Fastnet Oil & Gas - Depressed Share Price

http://www.fastnetoilandgas.com/

Fastnet Oil & Gas logo

With clear-cut value investments still being relatively few in number, it makes sense to add to the recent resource exposure with a final addition to the portfolio - Fastnet Oil & Gas (LSE:FAST). The company, whilst being more speculative than past reviewed companies, has the potential to yield material upside for investors from current levels through its dual-country, largely exploration-centric focus. Fastnet has had a rough time on AIM over the past few months as one of its key wells was commercially unsuccessful. However, the company has retained an attractive portfolio of assets, and has its £19.4m market cap largely backed by cash on the balance sheet. Fastnet has around 345m shares in issue and it's share price stands at 5.625p.


As per the chart illustrates, the company suffered a major setback in May when a well they had an interest in, was plugged and abandoned. Given the high-impact nature of the well, it was not surprising to see the share price sharply drop around 50% as investors sold out, and bearish sentiment took over. The drop was also combined with a bearish technical picture that has actually hung over the stock for around a year, ever since the 21p horizontal support was breached in 2013. The technical picture remains broadly neutral for now, pending a company stimulus.

There are usually 2 common scenarios for companies that have just drilled unsuccessful exploration wells. Both scenarios start with the sharp drop, often tens of percent (in this case, around 50%). The first scenario sees the share price drift for between one and five months, as sellers continue to exit their investment and buyers stay clear pending a trend change. The second scenario sees the share price drift for between one and three weeks, but then reverse upwards, before consolidating horizontally for one or two months before breaking out (dependent upon newsflow). Broadly speaking, the first scenario occurs when a company has no prospects within 6-12 months, which is typical of small cap companies, whilst the second scenario usually materialises because a company boasts important newsflow within a year. I anticipate that the second scenario will apply to Fastnet moving forward.

Unsurprisingly for an oil and gas company of this size, the shareholder list is sparse, with only a few notable names. Standard Life holds 6.24% of the total shares in issue, albeit when a pension fund is involved it is difficult to read too deeply into the holding. Pathfinder Energy also hold 11.78%. Importantly, Executive Chairman Cathal Friel holds 5.47% - this may not seem material until you look at the remuneration policy. The policy of Fastnet has always been to keep salaries low, and despite that probably having contributed to various directors leaving the company since the IPO, it is a refreshing change to most AIM companies, and especially those in the resource sector. Friel only has a base salary of £10,000. Although recent appointments have meant that admin costs will rise, the appointments look astute, and I will cover that later. Nonetheless, the final two directors are also taking respectable base salaries and look well aligned, with Managing Director Paul Griffiths on £60,000/year and Executive Director Carol Law on ~£70,000/year. In addition, Law recently purchased £60,000 of shares at 6p, which is a good vote of confidence moving forward, especially given her front-line involvement with the company.

Fastnet listed on AIM in 2012 after Sterling Green Group acquired Terra Energy and re-branded. Initially valued at £17.93m with £10m in gross proceeds from an 11p IPO, the company has made very credible progress - progress that is not reflected in the change of market cap since. Through acquiring Pathfinder Hydrocarbon Ventures in mid-2012 for a total consideration of $8m, the company was able to broaden its operating portfolio to two core areas, Morocco and Ireland. These are both frontier exploration zones that are generally high-risk, high-reward areas. Indeed, having gained access to the Foum Assaka offshore licence, the company proceeded to compile significant technical data on both the Celtic Sea licences and the offshore Moroccan licence, plus gain an option to acquire an onshore Moroccan asset called Tendrara Lakbir, which has a discovered resource. The strategy of the company is simple in design. Acquire high equity positions in 'hot' prospective assets with near-term value adding opportunities. Add value through technical work, before farming down Fastnet's stake to manage risk and attempt to gain access to a series of well carries.

However, out of all the 3 assets, it is Foum Assaka where most progress has been made. Morocco has become a very 'hot' region for oil and gas in recent years with attractive fiscal terms drawing in a mixture of major and supermajor companies to the region. These names include Chevron, BP, Galp, Total and many more - with the region still being early stage, the company holds sought after acreage. Indeed, Fastnet has noted that the value of one barrel of oil in Morocco is as valuable as 7 barrels in Nigeria, or as much as 13 barrels in Algeria. In addition, the country is well placed for exports to Europe and has good domestic pricing. With the Russian tensions currently prevalent and the need to diversify into new supply streams, Morocco looks well placed strategically.

That value is verified by two value accretive farmouts that Fastnet managed to secure. The first was to multi-billion dollar player Kosmos Energy, and later to SK Group (Korea's third largest conglomerate, which booked well over $100 billion in revenues in 2013). The latter farmout was initiated just before the spud of the Foum Assaka 1 well (FA-1), which was spudded in March 2014. In exchange for a 9.375% net working interest, Fastnet received $20.4m in back costs and are crucially carried through the first two wells on the block, up to well cost caps of $100m. Arguably, that already puts significant value on Fastnet's remaining interest.

