Sound Oil’s Orbell looks ahead to high impact drilling this autumn

Investors in junior oil and gas want a lot for their money these days. 

The ideal is a company which is fully funded; that has a pipeline of value-accretive blue-sky and development targets; and one which possesses a finely honed plan to bring at least one of these projects into early production. 

However, the brutal reality is that the vast majority of the rag-tag-band of explorers quoted on AIM fail to live up to these exacting and unrealistic standards. And even where these paragons of virtue do exist, our small-cap speculators have an odd habit of dismissing their potential.

Take Sound Oil (LON:SOU). It has an eight-well drilling programme onshore in Italy and Indonesia that will be rolled out over the next year, and, with £11 million of cash, the financial wherewithal to fund its ambitions.

Yet the shares have traded down from 6.5 pence in April to below 2 pence today, giving the company an enterprise value of £32 million (US$52 million). 

Of course chairman Gerry Orbell would have preferred to have kicked off the campaign in more emphatic style. And the cancellation of two offshore licences, following the Italian 5-mile drilling ban last year, hasn’t helped perception either. Crucially no drilling was planned, or budgeted for, on these early stage offshore assets until at least 2014.

“It (the cancellation) doesn't affect the high impact activity we are about to start in the Autumn and we are very optimistic that we will be awarded permits equally as attractive or even more so shortly,” Orbell explained.

The company’s Marciano well 1 in Italy flowed really well on test (3.5 million cubic feet gas per day) but contained insufficient gas reserves for commercial production.

Orbell describes the result as “clearly disappointing”. Yet Marciano knocks a little over US$5 million from the net present value of its Italian assets, which the competent persons calculate the discoveries alone to be worth US$226 million at a 10 per cent discount rate. 

 “Marciano was supposed to throw off about €700,000 a year,” the Sound chairman says. “The fact this hasn’t worked out isn’t good. But it is not going to cause me to jump off the nearest high rise tower. It seemed to shake the confidence of the investing community though, but I really don't think it should have. 

The existing Marciano well-head, production unit, generator and transformer unit can all be used elsewhere, and probably will be". 

In fact some of this kit is likely to be deployed on a concession near the Adriatic coast, though this acquisition still needs to be confirmed by the authorities, as our award. 

“It has been producing for 50 years and has still got 2.5 billion cubic feet reserves. When it was shut in, it was producing US$60,000 a month – of course we now have to put it back on-stream but there is a lot of production equipment already available, so this is likely to be quite quick.”

 “We expect this gas field will be officially awarded towards the end of the summer". 

It is possible that operations on this new concession will come before the Nervesa gas discovery, which is in the work schedule in the first quarter of next year. "I want to generate early revenue from our discoveries. It is possible that we can achieve this by starting up this new concession very soon"

Sound owns 50 per cent of Nervesa, and the well costs and capex combined were expected to come to more than US$10 million (net). When it starts up Nervesa will be the more valuable to Sound of the two ($17.5 million versus $5.3 million) but the time to first gas might just be quicker for the new concession.

“Nervesa has a longer lead time to production. The way forward is perhaps to use the money from the new concession to pay for part of Nervesa's production costs,” Orbell concludes.

However the first cabs off the rank are exploration rather than development of exisiting discoveries. 

Sound is farming in to the Montemarciano permit in the Ancona area and will be drilling the Casa Tiberi exploratory well in the autumn. Sound is paying approximately $1.5 million for the well costs to earn 75% in the permit. The target has a most likely potential of 6 bcf gas net, according to the expert report. 

“The structure as it is mapped is relatively simple and extends a long way down dip from the area which defines the most likely potential gas. It’s my view that you could find more gas in here - the upside is 15bcf net and that would be worth $37 million to us,” says Orbell. "Paying $1.5 million for a chance of $37 million seems the right sort of exploration we should do".

The planned and fully costed programme in Italy concludes with the Montefano gas discovery, which gets underway in the second quarter of next year and is due for completion in the third. 

In parallel, exploration work begins in Indonesia, which could have a huge impact on the company’s valuation. 

In Java it has a 20 per cent interest in the Citarum production sharing contract, which is being operated by TSX-listed Pan Oriental Energy Inc. 

Sound is committed to fund three exploration wells at a net cost of US$3 million which together have a most likely potential of over 900 million scfg (gross). 

However, Orbell says the company has set aside US$5 million to meet all eventualities. They were identified from the 850 kilometre seismic programme shot by Pan Oriental in 2010. Two of the three drill sites are in the process of being prepared for drilling and according the Pan Orient the rig will move onto location in the Autumn to drill all three wells, back to back.

Perhaps the most interesting and value accretive exploration is target is Bangkanai in Kalimantan. Operated by LSE-listed Salamander Energy, Sound has a 5 per cent free carried interest for two deep, exploratory wells and the development of the Kerendan Field to the point of first gas production.

There are three different layers to this particular project. The first is the re-development Kerendan gas field, which was initially discovered by Unocal during the 1980s.

The operator, Salamander, has a scheduled start in September for the four Kerendan development wells, which will supply a nearby power station with around 20 million cubic feet of gas a day. 

Drilling will continue throughout 2012 with production expected to start in mid 2013. This production will not use all the gas in the field and approximately 100 bcf reserves is available to the Joint Venture for additional sales.

The production horizon at Kerendan is at around 9000 feet. The first of the development wells will however continue below this level to an exploration target at around 14,000 feet where the potential is 900 bcf gas at a fifty percent probability. 

The upside could be up to two trillion cubic feet of gas (P10). This deep well is slated for 4th quarter 2011. A second exploratory well will follow at nearby West Kerendan and this has a potential of 366 bcf gas (P50) up to 800 bcf gas (P10). 

Exploration success would give the Salamander joint venture the quantities of gas required to justify a pipeline to the liquefied natural gas plant at the port of Bontang on the eastern coast of Kalimantan, where it could then be shipped for export.

“We are carried for all the costs on the two exploratory well, on the four Kerendan development wells as well, and for all the equipment that has to be put on site. The first worry we have on this is where we bank the cheque from production,” says Orbell.

However there are plenty more exploration and opportunities besides the ones we’ve outlined that add to Sound’s net present value.

They include the large Po Valley exploration gas prospect at Badile, as well as development projects Manfria (pending award) and Strombone.

In all Sound has 13 undeveloped discoveries and 13 exploration projects in its inventory. The company has produced a valuation matrix based on the CPR work done by independent consultants Fugro-Robertson and Senergy which can be found on its website.

This matrix indicates that the discoveries have a net present value of 8.9 pence a  share, or 3.7 pence a share using the more cautious expected monetary value calculation (which is still roughly double the current share price).

In addition the NPV10 valuation of exploration assets is 29.7 pence, or 3.8 pence on an EMV basis. 

“There is a lot of solid work gone into this company and into our assets. The valuations of our assets  have been calculated by respected independent experts - they are not our calculations. We publish the competent persons results whatever they may be,” says Orbell. 

2011-12 Campaign: eight drill-ready, fully funded targets

Name                                   Type                                 Location

Casa Tiberi                           exploration                       Italy

Nervesa                                discovery                            Italy      

Montefano                           discovery                            Italy

Kerendan Deep                 exploration/discovery        Indonesia   

West Kerendan                   exploration                       Indonesia

Cataka                                 exploration                        Indonesia

Jatayu                                  exploration                        Indonesia

Geulis                                   exploration                     Indonesia