SOLO OIL: AIMING TO BECOME A PIONEER OIL PRODUCER IN TANZANIA

Some investors were perhaps a little surprised when an audio technology company announced that it was changing its name and entering the field of oil and gas exploration. But with serial entrepreneur David Lenigas – who also heads Lonrho, the household-name, Africa-focussed company – at the helm as the Executive Chairman, something interesting seemed certain to happen. And  little more than six months later, London-based AIM-listed Solo Oil (SOLO) is partnered with FTSE100 Tullow together with Main Market listed Aminex in drilling a potentially high-impact well in onshore Tanzania. What’s more, David Lenigas has made no secret of his search for further assets for Solo Oil. We take a look at this ambitious low-overhead newcomer, its plans and portfolio.

LOW OVERHEADS = INCREASED FUNDS FOR EXPLORATION

Setting up a listed company almost invariably involves finding and paying for a costly board of directors and their offices, office furniture and all kinds of various expenses, before field operations ever really get underway. This can potentially deplete the coffers, and quickly. Solo Oil is based in St. James’s in London, but inexpensively - because the company’s very modest accommodation need is met by sharing costs with a number of other companies.. The Solo board is small, and are currently drawing very minimal salaries so as to help focus the use of funds on drilling.

This is an unusual business model for sure, and is hardly one which could be universally applied. But in this particular case, it has allowed the company, on a modest initial budget, to use some of its funds to acquire a 12.5% non-operating interest in the Likonde-1 well in Tanzania. Tullow Oil Plc, the operator of the well, owns 50% and Aminex Plc the remaining 37.5%.

The policy of Solo Oil is to acquire a diverse portfolio of direct and indirect interests in exploration, development and production oil and gas assets which are based in the Americas, Europe or Africa. Both on-shore and off-shore interests will be considered, and the intention is to acquire a widely distributed mix of oil and gas development and production assets.

This policy suggests that Solo Oil has ambitions beyond what its ‘penny share’ status might suggest to the casual observer. The company has been studying further investment opportunities for months, though aside from some internet speculation that assets in South America have been considered, it remains tight-lipped. The results of the Likonde-1 well, which we discuss next, will surely be of considerable significance in the company’s future plans.

TANZANIA: COMPANY-MAKING POTENTIAL AT LIKONDE

Among Tullow’s extensive exploration, development and production assets across 14 African countries is a 50% share of the Ruvuma production sharing agreement in Tanzania, which is divided into two licence areas. 80% of the Ruvuma PSA is onshore, with the remainder offshore. Tullow gained this asset through its acquisition of Hardman Resources, which had itself acquired it from Aminex in a 2006 farm-in. Aminex had itself gained the asset through its acquisition of Tanzoil in 2002. Research reveals that many international companies have sought, during the past half century, to discover oil in Tanzania. Gas has been found with relative ease, but oil has – so far – proved elusive. However, scientific advances make it increasingly difficult for significant oilfields, even in remote areas, to escape determined explorers.

The importance, to Tanzania, of finding oil is great. The country’s Energy and Minerals minister has very recently said:

“We are yet to discover oil, but we have high expectations that we will finally have oil discovered in the country” – William Ngeleya, 13 November 2009

Tullow’s 50% partner was, until very recently, Aminex - who decided to farm-down part of its interest in order to reduce risk and conserve funds for any follow-up drilling subsequent to the first exploration well. Africa, as always, offers great potential upside to explorers – but it requires a special understanding of the region and is not for everyone. It is perhaps unsurprising that, with its connection with Africa-focussed Lonrho, Solo Oil was interested in this exploration opportunity.

On 16 November 2009 Solo Oil announced a £6.4m Placing which would, among other things, allow it to earn a 12.5% interest in the first well to be drilled on the Ruvuma PSA in southern Tanzania. Following this first well, Solo will have earned the right to participate in any further drilling on the two licences through contributing 12.5% of ongoing costs, and hence become a full party to the Ruvuma joint operating agreement.

