Drill Watch

There are at least half a dozen oil and gas companies expecting to release drill results this month. This presents nimble investors with an opportunity to take a calculated risk on the outcome of the exploration - and potentially profit if a discovery is made. True, the geologic chances of success are, for the most part, slim. But that's what makes the gamble worthwhile, as a successful discovery can often add multiples to a company's market capitalisation and offset the losses from drilling failures.

As the speed of drilling and data analysis is often hard for companies to accurately predict, there is always the risk of slippage into the following month. This was the case with two of the companies we profiled in the inaugural November edition of Drill Watch: Faroe Petroleum (FPM) and Northern Petroleum (NOP). We summarise the investment case of those companies at the end of this article and review the results of the other wells drilled in November - one of which led to a 154 per cent share price rise in just three weeks.

Moreover, with over 200 oil and gas companies listed in London, our list does not claim to be entirely comprehensive - but rather will hopefully steer interested investors with an affinity for high-risk speculation toward the better prospects.

Antrim Energy (AEY) and Premier Oil (PMO) - Cyclone

Antrim and Premier, two respectable North Sea-focused E&Ps, have come together to drill the Cyclone exploration well in the UK Central North Sea. Premier is the operator with a 70 per cent interest in the joint venture, while Antrim holds the rest. Premier spudded the well in late November and expects to release preliminary drill results around the second week of December.

The Cyclone prospect is thought to contain roughly 30m barrels of oil-equivalent on a mid-case basis - a relatively small target by international standards but certainly nothing to be scoffed at in the North Sea. The chance of success, at about one in six, is fairly typical for this kind of well in the region. Broker RBC Capital estimates the well could add up to 24p a share to Antrim’s risked net asset value (currently 76p a share) in a success case; an unsuccessful well would conversely reduce risked NAV by 4p a share.

IC VIEW: If you want exposure to this play, go with Antrim. Even though it has a smaller stake in the well, Antrim's market capitalisation is much smaller than Premier's and consequently the effects of drill results on its share price will be greater.

Jupiter Energy (JPRL) - J-58

Jupiter spudded its sixth exploration well, J-58, on the drearily named Block 31 licence in Kazakhstan on 21 October. That wouldn't be very remarkable in itself, but all five of its previous wells on the block resulted in oil discoveries - a 100 per cent drilling success rate. Indeed, Jupiter's fifth well, J-55, recently discovered roughly 10m barrels of oil on a southern extension of the already discovered Akkar East oil accumulation. J-58 is testing the extension about 3.8km further south and believes it, too, could contain as much as 10mmbbl of potential resources.

Jupiter's licence boasts 37m barrels of oil reserves classified to Russian standards, and that's before the J-55 discovery. The company plans on bringing this up to international standards in 2013 and will look to add in new reserves from drilling the J-55 and J-58 wells.

Drilling and preliminary data analysis of the J-58 well is expected to take 60 days (J-55 well results were released 61 days after the well spud), so results should be out in the next few weeks.

IC VIEW: Jupiter's drilling success rate is impressive and previous drill programs have led to sharp increases in the company's share price before and after drilling. Success at J-55 also greatly derisked the J-58 prospect. That said, companies tend to drill their best prospects first, so it's still not a slam-dunk case. Nevertheless, if the well results in a discovery, Jupiter plans to spud another well within weeks to keep proving up the extension. We very much like the exploration odds on the play and upgrade the company's shares to a buy.

Magnolia Petroleum (MAGP) - Roger Swartz #1

This oil and gas minnow focused on onshore oil production in the United States is intriguing, to say the least. For starters, Magnolia is the second best performing stock on the Alternative Investment Market this year - it boasts a 572 per cent return since 3 January.

Most small E&Ps start out exploring first and hope to produce second. Magnolia's business plan involves the reverse. It has amassed tiny working interests (often as little as 0.5 per cent but on average about 2 to 3 per cent) in prospective licences in the popular Bakken shale region of North Dakota, as well as the Woodford, Hunton and Mississippi formations in Oklahoma. It then waits for other operators to drill wells on the licence, pays its share of costs, and hopefully recovers its costs and then some if the well is completed as a producer.

So far, the strategy appears to have been successful. Magnolia has interests in 86 producing wells with a further 15 wells currently drilling or completing and 13 waiting to spud.

It's not clear yet how much cash will be generated from the wells, or indeed how many barrels of oil per day the company is entitled to from its producing non-operated interests. But in any event, the company has decided to move on to the second phase of its business model: drilling its own wells.

The first well, Roger Swartz #1, is a vertical well targeting the Mississippi lime formation that should cost Magnolia $729,000 to drill. This is significant, as revenue for the first six months of the year only amounted to $282,208 from small interests in 80 producing wells. (Magnolia's representatives say revenue should grow significantly in the second half as a few big producing wells have come on stream in which the company owns a slightly larger interest - but still in the single digits).

Magnolia hasn't released any estimates of prospect size for the Roger Swartz #1 well or any indications of potential future production rates. But, promisingly, it has a 100 per cent working interest in the well, which goes down to about 87.75 per cent if the original vendor exercises a back-in right. Initial production rates for horizontal wells in the area have produced around 750 barrels of oil per day, giving some indication of potential production - but this is a vertical well and it would likely produce much less.

IC VIEW: We have our reservations about Magnolia's business model and the opacity of its revenue streams and net production rates. Yet the market is much more positive on the story and the company's shares have enjoyed spectacular returns so far. So, while we're giving this one a pass, we won't turn up our noses at investors who want to bet on Roger Swartz #1. The well reached target depth in late November, so results could be out in less than a week.