IOC rallies

Pretty solid action today, it seems that once again, the initial reaction to a drilling update (the fourth one, last week), was premature. The sell-off since can hardly have been caused by a disappointing quarter, as these figures were quite a bit better than expected. Both the retail business and the refinery had a positive quarter, for the refinery that’s quite an achievement, considering the fact that it’s operating at roughly half capacity.

So, it must have been that drilling update, but now that investors had a little more time to ponder that drilling update, it looks like they had a change of hearts. Why?

For starters, there was always a good chance that Elk4 was going to confirm the massive amounts of gas already found at Elk1. This has to do with the location of the drilling and the knowledge accumulated through the two previous drillings and the seismic program. We know that the limestone at Elk flows (it did so in both locations explored so far, Elk1 and Elk2), so it is likely to flow at Elk4, it will also do so.

The limestone at Elk4, unlike Elk2, doesn’t run the risk of being below the water contact.

So it was always likely Elk4 is going to be a success, but, after what we know from the fourth drilling update, has that chance increased or decreased?

At first, the investor reaction seemed to suggest the latter, but we cannot find any arguments for that. Two elements from that update:

– there was an even larger amount of background gas compared to Elk1 (which was the original gusher they found two years ago).

– there are indications that there is a reef structure on top of the limestone (a reef typically has the highest permeability and porosity of any structure, if it contains oil or gas, its bound to be in very substantial quantities and it will easily flow)

Although neither arguments guarantee a success, considering the fact that Elk4’s chances were pretty good to start off with, they really should be interpreted positively. Indeed, Wayne Andrews from highly respected research firm Raymond James was upbeat and reconfirmed his $65 price target.

That’s quite a run, but then again, the current estimates on the Elk property are between 3.5 and 18.8 Tcf of gas. That’s quite a lot of gas, if Elk4 narrows that wide margin down and confirms the deliverability, that LNG facility necessary to monetize the gas will be a couple of steps closer.

We have to go with Raymond James here, but hedge your position at least to some extent. It’s not a done deal yet, and any disappointment is likely to sink the stock for a while.

Read the fourth drilling update here

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