88 Energy: Plenty to ponder in the interim results

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88 Energy (LSE:88E) announced keenly-read interim results on Monday morning. While it’s hard to put a value on the shares at the company’s current stage of development, there are clear milestones ahead for future changes in valuation.

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For anyone unfamiliar with the business: it has a 77.5% working interest in Project Icewine, on the North Slope of Alaska.

The fields in this area sat dormant for decades after initial exploration, but 88 Energy says two new factors mean they are now economic.

Firstly, there has been “a quantum shift in seismic technology” – improved imaging techniques allowing operators to see accurately through deep permafrost.

Secondly, changes to the tax system now permit generous refunds of exploration investment.

Progress has been positive so far: the maiden well results in Q4 2015 indicated the potential for commercial development – “dependent on results from follow-up well”.

According to the company’s June 2016 presentation, the timeline for the rest of the year involves getting 2D seismic results, arranging funding/partnering for the new well, and preparing to drill in Q1 2017.

Internal estimates suggest that the mean prospective recoverable resource is 2.6 billion barrels of oil equivalent, of which 2.0 billion barrels is net to 88 Energy.

The presentation informs us that in a middle cost scenario, breakeven is estimated at $39 per barrel of oil. Or looking only at the extremes: if there is a successful flow test at the second well, breakeven is $27 (in a low-cost scenario) or $68 (in a high-cost scenario).

Junior oil companies are always somewhat speculative, but the ranges involved here demonstrate in stark terms the wide uncertainty in the eventual outcome at the second well.

Today’s update also clearly acknowledges that there is no guarantee of a successful flow test there.

The key share price driver, apart from the eventual seismic and flow test results, is likely to be funding news. The company had cash of $20 million at the end of June, but it also had bank borrowings drawn of almost $24 million, on which interest at 7.5% is being paid up front.

Paying interest up front is equivalent to borrowing a smaller sum of money at a higher rate.

During the six-month period to June, the company spent a net $26 million on operating and investing activities.

That seems like a fast rate of cash burn relative to the existing balance sheet, but the company says that the available bank facility of up to $50 million is sufficient to fully fund the tests at the second well.

The market cap is now £98 million /USD $130 million, but it’s very hard to put a value on this company, given the wide range of potential costs on the second well, and the need to finalise long-term funding or a joint venture partner there.

I like to anchor resource plays relative to their book values, and I note that 88 Energy’s net asset position at June was $39 million.

More than 100% of this was accounted for by $45 million of capitalised exploration and evaluation expenditure.

While I’m sure that many investors would hope that the company’s expenditure turns out to be highly profitable, and while that may indeed turn out to be the case, I would recommend keeping the $39 million book value in mind before dealing in these shares.

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