The Falklands oil story reignites

Last week a successful drilling result from Rockhopper (LON:RKH) reignited the story of Falklands oil.

Shares in Rockhopper (RKH), having earlier hit 290p, closed the week 17% higher at 259p while those of the other Falkland oil plays Desire Petroleum (LON:DES), Falkland Oil & Gas (LON:FOGL) and Borders & Southern (LON:BOR) also edged higher.

Rockhopper's success follows a sequence of dry wells that have dulled the optimism of investors. But, "recent market concerns are overdone", says Merrill Lynch. With the exploration program for the south Atlantic far from over, investors certainly should not be giving up hope.

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In fact, this latest well could finally establish the Falklands as an oil producing region - heralding a potential bonanza forpenny share investors.

Rockhopper's new well could be worth over $2.5bn!

Rockhopper is the only one of the group so far to have made a genuine oil discovery, at its Sea Lion prospect. Although a subsequent independent review, disputed by Rockhopper, suggested that this could represent an exaggeration of some 30%, the best estimate for the amount of oil recoverable from Sea Lion stands at 242 million barrels.

This latest successful well was drilled 2.3km west-north-west of the original discovery and was the first such appraisal well designed to investigate reservoir presence and oil column at a downdip location. Although the oil bearing zone here was a little thinner than at the first well, the result confirmed the conclusions of seismic surveys. This allowed Rockhopper's Chief Executive Sam Moody to state that Sea Lion is "highly likely to prove commercially viable".

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If so, this will finally establish the Falklands as an oil producing region and demonstrate that wildcat exploration can create real value for shareholders. Rockhopper's consultant RPS Energy has estimated that 170 million barrels of recoverable oil are worth $2.5bn, and that is on the basis of a reasonably conservative discount rate of 10% and oil at $80 per barrel.

In a presentation given in February, Desire Petroleum gave the estimates of its own consultant, Senergy. Again using a 10% discount rate, it calculated that a 150mmbl discovery would be worth $1.99bn at a $75 oil price and $3.17bn at $100.

Figures like these explain why investors have been willing to put up hundreds of millions of pounds for an exercise that has sometimes seemed like taking dollar bills down to the south Atlantic and scattering them in the ocean. So what comes next?

Who could be next to strike in the Falklands?

So far all the drilling activity has been in the North Falklands Basin, and conducted from the Ocean Guardian drilling rig. This has now moved to the Desire's Ninky prospect, where drilling has started and results should be known within 30 days. This is one of six wells for which Desire already has sufficient funding. Rockhopper, meanwhile raised £200m last October with which to drill new targets but also to do more appraisal work and field development plans at Sea Lion.

All of this is taking place in the North Falklands Basin, but progress has been slower in the South Falklands Basin. Here, the deeper waters require a different type of rig to the Ocean Guardian, and the two stock market plays are Borders & Southern and Falkland Oil & Gas.

Borders & Southern has contracted the Eirik Raude semi-submersible rig that will make its way to the Falklands on completion of its current contract in West Africa in October. Borders will then drill two wells, and have an option to drill three more. So at the end of this year attention will turn to Borders, which just leaves Falkland Oil & Gas.

Falkland Oil & Gas also has acreage in the South Falklands Basin, to the east of Borders. It has drilled one unsuccessful well at its shallower extremity, where it was able to utilise the Ocean Guardian, but for further exploration it needs a deep water rig. Last year FOGL's partner, BHP, decided that it did not wish to continue with a joint venture over the southern half of FOGL's license area, but it does still have a shared interest in the northern half.

A fortnight ago FOGL revealed that it is "at an advanced stage in contract negotiations for a suitable deep water rig for the Southern Licence area" and that "BHP Billiton is also engaged in related negotiations to secure a rig slot to drill Loligo".

Loligo is a massive prospect, with estimate reserves of 3.5bn barrels. On the basis of the valuation metrics applied by RPS Energy and Senergy 3.5bn barrels would be worth a mind-boggling $50bn, a massive sum, of which FOGL would have a 49% interest.

There is not much doubt that the South Atlantic is host to more than just the Sea Lion field. All four explorers have further shots at the board over the next year or so. This remains a territory where fortunes could be made.

This article was first published in Tom Bulford's twice-weekly small-cap investment email The Penny Sleuth.