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We look at the outlook for the oil price and discuss a quartet of exciting stocks
Thursday 02 Feb 2017 Author: Tom Sieber

Oil exploration can create substantial value overnight. Successful exploration can drive share prices higher as the market prices in the upside from a big oil or natural gas discovery.

In the past companies such as Tullow Oil (TLW) and Cairn Energy (CNE) rode exploration success all the way to the FTSE 100 index.

There are signs activity is now picking up following several quiet years for high impact drilling. Explorers are taking advantage of reduced drilling costs and increased availability of rigs.

In this article we highlight four examples where exploration results could impact the destinies of the individual companies and the continued recovery of the wider sector.

Cover - FTSE AIM SS OIL & GAS

Slick recovery

In January 2016, the oil price was bobbing around multi-decade lows below $30 per barrel as investors fretted about the Chinese economy. Twelve months later it is holding steady above $50 per barrel with producers’ cartel OPEC poised to take further action to support the market.

The oil exploration and production (E&P) sector has started to price in this reversal in fortunes.

For this run to be sustained over the coming months certain criteria must be met. We think the most important is drilling success.

Big discoveries have been in short supply for some time. The E&P sector was underperforming even before the oil price began to crater in June 2014. We believe that could change in 2017.


The E&P sector

What to watch in 2017

Oil prices

Predicting the future direction of oil prices is always a difficult job and in 2017 more than ever.

Investors need to balance several factors in their heads including the policies of US president Donald Trump who wants to boost domestic production.

The consensus expects a gradual build in oil prices as the market starts to rebalance.

The World Bank’s forecast for an average oil price of $55 per barrel in 2017 is not untypical of other people’s views.

Notably there have been noises that Saudi Arabia would be prepared to back further production cuts following last autumn’s landmark agreement to curb output from key producing regions.

Geopolitical factors and supply outages are the great unknown which could deliver short-term spikes in crude.

We think investors should focus on companies which can prosper in a stable price environment. Anyone really bullish on crude may wish to look at heavily indebted companies like EnQuest (ENQ) and Premier Oil (PMO) as they are highly leveraged to oil prices so could increase by a far greater amount than the commodity value itself.

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Exploration success

A Barclays survey of 215 global oil and gas companies implies a greater willingness to invest as OPEC has moved to provide a floor for prices. Spending is expected to rise 7% this year.

In January, Norwegian firm Statoil (STL:OSE) announced plans to increase exploration for the first time in four years with 30 exploration wells lined up for 2017.

This strategy makes sense. A big reduction in costs now makes drilling wells significantly less expensive. A potential recovery in crude down the line could make discoveries particularly lucrative once they are brought on stream.

Capital discipline

The ability of companies to keep a tight rein on costs is crucial for sentiment towards the sector given a patchy track record in this area.

The market is likely to be alive to any signs of renewed cost inflation.

Projects need to be delivered on time and on budget and the few companies which have tapped the equity markets need to demonstrate those funds are being put to good use.

The cash raised by the likes of Hurricane Energy (HUR:AIM), which raised more than £120m on separate occasions in 2016, and Amerisur Resources (AMER:AIM) demonstrates there is a market appetite for the right story.

M&A activity

Normally by this point in the cycle you would have expected more widespread consolidation. Those with plenty of cash at their disposal should have picked up barrels on the cheap, in our opinion.

This hasn’t happened apart from the £35bn tie-up between Royal Dutch Shell (RDSB) and BG. Instead, the market has been flooded with assets being divested by the big oil companies.

But are we at a turning point? The big five oil majors announced upstream acquisitions totalling $5.7bn in December 2016, according to consultant Ernst & Young. This is more than the combined value of all upstream acquisitions made by these companies in the other 11 months of that year.


01/12/15. Cairn Energy Board visit to Ocean Rig Athena, Dakar Senegal.  Picture Ian Rutherford

Cairn Energy (CNE) 240p

Chasing multi-billion barrel potential

Company background: Cairn Energy’s (CNE) fortunes soared in 2004 when a field in Rajasthan, northern India, was found to contain almost 1.1 billion barrels of oil. It bought the assets from Royal Dutch Shell (RDSB) for just $7.5 million three years earlier.

This discovery ultimately catapulted Cairn into the FTSE
100 index.

More recently, the company suffered a few patchy years which included expensive and unsuccessful drilling offshore Greenland and a tax dispute with the Indian authorities.

Cairn rediscovered its exploration mojo offshore Senegal in 2014. The SNE discovery is seen as having multi-billion barrel potential.

senegal map

What is it drilling and when? Cairn has announced its intention to drill two wells on its 40%-owned SNE project from late January. It has options for follow up drilling should the first round prove successful.

What is the funding situation? Investors can have confidence in Cairn’s ability to fund even an extended drilling programme without returning to the market.

It has one of the strongest balance sheets in the sector with net cash of $335m. However, Cairn is increasing its debt funding with a credit facility expected to hit $350m at its peak.

Capital expenditure is guided at $295m in 2017, of which $125m is committed to appraisal drilling and the remainder to its development projects in the UK.

How high are the risks? In E&P terms the risks are relatively modest. Cairn knows there is oil; the main question is how much of this oil it can commercially produce.

The company is not wholly reliant on this activity. It has a diversified portfolio which includes development assets in the North Sea.

What is the potential reward? The results from these wells should offer an indication of how much can be recovered from the estimated 2.7bn barrels in place at SNE. Current estimates stand at gross recoverable resources in the region of 500 million barrels. This number could swiftly ramp up if the upcoming drilling campaign is successful.


