A new year is upon us and good riddance to 2012, I say. The FTSE All-Share Index may have gained 5.8 per cent last year, but Alternative Investment Market-traded junior oil and gas shares fell 4.25 per cent on average as investors fled ultra-risky assets. Worse still, in a year when the price of Brent crude rose 4.3 per cent to $111 a barrel, large-cap FTSE 350 oil and gas equities tumbled an average of 13.3 per cent.
As we look towards 2013, the outlook for the oil and gas sector isn't much better. Oil prices are on a slippery slope and volatility looks certain to remain a central theme. Stock selection will be crucial: choosing companies with high-quality management, good projects and adequate working capital will be more important than ever.
That said, it's still possible to book seriously big gains from investing in the sector - more than a dozen Aim-traded exploration and production companies (E&Ps) experienced share price rises of well over 100 per cent during 2012. Investors Chronicle tracks every junior oil and gas share listed in London, and every month in Drill Watch we will profile the most exciting, high-impact exploration wells being drilled where results are expected to be released in the next 30 days.
In contrast to a busy December, very few E&Ps expect to release drill results in the month of January and we summarise the investment case of just two companies below. We also review the results of the wells from last month at the end of the article; in brief, one resulted in a sizeable discovery, two were uncommercial finds and two wells have slipped into January.
Asia-focused Salamander Energy is one of broker finnCap's top picks for 2013, with the company set to see an explosion of drilling activity across Indonesia and the Gulf of Thailand. Development drilling at the Bualuang field will involve 16 wells, but it is Salamander's 11-well exploration programme that really has us salivating. Nine of the 11 exploration wells are 'high impact' - or what finnCap describes as having the potential to add more than 10 per cent to net asset value when fully de-risked - targeting 673m barrels of oil-equivalent resources net to the company and offering a staggering 689p per share of upside potential (when fully de-risked).
The first well in the programme - South Kecapi - spud on 10 December and is expected to take 30 to 50 days, depending on testing, followed by a sidetrack that will target an additional three potential pay zones. Salamander is targeting a combined 275bn cubic feet of gas and 20m barrels of oil in a series of stacked channel sands. The company has a 100 per cent interest in the licence and estimates the well has a 44 per cent geological chance of success. A commercial discovery would add 56.5p per share unrisked to finnCap's total net asset value estimate of 249p.
IC VIEW: Salamander expects group production to increase 37 per cent in 2013, generating circa $350m (£220m) of pre-tax operating cash flow. This should help pay for Salamander's exciting exploration programme, which could create significant value for shareholders. With a good management team and plenty of funding following the signing of two new borrowing facilities in December, the shares warrant a buy at 192p.
Kazakhstan-focused Max Petroleum would definitely be described as one of the E&P 'losers' of 2012: its share price fell 65 per cent during the year after the company ran into financial and drilling difficulties. Max spent $43m trying to drill the deep, onshore NUR-1 well only to abandon it before reaching target depth.
The company has since had some success drilling shallower, post-salt Triassic targets on its Block E licence, including finding 20 metres of net pay in the Eskene North prospect last month. It expects to test the well early in 2013 after obtaining relevant government approvals.
In early January, Max spud the TOLW-1 well targeting 8m barrels of mean resources in the Tolegen West prospect in Western Block E. Results are due around the end of the month.
IC VIEW: Kazakhstan may be very prospective for oil and gas, but it's a slow and cumbersome country to operate in - and Max's shareholders felt the full brunt of Kazakh bureaucracy last summer. When drilling costs severely overran and Max needed to complete an equity raise, Kazakh regulations prohibited it and the company was forced to cut its drilling programme short. True, the company has since completed the initial closing of a $90m senior credit facility with SB Sberbank, allowing it to draw down $60m to repay $47m to prior lenders and partially fund its ongoing shallow drilling programme. But there are also concerns about the low porosity levels found in some of the recent post-salt Triassic discoveries. There could be value here, but we're not convinced the risks are worth it. Pass.
DECEMBER DRILLING SUMMARY