Bowleven Stockpedia write-up gives good reasons for investment case

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Bowleven Plc: assessing the investment case

Sunday, Feb 13 2011 by marben100

I first came across Bowleven (LON:BLVN) , as a potentially interesting investment, at the Oilbarrel Conference in Sep 2010. [1] What made it interesting to me at that time was:

• A strong management team, with key players being ex-Cairn [2] [3]and ex-BG [4]
• A decent cash position & sound, tested assets [see "Assets"]
• Partnership with a big player, in the shape of Vitol [see "Vitol Agreement" below]
• Lots of potential upside from drilling, with the major Sapele-1 well due to spud shortly

Against that, I had to balance the political risk of operating in Cameroon and risks associated with commercialising existing discoveries, meaning that they can currently only be classed as "contingent resources", as opposed to 2P reserves. Anyhoo... I decided to take a punt in October 2010 when, despite Sapele-1 having already spudded and initial results being expected soon, the share price had remained remarkably subdued. That proved a good decision with my original punt having now double-bagged.

Long story short, I believe that the market has misunderstood the company's latest RNS concerning the Sapele-1 well and that there may be considerable excitement to come - hence I have topped up today (Wednesday 9th Feb), with the SP well off its recent peak. AIUI one rig is standing by, waiting for government approval to sidetrack Sapele-1, in order to appraise a Tertiary oil discovery made in the original well and another, more capable rig, is on its way. That rig will drill a step-out well into deeper, more "challenging" Cretaceous prospects.

Lots more drilling is expected over the course of 2011 with those rigs, and Bowleven has the cash to fund it.

I will start by discussing the Sapele-1 well and then come back to discuss already tested assets that (at least to some extent) underpin Bowleven's current market cap. of £716m, irrespective of Sapele-1 results.

Sapele-1

Well/News Timeline

Sapele-1 is the second well drilled by Bowlen in its shallow-water MLHP-5 Block offshore Cameroon (75% equity interest). The first, D-1r well in 2007 made a gas-condensate discovery, flowing 25mmscf/d + 1,400bopd condensate in the Tertiary horizon. Following 3D seismic acquired during 2010, Sapele-1 is designed to intersect multiple prospects in both Tertiary and Cretaceous strata. It was spudded on 14th September 2010 [5] .

• On 9th November, Bowleven announced two Tertiary discoveries [6] .
• On 25th November, an increase to the discovered Tertiary net pay was announced [7] .
• Following a strong SP rise, Bowleven placed 22m shares @ 327p (11% dilution) raising ~US$110m and securing ample funding for the 2011 explo programme on 26th November [8] . Shrewd move. ;0)
• On 10th January, Sapele-1 reached a TD of 4,529m in the Cretaceous. A gas-condensate discovery in the Cretaceous and a STOIIP estimate for the previously intersected Deep Omicron Tertiary target of P90 65mmbbls - P10 430mmbbls were announced [9]  .

During this period, the SP rose fairly steadily from a base of around 160p, peaking at over 400p. It appears that there was some disappointment with the last announcement, probably due to the relatively thin pay in the "Cross-cut" objective and the Cretaceous (so far) only yielding gas-condensate and not oil, and the SP has subsequently declined.

Then, this Monday 7th February, Bowleven released the following announcement [10] :

Bowleven, the West Africa focused oil and gas exploration group traded on AIM, announces that the Sapele-1 exploration well drilling in the Douala Basin, offshore Cameroon has been drilled to a total depth (TD) of 4,733 metres.  Drilling was halted due to technical limitations after encountering a high pressure gas reservoir in the Cretaceous. The bottom hole section has been cemented and is now being abandoned in advance of planned appraisal drilling.

Update

· Oil, condensate and gas confirmed as present in the Cretaceous and the well may now have encountered a significant hydrocarbon column at TD.

· Proposed forward plan includes appraisal drilling and well testing to further evaluate Tertiary discoveries.

· Additional rig secured for drilling up to four wells on the Etinde Permit; expected on contract towards end February 2011.

Drilling update

The Sapele-1 well location was selected to intersect multiple independent exploration targets from the proven Tertiary fairway down to the deeper Cretaceous fairway from a single location.

