Mediterranean Oil & Gas confident as outlook brightens

After a difficult, frustrating 2010 that spilled over into the current year, Mediterranean Oil & Gas (LON:MOG), looks to have found its feet again. Big challenges remain but a recent boardroom shake-up, a fundraiser that has left it debt free, and some encouraging newsflow look to have breathed new life into the group.

Sentiment over the stock last year was badly undermined by a sudden decision by the Italian government, half way through the 2010 year, to prohibit offshore drilling activities for liquid hydrocarbons within five miles from the Italian coast and twelve miles from nature reserves.

That decree immediately appeared to rope in the company’s 100% owned Ombrina Mare oil and gas permit, located within five mile of the Italian coast. Before the decree Mediterranean Oil and Gas was quite happily moving Ombrina along the road to full project approval, with production projections of up to 5,000 barrels of oil per day (bopd), rising eventually to up to 10,000 bopd.

The trigger for the Italian government’s sudden decree on oil and gas exploration and development was, of course, the BP Deepwater Horizon oil disaster in the Gulf of Mexico.

For Mediterranean’s management the decision by the Italian government was a massive shock. As Michael Bonte-Friedheim recalls: “Well yes, we were completely stunned by the move …..it was entirely unexpected.  Italy was the only country in the world to respond to the Gulf of Mexico disaster in that manner.”

The repercussions of the Italian decision were far reaching for the company as it threw into serious doubt development and production plans for Ombrina, heavily undermining sentiment over the stock. It also heavily undermined the company’s capital raising efforts during the course of 2010 – funds it had been counting on and naturally felt very confident in securing on the back of Ombrina.

While the company had some income from small producing gas fields in Italy, it did need a substantial injection of funds to not only take Ombrina into production but also advance other promising projects and retire outstanding financial debt.

Bonte-Friedheim says the company is continuing to seek clarification from Italian authorities as to whether fields upon which previous exploration has confirmed the existence of commercial hydrocarbon quantities are exempted from the decree.

He explains: “It is unclear whether the new decree pertains to new exploration or development of existing assets. The previous hydrocarbon legislation states clearly that once you have an exploration licence, discover hydrocarbons or are producing, you have inalienable rights over those assets.”

The latest decree, by contrast, leaves many questions unanswered, most especially in relation to existing developments and discoveries.

Not surprisingly therefore, having already pumped over €20 million in cash into Ombrina, and shown the project holds proven and probable resources of 40 million barrels, the group will “vigorously challenge” any assessment that the decree is applicable to the permit.

While the market would like to know exactly when a conclusion over Ombrina is likely, getting clarification from the authorities is not proving easy. “We continue to actively pursue the matter, but it is impossible to say how long all this will take,” says Bonte-Friedheim.

He adds: “In the event the government informs us we cannot proceed with Ombrina, naturally we will commence legal proceedings and seek compensation for the value of the asset.”

With the asset boasting 40 million barrels in the proven and probable category, with 12 million in the proven category, that would equate to an awful big compensation claim to be sure.

Bonte-Friedheim is keen to stress that while the Italian decree weighed heavily on the company’s capital raising and restructuring over 2010, other aspects of the company were performing very well.

“From an operational perspective the company was absolutely fine over 2010, we were moving ahead quite rapidly. It was a difficult year, for sure, but really only from a financial perspective.”

But despite the difficulties, the company to its credit, kept focused on exploring avenues to alleviate its financial and liquidity constraints, which were particularly acute in the second half of 2010, in the wake of the Italian decree.

The reward for management’s persistence and belief in the company’s prospects was a successful £20m fundraising – via the issue of new shares at 6p - and capital reorganisation, announced in April 2011. That left the company debt free, with convertibles and loan notes swapped for equity and other financial debt repaid.  In addition, the company secured new supportive shareholders, including Och-Ziff and BlueGold.

It was a critical moment for the group as finally, despite the problems with Ombrina, it could start looking ahead to taking its other offshore Italy project, Guendalina, ahead to production.

The fund raising was accompanied with a boardroom shake-up, which included the appointment of Bonte-Friedheim as chief executive. He was previously the group’s non-executive chairman. One of the notable new non-executive appointments from outside, meanwhile, was Andrew Cochran, chief executive of Dominion Petroleum (LON:DPL).

Thankfully Guendalina, being 47 kilometres offshore Italy, is safe from the problematic decree that has cast a cloud over Ombrina.  Mediterranean Oil has a 20% stake in the project, where first gas is expected September this year.

A joint venture with Italian oil and gas giant ENI, Guendalina boasts proven gas reserves of 19 billion cubic feet (Bcf), with 22 Bcf in the proven and probable category.

Bonte-Friedheim assures that Guendalina remains on track to begin production towards the end of September. The company has already concluded gas sales contracts with Italian utility firm ElettrogasSpA.

“The main challenges, as always with such development activities, are drilling and well completion - those are where the biggest risks reside. At Guendalina, we have left those behind now, de-risked the project substantially, in our view, and are heading towards production. Once production begins we can then really begin to look forward to being a cash flow positive company in 2012/13.”

The group’s insistence that it now has a “strong foundation” for future growth also reflects recent good news from Malta.

Last month it announced it has entered into an agreement with Dominion Petroleum to farm out a 75% operated working interest in a production sharing contract for four blocks offshore Malta.

The agreement, conditional upon Maltese government approvals and upon a Dominion Petroleum shareholder vote, has been struck between Dominion and Mediterranean’s wholly owned subsidiary, Phoenicia Energy Company Limited (PEL).

The proposed deal relates to Blocks 4, 5, 6 and 7 of Area 4 offshore Malta, situated to the north of Libya, covering an area of 5,715 km2 in Maltese waters. An independent assessment by RPS suggests the total unrisked hydrocarbon potential of the Blocks to be around 5 billion barrels of oil in place with a resultant total “most-likely” un-risked prospective recoverable oil resources of about 1.5 billion barrels.

Under a Maltese production sharing contract, Mediterranean has been holding a 90% operated working interest through PEL, with Leni Gas & Oil Investments Limited holding the remaining 10% of working interest.

Following the completion of the deal, Dominion Oil & Gas will hold a 75% operated working interest in the contract. It will also be obliged to meet certain exploration costs up to US$1.26 million on behalf of Mediterranean and in relation to the latter’s remaining 15% working interest.

Dominion will also compensate Mediterranean for a total amount of US$900,000 in certain historic costs.

The first exploration period for the prospects runs until January 2013, and there is a minimum spend requirement of US$5 million. Mediterranean anticipates that the 3D seismic survey will cost between approximately US$8 million and US$10 million gross to undertake, which will satisfy the minimum spend requirement.

Mediterranean’s Bonte-Friedheim says the deal conclusion will allow his company to be “practically free-carried” for the completion of a 1,000 sq km 3D seismic survey, as well as receive a significant reimbursement of back costs.

More broadly, the firm is continuing to reassess the potential of its existing exploration and production acreage, while relinquishing exploration assets with low potential and/or high risk.

Mediterranean’s share price performance has reflected the group’s travails over the last 18 months, having trended lower all the way down to an all-time low of just below 8p in April 2011.

The capital reorganisation, boardroom shake-up, continuing good progress with Guendalina and the Maltese deal has helped improved sentiment over the stock and the share have very recently been on a modest, upward trajectory.

Its way too early to read too much into the shares coming off the lows of April but with the company “completely re-energised, reinvigorated and looking forward rather than firefighting”, Bonte-Friedheim is confident that the future is bright again for Mediterranean Oil & Gas.