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Drill Watch

We profile the most exciting, high-impact exploration wells being drilled this month
December 19, 2013

Champagne corks might not be the only things popping ahead of New Year's eve this year. If a few high-impact exploration wells go the right way, so will the share prices of half a dozen oil and gas companies profiled in this month's edition of Drill Watch.

True, 2013 has not yet proved a great vintage as far as new hydrocarbon discoveries are concerned. There have only been a handful of reasonably large, probably commercial discoveries made by London-listed companies featured in Drill Watch during the year.

Lekoil (LEK) and Afren's (AFR) Ogo discovery, offshore Nigeria, at 774m barrels of oil-equivalent recoverable resources, is probably the pick of the bunch. Further drilling is necessary to fully appraise the field in 2014, but shares in Lekoil and Afren are up by more than 50 per cent and 25 per cent, respectively, this year. Meanwhile, shares in Trinity Exploration & Production (TRIN) experienced a 25 per cent-plus bounce in December after the Trinidad-focused oil junior announced that it had made a 50-115-million-barrel oil discovery near one of its producing offshore fields.

Still, while Brent crude oil prices have bumbled along throughout 2013 above and below $110 a barrel, it hasn't been an easy ride for investors in oil and gas equities. The FTSE 350 Oil Producers index is up just 4.5 per cent in 2013, compared with the FTSE 350 average return of 12.6 per cent. Worse, the riskier Aim Oil & Gas index tumbled 9 per cent, while the Aim All-Share index has roared ahead 16 per cent.

Nevertheless, we firmly believe that with a discerning approach to stock-picking, alongside a bit of luck from the drill bit, it's possible to beat the average return in the oil and gas sector. The key is trying to limit downside risk while timing your investment correctly to benefit from imminent share price catalysts - a theme we touch upon regularly in Drill Watch and in our commodities-related private investor seminars.

With this in mind, let's look at six companies currently drilling high-impact wells where preliminary results are expected to be released in December or January.

 

Exploration well results expected in the next 30 days

CompanyWellCountryGross prospect sizeWorking interestGeologic riskPotential impactResults Expected
Ithaca EnergyStella A2UK - North Sea--55%LowHighDec-Jan
Cairn EnergyFD-1Offshore Morocco142 mmbbl50%HighMediumDec-Jan
Faroe PetroleumNovusOffshore Norway70m boe30%MediumMediumJanuary
Caracal EnergyBitandaChad277 mmbbl--MediumHighJanuary
Trinity ExplorationEl DoradoOffshore Trinidad13 mmbbl70%LowMediumJanuary
Ophir EnergyMlinzi Mbali-1Offshore Tanzania10 Tcf80%HighHighJanuary
AfrenMaqlubIraq661 mmbbl20%HighLowDecember
AfrenEl Kuran-3Ethiopia100 mmbbl30%HighLowDecember
Gulfsands PetroleumAl Krima 1Moroccoundisclosed (small)75%LowMediumDecember

Source: Investors Chronicle, Companies, finnCap

 

Cairn Energy - FD-1 could be transformational

Nearly a dozen large oil and gas companies plan to drill frontier exploration wells offshore Morocco from late 2013 through to 2015. Cairn Energy (CNE) is the first. Offshore Morocco is one of the hottest exploration regions at the moment because geologists believe the area could host huge new hydrocarbon deposits hosted in the same type of Cretaceous play that has yielded other major discoveries further down the West African Transform Margin. These include Tullow Oil's (TLW) flagship Jubilee field offshore Ghana, Afren's new Ogo field offshore Nigeria, and major oil fields in waters offshore Ivory Coast and Sierra Leone.

Cairn will spend up to $60m drilling its first exploration well, dubbed FD-1, on the exciting Foum Draa block where it holds a 50 per cent working interest. The block is close to interests Cairn picked up in 2012 when it bought Nautical Petroleum. The move is part of Cairn's wider plan to expand its portfolio beyond Greenland, where a recent two-year, $1bn drilling campaign failed to find commercial quantities of oil.

