Analysis: Falklands oil hopes survive Desire’s setback

By Alex Lawler

LONDON (BestGrowthStock) – The Falkland Islands could yet prove to hold oil resources worth developing, although a setback for Desire Petroleum there this week reminded investors of the risks of exploration drilling.

Desire (DES.L: ) said on Monday it did not make a Falklands oil find after previously saying it had, a blow to hopes that the British-ruled islands, over which Argentina claims sovereignty, will become a major new oil province.

Oil drilling resumed in February in the South Atlantic islands after a more than 10-year break. So far, British oil explorer Rockhopper Exploration (RKH.L: ) is the only company to have announced a find it believes to be commercial, Sea Lion.

“The companies have drilled six wells so far. One potentially commercial discovery out of six is not particularly bad,” said Scott Pearson of Wood Mackenzie, a consultant to the energy and mining industries.

“How the next couple of wells turn out will probably determine whether the companies proceed with further drilling.”

Desire said on Monday additional analysis of data from its well did not support initial indications.

A previous drilling effort, in 1998, failed. Royal Dutch Shell (RDSa.L: ), Hess (HES.N: ) and other companies drilled six wells. Big companies have not gone back, leaving BHP Billiton (BHP.AX: ) as the only major firm active in the area.

Setbacks and successes in drilling this year have given investors a bumpy ride. Desire’s shares have recovered from a low of 66 pence on Monday to close above 70 pence on Thursday, suggesting some investors are keeping the faith.

“It’s still relatively early days and the companies are still learning,” said Evolution Securities analyst David Farrell. “It’s too early to write it off, especially when we have had a discovery.”

Oil exploration has sparked protests this year from Argentina, which calls the islands the Malvinas. Argentina and the UK went to war over the islands in 1982.

Argentina’s stance may add to the difficulties and costs of developing any find.

ENCOURAGING

A former board-level executive with one of the firms that unsuccessfully drilled in the Falklands in 1998 said the results of the 2010 effort looked promising and, for now, justified further efforts.

“If in a new basin you find some hydrocarbons, it’s quite encouraging. So you shouldn’t give up immediately,” he said, declining to be identified. “But after four or five wells it begins to look a bit pessimistic.”

He said circumstances were better now with oil prices near $90 a barrel and an oil discovery of around 200 million barrels would be worth developing. Oil slumped to $10 in 1998, helping to kill off the earlier search.

“At these oil prices, you wouldn’t need an enormous find, a couple of hundred million barrels would probably do, if you were prepared not to make too much money out of it,”he said.

Rockhopper gave a best estimate for reserves at Sea Lion of 242 million barrels, but in October said it lacked sufficient data for a technical report to support its preliminary estimate.

An oil find around that size would indeed be commercial, although vast amounts of natural gas would need to be discovered to justify building export facilities, said Wood Mackenzie’s Pearson.

“A 200 million-barrel discovery can definitely be made to work even in an area with no infrastructure like the Falklands,” he said.

“If anyone’s going to find gas it would need to be a huge amount of gas because of the remoteness of the Falklands.”

EXXON SKEPTICAL

Some of the world’s largest oil companies have already deemed the Falklands to lack commercial reserves.

A U.S. diplomatic cable leaked last week quoted a senior executive of ExxonMobil (XOM.N: ) as saying he believed resources in the islands were not sufficient to be profitable.

The cable was dated February 2010, before the Sea Lion discovery was announced, which produced sustained rates of over 2,000 barrels of oil per day.

That would barely show up in the production of Exxon, which extracts 4.45 million barrels of oil equivalent a day. Other big companies have probably taken a similar view to Exxon, seeing potential Falklands resources as too small to matter.

“That sentiment would probably be shared by the other majors,” Pearson said. “We’re not talking about billion-barrel discoveries.”

The Falkland Islands government’s Department of Mineral Resources is optimistic, pointing out on its web site that of the six wells drilled in 1998, five had oil and or gas shows.

Not everyone is convinced. Angelos Damaskos of Sector Investments, a money manager focusing on energy and resources and overseeing $150 million, has avoided Falklands explorers. He did not rule out investing in the future.

“The Falklands could be a prospective basin, but it is so vast it is very easy to drill in the wrong place,” Damaskos said. “Basically, the odds are stacked eight to one against the explorer.”

“If Rockhopper or Desire or anyone else do find commercial accumulations there will be initial excitement, their share prices will double or triple and we will have time to assess what they have found and then decide whether to invest.”

(Editing by Anthony Barker)

Analysis: Falklands oil hopes survive Desire’s setback