UK Firms Mobilize in New Falklands

LONDON (THE WALL STREET JOURNAL via Dow Jones), Jan. 25, 2010

Twelve years after the last prospectors left the Falkland Islands, British oil-exploration companies are returning, lured by rising oil prices and advances in deep-water drilling technology.

But exploration and production around the remote, wind-swept islands -- best known as the location of a brief, bloody war 28 years ago -- have been handicapped by a harsh climate and dicey politics.

Analysts say that as much as 60 billion barrels of high-grade oil could be found in the 200-square-mile economic zone surrounding the islands. That could make the Falklands one of the world's largest oil reserves, comparable with the North Sea, which so far has produced about 40 billion barrels.

Next month, Desire Petroleum PLC and Rockhopper Exploration PLC will begin exploring a region of the North Basin, 22 miles from the islands, where they have shared and separate prospects.

They are drilling in the same area where a consortium of large oil companies, including Royal Dutch Shell PLC, led the first wave of drilling in 1998. Only six wells were drilled in an area half the size of Texas. Although oil was found, prices around $10 a barrel made the prospects commercially unviable and further development was abandoned.

But improved technology and higher prices are prompting oil companies to return. The four companies that are leading the campaign, all listed on the Alternative Investment Market, raised a total GBP 327 million ($527 million) in share placements in a single month. Desire's shares have nearly doubled during the past three months.

"Exploration and risk are back in vogue," says Howard Obee, chief executive of Borders & Southern Petroleum PLC, which has prospects to the south. Borders & Southern raised GBP 113 million in rights placements, more than its market capitalization.

Geologists believe the uncharted waters of the south could hold the largest finds.

Tim Bushell, chief executive of Falklands Oil & Gas Ltd., holds four prospects in the south in partnership with BHP Billiton. He compares the geology with that found near off Argentina's coast, where six billion barrels have been found.

If a company finds oil, it could be viable as long as oil fetches $25 a barrel, less than a third of current market prices, Mr. Bushell says. Crude oil closed Friday at $74.54 on the New York Mercantile Exchange.

The Falklands government takes only a 26% share of oil earnings plus a 9% royalty on each barrel of oil sold, making it one of the most favorable areas in the world for exploration.

Still, the hurdles to exploration are vast. The South Basin reaches depths approaching 10,000 feet. Temperatures in the basin, one of the southernmost prospects in the world, average a low around 36 degrees Fahrenheit in winter, and the average rainfall can be as high as 2.4 inches a day. While this environment is similar to the established oil fields of the North Sea, the costs of operating a rig run to around $1 million a day, meaning losses are high if drilling stops during storms.

Political tensions surrounding drilling are also high. After the 1982 Falklands War, the islands remained a U.K. overseas territory. But Argentina has done its best to isolate the Falklands and pressured neighboring countries, such as Chile, to do the same.

Tensions in the region have been growing in recent weeks, after Argentina's Congress passed a law on Dec. 9 identifying the Falklands, as well as part of the Antarctic shelf, as belonging to Argentina. Britain says it "firmly rejects" the claim, but Argentina continues to agitate in diplomatic forums to have its sovereignty recognized.

The political complications make it difficult to know who would be willing to purchase or operate any finds in the Falklands, says Malcolm Graham-Wood, an analyst with Westhouse Securities. None of the majors with operations in Argentina, including Spain's Repsol YPF SA, the U.K.'s BP PLC and Brazil's Petroleo Brasileiro SA, which are drilling in the nearby Cuenca Malvinas, have ventured into the islands.

But despite the politics, the Falklands will remain the next frontier. "Geology doesn't stop at political borders," says Mr. Obee, of Borders & Southern. "There are complications, but if it were that easy, everyone would be in exploration."

Copyright (c) 2010 Dow Jones & Company, Inc.

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