The FD-1 well is targeting the 'F prospect', which analysts from finnCap describe as "a slope apron fan with Lower Cretaceous/Late Jurassic reservoir objectives" and gross prospective resources of 142m barrels. As a frontier well, geological risks are very high, but success could bring significant upside potential. finnCap estimates the well is worth 10.7p risked and 107.5p fully unrisked, noting additional follow-on targets have been identified.

Drilling operations began on 28 October and are anticipated to take approximately 60 days. Once completed, Cairn will move the drill rig to the Cap Juby licence, also in Morocco, to drill another well early next year. Cairn's partners on the FD-1 well include London-listed juniors San Leon Energy (SLE), with a 14.2 per cent interest, and Serica Energy (SQZ), with an 8.3 per cent interest.

IC VIEW: Admittedly, the FD-1 well is about as high-risk as drilling gets. But, at 255p, Cairn's share price is near a 52-week low and in our view this is a rare chance to buy a strong name in the oil sector at a bargain basement price, where there is frontier basin upside, a fully financed drill programme and tangible downside valuation support based on the group's huge cash pile. We predict the shares will rerate on the back of near-term exploration success and reiterate our 'buy' advice.

 

Ithaca Energy - pour yourself another Stella

We're expecting good results soon from Ithaca Energy's (IAE) second well of a four-well programme in the Greater Stella area of the North Sea. We tipped shares in the North Sea oil group in May 2013 on the back of the company's all-important Greater Stella Area oil field development and haven't been disappointed - the shares are up 36 per cent since then. Most of those gains came after the company announced flow testing of the first development well at Stella, A1, had performed way above expectations. (Ithaca is pre-drilling four wells at Stella prior to first production in mid-2014).

The A1 well flowed at a restricted rate of 10,835 barrels of oil-equivalent a day in mid-September, well above the previous guidance as all four scheduled development wells combined were expected to deliver the initial production rate of circa 25,000 to 30,000 boepd.

After completing drilling at A1, the drill rig promptly moved to drill the second well. Each well takes about 80 to 90 days to drill, complete and test, so results could arrive within weeks.

IC VIEW: Admittedly, the A1 well raised the bar for A2 - but if it's another corker we expect a big second bounce in Ithaca's share price as the project would be significantly further de-risked. We continue to rate shares in the company a strong 'buy' ahead of this major catalyst. There are also other exploration wells looming such as the high-risk, potentially high-reward Handcross well in the UK due to spud before year-end.

 

Caracal Energy - Giant Bitanda

We first looked at Chad-focused Caracal Energy (CRCL) in the September edition of Drill Watch, ahead of results from the Krim-1 exploration well just south of the company's producing Mangara field. That well ended up striking black gold, flowing at a maximum rate of 2,580 barrels of oil per day (bopd) during testing.

Still, the Krim wel could merely be a drop in the bucket if the upcoming Bitanda-1 well is successful. The Bitanda prospect is a four-way dip closure structure very near the producing Badila field. Whereas Krim had pre-drill expectations of between 29m and 64m barrels of oil, Bitanda could contain anywhere from 142m barrels (median estimate) to 648m barrels (P10 estimate), with the P50, or average, estimate a whopping 277m barrels. According to analysts at broker First Energy, the well could be "company making" if successful; they ascribe a risked valuation of 93p a share to the prospect, rising to 648p unrisked. That's because success at Bitanda could unlock "a number of similar prospects across the southern edge of the Doseo-Borogop region", nearby Caracal's producing Badila field. Bitanda is just 19 kilometers from Badila and a pipeline connection.

 

 

IC VIEW: Bitanda could seriously move the dial for Caracal and we upgrade the shares to a 'trading buy' at 460p ahead of preliminary drilling results. The company began drilling the well on 5 December and it is expected to take 32 days, so investors can expect an announcement in early or mid-January. We note, however, that while we think east Africa has great potential as a new oil destination, we're generally uncomfortable with the political and corporate governance risks associated with some of the companies operating there. We would advise those readers with a strong bias toward ethical investing to steer clear of Caracal, given its poor corporate governance track record under previous management, which we've written about previously.

