Oil & Gas 88 Energy Speculative Buy Two Fat Ladies 8 April 2015 Price (A¢) 1.1 Target Price (A¢) 1.9 Ticker 88E Market cap (A$m) 10.0 Estimated cash (A$m) 7.0 Shares in issue Basic (m) 1,139 Fully diluted (m) 1,646 52-week High (A¢) 32.5 Low (A¢) 0.6 3m-avg daily vol (000) 6,385 3m-avg daily val (A$000) 65 Top shareholders (%) Computershare Clearing 15.3 Donald Smith 6.1 Eloten Group 3.5 Clairault Investment 2.3 Lydian Enterprises 2.2 Total 29.4 Board/ Management Michael Evans NE-CHR David Wall MD Brent Villemarette NED Stephen Staley NED Share Price Performance (A¢) 70 $0.30 60 $0.25 50 $0.20 40 $0.15 30 $0.10 20 $0.05 10 $0.00 Mar‐14 Millions $0.35 Jun‐14 Sep‐14 Dec‐14 0 Mar‐15 Source: Bloomberg 88 Energy, formerly called Tangiers Petroleum, has reinvented itself as a US shale oil company. The company is in the process of acquiring an initial 87.5% interest in 99,360 contiguous acres onshore the North Slope of Alaska: the Icewine Project. We believe this is a high-risk, potentially high-reward project. The company benefits from being an early mover in chasing shale oil resources on Alaska’s Northern Slope. It was able to acquire most of its acreage at rock-bottom prices in the last licence round as there was little competition due to collapsing oil prices. The Icewine Project also benefits from having the Dalton Highway and TransAlaskan Pipeline System pass through it; this should allow year-round access, lower the cost of early exploration and allow the export and sale of liquids at global prices should the project prove successful. Recent changes to Alaska’s fiscal regime have made North Slope exploration and production much more attractive than previously. DeGolyer and MacNaughton estimates that the Icewine Project has gross mean unrisked prospective unconventional resources of 493MMbbl. These unconventional resources are split across four distinct shale horizons: the HRZ, Hue, Kingak and Shublik shales. Of these shales, the HRZ has the most resources and is 88 Energy’s primary target. The HRZ Shale is thought to be a high porosity organicrich shale, with good top and bottom seals, that is in the volatile oil/wet gas window within the Icewine Project acreage. The project acreage also has significant, as yet unquantified, conventional oil potential. In 2013 the USGS estimated that the Central North Slope has 4Bbbl of mean undiscovered resources. In 2012 Great Bear Petroleum made a small, but promising, conventional oil discovery to the north of the Icewine Project. We estimate that 88 Energy’s shares have a fair value of A¢1.9/share (1.0p/share). This is based on Great Bear Petroleum’s recent winning bids for four blocks just to the north of the Icewine Project. Great Bear bid an average of US$212/acre for four blocks some five miles to the north of Icewine. Should 88 Energy be able to prove the HRZ Shale a commercial success, then the upside is huge. In recent years, good acreage in the Eagle Ford proven play has sold for well over US$20,000/acre (and in 1H14 Baytex paid over US$100,000/acre when it bought Aurora Oil & Gas). We are raising our rating to SPECULATIVE BUY. 88 Energy faces geological, operational, financial, regulatory, legal, political and commodity price risks. We believe that the RFC Ambrian acts as Broker and Nomad to this company Stuart Amor +44 (0)20 3440 6826 [email protected] main risk for the company is that it might be unable to get HRZ Shale oil wells to flow at commercial rates. 88 Energy 8 April 2015 Contents Summary 3 Valuation 5 Catalysts 7 The Icewine Project 8 Unconventional Plays Conventional Plays Fiscal Terms 9 13 14 Corporate Capital Structure Burgundy Xploration LLC Board and Management Risks 15 15 15 16 17 88 Energy 8 April 2015 3 Summary We estimate that 88 Energy’s shares have a fair value of A¢1.9/share (1.0p/share) 88 Energy, formerly called Tangiers Petroleum, has reinvented itself as a US shale oil company. The company is in the process of ditching the Tarfaya Block, its Moroccan licence where it drilled the unsuccessful Tao1 well last year, and acquiring an initial 87.5% interest in 99,360 contiguous acres onshore the North Slope of Alaska: the Icewine Project. We believe this is a high-risk, potentially high-reward project. DeGolyer and MacNaughton estimates that the Icewine Project has gross mean unrisked prospective unconventional resources of 493MMbbl of oil. These unconventional resources are split across four distinct shale horizons: the HRZ (GRZ), Hue, Kingak and Shublik shales. Of these shales, the HRZ has the most resources and is the primary target. The acreage also has significant, as yet unquantified, conventional oil potential in Cretaceous and Jurassic sands. In 2013 the USGS estimated that the Central North Slope has 4Bbbl of mean undiscovered resources. We estimate that 88 Energy’s shares have a fair value of A¢1.9/share (1.0p/share) based on Great Bear Petroleum’s recent winning bids for four blocks just to the north of the Icewine Project. Timing is important, and 88 Energy has got this right In Chinese culture the number 8 is meant to be lucky; 88 Energy has two 8s in its name and has been lucky in its timing in two ways: First, the Alaskan State Government has recently encouraged new oil exploration and production by offering substantial cash rebates on exploration (85% in 2015, 75% in 2016) and by lowering the fiscal burden on oil production. It has done this because without new fields being brought on-stream, lower North Slope oil production from currently-producing fields is likely to put the operation of the TransAlaskan Pipeline System (TAPS) in jeopardy over the next decade. And second, 88 Energy bid for its North Slope licences as the oil price was collapsing, limiting the competitive environment and allowing the company to gain entry into an exciting potential new shale oil play at a rock-bottom price. 88 Energy and partner Burgundy Xploration paid an average of US$29/acre for their licences in the recent North Slope Areawide 2014W licensing round (the minimum bid was US$25/acre). We believe that 88 Energy’s team has the right mix of financial, geological and reservoir engineering skills to take the Icewine Project forward We are not superstitious and believe that management has created its own luck. We think that the Board and management of 88 Energy has the right mix of financial, geological and reservoir engineering skills to take the Icewine Project forward. Clearly after last year’s disappointing Tao-1 well result, and the terrible cost overrun by operator Galp, the company was in a precarious position. Since then management has raised new capital, screened a number of new ventures and picked and landed the promising Icewine Project. 