Whilst the majority of exploration wells drilled worldwide turn out to be dry holes – an occupational hazard with which the industry and its investors simply have to live – some parts of the world, and some operators, have high success rates.  Tullow’s recent success rate with drilling has been remarkable: a 77% global exploration and appraisal success rate in 2008, and
an 85% success rate on exploration wells drilled in 2009 (data covering the period 1 January to 11 November).

Aminex have published an estimated chance of success of 25% on the Likonde-1 exploration well, which means that on their assessment the well is three times as likely to be a failure as a success. However, Tullow chose to drill Likonde-1 in place of the original Ruvuma target Mikindani-1 and do not appear to have released their own chance of success figure. This change of plan arose when Tullow undertook trial seismic reprocessing through its high-tech equipment in Ireland during 2009; when the 2D seismic data over the Likonde target was reprocessed, it persuaded the Tullow engineers to prioritise Likonde-1. The reprocessing of the Likonde seismic has indicated that it has a higher potential for oil rather than gas production. Tullow has made few detailed statements about Likonde-1, but Solo Oil and Aminex have been unable to contain their enthusiasm:

“Likonde-1 is the first hole being drilled in one of the last unexplored major onshore basins in Africa”  – David Lenigas, Executive Chairman Solo Oil, 16 November 2009

“Tullow’s geologists are very excited about this. It’s the same group that runs Uganda and they believe they can see a lookalike of the Buffalo discovery” – Brian Hall, Executive Chairman Aminex, 29 October 2009

Pre-drill estimates are at best of tenuous value, because only the drill bit and sustained production over a period of years can ever prove what is actually recoverable from a reservoir. But the estimate for Likonde is large: the gross oil-in-place figure (assuming there is any oil there; quite possibly there is none) is 500 million barrels, which would be a very large
field indeed. The recoverable oil from Likonde, on a P10 estimate has been put at 150 million barrels. If that were so, and Solo Oil were to fully participate in its development, its 12.5% stake would be 18.75 million barrels. We consider the financial implications below.

With the well spudded on 9 January 2009, and an estimated two months to drill the well, results should be known – assuming no delays – by around Easter 2010. However, whilst the well has a total planned depth of 3200 metres, there are three targets: the Tertiary, Cretaceous, and Permo-Trias Karoo. The shallowest formation would be entered quite early in the drilling. The well will be continuously wireline logged during drilling.

What evidence is there, other than the seismic data, that there might be oil in this acreage? The Ruvuma River is the boundary between Tanzania and Mozambique, and there is intense exploration activity on the Mozambique side. A well with oil shows was drilled there by Texaco in 1986, but low oil prices did not encourage further work. Anadarko Petroleum is committed to drilling seven wells on its acreage in the Mozambique Ruvuma Basin, and the first well Mecupa-1 was spudded on 11 October 2009. The US firm has described the Rovuma Basin as a lookalike of the Gulf of Mexico or Niger Delta. Oil seeps have been recorded in the area, in the Msimbati peninsula in the Ruvuma basin. Moreover, geochemical analysis of oils seeps and well cuttings suggest that oil in both Aminex’s Tanzanian licences shares a common source rock, potentially Jurassic and widespread.

Hydrocarbon generation in the distant past was far from rare. But for it to be trapped in a commercial reservoir requires a combination of porous rock, formed into traps of various types, and an effective seal rock above it, to keep it there for millions of years. Is this likely at Ruvuma? Aminex thinks so, and so does Tullow. Using old Texaco maps, Aminex originally identified a series of Tertiary and Cretaceous formations which combined folds and faults to form potential traps for hydrocarbons. Prior to this, several leads had been identified by the previous operator of the Ruvuma PSA, some with the potential to contain more than 100 million barrels of oil. The Likonde prospect is an anticlinal structure associated with a strike slip fault.

The Ruvuma PSA, which consists of the Mtwara (5045 square kilometres) and Lindi (7315 square kilometres) are also adjacent to the Mnazi Bay gas field, which was discovered and mothballed in the 1980s when oil was the goal; it is currently under development. The well Nyiuni-1, drilled by Aminex to the north, also found traces of oil. The circumstantial evidence for the acreage being prospective appears quite good, but until wells are drilled it is impossible to know what is there.