The second well carry is reliant upon SK Group participating in the drill, which is almost certain. Before going into detail on FA-1, the fact that Fastnet has that carry (up to $100m) is of utmost importance. It essentially means that future cash outflows are much reduced, and the investment case is much stronger. It's also worth mentioning that supermajor BP farmed into Fastnet's block prior to the drilling of the first well, and that is ultimately testament to the high prospectivity of the acreage. It is particularly good to see the raft of large corporations involved in the block as it is likely to accelerate work programmes (due to shared costs), but also boost the value of Fastnet's equity position, meaning that in the event of a discovery, substantial value would be extractable.

Many wells have been drilled by the industry in Morocco, but these have largely been confined to the carbonate shelf, and many of the play types within Fastnet's acreage remain untested - the licence also borders that of Genel Energy's (LSE:GENL) and is in close proximity to Galp's block. There is thus read-across between the blocks, and any future discoveries at these neighbouring licences would bode well for Fastnet's block. The region was buoyed by early indications of a gas discovery made by Longreach (now PetroMaroc) and partners at their Kamar-1 well.

The first well, FA-1, was drilled in March 2014 and was the well, which ultimately led to the share price collapse. The well was drilled to circa 4000m total depth (600m of water depth) and targeted a gross 360mmboe at the Pmean level, which would have equated to a net 33.75mmboe if successful. As noted earlier, Fastnet was carried through the well to a maximum $100m cap, which meant a sub-$3m cash outlay when the drill came in under-budget at ~$127m. The well failed to find commercial hydrocarbons and was the first in a series of play-opening wells designed to unlock the Agadir basin. However, the well did encounter oil and gas shows while drilling, plus in the sidewall cores. Has this completely damaged wider licence prospectivity? No, because the licence contains several independent play types that no doubt the partners will seek to explore through a further well. That said, the well confirmed all aspects of a working petroleum system except the presence of a quality reservoir section. The well proved the presence of a seal rock and hydrocarbon charge.

As stated earlier, this is only the company's first asset. What can be taken from the operations to date, is that Fastnet's strategy worked extremely well for Foum Assaka, even allowing for the exploration failure. Had the drill succeeded, the company would have held a very attractive slice of a large block with very credible partners, and would have found it easy to monetise. The company now has a second shot at success when the second well is drilled. The bottom line is that Fastnet's interest in Foum Assaka was very well managed and the collapse in share price upon failure was a re-alignment of investor expectations.

The second asset is also in Morocco, but onshore and in the form of an option. Fastnet has the option to acquire a 37.5% stake in the Tendrara Lakbir area in the East of the company should it sign up to a work programme aimed at developing an existing gas discovery. The opportunity is to appraise the TE-5 gas discovery made in the same Triassic reservoir that is productive in Algeria. Previously, upon a three-month well test, the discovery flowed 1.4mmcfd albeit the company claims the low rate may be due to a potential permeability barrier. In November 2013, an independent assessment assigned a best estimate gross contingent recoverable resource of 311bcf to the area, which would give a credible resource base if exploited successfully, and would open up the immediate area to further exploration. However, the company has stated that either a farmout partner would be required, or a reserve-based lending facility (RBL). The ideal solution would be a partner, but the company has very much kept their cards close to their chest on Tendrara - more details should be released over the course of Q3. With a gas price of $8.5m/cf seemingly achievable, the project could have attractive economics.

It is actually the third asset that sparks more major interest. The company has a series of licences in the Celtic Sea, offshore Ireland - an area that is seeing increased exploration interest as a result of discoveries made near Newfoundland, among other reasons including the significant Barryroe discovery by Providence Resources and partners. The area in which Fastnet operates is underexplored, but the company has been seeking to correct that having undertaken a sizable 2000km2 3D seismic survey during Summer 2013 at a cost of nearly $20m over the Mizzen and Kinsale areas



These blocks are very early stage, but have the potential to contain giant volumes of resource should resources exist. For example, several individual objectives within could contain over 1 billion barrels of oil, or multiple TCF of gas for Mizzen. Fastnet attempted to farm down this acreage back in 2013. However, despite coming close to securing a deal, the company failed to meet its high expectations, and that was most likely due to the fact that they could only promote 2D seismic as opposed to the much preferred 3D, which helps better define leads and add credibility to the data. The sheer size of the potential resources should be attractive to large companies, especially at Deep Kinsale where there is already a proven play with a producing field. These are seriously large resource numbers that remain to be tested through the drillbit, but are capable of attracting a large partner.

Industry interest seems to be building in the region, also as a result of a major conference held earlier the year. Despite Providence Resources and Lansdowne making slow progress on the farmout of their Barryroe discovery, the region remains of high interest and that can be seen through the entry of Australian major Woodside Petroleum into Petrel Resources' offshore blocks. Despite these being west of mainland Ireland, the entry of such a large player (capitalised at almost £20 billion) is a signal of increased interest. The 3D seismic that Fastnet shot should only improve farm down prospects, and the company has been bold enough to state that it hopes to achieve up to $20m in seismic back costs during the first stage farmout. Whilst appreciating that timescales have slipped in the past, the 3D seismic should re-invigorate the process.

