Is The Multi-Billion Barrel UK Oil Discovery Pure Hype?

Introduction

"The King is dead, long live The King!" Just as this expression conveyed the notion that royal control is passed onto the next monarch, the same can be said about the current state of the British oil and gas industry.

The North Sea, the reigning power in oil and gas production in the United Kingdom, is in terminal decline. As death draws near for the aging fields offshore, the mantle could be passed onto a younger heir.

The analogy sounds silly, but a small British oil and gas company raised hopes this week that they may be able to revive the floundering fossil fuel sector on the British Islands. UK Oil & Gas (LON: UKOG) announced that it made a "world class" discovery. UKOG says it is sitting on 100 billion barrels of oil located near Gatwick Airport, south of London. The April 9 announcement revealed that a petrophysical analysis of a the Horse Hill-1 well that a consortium drilled last year in the Weald Basin is holding about 158 million barrels of oil per square mile.

Horse Hill-1 is owned by several companies. A special purpose company, the Horse Hill Developments Ltd. (HHDL), owns 65% of the project. Through a subsidiary Magellan Petroleum (NASDAQ: MPET) owns the remaining 35%. UKOG has a 30% stake in HHDL. And another company, Solo Oil (LON: SOLO) has a 10% position in HHDL.

The news rocked the country, and indeed, made global headlines. On April 8, UKOG's share price was $1.11 per share. The following day after the announcement, UKOG's stock skyrocketed to $4.65, a more than 300% increase. It has since fallen back a bit, but the company is basking in the glow of a major discovery. For a company with a market capitalization of less than $40 million, the find is huge.

Who is UKOG?

It could be a company maker for the small British company. Before the Horse Hill-1 well, UKOG has had an extremely modest production portfolio. UKOG still has a 10% stake in the Horndean field, a mature field that saw its production peak in 1993 at 670 barrels per day. Although the field will continue to produce for another few decades, it is only expected to produce about 150 barrels per day in 2015.

Then there is the Avington field, in which UKOG only has a 5% stake. Production peaked at 600 barrels per day in 2007, and has quickly dropped to just 60 to 70 barrels per day.

UKOG has a larger stake in some offshore acreage that it thinks is promising. With a 65% interest in the P1916 play just offshore the tiny Isle of Wight south of the British mainland. But it has not moved forward in a significant way with developing the prospect.

There are half a dozen other projects that UKOG has stakes in that would evoke an unimpressed yawn from investors. Up until now UKOG has been a minnow not worth paying attention to.

But that all changed with the news of the Horse Hill-1 results. The well was spudded in September 2014, and UKOG moved to take a greater stake in the well in the intervening months. The April 8 announcement that the Horse Hill-1 is a massive find has made waves and raised hopes of a UK oil resurgence.

A British Oil Revival?

"We think we've found a very significant discovery here, probably the largest [onshore in the UK] in the last 30 years, and we think it has national significance," UKOG's CEO Stephen Sanderson told the BBC. Horse Hill-1 is located in the Weald Basin, which could prove to be profoundly more productive than previously thought. That could in part be due to the depths at which UKOG drilled. The well was drilled at a total depth of 8,770 feet, one of the deepest wells drilled in the region in the last 30 years. Horse Hill-1 could "comprehensively change the understanding of the area's potential oil resources," Sanderson says. See the map below - the Weald Basin is outlined in purple in the South.

Of course, UKOG won't be able to produce all of the estimated 100 billion barrels. Sanderson expects the company will be able to develop 5% to 15%, still a hefty volume. That would be enough to supply up to 30% of the total oil demand for the entire country. Compare the potential 15 billion barrels of recoverable oil to the 45 billion barrels that have been produced in the North Sea over the past few decades, and one can see how big of a deal the Weald could be. The find, Sanderson says, is of "national significance."

Maybe it's all Hype

But the hype has also raised the ire of skeptics. UKOG's Chairman David Lenigas has a reputation as a flashy and ostentatious executive, has previously been accused of exaggerating claims about his companies' potential in order to raise expectations and even share prices. UKOG says the Weald could hold 100 billion barrels. A separate study by a professor at the Imperial College of London concluded that there is only a maximum of 40 billion barrels. A still more modest projection of just 4.4 billion barrels came from the British Geological Survey. For now, the total oil in place is up for debate.

Even if the resources are in place, the question over whether or not they can be recovered is an important one. One problem facing UKOG and others is that individuals do not own the mineral rights on their land. In other words, if a company wants to drill for oil and gas on someone's land, it receives the permission from the government to do so, without of the benefits going to the landowner. This could contribute to greater public opposition than is normally found in the United States, for example.

To mitigate public concerns, UKOG has stated that hydraulic fracturing will not be necessary. The environmental group Friends of the Earth has already promised "huge opposition" if fracking is proposed.

The UK's New Oil King?

The Weald Basin suddenly has a lot of excitement swirling around it. Perhaps it could pick up where the North Sea is leaving off. With its mature fields and high cost of production, oil companies are packing up and leaving the North Sea, an area that birthed the Brent oil benchmark.

UKOG and its partners have now potentially discovered 100 billion barrels of oil, which will keep the British oil and gas industry alive for quite some time. But, it is ultimately up to these companies to prove that they can turn the Weald Basin into the new leader of British oil production. Much remains to be seen.