88 Energy has a partner with great shale oil experience: Burgundy Xploration LLC Any success at the Icewine Project will depend on having picked the right acreage. Here, 88 Energy management has been ably assisted by its partner Burgundy Xploration LLC, whose founder is geologist Paul Basinski. From 2005 to 2008 Paul spearheaded ConocoPhillips’ programme to lease over 300,000 acres in what today is the ‘sweet spot’ (the volatile oil/wet gas window) of the Eagle Ford play. More recently he used his knowledge and understanding of what geologic conditions are required to produce the most economic wells gained from this experience to analyse the shales of the Alaskan North Slope. He came up with a new shale oil play that others had overlooked: the HRZ/Hue shales to the south of where most of the North Slope licences had been acquired. Others, such as Great Bear Petroleum, had focused on the Shublik Shale to the north. 88 Energy 8 April 2015 4 Project Icewine acreage is thought to sit above where the HRZ Shale is in the volatile oil/wet gas window What Paul was looking for was a high porosity organic-rich shale, with the right thermal maturity (volatile oil/wet gas), which had good top and bottom seals. In Figure 1 we show a schematic of how the thermal maturity of North Slope source rocks changes from south to north. Project Icewine acreage is thought to sit above where the HRZ Shale (the lower Brookian source rock) is in the volatile oil/wet gas window (ie, it moves from the oil window into the gas window, or is on the red line in Figure 1). Figure 1: Alaskan North Slope Source Rock Thermal Maturity Source: Rampart Energy Presentation, RFC Ambrian estimates Expected top and bottom seals should make HRZ Shale wells highly productive The seals are important as they force the hydrocarbons, created by organic-rich shale at the right thermal maturity, into a supercritical fluid phase. Supercritical fluids are at a temperature and pressure above their critical point, where distinct liquid and gas phases do not exist. They can effuse through solids like a gas and that greatly enhances the liquid production of wells. This dramatically improves well economics. Paul believes that the HRZ Shale within the Project Icewine acreage fulfils the right conditions to have hydrocarbons in the supercritical fluid phase. Perhaps what makes the HRZ Shale stand out from all other US shale oil plays is the expected high porosity Perhaps what makes the HRZ Shale stand out from all other US shale oil plays is the expected (inferred from well log data) high porosity. Both management and DeGolyer and MacNaughton estimate that the HRZ Shale has a mean porosity of 14%. Improved overall porosity should increase the capacity for the HRZ member to retain hydrocarbons, all else being equal, resulting in high resource concentration. Resource concentration is highly correlative to well performance and ultimate recovery levels. Valuation based on Great Bear’s US$212/acre bid for four blocks some five miles to the north of the Project Icewine acreage In November 2014 Great Bear was the apparent winner of four blocks just five miles to the north of Icewine Project acreage. Great Bear bid an average of US$212/acre for these blocks. We have used this level to value the Icewine Project acreage as we believe it better reflects the true value than the acquisition cost. Should 88 Energy be able to prove the HRZ Shale a commercial success, then the upside is huge. In recent years, good acreage in the Eagle Ford proven play has sold for well over US$20,000/acre (and in 1H14 Baytex paid over US$100,000/acre when it bought Aurora Oil & Gas). Risks Like most junior oil and gas companies, 88 Energy is a speculative investment. The company faces, geological, operational, financial, regulatory, legal, political and commodity price risks. We believe that the main risk for the company is that it might be unable to get HRZ Shale oil wells to flow at commercial rates (see the Risks section later for a more detailed description of these items). 88 Energy 8 April 2015 5 Valuation We estimate that 88 Energy’s shares have a fair value of A¢1.9/share (1.0p/share) based on Great Bear Petroleum’s recent winning bids for four blocks just to the north of the Icewine Project. On a fully diluted basis, but excluding cash raised from the exercise of options, we estimate that 88 Energy’s shares are worth of A¢1.3/share (0.7p/share). In Table 1 below we show our fair value calculation. We estimate that 88 Energy’s shares have a fair value of A¢1.9/share Table 1: 88 Energy Fair Value Estimate Gross Net Interest Net Acreage Valuation Value Value Value Acres (%) Acres (US$/acre) (US$m) (A¢/share) (p/share) 99,360 77.8% 77,302 212 16.4 1.9 1.0 Alaska Project Icewine Cash, G&A and work programme expenditure Net cash/(debt) Dec 2014 0.6 0.1 0.0 Feb 15 equity issuance 5.3 0.6 0.3 2015 cash expenditure (5.5) (0.6) (0.3) Cash NAV 0.4 0.0 0.0 Total 88 Energy fair value 16.8 1.9 1.0 Note: Based on 1,139.3m issued shares; Source: Company data, RFC Ambrian estimates We estimate 88 Energy’s interest in the Icewine Project to be worth US$16.4m Great Bear bid an average of US$212/acre for four blocks just north of the Icewine Project in the last licence round. Using this metric to value the Icewine Project’s 99,360 acres gives a value of some US$21m. Should a well be drilled on Burgundy Xploration’s first licences, 88 Energy’s initial 87.5% interest in the project would be reduced to 77.8%. We use the latter interest to estimate the value of 88 Energy’s interest in the project at US$16.4m. Great Bear bid an average of US$212/acre for four blocks just north of the Icewine Project in the last licence round In November 2014 Great Bear was the apparent winner of four 1,440 acre licences (480A, 480B, 480C & 480D) in the North Slope Areawide 2014W licence round. Great Bear’s four blocks are just five miles to the north of the Icewine Project acreage. Great Bear bid US$1.2m for the four blocks, or an average of US$212/acre. In the same November 2014 North Slope Areawide 2014W licence round, Burgundy Xploration (on behalf of 88 Energy) was the winner for sixty-three 1,440 acre licences. Burgundy bid US$2.6m for the blocks, or an average of US$29/acre. We believe that Great Bear’s bid is the most appropriate acreage valuation metric We believe that Great Bear’s bid is a more appropriate acreage valuation than Burgundy’s bid as it