Fastnet are looking for a very large company to partner them and to tackle the technical issues of the licence. Further down the line, Fastnet would plan to farmout another slice of the acreage in exchange for free carries in drilling during 2015/16. This is a replica of the model they deployed offshore Morocco. If the first stage farmout is highly successful, then the balance sheet could be bolstered up to the tune of ~£12m. With the 3D seismic under their belt and already several prospects being most closely defined, a farmout with a large name would act as a material catalyst for Fastnet. The target is to get a farmout secured by the end of 2014.

Indeed, having completed FA-1, the company noted that the "remainder of the portfolio ... contains much lower risk, but equally high reward multiple prospects". One of the biggest assets that Fastnet has is its management team, which carries bags of experience. Managing Director Paul Griffiths has extensive experience operating in Morocco and Ireland with one example being that he was the former CEO of Island O&G - an outfit with assets in the two companies that was acquired by San Leon Energy during 2009. Non-Executive director Michael Nolan was the former founder and CFO of AIM success, Cove Energy, and Executive Chairman Cathal Friel has significant experience in the corporate finance sector. Aside from newly appointed CFO Will Holland, Executive Director Carol Law was the former exploration manager for Anadarko East Africa over a period of time when Anadarko encountered huge volumes of gas in the Rovuma basin, Mozambique/Tanzania. That experience is invaluable, hence the £60,000 buy earlier this month is very interesting.

Whilst I personally attribute little real value to broker estimates for resource stocks given how inaccurate they usually are, Cantor Fitzgerald currently holds a 19p price target, Edison has a 26p RENAV and Davy have a net asset value for Fastnet of 24p.

Summing up the investment case is currently very easy. Fastnet is capitalised by the market at £19.4m. Fastnet has circa £13m in cash and minimal cash burn (aiming for low operating costs of £110,000/month). Fastnet has prudently managed their Foum Assaka asset and are seeking to perform similar exercises at the Tendrara Option and for the Celtic Sea asset, both of which are potentially very high reward. Fastnet has excellent partners at Foum Assaka, and a well is likely to be spudded either late in 2014 or early in 2015. Fastnet could RBL or farmout and enter the Tendrara option - newsflow should be expected over the next quarter. If Tendrara is entered, a drill should be spudded before or during H1 2015. Fastnet's Celtic Sea interests cover areas of substantial resource potential that should attract a major, especially with the 3D seismic now acquired - farmout targeted to close by the end of 2014. Fastnet has a highly respectable management team and the shares are suffering from the recent exploration failure - more prospects within Foum Assaka exist, and the other assets are high-impact in nature. Fastnet's acreage could be positively impacted by third-party events in both Ireland and Morocco.

With a cash-backed balance sheet, a material carry for a second well at Foum Assaka that should be spudded by the end of Q1 2015 and newsflow from the Celtic Sea and Tendrara option, there looks to be appreciable upside in Fastnet's share price over the rest of 2014 after the disappointment of FA-1 fades. For all intensive purposes, the current EV is between £6m and £7m and post-well failures are often among the best times to invest in oil and gas stocks. I have therefore put a Buy tag on Fastnet at 5.625p with a half slot. Target is at least 50% upside by the end of Q1 2015.

6 comments:

  1. Ireland is hot o&g property according to my friends in the oil and gas space. aall it takes is one success of size!

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    1. yes it is deep kinsale that looks really nice to the big boys. It is Carol Law that is really peaking my interest. A real seasoned professional! She said to proactive “I believe Fastnet has a very strong exploration portfolio of opportunities to which we will be able to attract major Oil & Gas players,”
      “I hope the market perceives this as the strong show of faith that it is intended to be. This is a long term hold position for me.”
      It pays to follow the money. Celtic sea could be a game changer.

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  2. Needless to say, I enjoyed reading this :0)

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  3. A huge body blow to us investors with the news this morning, any thoughts on the announcement Elite? Thanks

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    1. From a purely objective perspective, Fastnet does look rather attractive as an investment opportunity again on the basis that the market cap is comfortably below cash and the remaining assets are offshore Morocco and the Celtic Sea, which don't require any real CAPEX from Fastnet to pursue. That said, the loss of onshore Morocco was unlikely down to choice, and more likely down to an agreement to extend the licence not able to be struck. And that is probably down to Fastnet not being able to provide an assurance over the development timescale.

      With offshore Morocco out of the picture until 2016 and the Celtic Sea asset farmout unclear at this oil price, a full cash return to shareholders or at least a partial one would create good value from this level, back up to around the enterprise value (currently about 39% higher and attributing zero value to either of the above assets). Carol Law is still credible, which perhaps makes that decision to see residual value easier.

      Of course, should the oil climate change or should Fastnet be able to buy a cheap stake in a gas prospect with near-term drilling, then the share price is definitely worth north of the current level. Therefore, as long as the low overheads can be kept, the share price will probably see higher days in the future.

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    2. Thank you El1te, an erudite analysis as usual. Happy New Year to you.

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