Hunting for elephants offshore Morocco

Morocco is still relatively underexplored, with fewer than 40 wells drilled offshore since oil explorers began looking for hydrocarbons there in the late 1960s. In comparison, more than 10,000 have been drilled in the UK Continental Shelf over the same period. Apart from the occasional gas discovery, the vast majority of Moroccan wells have been unsuccessful and, despite big finds in other nearby African nations, the region was widely ignored until recently.

Yet advances in prospecting techniques, such as better three-dimensional seismic imaging, and new geologic theories of a link between Morocco and parts of West Africa - and even offshore Brazil - are tempting oil companies to spend hundreds of millions of pounds on high-risk exploration drilling. The North African country also boasts some of the most favourable fiscal terms in the world for oil and gas projects, as it currently imports more than 90 per cent of its gas and 99 per cent of its oil.

Last month, Texas-based Kosmos Energy spudded the deep-water Foum Assaka-1 well, in which BP and Aim-traded Fastnet Oil & Gas (FAST) are minority partners. The high-risk, high-reward wildcat well is expected to take three months to complete and the companies hope it will locate a whopping 360m barrels of oil-equivalent (mmboe) resources. The odds of success, however, are estimated at a meagre one-in-10.

Interestingly, it was Kosmos's work in the mid-2000s elsewhere in Africa that has led to Morocco's re-emergence as an exploration destination. After enormous oil deposits were found deep beneath the salt layer off the coast of Brazil, Kosmos's geologists had a hunch similar deposits might also be found off the coast of West Africa (in an area called the West African Transform Margin). The two land masses were, after all, once joined before slowly starting to break apart about 200m years ago.

Kosmos began looking at Cretaceous-age rock formations offshore Ghana - rocks around 66m to 145m years old - since some of the largest sub-salt oil deposits of Brazil were also found in this rock layer. Oil companies on both sides of the Atlantic had been drilling shallower targets based on unsophisticated two-dimensional seismic data because they were easier to see on charts, but innovations in 3D seismic allowed operators to find deeper, Cretaceous-age reservoir targets more effectively.

Kosmos's geologists' theory proved correct, and in 2007 the company discovered the world-class, 600m-barrel Jubilee oil field in waters off Ghana, in partnership with Tullow Oil (TLW) and Anadarko Petroleum.

This was followed by Anadarko's Venus gas discovery 1,100 km away offshore Sierra Leone, and a handful of other major discoveries along the West African Trasform Margin. In 2012, African Petroleum had success with the same play offshore Liberia, while Afren (AFR) discovered 774mmboe resources in upper Cretaceous rocks offshore Nigeria last year. In most cases, the original discovery has also been followed up with the successful drilling of smaller targets in the immediate vicinity.

"As with elephants," says Stuart Amor, head of oil and gas research at broker RFC Ambrian, "petroleum fields tend to be found together. Furthermore, once a particular play type is shown to work, this de-risks the same play type elsewhere. Thus, once a frontier wildcat well makes a discovery, several more successful exploration or appraisal wells tend to follow."

This hasn't proved to be the case with Morocco, though - at least not yet. Yes, explorers have followed the West African Transform Margin up and down the western sub-Saharan coast with relative success, but the play type has yet to be proven as far north as Morocco.

Two exploration wells earlier this year, drilled by Cairn Energy (CNE) and Genel Energy (GENL), failed to find commercial quantities of hydrocarbons. One of the wells had been targeting a different play type - the Upper Jurassic and Middle Jurassic - but the other was targeting "Late Jurassic" and Early/Lower Cretaceous reservoirs. It did not encounter good-quality reservoir rock but, encouragingly, there were some gas shows which confirms a deepwater hydrocarbon system in the area.

The main target for Kosmos's well, currently drilling, is the mid-Cretaceous formation. The well will also test two other intervals at the same time, the Lower Cretaceous (recently targeted by Cairn) and a shallower Tertiary play (from the younger Paleogene period, between 65m and 23m years ago).

Below, we provide a brief profile of London-listed oil companies with exposure to upcoming exploration in Morocco.

Fastnet Oil & Gas (FAST)

Dublin-based, Aim-traded Fastnet holds a 9.4 per cent net interest in Kosmos's Foum Assaka block and is carried through its share of the drilling costs of the FD-1 well. Fastnet also holds an interest in several early-stage exploration licences onshore Morocco, as well as acreage offshore Ireland, where it is currently looking for farm-in partners.

Tangiers Petroleum (TPET)

Perth-based Tangiers has a dual listing on Aim and Australia's securities exchange. The small exploration company bought the rights to the huge Tarfaya block offshore Morocco in 2009, and signed up Portugal's Galp Energia last year to pay for exploration drilling. Tangiers is left with a 25 per cent interest in the licence and its portion of the costs for the first exploration well, due to spud in the second quarter of 2014, are covered. The well is primarily targeting a monstrous 867mmboe resource in four stacked prospects, all of which are in the Upper to Lower Jurassic formations. However, Tangiers says its geologists have already identified additional leads in the shallower Cretaceous formation. Early assessment by Tangiers indicates that the Cretaceous may contain prospective resources similar to the Jurassic.

