The Premier Oil and Rockhopper deal – some lessons for private investors

On Thursday, North Falklands Island oil explorer Rockhopper Exploration announced a $1 billion farm-out deal with Premier Oil in exchange for a 60 per cent stake in Rockhopper’s licences in the Islands. The deal makes Premier operator of the Sea Lion discovery with Rockhopper being the sub-surface lead as well as Premier also gaining access to the smaller discoveries at Casper and Casper South.

Rockhopper will get a $231 million upfront cash payment on completion of  the deal and a $722 million Sea Lion development carry (net to Rockhopper) as well as a $48 million exploration carry (net to Rockhopper).

The companies will also work on Area of Mutual Interest (AMI) for future co-operation in the North Falkland Basin South Africa, Namibia and Southern Mozambique.

The submission of the final development plan is expected by the first half of 2014 with the field coming onstream in the first half of 2017.

As a reminder, on 6^th May 2010, Rockhopper announced a ground breaking RNS saying that the well – 14/10-2 on the Sea Lion prospect was the first oil find in the North Falkland Basin. The Sea Lion discovery was followed by further smaller finds at the Casper and Casper South prospects.

Fellow North Falklands explorer, Desire Petroleum, in contrast to Rockhopper, suffered a series of drilling disappointments in conjunction with enormous share price volatility as rumours and contradictory RNS releases drove shareholder interest.

In April 2012, Rockhopper issued a revised CPR (competent persons report) prepared by Gaffney, Cline & Associates which showed 355.6 millon barrels net to Rockhopper 2C contingent oil resources attributed to Sea Lion and adjacent discoveries. Sea Lion and adjacent discoveries were estimated to have, net to Rockhopper, a 2C risked NPV10 of US$ 4.1 billion and an unrisked NPV10 of US$ 4.7 billion.

Rockhopper/Premier will use a Floating Production Storage and Offloading vessel (FPSO) to exploit the field with a plateau production rate of 70,000 barrels per day for the first three years.

This week’s deal produced an astonishing oscillation in Rockhopper’s share price. On Thursday morning, the shares opened significantly higher and moved to around 335p (a 22% gain on the day at that point) and taking the shares of fellow Falkland Islands oil explorers with it (Falkland Oil and Gas, Borders and Southern, Desire Petroleum). However, this proved the high water mark as investors started to look at the deal in more detail and the shares reversed sharply, eventually hitting a bottom of 230p in mid-afternoon before bouncing back to close just below 250p (a 9% decline). After further oscillations between 231p and 258p on Friday, they finally closed at 255p, valuing Rockhopper at £724 million.

After all the hype surrounding Rockhopper that took the shares over £5 at one point (from below 50p pre-discovery) in 2010 following the Sea Lion discovery, investors are disappointed with the Premier Oil deal. With the CPR valuing Rockhopper’s assets at around $4 billion, the $1 billion represents a significant discount.

The question for investors is why they feel that Premier has come off better? The key to the answer probably lies in the level of risk that the oil majors are willing to take and clearly they feel that this frontier oil province has too many to put a good bid on the table. Instead, Rockhopper has had to rely on a FTSE 250 oil and gas company with a market capitalization of £1.95 billion, barely three times that of Rockhopper.

David Cameron’s clash with Argentina’s president Cristina Fernández de Kirchner at the G20 summit in June shows that the Argentinians are still putting the pressure on with the claim that they have sovereignity over the Falkland Islands. It seems unlikely that their claim will ever be enacted but with many of the South American countries siding with Argentina and not allowing vessels associated with the oil exploration work to dock in their ports it adds to logistical complexity and cost.

Simon Lockett, Premier’s chief executive, said the company had “thought long and hard” before signing the Rockhopper deal and had sought advice on the situation, including from the UK government, before deciding it was “a good project to invest in”. “Our conclusion was that this is a risk worth taking,” he said: “It would be foolhardy of us to dismiss the risk as nothing.”. In contrast to Premier, the oil majors, clearly believed it wasn’t a risk worth taking!

Simon Lockett

The significant development costs of around $5 billion and relatively long period before first oil in 2017 also makes the economics of the project less enticing for many less well funded players. Much of the capital expenditure will be needed during 2015/16. Falkland Islands holdings who own much of the islands port infrastructure rose 6% this week as Premier will need to build significant infrastructure to accommodate the oil from Rockhopper’s acreage.

The Chief Executive of Rockhopper, Sam Moody,  has been quoted as being surprised as to the share price fall citing that the company now own 40% of  a fully funded project.

Sam Moody

The lesson in all this for private investors is that with any major oil project in a riskier part of the world, financiers will want their “pound of flesh” to cover the risk and ensure they make money. It is the interests of major institutional investors that are considered and unfortunately not private investors. If you put money into companies drilling in frontier provinces you should not expect a bonanza when the time comes to find money in a tight market. It is those with the cheque book who are in control at the moment with credit markets being very difficult (just look at Xcite Energy and its difficulty in funding the relatively safe North Sea Bentley field and its use of finance houses such as Socius to cover funding gaps and which have killed the share price).

If you have a very long term view on an investment that is fine, but for those wanting a sharp appreciation in the share price on a deal, there may be disappointment ahead. Small cap oil companies are between a rock and a hard place at the moment having to choose between takeovers, farm in deals or financing – both of which are nowhere near as appealing as they were pre 2008/2009. Those companies best placed ain this enivironment are those with cash flow from existing operations to fund exploration activity and field development elswhere. This is why the Heritage Oil deal done in Nigeria makes a lot of sense allowing steady money from these fields to be ploughed into Kurdistan.

So in summary, investors in RKH may be feeling a little aggrieved with Sam Moody that he’s given away the company on the cheap but finding $5 billion to develop Sea Lion whilst retaining 40% of the prospect is quite an achievement in this era of “difficult money”. Premier Oil have plenty to worry about in the next few years, a significant engineering challenge, lots of cash to find to fund infrastructure and then the challenge of actually delivering the oil to markets. AIM oil investors need to walk into their investments with their eyes wide open that the power lies elsewhere!

Contrarian Investor UK