reflects a competitive bid over acreage whose main target is the well-known, but as yet unproven, Shublik Shale play. By contrast, we believe only 88 Energy and its partner Burgundy saw the potential of the HRZ/Hue Shale play in the Project Icewine acreage, allowing them to make, and succeed with, low-ball bids. The minimum block bid was set at US$25/acre. Acreage in US Lower 48 proven plays has sold for well over US$20,000/acre To put our US$212/acre valuation of the Icewine Project into further perspective, we estimate that the see through value from three North Slope farm-outs over the last few years range from roughly US$400/acre to US$1,400/acre. Acreage in US Lower 48 proven plays has sold for substantially more than this. Good acreage in the Eagle Ford has sold for well over US$20,000/acre. For example, in June 2011 Marathon paid Hillcorp Resources US$3.5bn for 141,000 net acres in the volatile oil and dry gas windows of the Eagle Ford. This equated to roughly US$24,800/acre. 88 Energy 8 April 2015 6 At that time this acreage had just 36 producing wells, which generated approximately 7,000 net (17,000 gross) barrels of oil equivalent (boe) per day. Marathon estimated that the acreage had the potential to allow it to book up to 100MMboe of proved reserves by the end of 2011. In 1H14 Baytex bought Aurora Oil & Gas for C$2.6bn, including debt. Aurora had 22,200 net acres, containing 167MMboe of 2P reserves and estimated 2014 production of 30,500boepd in the ‘sweet spot’ of the Eagle Ford. Thus, Baytex paid over US$100,000/acre. Admittedly, oil prices were much higher when these transactions occurred, but we believe this shows the potential for value appreciation of the Icewine Project acreage should 88 Energy be able to prove the commercial viability of HRZ/Hue Shale wells. Risked discounted cashflow analysis and recent farm-out valuations are problematic valuation metrics We believe it is too early to perform a risked discounted cashflow analysis of 88 Energy’s interest in the Icewine Project. The uncertainties, particularly around well performance, are currently just too large to provide a meaningful value. Industry farm-out valuations of North Slope acreage are likely to have changed given the new fiscal regime enacted in April 2013, and in view of the recent dramatic fall in oil prices, making use of this metric is difficult. See through value from three North Slope farm-outs range from roughly US$250/acre to US$1,000/acre We estimate that the see through value from three farm-outs over the last few years range from roughly US$400/acre to US$1,400/acre. However, the Alaskan oil industry environment has changed significantly since these farm-outs were announced; two of these farm-outs occurred before the 2013 enactment of the better fiscal regime under the ‘More Alaska Production Act’, which was passed in April 2013. All the farm-outs took place before the recent dramatic fall in oil prices. Halliburton farm-in to Great Bear Petroleum licences In November 2011 Great Bear farmed out a 25% interest over about a quarter of its ~500,000 acres to Halliburton for work programme carry. Great Bear’s acreage lies immediately to the north of Project Icewine. Exact details of the farm-out have not been disclosed. We estimate the work programme cost US$60m, implying a look through value of around US$1,400/acre. Great Bear’s main focus is an unconventional Shublik Shale oil play. Repsol farm-in to 70 & 148 LLC GMT Exploration LLC licences In March 2011 Repsol farmed into 2,000km2 (~494,000 acres) of North Slope licences owned by 70 & 148 LLC (an affiliate of Armstrong Oil & Gas Inc) and GMT Exploration LLC. These licences lie to the north-west of Project Icewine, and just to the west and south of the Kuparuk River oil field. Repsol obtained a 70% working interest in the licences in return for agreeing to carry out the investment necessary to explore the blocks’ resources. Repsol estimated that the minimum exposure of this investment, including amounts to be paid to its partners and the cost of exploration to be carried out over several years, was US$768m. We think that this implies a look through value of around US$700/acre. Repsol and its partners are focusing on conventional plays in their licences. Rampart Energy farm-in to Royale Energy licences In May 2013 ASX-listed Rampart Energy farmed into 50,000 acres of North Slope licences in two blocks owned by Royale Energy. These licences lie to the north-west of Project Icewine. To earn up to a 75% working interest in the licences Rampart agreed to pay ~US$5.1m in cash, issue options over US$1.7m of stock and carry Royale through a defined work programme. The work programme included acquiring and processing 120 square miles of 3D seismic, and drilling, testing and completing two wells. We estimate the work programme should cost US$40m, implying a look through value of around US$400/acre. However, it appears that Rampart was unable to meet an unexpected 2014 cash call by Royale part way through the staged farm-in process and the companies are now in litigation. 88 Energy 8 April 2015 7 Catalysts We believe that third-party drilling on the Central Northern Slope has the potential to provide significant catalysts in the near term 88 Energy could benefit from some catalysts that it has some control over (completion of the licence acquisition, prospect/lead identification through reprocessing of vintage 2D seismic, farming out an interest in the project, etc). The initial Icewine Project work programme is focused on moving it forward towards drilling of the first well and/or attracting a farm-in partner. The estimated 2015 budget of US$2.1m comprises the purchase, reprocessing and re-interpretation of existing 2D seismic, in addition to well planning activities and overheads. Furthermore, we believe that thirdparty drilling on the Central Northern Slope has the potential to provide more significant catalysts as the results of these wells could help inform the market about the Icewine Project acreage prospectivity. Great Bear began drilling the Alkaid-1 well in February 2015 Great Bear Petroleum mobilised the Nabors Rig 106 AC late last year and began drilling the Alkaid-1 well in February. Two further wells, Phecda-1 and Talitha-2, will be drilled later this year. The Talitha-2 well is just five miles north of Project Icewine’s acreage. All three wells will be drilled a few miles west of the Dalton Highway on ice pads supported by ice roads (the 2012 wells, Alcor-1 and Merak-1, were on rig mats adjacent to the highway). It may take some