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Falcon Oil & Gas insulated from oil price turbulence, and potentially on cusp of something exciting

Falcon can withstand several more bouts of the jitters as Saudi Arabia and the US slug it out for oil supremacy, but not just that, it is also on the cusp of something potentially very exciting.

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There are few oil and gas companies that can claim to be insulated from the turbulence caused by US$50 a barrel oil.

But if you have zero capital expenditure, no debts, a decent cash pile and your drill commitments are fully funded then life looks a lot rosier than it might for a junior sitting on a dwindling source of funds with contractors to pay.

The position of Falcon Oil & Gas (LON:FOG), with over US$18mln in the bank at the last update, is that it can withstand several more bouts of the jitters as Saudi Arabia and the US slug it out for oil supremacy.

Not just that, it is on the cusp of something potentially very exciting, even if the true worth will only be fully captured once the price of a barrel of crude moves back to more normal levels.

It is a 30% shareholder in 4.6mln acres of the Beetaloo Basin, an unconventional play in Australia’s Northern Territory, where its farm-in partners are local firm Origin Energy and South Africa’s Sasol.

The pair are committed to a US$64mln drill programme that starts in June designed to unlock the mysteries of the area. This is part of a larger nine-well deal valued at US$200mln to Falcon.

The resource potential of the Beetaloo could be enormous if it does shape up to be the massive shale play modelled by current estimates.

A 2013 report by industry consultants RPS estimated its gross recoverable resource potential to be 162 trillion cubic feet of gas (at a 50% confidence level) 21.3bn barrels of oil.

Early results from Aussie explorer Santos in the McArthur Basin targeting the same mid-Velkerri horizon to be probed by Origin returned some interesting results.

Remember first, the Beetaloo is a subset of the McArthur Basin so the Santos data when it is seen in full will have some resonance for neighbours.

All we know at the moment, however, is Santos found 500 metres of net pay – that’s large by any standards – and elevated gas shows. Talk is the attributes of mid-Velkerri matched those of the best US shales.

Only time – and a good deal more exploration - will tell if this turns out to be true.

As Santos is playing its cards close to its chest at the moment, Falcon and its partners will have to wait and see for themselves what lies within the Beetaloo. The drill rigs are finally set to start turning in June.

The risk, and it weighs on the current valuation of Falcon, is that its partners won’t actually pull the trigger on the initial exploration programme.

It is wise to be guarded on these matters, particularly with Big Oil retrenching in Australia and elsewhere around the world as they are forced to make their limited funds somehow go further.

But a point to be borne in mind is that Falcon’s deal with the operator Origin and Sasol is a drill or pay. It covers five wells, three this year and a further two next.

So, failure to carry out the work would result in some sort of financial compensation – whether the full US$64mln would be forked over is open to debate. But the contract is drill or pay.

That said, those with the ears to the ground in Australia suggest the preparatory work such as rig contracts, civils and landholder access are all in the process of being finalised.

If this is true, then we can expect the second half of 2015 to be fairly significant and reasonably exciting for Falcon.

But be warned, the three initial wells planned for this year are unlikely to deliver the sort of information on which meaningful economic modelling can be based.

They are designed to assess the carbon content of the Velkerri and to identify the thickest shale of sequence.

All of it will be part of the sweet spot hunting that will then direct next year’s two big wells – one vertical, the other horizontal. Both will be fracked.

An interesting aside to the work about to start in the Beetaloo is the emergence of the Japanese gas giant Inpex as next door neighbour to Falcon and its cohorts.

It picked up 2.4mln acres shed by Falcon just before it signed on the dotted line with Origin and Sasol.

It will be interesting to see whether a relationship develops there with the owner of one of Australia’s three major liquefied natural gas trains.

In South Africa, investors have stopped trying to guess when the oil and gas companies will receive exploration licences for the Karoo Basin. Here, Falcon currently has a technical co-operation permit covering 7.5mln acres.

The Karoo covers 600,000 square kilometres of semi-desert north of Cape Town that contains thick, organic rich shales similar to those seen in the Permian Whitehill Formation. The US Energy Information Administration estimates it could be host to 390 trillion cubic feet of technically recoverable gas.

Those who have followed the situation closely will have noted a change in the mood music from the legislative authorities, although some will have been spooked by the departure of Shell from the country.

Progress is being made on the issue of fracking and the authorities are widely expected to start issuing exploration licences for the Karoo by the end of this year as legislation is re-fettled and made fit for purpose.

If Falcon does indeed get its long-awaited licence, this allows the company to solidify its relationship with American oil major Chevron.

In Hungary things haven’t been particularly positive with a record of two dusters from two wells drilled in Mako Trough.

However, most in the know expected this result. Remember, NIS was supposed to drill three in total, so it will be interesting to see what happens next. For its part, Falcon says it is doing everything possible to derive shareholder value.

Predictably, Hungary has been a drag on sentiment. Perhaps surprisingly, the prospect of drilling in Australia and progress in South Africa haven’t really been factored in. On that basis there may be an opportunity for those brave enough to grasp it at this phase in the oil price cycle.

Falcon shares eased 2.33% to 5.25p.

Quick facts: Falcon Oil & Gas Ltd

Price: 12.4 GBX

AIM:FOG
Market: AIM
Market Cap: £121.75 m
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