Is there oil in the Falklands?

The moment of truth approaches for what could be the biggest oil story of 2012

(Published in Red Hot Penny Shares on 5th December 2011)

The state-of-the-art Leiv Eiriksson semi-submersible drilling rig is an impressive piece of kit. Measuring 120 metres long by 85 metres wide and weighing in at some 59,000 tons, it’s designed to work in ultra-deep waters and harsh environments.

It’s also the equipment that will finally tell us whether one of the most exciting penny share stories could be set to make investors staggering returns... or fall off the radar for good.

In its 10 year life, the Leiv Eiriksson has already seen service in the harsh Atlantic waters off the coast of Angola and the Congo, for energy giant Petrobas in the Black Sea off Turkey and in the oceans of Ireland, the Shetland Islands, Norway and most recently off Greenland for Cairn Energy.

Any day now it should leave Greenland and start a 9,000 mile journey for its biggest assignment yet – to the Falkland Islands. When it arrives at the end of January, we will finally find out whether the Falklands’ Southern Basin holds the massive oilfields that many believe exist.

A manic year for the oil business

The timing could not be more favourable. Oil supplies are tight, the price is high and big oil companies are desperate to add to their reserves. According to Michael O’Dwyer, Director for Oil and Gas at Morgan Stanley: “the race for exploration has become hotter than ever. The biggest change I’ve seen in the activities of oil companies over the last 24 months is the focus on exploration.”

He’s not the only one. Helge Lund, Chief Executive of Norway’s largest oil company Statoil echoes his view: “It’s very hard to grow and make a profit as an oil and gas company unless you are good at, and invest in, exploration. Compared to what we saw in the 90s, oil and gas companies are exploring much more now.”

This all points to a manic year ahead in the oil business. Morgan Stanley reckons that 30% more wells will be drilled in 2012 than 2011, with about three quarters of these offshore. The hunt is well and truly on and the stakes are high. And today I want to bring you right up to speed with what could be the biggest oil story of 2012.

No other offshore drilling campaign will be watched with such keen interest as that in the Southern Basin of the Falklands. Already we know that there is oil in the region – Rockhopper Exploration (RKH) has proved that conclusively with its massive Sea Lion find in the basin to the north of the Falkland Islands.

But even though Rockhopper has already established a sizeable oil find of c.500 million barrels of oil (mbbls), the oil industry’s major players have not taken the bait and moved in to the zone. There are good reasons for that. The region is remote and the Argentine government continues to claim sovereignty. That brings complications.

But oil producers cannot afford to be too fussy. They have to go to where the oil is. And if the next phase of the Falklands exploration can prove that this is a major new oil province they will not want to miss out. They will want a slice of the action. That means cutting themselves into the licences that are today held only by a few bold pioneers…

Meet the players in the great Falklands oil hunt

The waters around the Falklands are split into the Northern Basin, where the water is relatively shallow and the Southern Basin, where it is deep.

So far drilling has only taken place in shallow waters and, as it has been the only company yet to make a discovery, it’s Rockhopper Exploration that is leading the way.

Let’s just look at Rockhopper and the other players:

ROCKHOPPER EXPLORATION (RKH): At the beginning of 2010 the share price of Rockhopper was about 50p. By September of that year it had topped £5. Although it has since retreated to today’s 265p, it still shows just what a successful oil strike can deliver to bold investors. Rockhopper has spent $279m already and will spend plenty more before it finally produces any oil. But still the company is valued today at around £700m and the biggest reason for this is Sea Lion, the field where Rockhopper struck oil in May 2010. Since then Rockhopper has drilled several more wells to improve its understanding of this oil reservoir and its best estimate now is that it contains 1,086m barrels of oil, within a range of 608mbbls to 1,279mbbls. Assuming that 30%-40% of this can actually be recovered, Sea Lion can yield c.380mbbls, worth over $40bn at today’s oil price.

And it gets better. Last month Rockhopper made a second discovery. In the course of drilling down towards Sea Lion it passed through another band of oil-bearing rock. This is the Casper oil discovery, for which the best estimate of oil in place is 163mbbls. On a similar 30%- 40% recovery ratio this could add another c.60mbbls of recoverable oil.

Meanwhile, Rockhopper believes that it can increase the size of the Seal Lion discovery by some 10%-15% by drilling on adjoining acreage formerly under the control of Desire Petroleum.

All told then, Rockhopper could soon establish an oil find of around 500mbbls, which it thinks is sufficient to make it a commercial proposition. But before that, Rockhopper must submit a field development plan to the Falklands government by April 2013. It plans to take the oil directly from the seabed to floating vessels, before onward transportation to refineries.