time before the results of these wells are widely known. Great Bear is a private company and is not obligated to publicise the results quickly. The company must notify the Alaskan Department of Natural Resources with a list of data sets available within 30 days of completing a well. However, well data requested by, and submitted to, the DNR will only be made publicly available after the expiration of the 24-month confidentiality period, followed by 30 days public notice. Seismic or other geophysical data will be made publicly available after ten years, followed by 30 days public notice. Figure 2: 2015 Regional Exploration Activity Source: Great Bear Petroleum, 88 Energy Repsol is planning to test the Brookian Fairway with a threewell programme In 1H15 Repsol is planning to test the Brookian Fairway roughly 80 miles NW of Project Icewine. Three wells are planned in Qugruk area (see Figure 3). As a public company, Repsol is likely to announce any significant results relatively quickly. 88 Energy 8 April 2015 8 The Icewine Project Figure 3: Alaskan North Slope Lease Ownership Map Source: Company data DeGolyer and MacNaughton estimates that the Icewine Project has gross mean unrisked prospective unconventional resources of 493MMbbl of oil The Icewine Project consists of up to 99,360 contiguous acres located onshore on the North Slope of Alaska (see Figure 3). 88 Energy has agreed to work with Burgundy Xploration (BEX) and Arktos Energy Management (AEM) on acquiring and managing the leases; once these have been formally awarded and paid for, 88 Energy will be the operator and have an initial 87.5% working interest in the project (which will reduce to 77.8% on the spudding of the first well on BEX leases contributed to the project). DeGolyer and MacNaughton estimates that the project has gross mean unrisked prospective unconventional resources of 493MMbbl of oil from roughly 8Bbbl estimated oil in place. The acreage also has substantial, as yet unquantified, conventional oil and gas resource potential. The leases are advantageously situated adjacent to the Dalton Highway and Trans-Alaska Pipeline, resulting in year-round access for operations and immediate market access for crude oil sales should the project be successful. There is no urbanisation or agricultural activity across Project Icewine acreage Due to the Arctic conditions, there is no urbanisation or agricultural activity across the Project Icewine acreage. This is often not the case in the US Lower 48, where shale development can be challenging in populated or agriculturally intensive areas. There is also a lack of potable water aquifers in the central North Slope area, mitigating the possibility of municipal ground water contamination. There are, however, ample surface water supplies for drilling and stimulation programmes. 88 Energy 8 April 2015 9 Combined with the attractive lease term and royalty, we believe that the fiscal regime makes the Icewine Project very competitive with similar projects in the US Lower 48 The primary lease term is ten years, with a base royalty rate of 12.5% (16.5% after vendor overriding royalty). The State of Alaska is also offering an 85% cash rebate on exploration activity through CY15 (reducing to 75% from January 2016 to July 2016 and then to 35% thereafter). Combined with the attractive lease term and other fiscal terms, we believe that the fiscal regime makes the Icewine Project very competitive with similar projects in the US Lower 48. Lease acquisition 88 Energy, through BEX, bid on leases covering 90,720 acres in the Alaskan North Slope Areawide Sale on 19 November 2014. 88 Energy paid the 20% deposit (~US$0.5m) on behalf of BEX under the terms of their Joint Development Agreement. On 20 November BEX was advised that it was the apparent highest bidder on the leases. Formal award of the leases to BEX by the Alaskan Department of Natural Resources is expected to occur during 2Q15, at which point BEX has 30 days to pay the remaining 80% of the lease costs, which total some US$3m. 88 Energy has agreed to pay this sum and will then gain an initial 87.5% working interest in the project. Prior to the November 2014 licence round, BEX already held an interest in oil and gas leases over 8,640 acres located on the Alaskan North Slope, which it has contributed to the Icewine Project. 88 Energy has agreed to free carry BEX in respect of the CY15 budget for the Icewine Project, which currently totals ~US$2.1m. Unconventional Plays Figure 4: Alaskan Central North Slope Stratigraphy Source: AAPG Project Icewine unconventional resources are split across four distinct shale horizons: the HRZ, Hue, Kingak and Shublik shales DeGolyer and MacNaughton estimates that the Icewine Project has gross mean unrisked prospective unconventional resources of 493MMbbl of oil. These unconventional resources are split across four distinct shale horizons: the HRZ (GRZ), Hue, Kingak and Shublik shales. 88 Energy 8 April 2015 10 Of these shales, the HRZ has the most resources and is the primary target. Given the limited data (seismic and well logs) over the licences, the uncertainty surrounding the level of prospective oil resources is large. The HRZ Shale has P90 gross prospective resources of 65.8MMbbl and P10 gross prospective resources of 501.5MMbbl. Table 2: Project Icewine Unconventional Prospective Resources Gross Prospective Resources (MMbbl) P90 P50 P10 Mean HRZ Shale 65.8 192.5 501.5 250.4 Hue Shale 15.9 56.1 160.7 76.1 Kingak Shale 19.6 80.4 213.1 104.0 Shublik Shale Total Project Icewine 13.5 45.8 135.4 61.9 244.3 446.4 813.2 492.5 Source: DeGolyer & MacNaughton Promising source rock characteristics A comparison of the four main Alaskan source rocks with the Bakken and Eagle Ford source rocks is given in Table 3 below. Whilst individual source rock characteristics do not correlate that strongly with success, the Alaskan source rocks all show some promising characteristics. In particular, they all have Total Organic Content (TOC) above the minimum threshold, and have thermal maturities that range from immature oil to dry gas. Thus, there will be Alaskan licences that will have each of the source rocks in the volatile oil/wet gas window, which we would expect to have the best well economics. Different licences are likely to have optimum thermal maturities for each of the different shales. We believe that the only way to be sure that an Alaskan shale oil play will be successful is when the production results from several/many horizontal hydro-fractured wells are available. Table 3: Source Rock Comparison of Geologic Characteristics Bakken Eagle Ford HRZ/Hue Kingak Shublik Total Organic Carbon (%) 10% avg 2-7% 3% avg 5% avg 2-3% avg Main Kerogen Types I/II (oil) I/II (oil) II/III (oil-gas) II/III (oil-gas) I/II-S (oil) 42° 30-50° 38° 40° 24-45° Thickness (ft) up to 100ft 50-250ft 100-800ft 175-550ft 0-600ft Thermal Maturity Imm-Oil-Gas Imm-Oil-Gas Imm-Oil-Gas Imm-Oil-Gas Imm-Oil-Gas Sh-Slts-Sh Sh-Slts-Ls Sh-Tuff Shale Sh-Slts-Ls Yes - Quartz Yes - Calcite No ?