On 10 January 2011, Bowleven advised that further Cretaceous targets had been identified beneath the original planned target depth of the well (4,450 metres) and the plan was to deepen the well.  The well was drilled to a TD of 4,733 metres before drilling was halted due to a rapid influx of very high pressure gas.  Consequently, logging of the interval was not possible and the bottom hole section is being abandoned.  Based on an initial analysis of the major step change in pressure encountered and the interpretation of the seismic, it is considered that the well may have encountered a significant hydrocarbon column in the Cretaceous.

Further analysis of mudlogging and wireline data, together with gas chromatograph ratio analysis, has confirmed oil shows were encountered within thin sands in the upper part of the Cretaceous Epsilon Complex.

Further interpretation and calibration of the well and seismic data is required to assess fully the implications for Cretaceous volumetrics...

The market didn't seem to like this much at all, and the SP has continued declining since, now standing at around 333p.

It is possible, however, that the market has got it wrong. Firstly, judging by comment I have read, including those by some analysts, "high pressure gas influx" has been widely interpreted as meaning that the well has just found gas in this deeper Cretaceous section. However, as those of us that followed the sad Macondo saga know, a high pressure gas influx doesn't necessarily mean that there isn't oil there too!

Considerably more detail/information is contained in a presentation [11]  that Bowleven gave at a Credit Suisse energy conference, the same day as the announcement. This includes diagrams that help to understand the well context and sequence. However, the most interesting information was in an analyst/investor conference call that Bowleven held and which I highlighted here.

Analyst/Investor Teleconference

I took the following notes from the telecon:

• All targets confirmed hydrocarbon bearing
• Tertiary “unequivocal”
• Lower Omicron gas-condensate 20m net pay 290bcf GIIP
• Deep Omicron oil 20m net pay 21% porosity 217mmbbls OIIP P50 estimated
• Gas condensate in base of Cretaceous Epsilon Complex 4m net pay 13% porosity
• Deeper potential – intended to drill on
• Since established (from logs) that there was oil in thin sands in upper Cretaceous Epsilon Complex, more work needed (encouraging)
• Beneath Epsilon, cemented liner, drilled on in 6” hole to 15,529’ – extreme pressure found resulting in kick. Bottom hole pressure calculated as 15,180psi, step change of 4,500psi from previous value – extreme HPHT.
• V pleased with outcome to date but unable to log bottom section properly
• Major cement needed downhole to control well after this, so impossible to perforate Deep Omicron. Significant flow expected from Deep Omicron, given quality of logged reservoir sands.
• Intend to sidetrack to location 2km from current well to appraise Omicron with current rig. In talks with Cameroon govt at present to agree this.
• Intend to test Cretaceous downdip, 7-8km step-out, with new, more capable, rig as its first task.
• Sidetrack will take 50days from start (once govt agrees & ops restart)
• Cretaceous step-out expected to be 60 day well.
• Believe acreage may be a fairway - need to demonstrate connectivity. "May have a tiger by the tail."
• Considerable interpretation work to be done to determine further drilling locations.
• Will be expecting extension to licence beyond 2011 to allow for appraisal period.

My key "takeaways" from this are:

• We have an excellent discovery in the Deep Omicron target, maybe ITRO 100mmbbls recoverable, plus a "bonus" gas volume in the shallower target.
• In this well, thin oil-bearing sands were discovered in the Epsilon Complex. If MLHP-5 contains a "play fairway", as hypothesised, they may be thicker at a different location
• The 4,500psi step change indicates something very serious going on in the deep Cretaceous (below Epsilon Complex). There were clearly serious well control problems, given the need for emergency cementing to kill the well.
• Given that the deeper Cretaceous section couldn't be logged properly (due to the well control issues), we don't know what hydrocarbons are present there.
• A 7-8km step-out downdip is a very interesting prospect. I presume that by going downdip, they are more likely to encounter oil (or water!), as gas/condensate will tend to migrate updip? Moreover, if they DO find oil 7-8km away it adds strong weight to the connectivity/play fairway theory and we'll have a very exciting discovery on our hands.
• If the "fairway" theory is correct, Bowleven may have acreage holding prospects much larger than analysts are currently gving credit for.
• Exciting drilling should start and be announced soon: the sidetrack to flow test the Omicron targets is just awaiting government approval, so could be announced any time. The other rig seems likely to arrive and spud the stepout well next month (but I think 60 days drilling time is optimistic, given the HPHT issues - hope it doesn't turn into another TGD!).