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Hurricane Energy (HUR:AIM) 46.6p

Targeting new reservoirs in UK waters

Company background: Hurricane was established to exploit so-called ‘fractured basement reservoirs’.

Co-founder Robert Trice says these overlooked assets could provide a fresh wave of commercial discoveries in what is a mature oil and gas province.

A fractured basement reservoir is a body of rock beneath the earth formed more than 2bn years ago. In certain places these massive structures – located deeper than the sandstones which have traditionally been the focus of oil exploration in the UK – have been pushed up and violently fractured by earthquakes and other tectonic forces.

The hydrocarbons discovered by Hurricane are contained within the cracks in these formations.

Yemen, Libya and Vietnam have successfully exploited fractured basement reservoir potential and Hurricane looks to be on the road to emulating this success.

Hurricane is concentrating its efforts in the area of the North Sea West of Shetland. Its first big success came with the Lancaster well in June 2014 and, ultimately, it is estimated the company has uncovered as much as 500 million barrels of oil.

This activity has been backed by shareholders with the company raising more than £120m during 2016.

shetland islands map

What is it drilling and when? This latest well on the Halifax prospect is already in progress with results expected around the end of the first quarter of 2017.

What is the funding situation? The company is funded for this well by the money raised on the stock market last year. However before it submits a field development plan for the Lancaster field it needs to raise as much as $400m (£320m).

How high are the risks? This is not a wildcat exploration well. It is being drilled in relatively close proximity to an existing discovery although the exploitation of fractured basement reservoirs in UK waters is still in its infancy.

What is the potential reward? If it can demonstrate that Halifax is an extension of the existing Lancaster discovery then resource estimates of around 500 million barrels of oil could be doubled.


Oil and gas industry in the Firth of Forth, Scotland

Jersey Oil & Gas (JOG:AIM134p

High risk given single well focus

Company background: Previously known as Trap Oil, the company was renamed and relaunched in 2015 following severe financial difficulties. Chief executive Andrew Benitz joined the business along with chief operating officer Ron Landsell; both previously worked for Aussie explorer Longreach Oil & Gas.

Their main achievement has been to secure Norwegian firm Statoil as a partner on Jersey’s PL2170 licence in the North Sea. This helped drive a big increase in the share price in the second half of 2016.

What is it drilling and when? The plan is to drill the Verbier prospect on PL2170 this summer.

What is the funding situation? Under the terms of the agreed farm-out deal, Jersey enjoys a full carry from Statoil on its 18% interest in Verbier up to a gross well cost of $25m.

An oversubscribed placing in November 2016 raised £1.6m and the company currently has no debt.

scotland map

How high are the risks? In a recent research note, stockbroker WH Ireland commented: ‘We believe a well drilled by Talisman in 2006, the 20/5a-10Y well, materially de-risks Verbier as a viable prospect.

‘That well was production tested at 4,800 barrels per day plus 2.6 million cubic feet of gas per day from sands of similar age to those being targeted at Verbier.’

The broker puts the chance of success at 18.7%. A rig is not yet secured for the well but Statoil has provided the UK Oil & Gas Authority with a firm commitment to drill.

Jersey’s fortunes are heavily tied to this well and an unsuccessful result would damage its share price.

What is the potential reward? Based on Jersey’s pre-drill estimates a successful exploration well at Verbier would uncover 113 million barrels of recoverable oil (gross), which according to WH Ireland’s calculations could have a value net to Jersey of 986p per share.


An oil rig at night, being repaired in dry dock, Belfast, Northern Ireland.

Providence Resources (PVR:AIM)

Providence has a lot to prove

Company background: Founded and headed by Tony O’Reilly Jr, the son of Irish entreprenuer Sir Anthony O’Reilly, the company is notable for the Barryroe discovery in Ireland’s Celtic Sea. It is still seeking a farm-out partner nearly five years on.

Providence also drilled a well in partnership with ExxonMobil (XOM:NYSE) on the substantial Dunquin prospect in the Porcupine basin.

This geological feature is located in the Atlantic Margin to the west of Ireland. Pre-drill Dunquin had been estimated to contain as
much as 8.4 trillion cubic feet of gas and 316 million barrels of associated liquids. Initial results were disappointing and follow-up drilling also failed to deliver.

The company was forced into a $48m placing at 12p in June 2016. The 17p share price is a long way below Providence’s all-time peak in 2012 of more than 700p.

ireland map

What is it drilling and when? Providence has booked in the drill ship Stena IceMAX for a one-well slot in 2017 with the option of a second well.

The first well will be designed to target two separate prospects – Druid and Drombeg – and is likely to be drilled this summer.

Like Dunquin, they are located in the Porcupine basin and the company has an 80% interest in both prospects.

A third well on the Newgrange prospect, in the same basin, is a possibility but would probably require the company to secure a farm-out partner.

What is the funding situation? It looks pretty tight but Davy estimates the company has $35m at its disposal to cover drilling costs and this is the rough estimate of cost of drilling a well on Druid and Drombeg.

The relatively modest budget shows the benefit of drilling at the point in the cycle when costs are substantially reduced. A previous well on Druid in 2013 reportedly cost more than $200m.

How high are the risks? Significant. The balance sheet situation means cost over-runs could be damaging and the company is yet to secure regulatory approval for the well. Davy has a 10% chance of success for Drombeg and Druid.

What is the potential reward? Again, significant. Druid is estimated to contain up to 3.1 billion barrels of oil and Drombeg 1.9 billion.

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