* No ? Yes - Calcite Natural Fractures Yes Locally ? ? Some Zones Overpressure Yes Locally Locally Probably ? Oil Gravity (°API) Lithology Brittleness *However, Great Bear reported HRZ/Hue Shale to have brittle lithology in Alcor-1 and Merak-1 wells; Source: Alaskan Department of Natural Resources The HRZ Shale is the primary unconventional shale oil The HRZ Shale is the primary unconventional shale oil target at the Icewine Project. DeGolyer and MacNaughton estimates that the Icewine licences have gross mean unrisked prospective unconventional resources of 250MMbbl in this formation (P50 gross mean unrisked prospective unconventional resources of 193MMbbl). The Cretaceous HRZ Shale is an already proven and prolific source rock on the North Slope, having sourced the Tarn Oil Field and co-sourced the Prudhoe Bay Oil Field Complex (the largest oil field in North America). The Project Icewine acreage was chosen because management models suggested that the HRZ Shale is in the volatile oil/wet gas mature window over these licences. The Cretaceous Hue Shale is a secondary unconventional target, lying just above the HRZ Shale. The Jurassic Kingak shale has a relatively high clay content, which we believe will make hydro-fracturing ineffective. The deeper Triassic Shublik Shale is the main source of the Prudhoe Bay Oil Field, but we believe that it is likely to be in the gas window over the Project Icewine licences. 88 Energy 8 April 2015 11 The HRZ Shale exhibits important shale attributes found in other successful US tight oil plays The HRZ Shale exhibits important shale attributes found in other successful US tight oil plays. These include: Source Rock Total Organic Content (TOC) — A decent TOC is required to create a concentrated hydrocarbon reservoir. Reasonably high TOCs (up to 8%) have been reported in wells from the HRZ/Hue Shale on adjacent acreage. TOC averages 3% across the North Slope. Source Rock Kerogen Type — The source rock must be oil prone — Type I or II kerogen. The HRZ Shale contains deepwater marine Type II kerogen. Organic matter type also can contribute organic porosity and could augment storage potential within the shale. Source Rock Thermal Maturity — Ideally the source rock should be in the volatile oil/wet gas window, as this would maximise the value of produced hydrocarbons. The lower viscosity of the light oil, gas liquids and gas mixture in this window allows for higher production rates, while the presence of liquids increases the value of the production (over dry gas). Well data (rock-eval and vitrinite reflectance) from wells located in and near the project area confirm management’s burial history and heat flow models. These indicate a depth and maximum bottom hole temperature that should generate the desired ratio of gas and high value liquids. Shale Porosity — The HRZ Shale contains a significant airborne glass and ash component contributed by volcanic activity during the time of deposition. This component has the potential to increase favourably the HRZ Shale’s capacity to retain hydrocarbons through increasing the porosity of the rock as a result of differential compaction and subsequent dissolution. Well logs of three historical wells drilled in adjacent acreage and one well within the Icewine Project licence area support a mean porosity level of 14%. Overpressure — Shale overpressure aids the commercial recovery of hydrocarbons as it assists the lifting of hydrocarbons to surface. Petrophysical analysis of the bottom seal provided by Pebble Shale (immediately below the HRZ Shale) indicates overpressure of >0.55psi/ft. Management believes that the HRZ Shale should also have a good top seal (Hue Shale). This is important because the top and bottom seals should help keep any generated gas, gas liquids and light oil within the shale and cause the internal shale pressure to be higher than it otherwise would be. Brittle Lithology — Great Bear Petroleum has reported that wells on adjacent acreage have encountered brittle lithology in the HRZ/Hue Shale. This bodes well for the ‘fraccability’ of these shales. Tectonic Setting — The best shale plays are in tectonically relaxed regions providing good reservoir continuity. This is because hydrofracturing near faults does not work (newly created fractures head straight to the fault and stimulate a low reservoir volume). The Icewine Project acreage is outboard of the Brooks Range compressional complex in a structurally simple and tectonically relaxed foreland basin. 88 Energy 8 April 2015 12 Figure 5: Well Logs of HRZ (GRZ) and Hue Shales: Total Organic Content Estimates Source: Alaskan Department of Natural Resources High porosity should increase the capacity for the HRZ member to retain hydrocarbons, all else being equal, and allow good (economic) well performance Perhaps what makes the HRZ Shale stand out from other US shale oil plays is the expected high porosity. Improved overall porosity should increase the capacity for the HRZ member to retain hydrocarbons, all else being equal, resulting in good resource concentration. This resource concentration, or oil in place per acre per foot, is highly correlative to well performance and ultimate recovery when combined with other requisite attributes for a successful shale play. Management believes that HRZ Shale hydrocarbons are likely to be in a supercritical fluid phase, which should lead to excellent well performance The other part of the geological situation that sets the HRZ Shale in the Icewine Project apart from many other US tight oil plays is the presence of both a top and bottom seal. This, combined with the modelled thermal maturity of the shale, should mean that the hydrocarbons are in a supercritical fluid phase. Supercritical fluids are at a temperature and pressure above their critical point, where distinct liquid and gas phases do not exist. They can effuse through solids like a gas, and dissolve materials like a liquid. Any hydrocarbons in the supercritical state in the reservoir form gas, condensate and light oil when brought to the surface (below the bubble point). This should improve well performance and economics dramatically. The other US shale play where this occurs is in certain parts (the volatile oil window) of the Eagle Ford. Wells in the volatile oil window of the Eagle Ford have some of the best economics of all the US tight oil wells drilled. Great Bear Petroleum is chasing unconventional production from the Shublik Shale Great Bear Petroleum’s main focus is chasing unconventional production from the Shublik Shale on the Central North Slope to the north of Project Icewine, where it has found the thermal maturity of this shale to be in the volatile oil/wet gas window. However, it is unclear to us whether there is both a good top and bottom seal surrounding this shale that could force the hydrocarbons into a supercritical phase. Although the Shublik and Kingak shales account for most of the oil found on the Alaskan Northern slope to date, this could be because their seals are ‘leaky’. 