Why I’d Sell Rockhopper Exploration Plc And Buy Faroe Petroleum plc And Amerisur Resources plc

Roland Head explains why Rockhopper Exploration Plc (LON:RKH) is a risky buy compared to low-cost producers Faroe Petroleum plc (LON:FPM) Amerisur Resources plc (LON:AMER).

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Shares in Rockhopper Exploration (LSE: RKH) fell by nearly 10% in early trading this morning, following news of a UN ruling that has expanded Argentina’s territorial waters to include the Falkland Islands.

Rockhopper’s main asset is the undeveloped Sea Lion field in the North Falkland Basin. The firm hopes to develop these assets in partnership with Premier Oil. The firms’ exploration licences are issued by the Falkland government on terms similar to those issued under UK law.

If the Falkland Islands were to become Argentinian territory, these licences could be revoked or reissued on less favourable terms. Although oil companies regularly have to deal with issues of sovereignty, these risks won’t help the investment case for Sea Lion.

We don’t yet know if the UN ruling will have any immediate implications for the Falkland Islands. It’s also worth noting that Premier Oil, which will lead the Sea Lion development, hasn’t yet made a final decision about whether to proceed with the project.

My concern is that a large part of Rockhopper’s current valuation is based on the assumption that Sea Lion will go into production. In my view, this could take much longer than expected. Premier already has challenging levels of debt. The combination of low oil prices and political uncertainty may encourage the group to delay Sea Lion.

I believe Rockhopper shares could have further to fall. That’s why I’m much more interested in buying shares in small oil producers with ongoing production, plenty of cash and proven low costs.

30% cost reduction

Two companies that fit the bill perfectly are Faroe Petroleum (LSE: FPM) and Amerisur Resources (LSE: AMER).

Faroe published 2015 results this morning, showing that the group’s production rose by 15% to 10,530 barrels of oil equivalent per day (boepd) last year. The average operating cost per boe fell by 30% to $23, improving cash flow.

Meanwhile Faroe’s proven and probable reserves rose by 88% to 57.4m barrels of oil equivalent, thanks to the successful Pil and Butch wells.

Faroe ended last year with net cash of £68.5m, almost unchanged from £69.6m at the end of 2014. The group’s focus on the Norwegian North Sea means that it benefits from a 78% tax rebate on all exploration activity in this region.

Three exploration wells are planned for this year and the group is also on the lookout for potential acquisitions.

In my view, Faroe offers good downside protection and could be a profitable medium-term buy.

Production should rise sharply

Amerisur Resources also updated the market this morning. The firm’s shares edged higher after it announced proven oil reserves for the Platanillo field of 15.2m barrels. When last year’s production of 1.62m barrels is factored-in, field reserves actually rose slightly despite cuts to capital expenditure.

Amerisur’s reserves and oil production should rise significantly in 2016. The group plans to restart production from wells that were shut in the last year ahead of the completion of the group’s new pipeline connection. This pipeline is expected to reduce Amerisur’s break-even oil price to just $15 per barrel.

Amerisur has low costs and the balance sheet looks strong after a recent $35m placing. I believe the stock could be a good buy at current prices.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

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