Falkland Islands: The New North Sea?

In a remote corner of the South Atlantic, nearly 8000 miles from the UK, lies the self-governing British Overseas Territory of the Falkland Islands. Whilst for many people the islands are associated with a barren inhospitable landscape with a few sheep and even fewer people, a fledgling oil industry may be starting to take shape.

This week saw the announcement by Rockhopper Exploration, one of five British oil companies with operations in the Falklands, of continuing success in its exploration and appraisal programme of the Sea Lion discovery. This was the first confirmed oil discovery of the region, and the company now estimates the field to hold 325mmbbls of recoverable oil based on its mid estimate. Could it be that this remote area is starting to realise its much debated potential, estimated by the British Geological Society to hold billions of barrels of oil.

Background to Current Campaign

The prospect of the Falkland Islands developing into a major oil producing region has captured the imagination of geologists and investors alike for decades. For many, the area has significant potential as a new ��North Sea', bringing opportunities for oil and services companies for years to come. The exploration area surrounding the Falklands to which the UK has a territorial claim is some fifty percent larger than the UK's portion of the North Sea. In fact, despite being thousands of miles apart there are many similarities between the two. Environmental conditions and water depth are comparable to those west of the Shetland Islands, whilst in terms of geology the basins of the Falkland Islands possess structures similar to those found in the North Sea. The exploration area itself is separated into the geologically distinct North Basin, where the Sea Lion discovery was made, and the South Basin where fellow explorers Falkland Oil & Gas and Borders and Southern Petroleum intend to embark on the own campaign from the end of 2011 having secured an additional rig.

Despite the recent success, there are still those who doubt the Falkland Islands will ever see large scale oil production. One reason for this is the largely unsuccessful drilling campaign carried out by Majors including Shell, Hess and Lasmo in 1998. Six wells were drilled, with only one returning live oil to the surface in small amounts. Faced with high exploration costs, and a depressed oil price of approximately $10 a barrel, it was difficult to make an economic case for continued activity in the area, at which point the companies pulled out. Over the next decade a new round of licenses were handed out to several small British companies, each with only a handful of full-time employees. After a long period of little activity, the Falklands Oil dream sprung back to life with the contracting of the Ocean Guardian rig by Desire Petroleum.

Following a much hyped resumption of drilling activities in February 2010, the first well ��Liz' produced disappointing results, and it seemed that the region was destined never to realise its potential. That is, until the results of Sea Lion were known.

Meanwhile, whilst drilling activity continues, the protests from Argentina rumble on in the background. Critics point out that the Falkland Islands are often used by the Argentine government to divert attention away from domestic failures. This was the case in 1982 when Galtieri, leader of the Military Junta at the time, launched an invasion of the islands in the face of failing domestic popularity and an economic crisis. This time around, after unilaterally tearing up an agreement on oil sharing revenues in 2007, the Argentine government has once again begun to re-assert its claim to sovereignty. At a UN summit in Mexico in 2010, the country won unprecedented support from other Latin American states, drawing in vocal support from the leaders of Brazil, Venezuela, Uruguay and even Chile, a long-term British ally. Argentina, and more recently Brazil, have both imposed bans on allowing any Falklands' flagged vessels! from do cking at their ports in a deliberate attempt to impede drilling activities. One thing is for sure, and that is that the more oil that is discovered, the greater the protestations from Argentina will be. Britain, for its part, maintains that under UN charter the islanders have the right to self-determination and rejects the prospect of any potential change in its position, whilst maintaining 1,000 troops on the islands.

Looking to the Future

Political issues aside, considerable uncertainty remains over the future for oil exploration in the Falkland Islands. Given a discovery of this magnitude, it seems highly unlikely that the Sea Lion field exists in isolation. Therefore, as the exploration programme intensifies hopes of additional discoveries increase which can only serve to build the case for the region as an economically viable location for oil production. Returning to comparisons with the North Sea, initial excitement of explorers there in the 1960's quickly faded following a succession of dry wells and only minor gas discoveries. It was only the discovery of the giant Forties field, and of the Brent oilfield shortly after, which heralded the birth of one of the world's major oil producing regions and finally silenced the sceptics. Similarly in the Falklands, Sea Lion aside, the current round of drilling over the last 18 months has been fairly dismal. Nevertheless, a field the size of Sea Lion is too large to ignore, and will almost certainly be brought to production. In answering the question of how best to monetise the discovery, Rockhopper has unveiled ambitious plans of field development using a leased Floating Production Storage & Offloading vessel (FPSO). It estimates that first oil will be achieved by 2016, with maximum daily production reaching 120,000 bopd by 2018.

Figures of this size will surely make the world's biggest oil companies sit up and take notice given the potential profit to be made.

In addition, the intended use of an FPSO by Rockhopper ne! gates th e argument put forward by sceptics of a lack of local infrastructure, while the dual Argentine/Brazilian ban on Falklands shipping vessels will not impede drilling activities given the decision made at the beginning of the campaign to source materials from the UK. In terms of development costs, Rockhopper estimates that a not insignificant amount of $2billion will be required to the point of first oil production. Whilst the company has repeatedly signalled its intent to move into production alone, this would likely require a significant fundraising that may prove difficult given the recent tightening of credit availability. Existing investors would also be unreceptive to a large dilution of their holding through any equity issuance. Given that Rockhopper is in the enviable position of holding a 100% in the PL032 licence containing the discovery, a more likely option would be a farm-in of a portion of it's ownership to one of the Majors who could provide the dual benefit of a large cash position and the technical expertise in bringing the field to production.

Any commitment by a Major to drilling in the Falkland Islands would of course immediately alienate it from the Argentine administration. This would appear to prevent the involvement of companies such as Total, Chevron and Petrobras. Interestingly, Shell has recently begun divesting assets in Argentina, reaching agreement with Chile's Luksic family group to sell interests in service stations and the country's second-largest oil refinery. The company would fit the requirement for a partner nicely, and has a wealth of experience in field development using an FPSO. The question remains though, whether management would be prepared to swallow their pride and pay big money to regain an interest they gave up for nothing. BP is another which has been mentioned, with the obvious parallels to be drawn from the company's wealth of experience in the North Sea, in addition to its continued portfolio re-alignment following the fallout from the Deepwater Hori! zon inci dent last year. It is also possible that the Chinese National Oil firms could get involved, in order to satisfy the needs of a growing economy thirsty for oil. Whoever any potential partner turns out to be, it has to be said that Majors face a continuing quest to replenish reserves. If the Falklands prove to be anywhere near the size it has been claimed, then they may well decide it is worth the risk of transcending political disputes. Sometimes the opportunities are just too good to pass up.

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