The oil gamble of the decade could finally pay off

With the discovery of oil in the Sea Lion field - and the prospect of more to come – the Falklands oil story is nearing the moment of truth, says Tom Bulford.

There is quite a buzz surrounding the Falkland Islands right now. UK listed explorer Rockhopper's Sea Lion field discovery marked the first major oil finding in the islands. And many other oil explorers are scouring the Falkland basins for prospects as we speak.

Even Hollywood actor Sean Penn was moved to give his take on the Falklands declaring that the UK was acting "colonialist" in its relations with the islands.

Not that we should concern ourselves too much with Sean Penn's position on the Falklands. After all, he is a bit of late comer to this story.

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Most of us however have been following developments in Falklands very closely over the last few years. We know that there is an estimated total recoverable oil of 448 million barrels in the Sea Lion field alone not far short of the discovery single largest field in the UK North Sea this century.

According to Edison Investment Research, Sea Lion is a highly attractive project even at an oil price as low as $80 a barrel, and it is confident that Rockhopper will find a partner willing to put up the $2bn needed to bring the field into production.

We also know that there are a number of very promising prospects that could reach those reserves in the coming weeks. Let's take a look at those.

How each Falkland islander could become £2m richer

The Sea Lion field success by Rockhopper could transform the fortunes of the Falkland Islands. The government, for example, should expect to see $3.9bn in royalties and $6.6bn in tax revenues over the life of the field. To put this in context, the government only received $39m in tax and other income in 2009/2010. From another perspective, the population of the Falklands is about 3,000. Divide that number into the $10.5bn income from Sea Lion and it gives each islander a potential bounty of over £2m.

That is a handy sum, but it pales into insignificance compared with what could happen.

On 31 January, Borders & Southern (BOR) spudded its first well in the ocean to the south of the Falkland Islands. It said that this operation would take about 45 days. That means we should now be less than a fortnight from discovering whether it strikes oil. With 2 April marking the 30th anniversary of the start of the Falklands war, and the price of oil edging up towards fresh highs, a storm is brewing, and success for Borders & Southern could turn this into a hurricane.

The Leiv Eiriksson rig could deliver ten times the payload of Sea Lion

So far, recent drilling in the Falklands has been confined to the shallow water northern basin. With Rockhopper now focussing on bringing Sea Lion into production, further exploratory drilling in the northern basin is unlikely until 2015, so the focus is now on the southern basin.

After completing the first well for Borders & Southern, the Leiv Eiriksson rig is set to drill three more one more for Borders and two for Falkland Oil & Gas. The biggest of these is the latter's Loligo prospect which, with an estimated resource of 4.7 billion barrels, is ten times the size of Sea Lion.

It is the second largest exploration prospect to be drilled anywhere in recent years, with its resource potential exceeded only by the 7.9bn-barrel Libra discovery off Brazil. In all, the four prospects targeted by the Leiv Eiriksson have estimated potential resources of almost eight billion barrels, three times current UK oil reserves.

Despite the fact that the government of the Falklands takes a lower cut than any government except French Guiana, that would still be enough to virtually submerge the islands beneath a stream of tax revenues and royalties. Edison estimates that success for these four prospects could generate tax and royalties of $177bn, which is about £37.5m per islander.

It may not end there. If the region is as oil-rich as some have estimated, there could be 60 billion barrels. Revenues from all that would be worth c.£280m per islander!

Short of laying on direct flights to Las Vegas, it is impossible to see how the islanders could ever get through this kind of money. The Falklands government, with help from the UK, is going to have to come up with a strategy or else Argentina, which last week prevented two cruise ships from docking in Ushuaia, apparently because they had previously visited the Falklands, is certain to turn up the pressure.

Could we see another 500% share price gain?

Corporate investors in the oil sector are used to political risk - although BHP Billiton is thought to have pulled out of its joint venture with Falkland Oil & Gas for fear of offending South America. Rockhopper is confident of striking a farm-out deal for the development of Sea Lion, with the UK's Premier and Cairn, and the USA's Anadarko and Noble Energy rumoured to be in the frame.

Assuming that it can bring Sea Lion into production within its 2016 targeted time frame Edison argues that its shares can double from here. But the biggest near term potential undoubtedly lies with the southern basin licence-holders Borders & Southern and Falkland Oil & Gas.

In the month after the Sea Lion discovery, Rockhopper's share price gained 644%, as the market not only took on board the significance of this find, but also started to price in the possibility of more. "This", says Edison, "is not uncommon, and forms the basis for what we can expect the other Falklands explorers to do if they have equally encouraging is therefore not unreasonable to assume that share price gains running in excess of 500% could be possible with both companies. The large size of the prospects.are of a magnitude that is difficult for investors to comprehend"

The oil gamble of the decade is upon us if you want to place your bets, you had better hurry. The moment of truth is nearly here. I'll keep you up to date on this tremendous, and long running saga, right here in Penny Sleuth.

This article is taken from Tom Bulford's free twice-weekly small-cap investment email The Penny Sleuth. Sign up to The Penny Sleuth here.

Information in Penny Sleuth is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. Penny Sleuth is an unregulated product published by Fleet Street Publications Ltd.

Tom worked as a fund manager in the City of London and in Hong Kong for over 20 years. As a director with Schroder Investment Management International he was responsible for £2 billion of foreign clients' money, and launched what became Argentina's largest mutual fund. Now working from his home in Oxfordshire, Tom Bulford helps private investors with his premium tipping newsletter, Red Hot Biotech Alert.

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