88 Energy 8 April 2015 13 Conventional Plays The Central North Slope has only seen limited exploration to date given its potential The Central North Slope has only seen limited exploration to date given its potential. There have been less than 500 exploration wells; by way of comparison, Wyoming (roughly two-thirds the area of the Central North Slope) has more than 70,000 exploration wells. In 2013 the USGS estimated that the Central North Slope has 4Bbbl of mean undiscovered resources. The only US region with more undiscovered resources is the protected Alaskan reserve area. Recent improvements to 3D seismic imaging technology now allow better resolution of rock strata Part of the reason for the limited exploration to date is because the Central North Slope has a thick permafrost layer that makes seismic imaging challenging. However, recent improvements to 3D seismic imaging technology should now allow better resolution of rock strata. Figure 6: Schematic Brookian Seismic Source: Company data Management has identified three significant conventional plays that work well to the north of the Project Icewine acreage that may extend onto its acreage. These are: Brookian Turbidite Sands — These Upper Cretaceous slope and deepwater sands are relatively widespread on the Central North Slope. Successful discoveries have been made predominantly in stratigraphic traps, often in base-of-slope settings. The reservoirs are sourced by the HRZ and Hue shales. Some examples include the Tarn and Meltwater oil fields (+100MMbbl combined reserves). Beaufortian Transgressive Sands — These sands are on the Lower Cretaceous Unconformity. Oil has been found in combination structural/stratigraphic traps. Successful examples include the Kuparuk River (>2,000MMbbl OOIP) and Fiord (+50MMbbl reserves) oil fields. Beaufortian Shelf Sands — These are Lower Cretaceous to Upper Jurassic sands. Reservoirs have been found in stratigraphic traps, often characterised by seismic amplitudes. The Alpine oil field (430MMbbl of reserves) is an example of this play type. 88 Energy 8 April 2015 14 The initial focus of Project Icewine’s conventional exploration programme will likely be on the Brookian turbidite sand play The initial focus of Project Icewine’s conventional exploration programme will likely be on the Brookian turbidite sand play. The USGS estimated that Brookian Clinoforms (slope and fan sands) on the Central North Slope have 1,600MMbbl of mean undiscovered oil resources. In 1989 Texaco drilled the Wolfbutton 25-6-9 well with good oil shows in the Brookian roughly 20 miles north-west of the Project Icewine acreage. E&Enews have also reported that, according to state officials, Great Bear Petroleum's 2012 drilling operation hit a small but promising pool of conventional oil. Great Bear, a private company, won’t say whether it encountered commercially-viable resources. The Icewine Project’s ability to drill an exploration well that targets both a coventional prospect and the HRZ unconventional play is tantalising. However, we believe that it might be some time before 88 Energy drills an exploration well targeting a conventional prospect as the the company will need to shoot and analyse 3D seismic first. In late 2013 Great Bear acquired some 280 square miles of 3D seismic over its acreage to the north. It has only just started to drill the first well (Alkaid-1) based on an analysis of this data. Before 88 Energy can shoot 3D seismic over its acreage the company will need to complete the acquisition of the licences and farm out an interest in the project for work programme carry. Fiscal Terms The 2013 ‘More Alaska Production Act’ has improved the Alaskan fiscal terms We believe that the 2013 ‘More Alaska Production Act’ means that the fiscal terms for Project Icewine’s acreage are better than those in some other prolific onshore producing basins (such as those in Nigeria or Russia). Oil and gas producers pay three main taxes. The State Royalty rate is 12.5%. Producers must also pay Severance Tax (production tax) at a flat rate of 35%. This tax is based on the net value of oil and gas, which is the value at the point of production less all qualified lease expenditures. Qualified lease expenditures include certain capital and operating expenditures, with 20% of new production being exempt from Severance Tax. The tax code also allows for Severance Tax to be offset by certain tax credits. These include a small producer credit of up to US$12m pa and a US$5/bbl new production credit. Finally, companies have to pay US Federal Income Tax at 35%, and State Income Tax at 9.4%. Generous exploration cash rebate programme In order to encourage exploration, the state operates a generous exploration cash rebate programme: 85% of 2015 qualified exploration expenditure, 75% of 2016 expenditure and 35% thereafter will be rebated. 