On November 27, 2012, Falklands Oil and Gas (OTCPK:FLKOF) announced disappointing results on the Scotia well. Scotia was the second and last well to be drilled in this drilling campaign. Hydrocarbons were encountered in the well, however, reservoir quality (permeability and porosity) was poor and deemed uncommercial. FOGL stock plummeted 50% on the news.
The companies involved in the Scotia prospect are FOGL, Noble Energy (NYSE:NBL) and Edison SPA. Noble is a major partner in the play having a 35% working interest (WI) and set to take over operatorship of the license in question in 2013. FOGL has a 40% working interest with the remainder held by Edison SPA. Noble has carried FOGL for 60% of the Scotia well costs.
The question that I think most investors are asking right now is: Is FOGL a good investment? Should I stick with it? Let's go over some of the pros and cons of FOGL and the Southern Falklands Basin.
- After the Scotia well is plugged and the current drilling campaign is over, FOGL has stated it will have $220M in cash. It has plans to shoot a large amount of 3D seismic and has said this will cost FOGL net $29M. This brings FOGL down to $191M in cash. If two years go by before another drilling campaign, FOGL will probably burn another $5M in administrative costs, bringing the cash balance to $186M. Along with the carries noted below, this cash is sufficient to take FOGL through the next three to four well drilling campaigns without any fundraising.
- Noble has committed to carry FOGL on one, possibly two additional wells. Noble will pay 60% of FOGL's costs on a regulatory commitment well in the southern license. The southern license is near the area where Borders & Southern (OTC:BDRSF) previously drilled the Darwin and Stebbing prospects. Additionally, if Noble chooses to participate in another discretionary exploratory well, FOGL will receive a 45% carry on this well. The details on this 45% carry well are pretty hazy.
- A massive 3D seismic program is being commissioned to explore for new prospects and further define existing prospects. FOGL has an extremely large amount of land to work with.
- 3D will be necessary to better determine the areal extent of the various sands (especially the T5 sands) that were penetrated by the Loligo well. Sidewall core data is also still pending for Loligo. Being able to tie in the Loligo well to the 3D seismic will be extremely helpful in trying to determine reservoir quality throughout the rest of the Loligo complex.
- As above, having the ability to tie wells into seismic data will help FOGL better correlate the 3D seismic to actual formations, which will lead to more informed decisions about prospects in the future.
- FOGL has drilled three non-commercial wells in the South Falkland Basin. Toroa was a dry hole drilled in 2010. Loligo and Scotia both found gaseous hydrocarbons, however, reservoir quality was poor enough that flow testing could not be achieved. In the case of Loligo, this is possibly due to penetration of the sand edges. I don't believe this is the case at Scotia. Looking back at presentations FOGL published, it appears that it was targeting the dead center of the amplitude anomaly. Poor reservoir quality in the center of the prospect is not something you want.
- The next drilling program is not until Q4 2014. Two years from now is a long time. Many things can change. The world could be an entirely different place given the huge fiscal challenges many of the world's governments face.
- If FOGL were to strike out again on the next drilling program, it would have to raise funds to continue operations. It may find difficulty doing this coming off such a poor exploration campaign. The only way to raise funds might be to sell down more working interest in the prospects if anyone else is willing to continue exploration.
- Toroa discovered excellent sands in the Mid-Cretaceous, which excited folks for the potential of the reservoir rock at Scotia. The two sands couldn't be more different, though. The theory behind deposition of the Loligo/Scotia are underwater debris flows that leave behind (in a fan shape, aka the reservoir) larger particles such as sand grains while smaller particles are carried farther out as they are able to be suspended in the water with less energy. Perhaps this basic geologic assumption is simply not true in the northern part of the South basin and the silt, clay, etc has been deposited along with the sand. The clays, etc are deposited along with the fine grained sand and take up porosity space within the sand and constrict pore throats reducing permeability. Are all of the deepwater sands in the northern part of the basin this way? Are there any high quality sands up there at all? Perhaps core analysis from the two wells, specifically Scotia, will help answer these questions.
