Does New Discovery Make Rockhopper Exploration Plc, Falkland Oil and Gas Limited and Premier Oil PLC A Buy?

Shares in Rockhopper Exploration (LSE: RKH) and Falkland Oil and Gas Limited (LSE: FOGL) rose by as much as 15% this morning.

The gains came after news that the re-drilled Isobel Deep well has made a potentially commercial oil find in the North Falkland Basin. This has rekindled hopes among investors that the commercial development of the region’s oil resources will go ahead.

Shares in Rockhopper and Falklands’ bigger partner, Premier Oil (LSE: PMO), which operated the well, were flat following news of the discovery. However, this isn’t surprising given Premier’s much larger size and valuation.

“Highly likely” to be commercial

Today’s discovery is the result of the successful re-drilling of the Isobel Deep well. The original well failed to reach target depth in May 2015 but this latest well was successful. The well found 27m of net oil pay in the Isobel Deep, Isobel and Emily reservoirs.

Oil shows were also found in the Elaine South and Irene fans. Rockhopper and Falkland Oil said today that they believe better quality oil reservoirs are likely to exist in the main bodies of these fan systems.

The well didn’t find any oil-water contact, despite this location being 350m downdip from the original Isobel Deep discovery well. According to Rockhopper, these drilling results indicate that the total oil column established by this well is likely to be in excess of 480m.

The view of Rockhopper management is that the Isobel/Elaine complex is “highly likely to contain a commercially viable quantity of recoverable oil”.

Indeed Sam Moody, Rockhopper’s chief executive, said this morning he believes Isobel/Elaine “can become a third phase of development in the North Falkland Basin”.

How to profit from Falkland oil

Rockhopper and Falkland Oil are due to complete their planned merger later this month. The resulting company will have a 64% interest in the licence area containing today’s discovery. In total, the new company will have net 2C contingent (discovered) resources of more than 250m barrels.

It seems increasingly likely that there’s a commercial quantity of oil in the North Falklands Basin. Rockhopper is probably the best way to play this potential. Rockhopper is well-funded and after the merger with Falkland is expected to have a net cash balance of about $130m. The group should be able to ride out the current slump quite comfortably.

However, it’s worth remembering that Rockhopper can’t carry out this development without a bigger partner. So far only Premier Oil has expressed a serious interest in developing Rockhopper’s flagship Sea Lion discovery. In my view, rapid progress is unlikely.

Premier’s share price has fallen by 80% over the last year. The group hasn’t yet made a final investment decision about Sea Lion. Behind the scenes, I suspect that net debt of about $2.3bn and plummeting oil prices are creating significant financial challenges for Premier.

I very much doubt that the Sea Lion development will be attractive at less than $50 per barrel. I don’t expect Premier or any other firm to give the go-ahead for Sea Lion or a wider Falkland development plan until market conditions improve.

For this reason, I suspect that an investment in Rockhopper will require some patience.

Personally, I believe there are less risky and more profitable buys elsewhere. One example is the firm tipped as A Top Growth Share From The Motley Fool.

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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.