BP (BP.)

Oil major BP struck a deal with Kosmos Energy last year to acquire a minority, non-operated interest in three blocks off the coast of Morocco totalling more than 25,000 sq km. Drilling success is unlikely to significantly impact BP's share price due to the company's size, but spokesman Robert Wine said of the deal at the time: "It fits with our exploration strategy of looking for significant opportunities in new basins."

Genel Energy (GENL)

Genel's first exploration well in Morocco, drilled earlier this year in partnership with Cairn Energy on the Juby Maritime licence, was a duster (a dry well). But the Kurdistan-focused oil group still has majority interests in two other big offshore blocks in the country. Exploration wells are planned on both the Sidi Moussa and Mir Left licences during 2014. We note, however, that Genel is "specifically focusing on the proven hydrocarbon system in offshore Morocco associated with Jurassic carbonates", rather than the unproven Cretaceous play that we are more interested in.

Cairn Energy (CNE)

Cairn has completed its drill programme in Morocco for 2014 and has yet to announce any plans to further explore its licences there.

Serica Energy (SQZ) and San Leon Energy (SLE)

Aim minnows Serica and San Leon were understandably disappointed with the unsuccessful exploration well drilled last year on Cairn's Foum Draa licence - Serica and San Leon held an 8 per cent and 14 per cent minority stake, respectively. There's still hope, however. Genel plans to drill a well on its Sidi Moussa licence later this year, and Serica and San Leon hold a 5 per cent and 8.5 per cent interest in that licence, too.

Chariot Oil & Gas (CHAR)

Chariot holds interests in three early-stage licences offshore Morocco, but seismic work is not complete and drilling is not expected until 2016 at the earliest.

Gulfsands Petroleum (GPX) and Circle Oil (COP)

Both companies own extensive acreage onshore Morocco, where they are exploring for shallow gas deposits. Gulfsands is a rather new entrant, having acquired most of its acreage in December 2012, but Circle Oil is already producing around 7m cubic feet per day from its fields, generating about $20m (£12m) in revenue per year.

FAVOURITE

We think Kosmos' Moroccan Cretaceous targets are the most prospective of the bunch, and Fastnet offers a cheap way to gain heavy exposure to the play. At 10p a share, Fastnet's shares are trading at a substantial discount to broker Cantor Fitzgerald's core value of 16.5p a share and 28p estimate of risked net asset value. However, on the admittedly small chance drilling is successful at FD-1 next month, Cantor estimates Fastnet's share of a discovery could be worth 34p a share fully de-risked. Ahead of drill results, we rate the shares a speculative buy.

OUTSIDER

Chariot Oil has been restocking its exploration portfolio with early-stage licences ever since its shares nose-dived in 2012 following unsuccessful drilling offshore Namibia. Chariot now has interests in three Moroccan near-shore blocks far to the north, reportedly prospective for a mix of Jurassic, Cretaceous and Tertiary plays. Drilling is not expected until 2016 at the earliest, though, and remains subject to farm-out deals being completed. In the meantime, catalysts for the shares to re-rate are hard to spot.

THE BROKERS' VIEW

As a significant proportion of North Africa struggles with political unrest and growing investor uncertainty, Morocco's oil and gas sector has come to the fore, with the arrival of international majors and independents in search of Africa's next big hydrocarbon province. Material discoveries offshore Brazil have raised hopes that similar hydrocarbon formations lie unexploited off the African coast. In addition, early finds offshore Ghana and Angola have further attracted the interest of majors with deep-water experience.

After modest interest over the past 10 years, 2013 saw a number of significant entrants to both onshore and offshore licences. BP, Chevron, Kosmos and Cairn have all announced new projects or farm-ins in the past six months alone, illustrating a rapid increase in corporate appetite for the region. These major players have commenced targeting the country's potentially significant resource base, particularly offshore with more than 10 wells planned this year.

Equity investors looking for an entry point into Moroccan explorers can sufficiently de-risk their positions while still benefiting from the potential upside any discovery would yield. On the smaller end, Fastnet Oil & Gas has materially de-risked its exposure both financially and geologically. The company successfully executed a farm-out of its interest in the Foum Assaka licence, gaining up to a two-well carry on the drilling costs. The FA-1 well, which is currently drilling, will target three formations, one of which has a prospective resource base of 360mmboe alone - on that basis, we believe Fastnet's share price represents a compelling entry point ahead of drilling results this summer.

On the larger end of the scale, investors can gain exposure to this up-and-coming hydrocarbon province through BP, Kosmos, Cairn and Chevron - all having key acreage and healthy balance sheets to fund frontier exploration.

Sam Wahab is a research analyst at Cantor Fitzgerald