So, for the traders amongst us ;0), we should have drilling resumption/spudding news soon that may reinvigorate the SP. The upside here, if these wells are successful, is potentially very large: a recent Evolution note puts the upside at around 800p/share (i.e. over 1150p overall SP). From the presentation, drilling in MLHP-5 is planned throughout 2011 (5 wells, including the Sapele-1 sidetrack), so Bowleven have a good chance of finding/delineating whatever oil/gas there is in the block.

Assets

As I've said, the upside is potentially very large. What about the downside protection?

Cash

For a start, we have ~$190m in cash as at 31st December (88p/share) - but, of course, this will be eaten into heavily by the intensive 2011 drilling programme.

EOV

From the annual report (dated 8th November 2010):

Gabon – EOV Permit

Following the initialling of an SPA last year for the

disposal of the Group’s entire interest in the EOV

Permit, offshore Gabon, the focus for the current year

has been engaging with the various authorities in Gabon

to formalise the disposal. Progress has been made and

completion is anticipated within the next six months.

Proceeds expected include a cash consideration of

$35 million and a working capital adjustment from

the effective date of the transaction.

So, that should be another 16p/share.

Etinde Permit

This comprises blocks MLHP-5, -6 and -7, all shallow water offshore Cameroon.

Bowleven has already made several discoveries in MLHP-7 (see slide 15 of the Credit Suisse presentation). These total 959bcf of GIIP, 119mmbbls of NGLs (condensate) IIP and 232mmbbls of STOIIP. These are subject to appraisal, scheduled to begin in Q2 of this year. The slide also shows unrisked potential upside in that block of a further 2Tcf of gas and 91mmbbls of condensate IIP.

The annual report claims Pmean contingent recoverable resources of 494bcf of gas, 30mmbbls of condensate and 72mmbbls of oil (net of Vitol's interest - see below). These resources remain contingent until a clear route to commercialisation is established. Clearly, the more hydrocarbons Bowleven find at Etinde, the stronger the chances of commercialisation. Bowleven's appraisal effort, in conjunction with Vitol, is designed to establish commerciality. Note that GdF is studying LNG feasibility for other existing Cameroon gas discoveries.

Given the contingent nature of the resource and the impact of political risk in Cameroon, I would put a low figure of $8/bbl on the value of oil & condensate - and, for simplicity let's disregard the gas entirely. Any views/comment on my choice of that figure welcome! That still yields $816m of current value - but with risk attached in the (not very likely, IMO) event that commerciality is not proven.

In addition to this, the Sapele-1 Deep Omicron discovery alone could add a mean recoverable resource of around 60mmbbls of oil (using 30% recovery factor), subject to forthcoming appraisal - maybe another $480m.

So, a successful appraisal of these discoveries would lead to around $1.3bn of value = 376p/share.

Bomono Permit

This comprises two blocks onshore Cameroon, with a 100% W.I. Evaluation and further 2D seismic acquisition is ongoing. Drilling is planned for 2012. I'm not assigning any core value here.

Epaemeno Permit

This comprises two blocks onshore Gabon, with a 50% W.I. - the other 50% having been farmed out to Addax (now owned by Sinopec). Drlling is planned for 2012. No core value assigned.

Summary

Subject to successful appraisal and commercialisation negotiations, ISTM that the current SP is pretty well underpinned by discoveries already made.

Vitol Agreement

Vitol is one of world's largest energy trading companies ($143bn revenues in 2009). In June 2010 Bowleven successfully completed a farm-out agreement with Vitol over the Etinde permit [12] .

Bowleven, the West Africa focused oil and gas exploration group listed on AIM,

is pleased to announce that the Etinde Permit (Etinde) farm-out transaction

entered into with Vitol E&P Limited (Vitol) has completed.

