urge to put a significant amount of your portfolio into a high-risk, high reward investment.

We know from past experience that major oil companies only move into area of geopolitical risk after small exploration companies do the dirty work of securing rights, drilling test wells and presenting compelling evidence for further development.

So the only way you can make really big money investing in oil is to buy these exploration stocks when they're at the cusp of major developments.

And right now, this small company is at that cusp.

If the company hits oil in any of their blocks, the stock will do incredibly well for shareholders. Conversely, if they fail, the stock will most likely go to zero. There are no guarantees in the resource exploration business no matter how good the prospects look on paper. The company is also exposed to major political risks in Ethiopia and Somalia, which could result in the company losing their exploration licenses. Overall, I think the potential far outweighs the risk and I am willing to invest in the company.

However, allocating a small portion of your portfolio as part of a diversification strategy is good practice -and you should always average into a position in this company by buying shares over time. That is the best way to spread out risk, while participating in the upside potential.

If you're interested in finding out more information about these types of companies, click here now for my latest research on oil and gas exploration stocks.