Drill Watch

Analysts at small-cap broker finnCap have decided to cut net asset valuations for companies they cover by about 10 per cent on average, in light of the oil price volatility and adverse currency movements (sterling has gained more than 2.3 per cent against the US dollar this past month). Meanwhile, analysts at Investec reiterated that their long-term oil price assumption of $100 a barrel - similar to most other brokers - remains the biggest risk factor for the sector given the geared nature of many exploration and production companies (E&Ps). Investors would be wise to remember the that price of Brent plummeted from $130 barrel to nearly $90 this time last year - although most pundits don't expect a plunge of that proportion this time around.

This month we profile three exciting explorers, two of which are new to Drill Watch and one that's fast becoming a stalwart. While investors usually needn't concern themselves much with the oil price direction for many of the smaller explorers we cover here, all three companies profiled this month are significantly exposed to oil prices, as they are all currently producing.

Jubilant Energy - North Atharamura-1

India-focused Jubilant Energy (JUB), 85-per-cent owned by the Bhartia family, may have been exploring for oil and gas in the subcontinent for the better part of two decades, but it's a relative unknown in London. Given that the company raised over £50m from institutional investors at 77p a share when it listed in London in late 2010, you'd have to say the company has made a pretty miserable show of things since then; its shares currently trade for 14.5p apiece.

Production from the group's Kharsang field in India's northeast averaged 1,974 barrels of oil per day (bopd) before listing. Yet in Jubilant’s most recent financial reporting period, production averaged just 1,857 bopd due to natural decline and maintenance activities - this is despite the company successfully bringing six new development wells online at Kharsang during the year (together contributing around 700 bopd). So, will 2013 see a return to growth?

Jubilant's Indian owners must think so; they bought back 4.08m shares in April at 15.5p apiece to bring their total stake to 354m shares. And Jubilant is drilling another six infill wells this year at Kharsang, the third of which recently spud and the first two are currently being tested.

What's more, progress is apparently being made at two of Jubilant's other licences in the country - including the offshore Krishna Godavari (KG) block and the onshore Tripura block.

Jubilant has a 10 per cent interest in the KG block, where the operator, a state-run oil company, expects first gas to come onstream in the first half of this year. And at Tripura, where Jubilant is the operator and holds a 20 per cent interest, the group recently submitted a permitting application ahead of development. Jubilant has made two gas discoveries there over the past few years, and is now drilling a third exploration well, North Atharamura-1, targeting deeper objectives in the Atharamura anticline. The 4,000-metre deep well spud in February, so results are expected in May or June.

Jubilant has not disclosed prospective resource figures for the exploration well, but a successful discovery would doubtless firm up the commerciality of the field.

IC view: Admittedly, Jubilant's shares hardly trade much in London, and the Indian group's share structure puts us off. Net debt of $328m as of September 2012 looks unappetising, too, given the relatively small amount of cash flow being generated at Kharsang and the fact that Jubilant has been operating at a loss for a while now. So, even at the discounted price of 14.5p, we'll pass on this one.

Genel Energy - Tawke Deep

Anglo-Turkish mid-cap Genel Energy (GENL), run by ex-BP chief Tony Hayward, is a high-risk, high-growth oil group with substantial oil production and development assets in the semi-autonomous Kurdistan region of Iraq, as well as exciting early-stage exploration assets in Africa.

Not only does Genel control large interests in several untapped, world-class oil fields, but the group also has a very active exploration and appraisal drilling program planned for 2013 that provides significant upside potential. In Kurdistan alone, Genel is drilling five high-impact exploration wells this year - with results from four still to be announced - and all of them boast a relatively high potential for exploration success given the prospective nature of the region and the group's underexplored land package.

The first well, Chia Surkh, discovered what is believed to be around 300m barrels of oil-equivalent (boe) in April. Initial flow testing yielded an impressive 11,950 boe per day from the main section of the reservoir and prompted a run-up in the group's share price of more than 12.5 per cent.

Now, attention is turning to Genel's Tawke Deep well, which recently reached target depth. According to early reports from Genel, the well intersected over 2,000 metres of previously untested Jurassic and Triassic sections (underneath the producing Cretaceous reservoir) "in which oil and gas shows were encountered during drilling".

Genel has begun an extensive well testing programme at Tawke Deep, which is expected to last up to three months, although early results could potentially be released before that. Meanwhile, the group continues to drill the Taq Taq Deep well, which spud in late March. The well is targeting 250m boe of resources in the deeper Jurassic and Triassic reservoirs.

IC view: Broker Investec estimates Genel's core and development assets are worth 933p a share after discounting for operational and political risk. But if exploration assets are included, the risked valuation rises to 1,128p a share - representing 26 per cent upside to Genel's current share price of 893p. Unrisked, however, the prospects could be worth more than 1,400p a share. So, should Genel continue to have luck with politics and the drill-bit, expect the share price to rise significantly higher. We rate the shares a strong buy.

Salamander Energy - Bedug-1

South-east Asia-focused Salamander Energy (SMDR) has one of the most active exploration programs for a company of its size in London, with 11 exploration and 16 development wells planned for this year. We first profiled the company in our January installment of Drill Watch, right before it made the successful South Kecapi-1 discovery in early February, which flowed at a rate of 6,000 barrels of oil and 8m cubic feet of gas per day from the BT45 reservoir.

Salamander estimates that reservoir alone could hold between 13m and 133m barrels of oil, but the company needs to prove up the size of the discovery in order to justify building expensive hub infrastructure for the licence. To that end, Salamander recently spud the Bedug-1 well, which has a relatively shallow total depth of about 2,050 metres. The well is being drilled four kilometres to the east and 500 metres up-dip of South Kecapi, with broker finnCap estimating the gross prospect size could reach 167mmboe if successful.

IC view: Admittedly, there's significant downside risk should exploration be largely unsuccessful in 2013. At 190p a share, broker Canaccord estimates there is roughly 30 per cent downside to its estimate of core NAV at 135p a share. Yet we believe this is more than counterbalanced by the huge exploration upside on offer: Salamander's remaining prospects are potentially worth 800p a share fully derisked, according to the more bullish analysts' estimates. There should be plenty of drill-related share price catalysts, too, as Salamander plans to continue drilling further, enticing prospects back to back. We tipped the company's shares as a buy at 206p in March and, although the shares have slipped marginally since then, we reiterate that advice. Buy.