I last wrote about FPL prior to the results of the JW Powell well (here), the stock was $0.011 and ran to a high of $0.019 (+72%). With the next well, Vespucci, currently being drilled and moving towards fracking later this week, by the world’s largest drilling company Schlumberger, we see the price is back to $0.011 and in much better shape running into these results. The capital raise overhang has been removed, with $5m raised in March. If we look at the position of FPL we can see why the risk-reward might be better this time around.

Also, keep in mind, whilst an explorer, it already has a P90 resource (90% probability) of 54m barrels of oil/540 BCF from its shallower formations, and cash flow of ~$100k/m from oil sales. 

What is FPL trying to Prove?

To refresh, FPL picked 21,500 acres of land that was re-gazetted for oil and gas exploration in Fremont County, Colorado. At the time, most thought the land had been picked over for shallow oil with nothing much of value below, so they got it relatively cheaply. FPL’s theory was the “Niobrara” formations in the massive Wattenberg field some 200km to the North, the 4^th largest oil-producing field in the US, extended down to their land in Florence. If they could prove they did, they would own and operate 100% a potentially highly productive, very large contiguous asset, in a very oil-friendly county, with the main Kinder Morgan gas pipeline some ~40kms to the North.

JW Powell Well – how did it go?

(Announcement 18th March)

• Initial Production (IP) rate of 220 BOE/day demonstrates Niobrara Formation in FPL’s Pathfinder Field is highly productive. Re-rates the value of Pathfinder’s acreage to that of nearby Wattenberg Field

• The well recorded a peak gas flow rate of 2.1 MMcf/day but was choked back to allow for oil production

What we also learnt was the 80/20 split of gas to liquids. There is a split of condensate in the liquids, which is equally valuable. The well was capped, as they would not seek to flare the gas to extract the liquids for quick cash flow, which makes sense (ie don't burn $4 to sell $1). Expect this with each well going forward unless they identify particularly oil-rich areas from the 2D seismic currently being run.

JW Powell – what we learnt?

I am going to make some generalisations, without getting lost in the deep technical details (from the public announcements and talking with the company).

• The gas component is high BTU.
• The formation appears the same as in Wattenberg, with one key difference, they appear thicker. The Niobrara formation was about twice as thick, and the lower untested Codell formation appears 3 times as thick.

Depth, rock formations, seam composition, pressures, water content etc all largely similar to Wattenberg. 

Table: Comparison - Pathfinder’s Niobrara Formation ~twice as thick as the Wattenberg Field (Source: Mar 19 Investor presentation)

Log Comparison: This compares a number of Wattenberg logs to the JW Powell well. Similar depth, same seam sequence, thicker intervals. (Source: Mar 19 Investor presentation)

Schlumberger (SLB) have said JW Powell is analogous with Wattenberg

It is significant that the company that has drilled the most wells in the Wattenberg, has come out in a rarely approved announcement, and made the comparison with the Wattenberg, for Fremont. (Announcement) 

The Schlumberger/Drilling Technique is the game changer for FPL.

Again, in simple terms, why the relationship with Schlumberger and the radial drilling technique are critical.

We have a small FPL (A$18m MKT Cap on a good day) that uniquely owns 100% of a large contiguous land package, in an area thought to be largely explored (Canon City was one of the first places oil was discovered in the US, in the 1860's). Why does Schlumberger the world’s largest drilling companies (there is Schlumberger SLB.NYS $52b then Halliburton HAL.NYS US$20.5b and daylight for 3^rd) take such a keen interest and do a friendly deal to frack FPLs wells? The answer is proving the radial frack technique. And if they are right on the technique, a possible game changer for tight shale drilling.

Traditionally in the Wattenberg field, a vertical well is drilled to target depth, then they drill a horizontal which they then fracture (frack), by denoting small charges and pumping in frack fluids and sand into the fractures. The fluids and sands can differ and the mix an artform in themselves. They are trying to always get the mix right to suit the source rock they are fracking, getting the mix right can make a large difference to productivity. The right mix allows the oil/gas to more readily move out of the rock over time. One well drilled this way costs ~US$7m

With this new radial technique, only being offered by SLB, they drill the vertical to target depth, and instead of drilling horizontally, they drill a series of “spokes” in each direction off the main vertical. They then frack the spokes. The key difference is cost. US$1.5-$2.0m to complete.

The key target metric with this technique is to get 70-80% of the performance of a horizontal well, with only 20-25% of the cost. The decline curve is the other key thing to note. Tight shale wells, unlike conventional oil wells, tend to have more rapid declines. In other words, the majority of the economic value is achieved often in the first 2-3 years. This is a generalisation, but important to considering funding and paybacks. If drilling wells at 25% of the traditional cost, payback is achieved much earlier when developing a field.

FPL acreage is currently trading at a large discount to Wattenberg acreage.

Recent comparable transactions (provided by FPL) range in the order of US$3,000 to US$17,000 per acre, which is significantly above the current value of FPL at US$510 per acre. Events that de-risk the field development, can have the effect of closing this gap. The next 12 months are critical in this timeline, and I will discuss those below. 

If we look at the average US$ per acre paid for the selected transactions above, then FPL, with further de-risking looks like this (Ignoring any further dilution. Note this is not a forecast). 

Key de-risking events.

The key events as I see them.