 

Ophir Energy - don't be stingy, put some money on Mlinzi

East Africa-focused explorer Ophir Energy (OPHR) has been hugely successful in recent years discovering gas offshore Tanzania and then selling interests in the fields for billions of pounds to larger companies. Now, Ophir is looking to strike gas again, this time to the north of its existing discoveries in a licence called Block 7, in which it holds an 80 per cent interest (68 per cent post government back-in rights).

 

 

Ophir's high-impact Mlinzi Mbali-1 exploration well is targeting an enormous 10 trillion cubic feet of gas within a Lower Cretaceous turbidite channel complex and secondary targets in the Upper Cretaceous and the Jurassic. That's nearly two-thirds as much gas as the company and its partners have already discovered across Blocks 1, 3 and 4. Moreover, a successful discovery would significantly de-risk other nearby prospects and as much as 20 Tcf held in the entire channel complex.

Ophir spud the well on 27 November and drilling is expected to take approximately 50 days, so initial results could reasonably be expected in mid-January.

IC VIEW: Analysts at Investec value the prospect at 31p risked and 209p unrisked net to Ophir; that represents nearly 66 per cent upside to net asset value (NAV) in a best case scenario. At 309p, we continue to rate shares in Ophir a strong 'speculative buy' based on the company's significant cash resources and industry-leading exploration prospects. We caution, however, that this well is a big long-shot; Investec assigns just a 15 per cent chance of success to the frontier Mlinzi well.

 

Faroe Petroleum - champagne super Novus

Compared with some of the other well results expected over the next month, we think it's fair to describe Faroe Petroleum’s (FPM) Novus exploration well in the Norwegian Sea as low- to medium-impact. It is Faroe's second well in an exciting six-well exploration programme in the UK North Sea and Norway that began in late 2013 and will end in mid-2014.

On that count, investors must hope Faroe has better luck than in 2012-13, a freakish year when all six wells drilled were unsuccessful. But 2013-14 is already shaping up to be better; the first well, Snilehorn, also offshore Norway, intersected several long oil columns and operator Statoil pegs the size of the oil discovery at between 57m and 101m barrels of recoverable oil-equivalent resources.

The Novus prospect is thought to contain some 70m boe, but has the advantage of being located just nine kilometres to the south of Statoil's producing Heidrun oil field in the prolific Halten Terrace hydrocarbon province. Faroe has made several discoveries in the province in recent years and Novus has encouraging seismic ties to the Heidrun field, suggesting "the presence of an analogous high quality reservoir". The main targets are the Jurassic reservoirs in the Novus West horst block; drilling of a sidetrack into the Novus East fault block is contingent on results in Novus West.

Faroe is the operator of the well, but holds a 30 per cent equity interest in the licence after farming down its interest in August to Centrica and other partners.

IC VIEW: Analysts at Investec estimate Novus is worth just 4p a share fully risked, suggesting downside is limited since Faroe's costs have been reduced by farm-down agreements. But a successful discovery could add 39p a share once fully unrisked, suggesting moderate upside. At 118p, we keep our buy recommendation.

 

Trinity Exploration & Production - searching for El Dorado

Fresh from its impressive TGAL oil discovery earlier this month within the Galeota licence off the east coast of Trinidad, Trinity Exploration & Production is now drilling an independent prospect in its PGB licence off the west coast of Trinidad.

The El Dorado exploration well, like the TGAL well, is exactly the type of well we look for in Drill Watch: relatively low-risk exploration that boasts high geological odds of success and can act as a strong catalyst for rapid share price appreciation. The El Dorado well will test a 13-million-barrel oil prospect on the west flank of the Trinity-operated, producing Brighton field, where management estimates the chance of success at 51 per cent.

And because the well is being drilled just two kilometres from Trinity's production facilities, upon success it could be easily tied back to Trinity's recently refurbished MP 8 platform and put onto a long-term production test.

The well spud on 6 December and is expected to take 35 days to drill, so preliminary results should be released in mid-January.

IC VIEW: True, at 13m barrels, the El Dorado prospect is reasonably small. But it offers rapid potential for significant reserve growth and future near-term production, along with great geologic odds of success. We have been fans of Trinity since we wrote about the company extensively in June and reiterate our 'buy' advice ahead of this important share price catalyst, with Trinity's shares trading near 138p.