Looking ahead to potential production from Likonde might seem, at this stage, to be somewhat premature. But finding oil in an area with infrastructure and access to markets is a major advantage. The Ruvuma PSA is next to the coast, with easy access to a deep-water port which could be used for oil export. With Tullow achieving a production level of around 38,000 barrels of oil and equivalent per day from Africa in 2008, Solo would seem to have an ideal production-focussed partner – if the oil is there.

Aminex have recently indicated a conditional second exploration well on Ruvuma in the 3rd quarter of 2010; the PSA commitment is to drill one well in each licence.

FURTHER DEVELOPMENTS

We will first address the Solo’s audio technology assets. The company’s patents underpin designs of up-market electro-static loudspeakers, which have been successfully put into production and marketed - albeit with disappointing sales levels during the current recession. The potential extension of this flat speaker technology into such commercial venues as nightclubs is under consideration, but the audio technology business appears of relatively limited significance compared with Solo’s oil and gas ambitions and is beyond the scope of this review.

The company’s new investing policy is defined so as to be very broad, and any number of different opportunities could be accommodated. The Ruvuma PSA in Tanzania is clearly the near-term priority; if that were to prove successful, the resultant strengthening in the company’s market capitalisation would potentially open various doors. On 15 December 2008, Solo advised its shareholders that – after paying its contribution for the drilling of Likonde-1 – over £3 million was expected to remain from the Placing. In the current capital markets, there are various “distressed” assets available, as well as potential partnerships or joint ventures with other listed and unlisted companies. It is impossible to write about Solo Oil without veering into the realms of speculation, because the company is at an early stage with its oil and gas assets and the future remains, unavoidably, indistinct. That said, £6.4 million is not a small amount to raise in current markets, and is broadly suggestive of some fair degree of investor support for the company’s management and the overall shape of its strategy.

FINANCIALS

During the year ending 30 June 2009, Solo Oil made a loss of £1.1 million, which was a significant improvement over the previous year’s figure of £2.469 million. A substantial part, £0.7m, of the loss was due to an impairment charge on discontinuing operations. Provided that that Solo continues to manage its costs very tightly, most of its current cash funds should be available for investment opportunities.

What is the value of the Ruvuma asset? On 26 October 2009 Omni Investment Research assessed the value of the Aminex 50% share of Ruvuma (i.e. prior to one-quarter of this subsequently being farmed-out to Solo Oil) at $441 million “unrisked”. This figure was derived from work done by the consultants ISIS on the Tanzanian assets in the Aminex portfolio. This valuation was based upon a value of $6 per barrel for the Ruvuma resource estimates, against the backdrop of an average oil price of $40 per barrel in 2009, rising to $72 in 2015.  Such price assumptions may prove conservative, in view of current oil prices and industry views regarding the longer-term.

Taking 25% of the Omni/ISIS figure as the Solo Oil part of the asset, we arrive at $110m “unrisked” which reconciles with the estimated number of barrels as above; 18.75 million barrels at $6 per barrel is $112.5m. However, if oil prices were higher than assumed, this value would increase. With a total of 2.08 billion shares in issue, the figure of $110m would suggest an “unrisked” value for Ruvuma of some 5.3 cents per share – on those oil price assumptions.
 
In broad- brush terms, assuming rather higher oil prices going forward, this would perhaps suggest something like 5p per Solo Oil share. Applying a “risk” factor to such a valuation, which is commonly used by oil and gas analysts within the context of valuing a portfolio, is meaningless where a single asset is involved. Investors can only hold their breath and hope that the well comes in – or that the next one will. We note that this figure of 5p would increase if further leads and prospects within this extensive acreage were to be quantified by the PSA partners. At that stage, it would be more appropriate to apply “risk” factors so as to establish a risked valuation for the Tanzania assets.

At the time of writing, the Solo Oil share price is around 0.5p, with a market capitalisation of some £10m. The potential upside is clear – as is the company’s intention is to expand the portfolio. Investors in Solo Oil should know, fairly soon, whether or not this first throw of the dice has paid off.

The author holds shares in Solo Oil.