1. Gas contract – As alluded to in announcements, a gas contract appears advanced. This is, after all, is primarily a gas field. They will not flare the gas to immediately extract the oil, so cash flow is only likely to start as they sell gas. There are large industrial users in the area, that may be obvious buyers of the gas. They can also sell as much gas as they can produce into the Kinder Morgan line, some 40+ km away. In the end, the company can articulate a number of sales strategies for the gas in my view.
   
   
2. Further Drilling – JW Powell is a success. The second well Vespucci will be closely watched. Combine comprehensive seismic, being run now, and they need a further 3-4 wells to attract interest at much higher acreage values. At the outside, that means a further $8m in well funding needs to be considered, to maximise value.
   
   Vespucci if successful is significant. Shows consistency, which is more important perhaps than very high flow rates, and will see additional upgrades to the resource.
   
   
3. Seismic - The seismic might not be viewed as that important by the market, however, they would be missing the point. The seismic will give a clearer picture of the consistency of the various benches they are targeting and correlate the potential field to the 21,500 acres. They will also help refine future drill targets and allow the company to target oil-rich entrapments if oil cash flow was the goal.
   
   
4. Board – passing no judgement on the current board, however, it makes sense to bolster the board with US facing contacts/experience. This is important for pursuing funding options.
   
   
5. Schlumberger (SLB) – let’s not underestimate the value of the support of SLB. It is clear that there is a strong economic motive for them. Even on FPL’s 21,500 acres, there could easily be more than 100 wells drilled if the results prove consistent, and with a sales solution in place. More broadly refer above to the economics of the radial drilling technique vs horizontals. And the key thing about tight shale is that whilst you get oil and gas quickly, you need to keep replenishing the wells given decline (2-4yrs for the majority of economic value). The productivity of shale is the reason that the US, for the first time decades, has become a net exporter of oil.
   
   SLB will shift up gears between JW Powell and Vespucci. What I mean is perhaps instead of doing 4 radials, they do many more (8-16). They should also progressively perfect the fracking technique. In talking with experts, they say you generally perfect your approach by well 6-7 in tight shale formations.
   
   
6. Funding – The company needs to bridge about $10m in funding (my numbers not the company), provided drilling supports further development. Not a small number, however, there are more options open than some might think. Debt financing can be sourced with a US Govt guarantee. There are private oil funders, and we would be surprised if they have not already engaged. They can look at drill for equity engagements. Perhaps from left field, Schlumberger is an option, however, I understand that is not normally how they operate. They can come back to the AUS market provided results continue to fall their way. It is easy to be convinced that US funding may be less expensive given the depth of the market. A lot of funding options may also be tied back to a gas contract. The more value creation prior to funding, the less dilutive or better for FPL shareholders.
   

1. Share register – The company raised A$5m at 1.3c recently, a premium to the closing price. They took an additional $1m than initially considered. This additional stock is washing around the market post the placement, and with little immediate news (trading back to 0.0075). There was some institutional engagement in that raise, however, it is fair to say directors/retail still dominated register. Having said that, it would only take one serious informed buyer to tighten the register up. In talking with the brokers primarily involved, the stock appears to be moving gradually towards longer-term hands. Note that part of the management team purchased around 100m shares, and management has also been taking some benefits in shares.

Site Visit 

The company is hosting a site visit this coming week. This will hopefully coincide with Schlumberger fracking operations. Hearing their technical views will no doubt be key to building belief into field potential. I am heading across and will look to update post. 

Summary View.

As disclosed in the last note I wrote, I own shares in FPL. Since that note, I have increased my exposure through the capital raise at 1.3c and on the market. Given this is a very speculative company, that disclosure is particularly important. It is also a sign I think the prospects are improving for FPL. I don’t bank on fireworks from Vespucci, I would be happy with a result consistent with JW Powell. I am interested in getting to field development, not doing a calculation on how many barrels they might be able to truck off from individual wells. And whilst I think Vespucci is important, if a gas contract was announced in the short term, that would be materially more critical than a single well result. There is material uplift potential on this acreage, and a large part is dependent on management delivery, and an enduring relationship with Schlumberger. I hope to have a better feeling on both, after meeting in person.

Other Announcements

31/01/2019 - Quarterly Activities Report
31/01/2019 - Quarterly Cashflow Report
07/02/2019 - JW Powell Well Operations Update
14/02/2019 - JW Powell Well Fracking Operations Complete
05/03/2019 - JW Powell Well Operations Update
08/03/2019 - Strong Oil and Gas Flows Encountered on J.W. Powell Well

Disclosure - The author of this desk note owns shares in FPL and FPLOB Important Note - This note is not a recommendation or advice to buy or sell FPL shares mentioned. FPL shares should be considered very speculative, high-risk, and volatile. There are significant risks inherent in oil and gas exploration that are not discussed in this note. You should always seek professional advice before considering any share purchase or sale. This is a desk trading note, and not a research document, and the view of the authors only (Tom Schoenmaker). The author has not met the company management and company management have had no input into this note. Information is taken generally from public sources. Wentworth has not independently checked all information contained in this note for its accuracy. This document has been prepared without consideration of any specific clients investment objectives, financial situation or needs. Wentworth Securities does not accept any responsibility to inform you of any matter that subsequently comes to its notice, which may affect any of the information contained in this document.