Rockhopper Exploration's shares may have rocketed more than six-fold within days of the company striking oil in the Falklands, but the risks were stark in the event of failure: Rockhopper needed at least one commercial success from the two wells being drilled, both of which carried the long odds inherent in frontier drilling.
Junior resources companies regularly offer the potential for triple-digit returns, often without investors needing to take 'all or nothing' risks or be locked in for long periods of time.
Share price triggers
Improving the odds: As Rockhopper demonstrated, exploration discoveries often provide the strongest price triggers although by their nature they can be the hardest and riskiest for investors to try to anticipate. Falklands oil exploration offers arguably the ultimate in high risk and high reward: small companies hunting huge oil finds in distant, offshore frontiers that have mostly never previously been drilled.
Investors can improve their odds yet maintain the substantial growth potential offered by exploration by choosing companies that operate in more proven, less frontier territories, or in less challenging and cheaper onshore rather than offshore locations, and by choosing companies planning (and funded) to drill a series of wells, thus giving them more throws of the exploration dice.
Partnership deals: The higher cost of retaining large stakes in assets restricts the number of projects companies can undertake, and therefore the drilling frequency, which can lead to periods of seeming inactivity that can cause share prices to drift lower.
Working with a major firm reduces the financial risks to a junior and adds the technical expertise and cash and personnel resources of the partner. Crucially, it also provides the larger firm's endorsement of the asset and licence. In the best cases, the valuation of the project, sometimes even the entire company, can be more than underpinned by the imputed valuation of a so-called 'farm-in' deal.
Clearing key hurdles: Resources companies invariably need to clear a multitude of hurdles to progress their projects. Completing a bankable feasibility study can trigger a miner's share price as it opens the door to financing. Securing project finance, permits, licences, and environmental and other regulatory approvals are other vital milestones that can generate substantial price movements, particularly where these are difficult to obtain.
Production: Shares invariably trade at discounts to their net present value and reserves prior to production. This discount narrows as companies near production. The start of production triggers a major re-rating for many junior resources companies, since this immediately differentiates them from most of their peers.
