2011's Small Cap "Story of the Year" - The £1bn Falkland Oil Gamble

(This article first appeared in Penny Sleuth on 3 August 2010. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

The rush for Falklands oil is one of the most exciting penny share stories I’ve seen in my 30-plus career as a small cap investor. No doubt about it.

This year we’ve seen exhilaration and a buying frenzy after ROCKHOPPER EXPLORATION’s (ticker: RKH) success at its Sea Lion well in May. That sent Rockhopper’s shares up 758% in three months.

We’ve seen the disappointment of FALKLAND OIL & GAS (ticker: FOGL), when its Toroa well failed to find oil. FOGL’s shares fell 65% overnight.

But there’s still plenty to play for. Not just with Falkland Oil & Gas which has other wells to drill. But also with Rockhopper, DESIRE PETROLEUM (ticker: DES) and BORDERS & SOUTHERN (ticker: BOR), which all have other interests to explore in the area.

And as if we needed any further proof that the Falklands oil story is alive and well, we got it last Thursday.

That was the day that AIM newcomer, ARGOS RESOURCES (ticker: ARG) was listed. And the reception for these new shares was nothing short of rapturous.

Investors pile into the latest Falklands wannabe…

The latest buzz is around the new entrant to the Falklands oil rush, ARGOS RESOURCES (ticker: ARG).

Having raised £22m through an issue of new shares at 31p, it saw the price immediately go to 33.5p. That valued Argos at £72m.

Argos has nothing else in its locker. So it implies that the stock market is willing to put a value of £50m on two things. One is Argos’s license over 1,126kms of the North Falkland basin. The other is the expertise of its team, led by the former Chief Operating Officer of LASMO, John Hogan.

I’ve had a good read through Argos’s prospectus and a chat with Hogan. And that’s filled out the picture of what is happening in the region. It also gives us clues about how things might unfold over the next year or two. Let me show you what I learned.

Argos has a 100% interest in a license area that adjoins those of Rockhopper and of the consortium led by Desire. These are in the Falkland’s Northern Basin, while Borders & Southern (BOR) and Falkland Oil & Gas (FOGL) have licenses covering the Southern Basin.

Following the failure of Falkland Oil & Gas’s Toroa prospect, no commercial oil system has as yet been found in the Southern Basin, although it is as yet early days. BHP has committed to finding a rig to drill two wells on FOGL’s acreage, and this has been scheduled to happen before the end of this year.

However, I understand that BHP is keen to secure a high specification, deep water rig and that these are in short supply. So there may be some delay to the timetable. But BHP will eventually secure a rig. And when it does, it is possible that this may be shared with Borders & Southern, which has raised enough money to finance the drilling of two or possibly three wells on its own deep water acreage.

So that should be at least four wells that should be drilled, possibly next year, on the Southern Basin.

Meanwhile, let’s look at the Northern Basin. This is dominated by Rockhopper, Desire and now Argos. So far, two wells have been drilled in this Basin. These resulted in one failure (Desire’s Liz prospect) and one success (Rockhopper’s Sea Lion).

Well number three, Rockhopper’s Ernest prospect, is now being drilled, and the Ocean Guardian rig will then move on to test Rockhopper’s Sea Lion discovery and then drill Desire’s Rachel prospect.

But it will not end there. Desire has stated its intention to drill four other prospects. Two of these will, under the terms of a 2008 deal, be largely financed by Arcadia. That’s a private oil company run by Norwegian-Cypriot shipping billionaire John Fredriksen (which has a 35% interest in part of Desire’s acreage).

On top of that Rockhopper may want to drill further test wells on Sea Lion. And now, of course, Argos has joined the fray.

This could hold more than one billion barrels of oil…

John Hogan is confident that Argos has a promising location. The 242mmbl Sea Lion discovery of Rockhopper is next door. And straddling the acreage of Argos and Rockhopper is the Johnson gas discovery.

Found by Shell in 1998, the Johnson area could hold 8 trillion cubic feet of gas. But back in 1998 when the oil price was just $12 Shell judged this to be uncommercial and walked away.

Today, while the oil price is much higher, the price of gas has not risen to the same extent, and there are anyway a number of other gas reserves around the world looking to be exploited as LNG (Liquefied Natural Gas) projects. So Hogan does not see Johnson as a likely commercial proposition at this stage. But it is certainly further evidence of the presence of hydrocarbons in the region.

Argos has 2D seismic data, dating from 1996, upon which it identified seven prospects and five leads. The former is estimated to hold 747mbbls of oil with a best case of 1.75bn. It now intends to run 3D seismic surveys over the southern hemisphere summer months, in a program that could be shared with Desire and Rockhopper.

This will help to firm up drilling prospects and could also increase the reserve estimates. This could put Argos in a position to drill in late 2011. And given that the Ocean Guardian has no confirmed booking beyond its Falkland campaign, Hogan believes that it could still be in the region.

So we can now look forward to another ten or so wells being drilled in the region over the next eighteen months. This will keep the Falklands story very much in the headlines.

