Falkland Oil and Gas signs second farm in deal and spuds key Loligo prospect well – SBM moves to Speculative Buy

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Following the muted response to the Rockhopper farm-in deal with Premier oil announced just a few weeks ago in July, fellow Falklands Islands oil explorer, Falkland Oil and Gas (FOGL) was chirpy this morning on news of its own additional farm out agreement after the original one of a couple months ago with Edison. The shares are currently up 12.5% at 84.75p to buy, a strong endorsement of the recent deals for CEO Tim Bushell.

Tim Bushell CEO

FOGL has struck a deal with Noble Energy Falklands Ltd, an affiliate of Noble Energy, with a farm-in to the northern area licences of the South Falklands basin for a 35% interest except for two excluded areas. Noble Energy is an S&P 500 company with reserves of 1.2 billion barrels of oil equivalent (boe) with core operations onshore in the U.S. (primarily in the DJ Basin and the Marcellus Shale), in the deepwater Gulf of Mexico, offshore Eastern Mediterranean and offshore West Africa.

FOGL will secure total investment over the next three years between $180 million and $230 million leaving the company with around $200 million at the end of the current drilling campaign to continue exploration work or appraisals later in 2014 (equivalent to just under 50p per share). FOGL will continue as operator of the entire Northern Area Licences until early 2013, when operatorship of the farm-in area will be transferred to Noble.

In June this year, FOGL announced a farm out deal with Edison International. Edison has approximately 360 million boe of reserves in Italy, Egypt, Norway, Croatia, Algeria and the UK and is is now controlled by EDF, the world’s leading electricity company, who are looking to use Edison as a vehicle to expand its position in upstream oil and gas projects.

The excluded areas within the Northern Area Licences will be delineated both geographically and stratigraphically and comprise the Loligo complex and the Nimrod-Garrodia complex. Noble will not participate in certain stratigraphic horizons in these excluded areas and FOGL will retain a 75% interest and operatorship with Edison International S.p.a holding the remaining 25% interest. However, Noble will remain a participant in the excluded areas regarding other horizons.

Noble’s financial contribution comprises the following elements:

·    60% of the Scotia well costs, including associated costs incurred during 2011.

·    A $25 million cash contribution to be paid in January 2013 predominantly relating to certain historical costs.

·    60% of the costs of the Southern Area Licences commitment well.

·    45% of a discretionary exploration well, should Noble elect to participate in the well.

Resulting licence interests post farm-out

  • Northern Area Licences equity split: FOGL 40%, Noble (operator) 35%, Edison 25%                        
  • Excluded areas within the Northern Area Licences: Loligo complex and the Nimrod-Garrodia complex: FOGL: (operator) 75%, Edison 25%
  • Southern Area Licences equity split: FOGL: (operator) 52.5%, Noble 35.0%, Edison 12.5%

The Loligo exploration well 42/07-01 located 200km east of the Falkland Islands was spudded on Friday 3 August 2012 using the Leiv Eiriksson rig which has just completed the Darwin and Stebbing drills for Borders and Southern. The drill is expected to take around 2 months, but technical difficulties have plagued the Borders drills in this deep water environment so expect some slippages in timings. Rockhopper and Desire’s wells in the Northern acreage off the Falklands were in much shallower water so were less technically challenging.

Following Loligo, the rig will move to the Scotia prospect in Q4 2012.

After the disappointments of the failed Toroa drill in mid 2010 and then the handing back of the 51% interest in the Northern licences in March 2011 by BHP Billiton, Falkland Oil and Gas have made excellent progress in providing a solid financial platform for its activities. The Edison deal earlier in the year and now the Noble deal gives FOGL the financial flexibility to drill Loligo and Scotia and then drill at least 4 more wells in 2014. Compare this with Borders and Southern, whose cash resources to undertake further drills have largely evaporated following the Stebbing and Darwin drills (all eyes are now on the Darwin East gas condensate analysis).

Noble and Edison clearly have confidence that the South Falklands basin has significant potential for large oil/gas discoveries. The Falkland Island adventure continues and at a minimum oil will be being produced from Rockhopper’s Sea Lion prospect in the North Falklands basin in 2016. Lets hope for plenty of drilling success over coming months to allow the Falklands to be the UK’s next North Sea!

Editors noteIt is also worth pointing out that at the current 84p level, should both the drills this year prove unsuccessful, that the residual cash per share of 47p (current fx prices) this values these licences and potential future cash flows currently at just under £130m. Recall that going into the drills at Stebbing that Borders & Southern pre dill valuation was nearly twice this (cash adjusted). SBM is moving FOGL to a Speculative Buy today as we believe them to be the best risk:reward prospect in the Falklands region today. Strike oil and £4+ is likely, hit water and we doubt the downside on the first drill is much more than 60p. That’s a 16:1 upside v downside ratio – odds we like.

Contrarian Investor UK

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