88 Energy has entered into a Net Profits Partnership Agreement with Arktos Energy Management To get access to Project Icewine, 88 Energy entered into a Net Profits Partnership Agreement with Arktos Energy Management (AEM, who did most of the initial work on the project) under which it pays AEM a 4% overriding royalty on the project and a net profit interest (NPI). The NPI starts at 5% of net profit once Energy Alaska’s investment has been repaid (ie, once cumulative net profit is at a multiple on invested capital (MOIC) of 1x), increasing by 5% with each MOIC increment up to a maximum of 45% of Energy Alaska’s net profit at 9x MOIC. 88 Energy 8 April 2015 15 Corporate Capital Structure 88 Energy has 1,139m ordinary shares 88 Energy has 1,139m ordinary shares in issue after its February 2015 capital raising. It also has 404m listed options and 103m unlisted options. The strike price and expiry dates of the options are given in Table 4 below. Table 4: 88 Energy’s Options Options (m) Strike Price (A¢) Expiry Date 0.5 50.0 Apr-15 3.3 60.0 Apr-15 3.5 70.0 Apr-15 0.3 70.0 Apr-16 0.2 39.3 (25.6p) Nov-15 0.5 38.3 (24.2p) Nov-15 2.0 28.0 Nov-15 3.0 28.0 Nov-15 2.5 45.0 Mar-16 2.5 45.0 Mar-16 1.0 42.0 Jun-17 2.0 28.0 Jun-17 1.0 30.0 Apr-16 0.3 16.0 Jun-17 12.0 1.0 Oct-17 20.0 1.4 Mar-18 45.0 1.5 Feb-18 3.0 1.5 Feb-18 403.7 (listed) 2.0 Mar-18 Source: Company data 88 Energy raised A$6.9m of new equity in February 2015 88 Energy had A$0.8m in cash and no debt as at 31 December 2014. Working capital was slightly lower at A$0.7m. On 18 February 2015 the company announced the completion of a placement to raise A$6.9m, before costs. The placement of approximately 691m shares was undertaken at A¢1.0/share. Placement participants also received one free attaching listed option for every two placement shares, with the options exercisable at A¢2.0 and expiring on 1 March 2018 (see above). We estimate that currently 88 Energy has A$7.0m in cash We estimate that currently 88 Energy has no debt and A$7.0m in cash, of which US$3.0m (A$3.9m) is earmarked for Project Icewine 2015 lease payments (remaining acquisition costs and rental) and US$2.0m (A$2.6m) is set for 2015 G&A and exploration expenditure. Burgundy Xploration LLC 88 Energy has partnered with Burgundy Xploration LLC in Project Icewine. Burgundy is a private US company founded by geologist Paul Basinski. From 2005 to 2008 Paul spearheaded ConocoPhillips’ programme to lease over 300,000 acres in what today is the ‘sweet spot’ (the volatile oil/wet gas window) of the Eagle Ford play. More recently he used his knowledge and understanding of what geologic conditions are required to produce the most economic wells gained from this experience to analyse the shales of the Alaskan North Slope. He came up with a new shale oil play that others had overlooked: the HRZ/Hue Shale to the south of where most of the North Slope licences had been acquired. 88 Energy 8 April 2015 16 Board and Management We believe the Board and management of 88 Energy has the right mix of financial, geological and reservoir engineering skills to make a success of the Icewine Project. It is also encouraged to increase shareholder value as they own millions of shares and options (see Table 5 below). We provide brief biographies of the Board below. Michael Evans (Non-executive Chairman) Michael Evans, a Chartered Accountant based in Perth, has extensive executive and Board level experience with publicly-listed companies in the natural resources sector spanning 30 years. Mr Evans was the founding Executive Chairman of ASX oil and gas explorer FAR Limited, a position he held from 1995 until his resignation in April 2012. Under Mr Evans’ stewardship, FAR established and built up an extensive international oil and gas portfolio spanning Africa, North America, China and Australia, with industry partners including Amoco, Shell, BHP, BP, Exxon, CNOOC, Woodside and Santos, amongst others. Mr Evans is currently the Nonexecutive Chairman of ASX-listed TNG Limited. David Wall (Managing Director) As a leading oil and gas equity analyst for the past six and a half years, David Wall has extensive experience with junior oil and gas companies, with a particular focus on exploration. His skill set spans asset evaluation across many fiscal regimes and play types as well as corporate advisory/M&A and equity capital markets experience, having led >US$300m in capital raisings. Prior to his career as an analyst, Mr Wall managed a small team at Woodside Petroleum Ltd that reported to the executive committee. This team was responsible for vetting reports from all departments within the business prior to board approval, including exploration, development, operations, commercial and M&A. The team was also responsible for the annual budget as well as significant input into the five-year plan and the company strategic plan. Brent Villemarette (Non-executive Director) Brent Villemarette is a reservoir engineer with more than 30 years’ experience in the international oil and gas industry. This spans a wide range of disciplines, including reservoir engineering, development, operations, exploration, acquisitions and new ventures. He is currently Chief Operations Officer for Transerv Energy, which has assets in the onshore Perth Basin in Western Australia and in Alberta, Canada. He has been Operations Director for Latent Petroleum, a private oil and gas exploration company engaged in commercialising the Warro tight gas field in the northern Perth Basin. He has also held the roles of international reservoir engineering manager for new ventures with Apache Corporation based in Houston, Texas, and reservoir engineering manager for Apache Energy Limited based in Perth. Dr Stephen Staley (Non-executive Director) Dr Stephen Staley has 30 years’ of management and technical experience in the European, African and Asian oil, gas and power sectors, including with Conoco and BP. More recently, Dr Staley was founding Managing Director of upstream start-ups Fastnet Oil & Gas plc and Independent Resources plc and a Non-executive Director of Cove Energy plc. Table 5: 88 Energy Shares and Options Owned by the Board Shares Options (Strike Price, Expiry) Michael Evans Director 4,166,667 1,000,000 (A¢42, Jun-17) David Wall 5,416,666 Nil Stephen Staley 4,166,667 2,000,000 (A¢28, Jun-17) Brent Villemarette 1,221,222 1,500,000 (A¢60, Dec-14) Source: Company data 88 Energy 8 April 2015 17 Risks 88 Energy is a highly speculative investment Junior exploration and production companies like 88 Energy are, by their nature, high-risk. They face many areas of common risk, including commodity prices, geological, operational, financial, regulatory, legal, political and security. The main 88 Energy-specific risks are outlined below. Geological and Technical Risks DeGolyer and MacNaughton put the geologic probability of success at 40.7% As with all exploration, we consider the degree of geological and technical risk to be high. On a relative basis to other exploration companies, however, we consider this risk to be moderate due to confirmatory well log data from an old well on the project area (and three wells nearby). The proximity of work done by Great Bear Petroleum and its reporting of brittle shales and a small oil dicovery also de-risk the Icewine Project acreage to some extent. DeGolyer and MacNaughton put the geologic probability