And, of course, the more wells that are drilled the better the chances of making the discoveries necessary to turn the Falklands into a new oil producing province. I’ll be watching the story unfold and will keep you up-to-date with what I find.

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Here’s my original article on the Falklands story…

The £1bn Falkland Oil Gamble…

(This article first appeared in Penny Sleuth on 15 January 2010. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)

Down in the Falklands, there are unusual rumblings of activity going on. And these rumbles are about to become a roar. The usually tranquil archipelago 13,000km away is about to be engulfed by the machinery and manpower of big oil exploration.

In February 2010 the towering frame of the Ocean Guardian drilling rig is due to arrive. An anchor-handling tug and a platform supply vessel are on their way. Due to dock in Port Stanley in January are two cargo ships carrying 14,000 tonnes of equipment.

A storage yard is under construction, modular office buildings are being assembled, helicopters are arriving to ferry rig personnel to and fro, and the helicopter re-fuelling facility at Cape Dolphin - last used during the previous round of oil drilling in 1998 - is being restored.

The cast is already assembling. Executives from Desire Petroleum and Rockhopper Exploration, the two companies that contracted the Ocean Guardian, are meeting government officials. Burly dockers and rig workers are appearing in town and seeking out the bars of Port Stanley.

There is a sharp sense of anticipation in this remote land. Within a few short months its future could be transformed. It all depends upon whether that oil, so often talked about, can now be found.

That this could be one of the biggest investment stories of the year is no secret. Bold investors have been placing their chips on the table for the last two years.

Sooner or later somebody was going to pay millions of dollars to drag a rig to the south Atlantic and plunge the drill bit into the ocean floor. At last it is about to happen.

So today I want to give you a reprise of the important facts, starting with the geology.

The constituents of 'the biggest investment story of the year'

About 400 million years ago the Falklands were squeezed between the tips of the South American and African continents as well as Antarctica.

Then tectonic plates parted and the Falkland Islands were left in isolation. But significantly for oil companies, in consequence of this tectonic split, the islands sit in the middle of four different basins. These are the Falklands Plateau to the east, the South Falklands Basin to the south, the Malvinas Basin to the west and the North Falklands basin to the north.

Two important things follow from this. First, that oil may be found in some areas but not others. Second, that while the drilling depths are below 500m in the North Falkland Basin, they are up to 3,000m in the southern basins. This of course effects the cost of exploitation...

There are six licence holders in the region. Two of these are private companies, Argos Resources and Arcadia. But the other four are all quoted on the stock market.

The big four Falklands oil shares...

Desire Petroleum (DES): Desire holds licences in the shallow waters of the North Falklands Basin. It has contracted the Ocean Guardian drilling rig. It expects to drill four wells, starting in February. Evaluation of its top ten prospects has indicated prospective recoverable resources of over three billion barrels (boe) - Update from Desire Petroleum.

Rockhopper (RKH): Rockhopper is the largest licence holder in the North Falkland Basin. It has indicated a possible 4.3bn boe in its licence area. The Ocean Guardian will drill two wells on its wholly-owned blocks.

Borders & Southern (BOR): Borders & Southern holds a 100% interest in five production licences in the South Falkland Basin. It has been cagey about how much oil could be here, referring only to "multiple targets". The biggest of these could contain over 1bn boe. It has also alluded to the contiguous Malvinas and Magallanes Basins to the west where discoveries of six billion boe have been reported.

In November Borders & Southern raised £113m, enough to finance the drilling of three wells. It may yet bring in a partner and it has also hinted at "sharing with other operators in the region". This is likely to mean Falkland Oil & Gas. This is partly because Borders & Southern's licences are in the deep waters to the south, but also because Desire and Rockhopper have already secured their rig.

Falklands Oil & Gas (FOGL): Having brought in BHP Billiton as a partner, FOGL has an interest of only 49% in its licence areas. But these areas cover an expanse the size of 223 North Sea blocks - more extensive than all the other licences put together. The joint venture plans to use the Ocean Guardian to drill one well at one of the shallower points of its acreage. But the licence areas are predominantly deep water. To drill here it needs to hire a dynamically positioned drillship or semi-submersible, which it hopes to do later this year.

The real attraction of FOGL is that it claims to have much more oil than the others - a total of 60 billion boe, with its top 20 prospects holding over 30bn boe. For that reason FOGL is perhaps the share with the greatest potential.

The important point for investors is that if any of the wells to be drilled this year strike oil, the impact is sure to be felt on the share prices of all the four quoted explorers.

Be warned. The combined value of these four is now approaching £1bn. That represents a huge bet on a prospect that has, so far, produced not a cent of revenue.

But time and again these bets have paid off, and will continue to pay off. And I'm on the hunt for them all the time. If you want a piece of the action, make sure you subscribe to Red Hot Penny Shares.

Good investing,

Tom Bulford
Editor, Red Hot Penny Shares

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(This article first appeared in Penny Sleuth in January and August 2010. Penny Sleuth is an unregulated free e-letter written by Tom Bulford and published by MoneyWeek Limited)