Falkland Oil and Gas blazes trail

Where once they had sheep droppings and not a lot else, today the Falkland Islands - that desolate remnant of the British empire off the Argentinian coast - is the focus of a rush for black gold, and Falkland Oil and Gas (Fogl) looks to be in a prime position to benefit.

The Falklands are one of the last frontiers for oil and gas exploration and offer huge, although unproven, potential. The region divides into independent and distinct north and south basins. In contrast to the North Falkland basin, where drilling in 1998 confirmed the existence of hydrocarbons, the South Falkland basin, where Fogl is active, is virgin exploration territory. True, this adds to the already-considerable exploration risk and renders all valuations of the south basin highly speculative. That said, prospects identified to date in the south look substantially larger than those in the north (perhaps 3,000m barrels of oil compared with up to 1,000m barrels in the north).

Fogl has farmed out a 51 per cent interest in its licences to the Anglo-Australian resources giant, BHP Billiton, in return for BHP paying 68 per cent of the work programme plus $13m (£8m) to cover past expenses. Equally important, BHP's presence adds to the credibility of Fogl's acreage, which is both extensive and covers several geological formations, thus maximising the chances of drilling success.

But there is a snag. With lots of off-shore exploration being undertaken, all the Falklands explorers struggled to secure a drilling rig until Desire Petroleum, which is operating in the north basin, contracted the Ocean Guardian rig in September 2009. This rig is scheduled to arrive in the Falklands in February. Its first two drilling slots will be to drill one well each for Desire and Rockhopper Exploration, the two explorers of the North basin. Hopefully, however, Fogl/BHP will get its third slot.

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The semi-submersible Ocean Guardian is designed to operate in waters up to 450m deep. That's ideal for the North basin, but waters are much deeper in the south basin - up to 1,200 metres. Luckily for Fogl, one of its best prospects, Toroa, lies in water of around 600m and Ocean Guardian will be able to drill that deep following modifications, some of which have already been completed. Toroa has gross, unrisked prospective (therefore, very speculative) resources of between 380m and 2.9bn barrels.

The Fogl/BHP partnership is in advanced negotiations with Desire to secure the rig's third slot. If they get it, that would significantly accelerate the partnership's drilling programme. The original plan was to drill the first well late this year or early in 2011. But the arrival of Ocean Guardian could bring forward the schedule to the first half of this year

Beyond sub-contracting Desire's rig for one well, Fogl/BHP plan to contract a deeper water rig to conduct the bulk of their exploration campaign from late 2010 onwards. To this end, Fogl recently raised £50m through a share placing to finance its share of the drilling costs, which it estimates at £30m.

If Fogl/BHP do secure a drilling slot with the Ocean Guardian rig, it will be very positive for two reasons. First, being able to piggyback on the development of the North basin rig will accelerate Fogl/BHP's drilling timetable by at least six months without the partners having to contract their own rig. Second, the share prices of all four explorers are likely to appreciate when the North basin campaign kicks off, even though any outcome in the north would be irrelevant to exploration in the south. In the best case scenario, investors in Fogl shares could be in the money long before their own company's drilling even begins.