Is the recent share price rise of 88 Energy justified? Gary Newman reviews...

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The recent rise in the share price of 88 Energy (88E) has been very noticeable and it has held those gains so far in spite of the company putting out a statement that it knew of no reason for the rise other than what had already been disclosed via RNSs. Many private investors focus solely on the share price and in the crazy market of today an increase from 0.5p to around 1.2p may not seem like a lot, but in reality it actually means that the market is now valuing the company at around £85 million more than it was last week! So, if you are holding shares in 88 Energy or considering buying, what you should be asking yourself if whether or not this rise is justified, and whether the shares are likely to continue going up?

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Hype is playing a big part in current market mechanics and it is easy to point to lots of companies that appear to be overvalued on the back of not a lot, and in this case the company is currently drilling for oil and targeting an amount that would potentially have a material impact on the business, in the success case and subject to further testing to prove the economics. Drilling for oil, especially where the target is significant, always attracts plenty of speculation, but these days fewer seem to hold on for the actual drill results – especially if they happen to be the placees from the recent fundraise, whose shares hit the market on February 22 – and there is certainly no guarantee of further rises as drilling nears completion. The company raised A$12 million via the placing of 1.5 billion shares at a price of 0.45p and I’d be amazed if those placees didn’t at least look to cash in on some profits now, given that the share price is over 150% higher now. I very much expect that will put a cap on the share price at somewhere around this level, and by the time actual drill results come it will be trading lower.

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So, if you’re buying now, or continuing to hold, you are pretty much committing to taking a risk on drill news and hoping that it is positive, or at least contains enough to keep the market happy that the current market cap of around £130 million is justified, despite the company not actually producing anything as of yet.  The company does of course have assets other than Project Peregrine, in Alaska, where drilling got underway a week ago, including the Icewine licence where it has a 78% working interest, and where a potentially significant oil and condensate discovery was made last year via the drilling of the Charlie-1 well, and where further appraisal is expected in the future, via a farmout to fund it. But given that nothing is really going on with that asset currently, and considering that there is a limited drilling season in Alaska – this drill at Peregrine will be the last one for 88 Energy during the current season, which is coming to an end – I think it is fair to conclude that the current interest and rise in valuation, can be attributed to the current drill, and that is also what will determine where the share price goes from here. The company acquired Project Peregrine last year via a merger with previous owner XCD Energy, in an all shares deal which saw XCD holders end up with around 20% of the enlarged group, and valued at a big premium to where the XCD shares had been trading prior to that. Subsequently last December, a farmout deal was secured to fund the drilling of the Merlin-1 well, via a special purpose investment vehicles, funded by private US investors, called Alaska Peregrine Development Company, and which receives a 50% interest in return for a $10 million free carry for 88 Energy, and equal sharing of any additional costs (it was expected that this would leave the company with $1.3 million to pay). Recent delays to the permitting process for the drill have added some significant additional costs and taken the total up to $18 million, with 88 Energy liable for $4 million of that, but it does have plenty of cash to cover that.

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Project Peregrine is a conventional onshore oil play located on the North Slope not far from Project Icewine, in northern Alaska, and ERC Equipoise recently assessed best estimate, unrisked prospective resources for Merlin-1 as being 270 million stock tank barrels of oil in place, and with a geological chance-of-success of 37%. Plenty of exploration drills have a much lower COS than that, but it still means the odds are stacked in favour of failure to even find hydrocarbons, let alone in quantities and with a reservoir quality that would make it economic (the eCOS is what really matters). And that is before you even start to consider how the value in the ground might be unlocked and how long that could take, even with an investment vehicle holding a stake in it, as raising significant funds won’t necessarily be easy.  Looking at it much shorter term though and from the point of view of where the share price might go, I personally don’t think that this offers good value on a risk/reward basis after it has already had such a large increase in the market cap. But at the same time, if the company does announce a significant find, then the share price will of course rise substantially, and even more so if the logging data that is being collected whilst drilling provides any indication to add weight to it being likely to be economic and flow at a good rate. The flipside is that failure will result in the share price plummeting, and even more so from this market cap level, and the odds are in favour of that outcome. The fact that this will be the last drill for some time, and that the planned Harrier-1 well has been postponed until next season, suggests there won’t be much to support the share price if news is bad when it comes within the next three weeks or so. But if you are the type of investor/trader who likes a gamble on these drills, then I would wait and expect that you will be able to get a much better price closer to target depth being reached, and when all those who don’t want to risk holding for results have sold. It wouldn’t surprise me to see the recent spike being almost totally reversed prior to news coming.

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