of success (the probabilty of discovering shale reservoirs that flow petroleum at a measurable rate) at 40.7%. Drilling and coreing a well should provide data that would narrow the possiblities considerably. Well performance is probably the key risk for Project Icewine’s unconventional play However, getting the rocks to flow some oil and getting them to flow oil at commercial rates are two quite different things. Given the Arctic conditions and lack of infrastructure away from the Dalton Highway and Trans-Alaska Pipeline corridor, all-in well costs are relativelely high compared with US Lower 48 onshore wells. This is likely to set a higher bar for commercial initial production rates than is seen in the US Lower 48 states (although access to global oil market pricing should offset some of the effect of higher costs). Having said that, the Dalton Highway and Trans-Alaska Pipeline cross the eastern part of the Icewine Project acreage, and initial test wells are likely to be drilled here. Management believes that the HRZ/Hue Shale hydrocarbons should be in the volatile oil window, which if true should allow for high initial production rates. Only the drilling and hydro-fracturing of a horizontal well can prove this to be the case. Indeed, given the high variability of individual shale oil and gas well performance, it is only when the production of around 30 wells is known that a proper assessment of the comercial viablity of a play can be made. There is no local market for gas on the Alaskan North Slope and no current export route The Icewine Project acreage was picked because management estimates that the HRZ and Hue shales should be in the volatile oil/wet gas window. If this is found to be the case, this means that the deeper Kingak and Shublik shales are likely to be in the gas window. These latter two shales make up 166MMbbl of DeGolyer and MacNaughton’s 493MMbbl gross mean unrisked prospective unconventional resource estimate. There is no local market for gas on the Alaskan North Slope and no current export route. In March 2012 ExxonMobil, BP, ConocoPhillips and TransCanada announced that they would work together on the Alaska Pipeline Project, which would take gas from the North Slope south to an LNG plant on the Kenai Penninsula and into Canada’s trunk pipeline system. However, given the project sponsors’ current capital constraints, this huge project (a capital cost of US$45-65bn) is unlikely to be sanctioned anytime soon. Currently producing North Slope conventional oil and gas fields reinject any gas produced into the reservoir to maintain pressure. Should the Icewine Project be successful, we believe 88 Energy will also have to reinject any produced gas into a reservoir. This probably doesn’t matter that much, as the economics of wells in the volatile oil/wet gas window of the Eagle Ford depend largely on the value of liquid sales, not gas sales. 88 Energy 8 April 2015 18 Operational Risks Operational risk remains key for all junior companies with limited operational experience Operational risk remains key for all junior companies with limited operational experience. It is likely that any farm-out will be to a large oil and gas company with significant operational experience, in our view. Funding Risks As for all junior oil and gas companies at this time, we believe funding risk is substantial We estimate that 88 Energy currently has around A$7m in cash after a recent funding round. Most of this is earmarked for 2015 lease acquisition and rental, vinatge seismic acquisition and processing, geological studies and G&A. Although the company will be eligible for a 85% rebate of 2015 exploration expenditure, it will have to farm out an interest in the project or raise more capital in 2016 to fund a 2016 work programme. Great Bear and partner Halliburton have spent over US$150m to date on a large 3D seismic survey and two cored, but not flow tested, wells. This year they are planning to spend a further US$100m on seismic and three wells. Fiscal Risks Alaska’s fiscal regime has seen several changes in recent times Alaska has experienced a number of changes to its fiscal regime over the last few years, all of which have been favourable. Whilst this is positive, the fact that the regime is subject to change indicates that risk remains for further changes, be they positive or negative. Environmental Risks We consider environmental risk to be low in Alaska We consider environmental risk to be low in Alaska as areas where operations can take place are clearly defined. There is no urbanisation or agricultural activity across the Project Icewine acreage. This is often not the case in the US Lower 48, where shale development can be challenging in populated or agriculturally intensive areas. A drilling and completion operation during winter leaves a minimal footprint. Project Icewine Entry We believe that the risk of licences not being granted, or them not being transferred by BEX, is minimal The granting of the new Project Icewine leases to Burgundy Xploration (BEX) by the state is subject to the Alaskan Department of Natural Resources completing its internal approval processes (expected in 2Q15) and the payment of outstanding lease costs. Once the leases have been granted, BEX will transfer them to an 88 Energy subsidiary, under the terms of 88 Energy’s agreements with BEX. We believe that the risk of the licences not being granted, or not being transferred by BEX, is minimal. Tarfaya Block Exit 88 Energy is in the process of divesting its 25% interest in the Tarfaya Block, Morocco, to Galp 88 Energy is in the process of divesting its 25% interest in the Tarfaya Block, Morocco, to Galp. Under an agreement with Galp, if the exit has not been completed by 19 September 2015 (or later as mutually agreed), 88 Energy is liable to Galp for US$3.4m. Given that the permit expired in February 2015, but was extended by Galp to November 2015, and that 88 Energy did not elect to participate in the extension, we believe that this contingent liability has a low chance of realisation. All documents to effect the licence assignment have been executed, with only ministerial execution required. Pre-approval by the minister has been granted and execution is expected prior to mid-2015. 88 Energy has also agreed a payment to Galp of US$3.4m, in shares or cash, if the market cap of the group exceeds US$50m within seven years of the agreement. This payment will also be required if the group delists for any reason, such as due to a change of control. 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