Assessing Rockhopper's Falklands campaign

Rockhopper Exploration is, perhaps, the most intriguing stock on the AIM exchange. Taken in isolation this oil exploration company, with a market capitalisation of £745m, is interesting in its own right.

Rockhopper cannot, however, be taken in isolation because its interests in the seas off the Falkland Islands and its success, so far, in discovering perhaps 400m barrels of oil make it a political as well as commercial concern.

Rockhopper was formed in 2004 with the express aim of finding oil in the pre-historic river basins which lie to the north of the Falklands Islands and which are now covered by the bitter waters of the South Atlantic.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

In April 2010 the company achieved its objective with well "14/10-2" in the Sea Lion basin, the first discovery of oil in the Falkland Islands.

Tests showed this first well flowing at a rate of 2,000 barrels of oil per day. A subsequent well dug two kilometres away then showed possible flow rates of 2,700 barrels per day. Then, in early 2011, one well was flow tested at 5,500 barrels per day.

The mid case estimate is now 389m barrels of recoverable oil. With black gold currently selling for around $110 per barrel the Sea Lion discovery could yield a value in excess of $4bn.

It's these numbers which have pushed Rockhopper shares up 435% since April last year. In fact, some might expect Rockhopper to be valued even higher than its current 264.5p. Certainly, EVO Securities has a target price of 450p, while analysts at Merchant Securities are aiming at 428p.

The trouble is several questions surround Rockhopper's prospects.

The most significant, according to Andrew Matharu, Head of Oil & Gas at West House Securities, is that a "mini Aberdeen" would need to be built on the Falkland Islands to handle the vast amount of oil that would be pumped up from the ocean floor.

The construction of industrial grade infrastructure in-and-around Port Stanley may cost £2bn. Finding finance for such a large development will be a particular challenge for Rockhopper in the debt market.

The second problem is that whoever does decide to take on the infrastructure project will face a deafening silence from Argentina which for obvious reasons is not expected to provide any logistical support. Given the isolated position of the Falkland Islands this will increase complexity and cost.

It is also possible (if unlikely) that Argentina may be militarily provoked when it finds hundreds of millions of dollars in oil money being made on its doorstep, in territory it considers its own.

Rockhopper, in other words, is no racing certainty. Raising money will be difficult, putting in infrastructure will be technically challenging and, if the neighbours get shirty, life could get very complicated indeed.

Recent, further discoveries of oil, however, are firming up the belief that Rockhopper could really make it to full production of the Sea Lion basin.

Early in November the company dug well "14/10-9" which firmed up expectations of achieving the mid case scenario of 389m barrels.

Merchant Securities believes this latest discovery was a critical development: "because the primary investment thesis for Rockhopper is about value recognition. We do not need more exploration success; we need only to firm-up the mid-case estimate."

With that assessment ringing in investors' ears, Rockhopper will continue to be one of the most closely watched UK equities.