Drilling In The Falkland Islands

The result of the first well is due within days.

Discussion board regular Hallucigenia continues his series on oil investing.

In my last article I gave an overview of oil exploration in the Falklands Islands. Now we can get down to specific investment opportunities. There are four AIM-listed companies looking for oil in the islands:

Desire and Rockhopper operate in the North Falkland Basin, Falklands Oil & Gas (FOGL) and Borders are active south of the islands.

The Ocean Guardian, the mid-range rig that started drilling last month is primarily working in the north for Desire and Rockhopper, although FOGL have one shallow-water target it can drill. FOGL's remaining targets and Borders' will need a top-end rig which they are hopefully going to contract in October.

Drilling programme

The Ocean Guardian has been booked for four wells with options for six more, I list the current plan below but it is subject to change depending on the results of the early wells.

The numbers come from either the Senergy report for Desire or the RPS report for Rockhopper (and both in the case of Liz), plus the FOGL placing announcement and my guesstimate of risking for Toroa. The two consultant reports go into a lot of detail about the prospects and are well worth reading if you're into that kind of thing.

I can't emphasise enough how sceptical you should be of any numbers relating to prospect size and chances of success, no matter how exact they appear. They are only as good as the data that goes into the computer models, and in this case that means a lot of guesswork. As such it's a waste of effort getting too complicated with valuation models, the underlying numbers could change by a factor of 2 or 3 after the first drill results.

This uncertainty is why I've quoted the prospect sizes as the P50 "best guess" recoverable volume, it just seems more appropriate than using the mean recoverables which can get distorted by uncertainty about the upper boundary of prospect size.

I'll talk more about how reserve numbers work in future articles so don't worry about jargon terms like P50 and P90, I just mention it now for anyone wondering why my numbers are so much smaller than the mean prospect sizes quoted elsewhere.

Chances of success

The chance of success (CoS) is something else to discuss in a later article, but it's worth noting that RPS uses a basic geological CoS, the chance of hydrocarbons flowing to the surface, whereas Senergy is more demanding in requiring hydrocarbons to surface and the presence of at least the P90 resource (around 15-20% of the P50 volume listed above).

This will inflate the CoS for Rockhopper-only prospects relative to targets controlled by Desire. As you can see from Liz (18% versus 17%) it may not be a huge factor but worth noting.

Looking at the table, the consultants are giving odds of 6/1 against most of the prospects in the North Basin. I'd guess that using the same methods they'd come up with odds of 1 in 6 for the first few FOGL prospects and 1 in 10 or worse for Borders'.

It's worth noting that in the past Desire have (very optimistically in my opinion) quoted a 50% chance of Ann containing hydrocarbons. Rockhopper has, with more justification, put Ernest at over 40% and FOGL suggested that it would not have got BHP Billiton (LSE: BLT) as a partner if their odds were less than 33%.

FOGL and Rockhopper can be more optimistic because most of their initial exploration targets give anomalies on an electromagnetic (CSEM) survey performed by Offshore Hydrocarbon Mapping (LSE: OHM).

OHM claims that CSEM has a very high success rate in identifying subsurface accumulations of hydrocarbons. This is less helpful in the North Basin, where we already know that there's lots of hydrocarbon about, but would be very useful in the undrilled South Basin. Unfortunately CSEM doesn't tell you whether the reservoir will allow the hydrocarbons to flow, which could be the main problem in the North Basin.

Of course, the geological CoS is of little interest to long-term investors. They don't care about finding oil in itself, exciting though that may be in the short term. What they are looking for is oil that can be produced commercially.

Senergy reckons that 56 million barrels of recoverable oil would break even in the North Basin at $50/bbl oil, so it would get developed on the assumption of $60-65/bbl oil.

Thus the commercial chance of success requires you to think about the chances of having at least that kind of volume of oil in a prospect, not just whether oil can flow to surface. It's not much of a problem for the big prospects like Liz and Jacinta, but there's a definite possibility that the likes of Ninky and Beth might not be commercial as independent oil projects.

Gas

It gets worse if the prospects for gas, since there's no easy way to get gas to market. It would require either a pipeline to Tierra del Fuego or a plant to make liquiefied natural gas (LNG). The huge expense of these options would only be justified by a big resource, 5-8tcf for a full-scale LNG plant -- say 1 billion barrels of oil equivalent.

There's a real risk that Desire and Rockhopper could find a lot of hydrocarbons, but it's all gas and they don't have enough of it for commercialisation. Certainly there's lots of gas-related structures on the seismic of both basins and the only booked resource is gas in the Johnson structure. I'm particularly worried about the prospects relying on a deep (Jurassic) source -- Dawn and Ernest.

Only Jacinta/Alpha could support a LNG plant on its own in the North Basin, maybe Johnson or Liz if they were brim full, but otherwise any gas discoveries would be worthless until there was enough of them to justify building export infrastructure.

On top of that, gas would only have half the value of oil. FOGL's prospects are big enough to justify substantial infrastructure investments if just one of them holds gas, Borders would probably need multiple gas finds.

Deepwater campaign

There are only 35 rigs in the world capable of drilling in the 1000m-plus water depths of the South Falkland Basin, and they are all busy in places like Brazil, Angola and the Gulf of Mexico. FOGL seem to be aiming to get a deepwater rig in October or so, but these things are never predictable. Its licence requires a well by the end of 2010, but that should be flexible.

I suspect FOGL will remain vague about its plans until they have studied the data from the Toroa well, at the moment it's talking about one definite deepwater well with the option for more if things go well. Its most likely target is the 3 billion barrel Loligo prospect.

Borders have the cash to drill three wells, at the moment they're talking about one well each on Darwin (300mmbbl recoverables) and Stebbing (710mmbbl) plus one option on an appraisal well.

In the next article, I discuss how to value the companies' prospects, and put a value on Desire.

More from Hallucigenia on oil investing:

• Why Invest In Oil Companies?
• Face up to Boe
• Cooking Cabbage Soup
• He Ain't Heavy
• Sweet And Sour
• Oil Investing: The Falklands

The author has a beneficial interest in Desire and FOGL.