Does Chinese Rig Deal Make Xcite Energy Limited A Buy?

Shares in Xcite Energy Limited (LSE: XEL) rose sharply this morning, following news that the North Sea firm has signed a memorandum of understanding (MoU) with China Oilfield Services Limited (COSL) for the provision of a new-build drilling rig, plus equipment and personnel for Xcite’s Bentley field.

Today’s announcement is the latest in a flurry of recent good news from Xcite, and also suggests a possible solution to the biggest problem facing the firm’s long-suffering shareholders.

Desirable asset

It’s worth reiterating that Bentley boasts 2P reserves of 257 million barrels of oil and has a net present value of $2.1bn — this is a potentially significant field for the North Sea, and is expected to have a 35-year lifespan.

Bentley’s proven reserves have enabled the firm to strengthen its finances this year, with a new $135m two-year bond issue and a small equity raise, which enabled the company to repay previous loan notes, and have left a cash balance of £41.5m, as of June 30.

Here’s the problem

Xcite’s cash balance means that it should have no short-term funding problems, but it’s clear that the firm won’t be able to fund the Bentley development alone — new jack-up rigs cost north of $200m, for example.

For a long time, Xcite has been in obvious need of a farm-in partner and despite today’s good news, nothing has changed — or has it?

Chinese whispers

This is only a guess on my part, but Xcite’s choice of COSL to provide its drilling rig could be significant: COSL is a subsidiary of China’s state-owned oil giant, CNOOC.

China’s activities in the global oil and gas market are often aimed at securing future supplies of oil and gas, rather than maximising profits.

It’s possible that Xcite’s MoU with COSL is the precursor to news of a full-blown farm-out deal with CNOOC, which could mean that COSL will foot the bill for providing the new rig, in exchange for its parent firm, CNOOC, enjoying a fat slice of Bentley’s eventual production.

Given that Xcite’s market cap is currently just £150m, this could be a good deal for shareholders, but it’s worth noting that such deals often involve very high levels of dilution; I think that Xcite shareholders should be targeting a share price of 100p, at most.

As a result, my view is that Xcite remains no more than a speculative buy, until it announces a farm-out deal.

Indeed, careful position sizing is essential for oil and gas investments, to protect you from significant capital losses when early-stage investments don't go to plan.

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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.