So that’s the one success story so far. Now let’s look at the other players, hoping to get a slice of the Falklands riches…

DESIRE PETROLEUM (DES): Having drilled six wells without any material success, Desire is running out of money. It is not quite dead yet, though. Its immediate hope is that the Sea Lion play extends into its own acreage. To that end it has signed a farm-in deal that will see Rockhopper drill one well on this part of its licence area. Desire will have an interest of 40% in it. Assuming that Rockhopper is right in thinking that an extra 10%-15% of Sea Lion could be in Desire’s territory, this arrangement would leave Desire with an economic interest in c.20mbbls which could help it to raise the additional funds that it needs to explore its other prospects.

It is not short of them. Following the acquisition of 3D seismic data, it has recently published a Competent Persons Report that covers 40% of its northern licences. This has revealed 11 prospects containing best estimate gross recoverable resources of 322mbbls with a high estimate gross potential of 1,207mbbls. According to this independent report, the average geological chance of success – in other words the chance of oil being present – is better than 1 in 3. The report argues that a stand-alone find of as little as 42.3mbbls could be a commercial proposition. If these estimates seem a little optimistic, they do at least show that Desire is not without hope.

ARGOS RESOURCES (ARG): The third quoted company with a licence in the northern basin, Argos raised £22m when it came onto AIM last year and has since been gathering 3D seismic data to define drilling prospects in an area to the west of Sea Lion. The new 3D data has confirmed six previously identified structural prospects while mapping a further 22. Based on this work, an independent report by Senergy (GB) Limited has made a ‘Best Estimate’ of unrisked prospective recoverable resource of 2,107mbbls, with a High Estimate of 7,301mbbls. The next step will be drilling. For this Argos will need to book a slot with the Ocean Guardian drilling rig, which has been monopolized by Rockhopper of late. It also needs to raise the funds. However, only this week Argos has warned of the difficulty of raising sufficient funds for a multi-well programme. Since it is not prepared to drill only a single well, Argos has little room for manoeuvre.

So there is plenty going on in the Northern Basin. But soon attention will turn to the Southern Basin where the licence areas are a great deal bigger.

The two licence holders here are FALKLAND OIL & GAS (FOGL) and BORDERS & SOUTHERN (BOR) and they will be employing the Leiv Eiriksson rig.

BORDERS & SOUTHERN (BOR): Borders & Southern has $197m in the bank, most of which it intends to splash out on the drilling of two of its prospects in early 2012. These are the Stebbing and Darwin prospects which have recoverable resources estimated at 1,280mbbls and 760mbbls respectively. Borders & Southern’s total licence area is c.20,000kms2 and it lies next to Argentina’s Malvinas Basin, where drilling back in the 1980s resulted in several sub-commercial discoveries. The geology features the organic rich source rock of the same age as that which has hosted oil in South America, on the Antarctic Peninsula, in the Weddell Sea (between the Falklands and the Antarctic) and off the west coast of South Africa. Borders & Southern has kept a relatively low profile but will soon drill two major prospects, either of which would transform its value.

A major strike at Loligo?

FALKLAND OIL & GAS (FOGL): FOGL has much the largest license area, 49,000kms2 in all. It also has the biggest prospects. Its 15 leading prospects, identified through the usual mix of observation, sampling and seismic analysis have over 15bn barrels of prospective resources. The largest, Loligo, has 4.7bnbbls and a find on this scale would make it the second biggest oil discovery of recent years anywhere in the world. Only the massive Libra oilfield off the coast of Brazil is bigger. FOGL argues that the geology of its various prospects is mirrored by the known oil-bearing regions of West Africa, Argentina, Guyane (home to the recent Zaedyus discovery) and indeed Brazil’s Campos Basin. Meanwhile, financial modelling suggests that even a modest-sized find, whether of oil or gas, would be an economic proposition. The water depths are less than commonly encountered offshore Brazil or in the Gulf of Mexico and oil could be taken directly on to floating storage vessels for onward transport by tanker.

As I said earlier Rockhopper, which probably has around 500mbbls of oil, is now valued at around £700m on the stock market. That’s equivalent to c£1.40 for every barrel of oil ‘in the ground’. What does this imply for FOGL?

Well, assuming that Loligo does hold 4.7bnbbls and that 30% of this is recoverable, the same basis of valuation would make FOGL worth about £2bn. With 207m FOGL shares in issue, which would equate to about £10 per share.
 
So what happens next? Well, it’s back to the Leiv Eiriksson rig and its long journey...

Assuming it arrives in the Falklands at the end of January, drilling of Loligo is likely to start around May 2012. That much seems certain. Loligo is next in line after the Leiv Eiriksson’s work on Borders & Southern’s prospects is done.

What happens next is less certain. But, whatever happens, it should be an exciting ride for any brave investors willing to risk a bit of money on any new discovery…