- Another selling point of the Scotia prospect was that it was sitting on top of oil mature source rock. FOGL had previously stated that it thought the B&S Darwin discovery was going to be gas. It was correct. Noble, on a conference call, stated that the company elected to not participate in the Loligo drill because it thought it was gas. This was correct, however, it said it also felt differently about Scotia and thought it would contain oil. I think a lot of investors felt comfort that Noble was making these oil predictions. The discovery of gas at Scotia has to make a person concerned with the source rock maturity model. Noble has to be very concerned as well given the various locations that gas has already been found in the basin. With the other projects that Noble currently has, I don't think Noble is interested in developing a gas play in the Falklands unless it is truly substantial.
- As a result of the gas find (I assume), the Scotia well was deepened past the target interval to retrieve core samples of the assumed source rock. Analysis of these samples could be crucial to whether or not any oil could be expected from further exploration. All other source rock interpretation has come from the DSDP wells, which are many miles to the east.
- A total of four deepwater wells have been drilled from the south west edge of the basin to the very north east. All of the wells have shown to be gassy. The entire basin may just be mature for gas. With gas comes extremely high economic hurdles. Gas requires massive amounts of expensive infrastructure. Expensive infrastructure only gets more expensive when you are talking about installing it in one of the most remote places on Earth in some of the harshest conditions on Earth.
- Argentina still disputes ownership of the islands. To date its threats have been empty, however, this could change if significant oil was to be found. The UK would certainly defend the islands, but it is something that could severely complicate matters.
At the end of the day, it boils down to can a large enough, high quality reservoir be found before the cash runs out? This may be the T5 sands at Loligo or it may be another prospect discovered with the 3D.
My Thoughts Based on All of the Above
- I don't think much information will come from the Loligo sidewall cores other than what we already know from the lack of flow test and logs: the rock around the wellbore had poor permeability. The real information will come from tying that to 3D.
- The 3D will tell investors more about the extent of the T5 sands and hopefully help give a relative comparison of the sands in the immediate vicinity of the wellbore to the sands in the rest of the prospect.
- More prospects never seen on the 2D seismic may pop up on the 3D seismic. I believe based on the gas at Scotia and gas in the rest of the basin that these prospects will also have gas. Whether or not the gas comes with condensate and/or NGLs is anyone's guess. Liquids certainly make economics much easier.
- The core samples from the suspected Scotia source rock could be a severe blow to exploration if they are found to be gas mature or overcooked.
- Sand quality in the northern portion of the basin is suspect based on the results from Loligo and Scotia. Both Toroa and Darwin are in the southern portion of the basin and have shown high quality sands. Perhaps the focus should be down there. Although the ultimate size of the Darwin, Stebbing, etc lookalikes are not as large as the northern sands, Darwin is currently the only possibly commercial find. One possible drawback to focusing on the southern portion is drilling issues due to abnormal pressure issues, likely due to uplifting from faulting and folding. These issues were exhibited by the failure to get the Stebbing well to TD. Scotia core samples were taken in the middle of the prospect and when coupled with the 3D, should hopefully shed some information on what to expect from other sands as far as quality goes.
- The shares may drift up closer to a "current" cash value, but typically these usually drift flat or drift down on no news as folks lose interest and sell to move on to other things. See the 2010 chart for FOGL after Toroa.
- There is much uncertainty in the world along with other opportunities for capital given two years until the next drilling. There will be plenty of time to get in before the next drilling campaign if an investor so chooses.
Based on everything listed above and after a day and a half of thinking about it, I have decided to sell my shares and move on to other ventures. I debated keeping a portion of the shares "just in case" something happened, however, I believe there will be plenty of time to get back in and that the money is better deployed elsewhere in the time being. I will continue to watch from the sidelines and may buy back in after the 2014 exploration campaign if FOGL finds commercial hydrocarbons.
I wish everyone good luck on whatever path they may choose. As always, do your own research and make your own decision based on the facts.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Based on the most recent exploration findings, I have decided to sell my FOGL and FLKOF.PK shares.