The farm-out transaction announced on 12 August 2009 comprises the acquisition

by Vitol of an initial 25 percent interest in Etinde in return for funding a

$100 million gross work programme. Vitol also has an option (exercisable on or

before 30 September 2010) to acquire a further 25 percent interest in Etinde in

return for funding a further $100 million gross work programme and paying $25

million in cash to Bowleven to progress Etinde activities.

Clearly, Vitol's interest is a substantial indication of interest in Etinde - though it coud be taken as implying a value of only $300m for Bowleven's interest - but that was before the Sapele-1 well confirmed the prospectivity of block .MLHP-5.

On 1st October, Bowleven made the following self-explanatory announcement [13]  regarding the option mentioned above:

Bowleven, the West Africa focused oil and gas exploration group listed on AIM,

is pleased to announce that it has entered into a revised option agreement with

Vitol E&P Limited (Vitol) in respect of the Etinde Permit (Etinde), offshore

Cameroon.

Under the agreement, which replaces the previous option arrangement, Vitol have

an option to acquire a 10 percent participating interest in block MLHP-7,

Etinde, in return for funding an agreed $50 million gross appraisal work

programme. The option expires on the earlier of (i) the spud date of the next

appraisal well on block MLHP-7 or (ii) 31 March 2011. The option arrangement

excludes blocks MLHP-5 and MLHP-6, Etinde, where the Sapele-1 exploration well

is currently being drilled. Bowleven will retain operatorship of all three

blocks.

The nature of the option and its applicability to only block MLHP-7 reflects

Vitol's primary focus on appraisal and development activities and the

understandable requirement for further technical work to be completed prior to a

firm future development and appraisal plan being agreed on the IE and IF field

areas. In this regard, work is ongoing integrating the results of the recent

IE-3 appraisal well and on the processing and interpretation of the newly

acquired 3D seismic over the IF field area.

Bowleven and Vitol currently have participating interests of 75 percent and 25

percent respectively in the Etinde Permit. In the event of option exercise,

Bowleven's participating interest in block MLHP-7 would be 65 percent with

effect from the date of exercise, with its participating interest in blocks

MLHP-5 and MLHP-6 remaining at 75 percent. All participating interests are

expressed prior to the exercise of any state back-in rights...

Note that the option only offers additional rights in block MLHP-7, not MLHP-5 where Sapele-1 was drilled.

Political Risk

I have to say that IMO the poltical risk is considerable. Cameroon ranks as #146 out of 178 countries in Transparency International's Corruption Perceptions Index [14] , the same ranking as Haiti, Libya and Iran (amongst others). The current "authoritarian" regime has been in power under President Paul Biya since 1982. He is now 78 years old. ISTM that in the event of "regime change" there is a risk of PSAs being ruled invalid. However, there is no reason to expect imminent regime change. So, I am pleased to see Bowleven aiming to prove up their licences ASAP. I would not want to hang around as an investor during a lengthier development phase.

Conclusions and Summary

Bowleven has an exciting imminent (if you'll excuse my use of that word!) exploration programme. Results could be well in excess of current analyst expectations (Evo, for example, puts the unrisked upside in MLHP-5 at 336mmboe, gross resource, which I think is low - potentially). Geological and political risks remain, however, so IMO it would not be wise to "farm bet" this one, even though there is some decent asset underpinning, but a modest holding could be highly rewarding.

Readers will note that I have not attempted a full risked EV for Bowleven - I'll leave that to the professional analysts. This is not simply laziness but also because such analyses can appear to give a spurious accuracy to highly inaccurate numbers. CoS is a highly inexact science - and when you add in commerciality risks (which include judgement on politics and future commodity prices) things can really get silly. Senior oil industry executives that I've spoken to and respect highly (I'd better  not mention names, as I wouldn't want to upset their relationships with the analyst community ;0) - but I am not talking about Bowleven's executives) are very scathing about the validity of such analyses.

The bottom line is that you have to make your own judgement of risk vs reward.

Regards,

Mark

Disclaimer:

The author may hold shares in this company, all opinions are his own and you should check any statements that appear factual and not rely on them before making an investment decision. The author is NOT a qualified analyst nor authorised to give investment advice.