Drill Watch

March certainly began brightly enough as Ithaca Energy (IAE) announced a £203m friendly takeover of North Sea oil junior Valiant Petroleum (VPP), ending Valiant's long-running strategic review and sparking investor hopes of a fresh round of takeover activity. Analyst Will Arnstein of finnCap isn't convinced, though, given the inclement financial climate: "[Ithaca's offer] is just 25p below the maximum price we envisaged at the start of the year so, while it leaves some value on the table, it looks like a reasonable exit. We don't, however, believe this transaction is likely to ignite another round of M&A, with industry activity set to remain at the asset level".

Happy hunting

This month, we profile three different explorers drilling four exciting wells, three of which have the potential to be high-impact and deliver "M&A-like returns in a success case", according to Mr Arnstein.

As always, there is the risk of slippage into the following month since the speed of drilling and data analysis is often hard for companies to accurately predict.

A quick reminder for those readers who are interested in learning more about junior oil and gas exploration: tickets are almost all sold out for our next investor seminar, 'Drilling for profit in small-cap resources', on 22 April. Click here to book your place.

Exploration well results expected in February

Trap Oil (TRAP) - Scotney and Magnolia

While there continues to be a dearth of big new hydrocarbon discoveries in the UK North Sea, operators are having plenty of success finding and developing smaller fields. That's because advances in exploration techniques, persistently high oil prices and a more favourable tax regime have combined to create a perfect storm for junior North Sea oil and gas specialists such as Trap Oil.

Headed by 30-year industry veteran Mark Groves-Gidney, Trap holds 20 licences in 46 blocks throughout the UK Continental Shelf. In February, exploration wells were spud on two of those blocks, 20/5b and 13/23a, targeting the Scotney and Magnolia prospects, respectively.

Operator Suncor Energy began drilling the Scotney well in mid-February and it's expected to take about 36 days in a dry-hole case. The prospect could hold between 17.2m and 149.5m barrels of oil (mmbbls) gross, or between 2.15 to 18.68 mmbbls net to Trap, and is mapped as a four-way dip closure. This is also known as a 'buried hill' target and is one of the best types of potential reservoir seals.

Highlighted colours represent potential oil- or gas-bearing rock formations

Source: Trap Oil

Trap holds a 12.5 per cent carried interest in the well, which, according to independent consultants and 3D seismic data collected by CGGVeritas, has a relatively high 32 per cent chance of success.

As for the Magnolia well, it spud in late February and drilling is anticipated to last approximately 26 days in a dry hole case. The prospect is mapped as a "three-way dip closure and one-way pinch out" and is of a somewhat smaller, riskier vintage than Scotney.

A spokesman for the company couldn't disclose a probability of success, but pegged Magnolia's gross prospective resources at 20.46m barrels of oil-equivalent in a medium, or P50, case, and net prospective risked resources at just 0.25 mmboe.

If the well is successful, however, management says it would open up many other similar plays in the vicinity, which is near producing infrastructure. Dana Petroleum is the operator of the Magnolia well with a 45 per cent interest. Trap holds a 10 per cent carried interest.

IC VIEW: Trap Oil continues to be one of our favoured North Sea explorers due to its excellent management team, strategic industry partnerships and use of advanced exploration technology. The shares are currently well down on our buy tip (27p, 17 May 2012), but we're compelled to reiterate that advice in advance of two potentially large positive catalysts. Buy at 14p.

Kea Petroleum (KEA) - Mauku

Shares in Kea Petroleum climbed over 30 per cent last month on the back of a second successful well intersecting the Puka oil field onshore New Zealand, conveniently located near pipeline infrastructure and a sea oil terminal. Management says the field likely holds about 1m to 3m barrels of oil, gross, but upside of 7 to 10 mmbbls "continues to be a real possibility". Production test results from the Puka 2 well are expected in April or May.

Yet Puka is not the only string in Kea's bow. The company recently spud the onshore Mauku well targeting impressive gross prospective resources of 480bn cubic feet of gas and 28 mmbbls of condensates in a median success case. Because the well is located in a remote coastal region in the Taranaki basin of the North Island - the only producing hydrocarbon basin in New Zealand at the moment - spudding the well took longer than expected in light of challenging weather and road conditions. As a result, costs at Mauku are expected to run up to nearly NZ$15m (£8.3m) without accounting for potential well testing - expensive for an onshore well, albeit the actual reservoir target is located subsea. Kea should only have to pay for about half of this, however, under a canny agreement with gas plant operator Methanex.

Drilling is expected to be completed sometime in April and the odds of success are pegged at one in four. With cash on hand of only £11.35m as at 30 November, financing future exploration, let alone development drilling at Puka, is a significant concern.

IC VIEW: The positive backdrop of the Puka oil field should continue to provide support for Kea's shares. But should the Mauku well be unsuccessful, Kea might find it difficult to raise money to fund Puka's development as well as drill new prospects. We like the Mauku play, but for now it's just 'one to watch'.

Salamander Energy (SMDR) - North Kendang

We profiled Salamander in our January edition of Drill Watch and the company promptly rewarded us with a whopper of an oil and gas discovery in early February.

Now, Salamander has moved the drill rig to test a different, larger structure in Indonesia's North Kutei basin called the North Kendang prospect. Granted, it's high risk, but the prospect boasts 224m barrels of oil-equivalent of gross prospective resources. More specifically, the well is targeting gas and oil in a series of stacked Pliocene and Upper Miocene sandstone reservoirs, which combined could hold approximately 770bn cubic feet of gas and 91m barrels of oil. Results from the well are scheduled to be released around the end of March, with broker finnCap estimating it has just a 15 per cent chance of success. Salamander holds a 75 per cent interest in the licence.

After North Kendang, Salamander plans to bring the rig back to drill the Bedug prospect in order to prove the up-dip extent of the South Kecapi discovery. Bedug is located four kilometre to the east and 500 metres up-dip of the the South Kecapi-1 well.

IC VIEW: Salamander has an extremely active drilling programme lined up for 2013, with over 10 exploration wells and 16 development wells still to be drilled. Targeting 673m barrels of oil-equivalent resources net to the company and offering a staggering 689p s share of upside potential (when fully de-risked), we reiterate our 'buy' advice at 203p a share. Buy.