The Falklands Islands oil and gas industry has reached something of a hiatus as far as drilling is concerned, and it's one that will drag through into next year. With few material upgrades in prospect, share prices for the handful of companies operating in the region are likely to trend downwards in the coming months, so it would be worthwhile reviewing the overall state of play, together with what share price shenanigans investors can look forward to before the recommencement of exploration activity during 2014.
Grouchy gauchos
Although some investors might have become restless over the rate of progress, the residents of the Falkland Islands seem in no doubt that commercial exploitation of oil reserves is just around the corner. With projected royalties of $10.5bn (£6.9bn) from Rockhopper Exploration's (RKH) Sea Lion oil discovery alone, it's little wonder that local authorities have been seeking advice from Norway on the best way of managing a resources-backed wealth fund.
Argentina's claims to 'Las Malvinas' have always constituted a risk factor for investors in the region's fledgling oil & gas industry, but the increased white noise from Buenos Aires could well be an indication that the Argentines, too, believe that the ambitions of the UK companies in the region are justified.
Either way, the step-up in rhetoric from Argentina's President Christina Kirchner and her acolytes seem to have made little impact on the exploration companies themselves, not least Borders & Southern (BOR). The company made the headlines last April following a highly promising gas/condensate find at its Darwin structure in the South Falkland Basin. Unfortunately, its share price collapsed three months later after it was forced to plug and abandon the adjacent Stebbing well, reflecting the inherent volatility of prices for companies operating in the region. Pricing sentiment for Falkland Islands oil & gas assets has switched decisively from 'risk-off' to 'risk-on'.
The evolution of Darwin
Nevertheless, engineering and fluid analysis carried out at Darwin revealed a midpoint recoverable estimate of 210m barrels of oil equivalent (boe) with a relatively high liquid content. A subsequent feasibility study carried out by a subsidiary of ThyssenKrupp firmed up the commercial case for the Darwin find, which included a high-end daily production estimate of 56,600 boe with contingent capital expenditure of $1.59 to $3.77bn, depending on whether the production platform is leased or bought. The study also revealed that a 200m boe resource would be economically viable on oil prices as low as $65 a barrel.
A new 3D seismic survey is currently being carried out adjacent to the Darwin discovery, leaving Borders & Southern, like a number of its peers, looking for a willing farm-in partner to carry some of the future drilling and appraisal costs. More details on the company's plans should emerge during the second half of this year, although management has previously stated that production could conceivably commence by 2017.
The share price of Borders' neighbour in the South Falkland Basin, Falkland Oil & Gas (FOGL), has also been in the doldrums since it reported a dry hole at its Scotia well during November. Again, this followed on from an earlier success with its Loligo well. FOGL initiated a 3D seismic survey in December, which should be completed by the end of this month. Share price performance aside, at least FOGL exited 2012 with up to $230m in its exploration/appraisal costs covered through farm-in agreements with US independent Noble Energy and Edison International (a subsidiary of France's EDF).
The market, however, remains resolutely unimpressed, pricing FOGL at a 41 per cent discount to its estimated $220m cash pile. Of course, $175m of that cash is earmarked for FOGL's share of the 3D work, and a planned three-well programme at Loligo. However, it's doubtful whether the seismic survey in itself will have any impact on the share price, so investors will have to sit tight until 2014.
Premier rides Sea Lion
The Falklands explorer most likely to put President Kirchner's nose out of joint in the short term is Rockhopper Exploration. Last October, following a number of successful appraisal results, Rockhopper managed to bring in the FTSE 250's Premier Oil (PMO) as a 60 per cent farm-in partner on its Sea Lion discovery. In return, Premier will provide around $770m to help build infrastructure to get oil pumping from Sea Lion by the end of 2017.
An obvious advantage is that Premier is better placed to drive the development forward, given its superior access to floating production, storage and offloading vessels (FPSOs) and other infrastructure assets, while it allows Rockhopper to retain the lead on exploration. But not everyone is best pleased with the arrangement. Normally a farm-in deal of this magnitude would be seen as a coup, but a number of investors in Rockhopper were hoping for an early exit via a full takeover offer. The share price has contracted by around 40 per cent since the farm-in was announced, as it was held, with some justification, that Premier got the better end of the deal.
Any takers on Argos?
Meanwhile, Argos Resources (ARG) has been generating plenty of speculation, despite it being the only Falklands explorer yet to drill a well. It is also in the market to attract a suitable partner to foot its exploration costs. In exchange, Argos's partner will gain access - at least potentially - to 2.1bn barrels of oil (estimated through 3D seismic survey) adjacent to Rockhopper's acreage. Argos' share price has outperformed its fellow Falklands explorers by some margin over the past 12 months, but it will need to secure a farm-in partner in fairly short order in order to gain access to the drilling rig expected in the region next year.
IC VIEW: THE KEY QUESTION
The Argentine stance has usually been portrayed as little more than tub-thumping, but now that Rockhopper and Borders & Southern seem intent on initiating commercial production in 2017, investors will need to evaluate whether the development of an offshore oil & gas industry is feasible without regional logistical support. Analysts at Gaffney Cline & Associates have previously given the Sea Lion field a 90 per cent chance of being successfully developed. Latin America's trading bloc, Mercosur - including Argentina, Uruguay, Paraguay and Brazil - has already banned shipping bearing the flag of the disputed Islands from docking at their ports, although Brazil has been markedly less gung-ho than Argentina about extending this measure to include commercial vessels flying the Red Ensign. It's doubtful that the powerhouse economy of the region would want to inadvertently slip into a trade war at the behest of President Kirchner's government, which is already on the European Union's 'watch list' after expropriating 51 per cent of Spanish-owned Repsol's YPF business in Argentina.
