Disclosure: I am long POEFF.PK.
On January 31, Pan Orient Energy (POEFF.PK) released an update on testing operations as the recently completed L53-DC1 new pool discovery well in onshore Thailand. To summarize:
1) The well L53-DC1 well tested at oil rates between 250-500 barrels per day of 13.8 degree API oil, but after 72 hours, the water cut (percentage of water in the production stream) had gone to 100 percent.
2) This test was from the deepest of six pay zones identified by the company based on drilling and wireline log data. The zone tested represents 7.3 meters of a total of 55 meters of pay identified by the company in the well.
3) Additional testing of the other five zones is expected to commence in two weeks.
Unsurprisingly, the stock has sold off on the news, currently at C$3.84 as I write this. Given this initial test result, the market reaction is not surprising, as it arguably increases the risks (in terms of size, oil gravity, and volume) associated with this new fault compartment. There are however five more zones to test and a second well is planned at a structurally higher position in the same fault compartment (in layman's terms, oil that is greater than 10 degrees API floats on water, so going structurally higher should get you away from the oil-water contact). It is still early days, but a "caution light" is on and I believe that a successful up-dip appraisal well will be needed to settle the market's nerves with respect to this new pool discovery.
The oil gravity (viscosity) may be a risk factor to consider as well. Oil is characterized in a number of ways, but "API gravity" is the most broadly used. The lower the API, the higher the density of the oil. This is relevant for two reasons: 1) heavier oil can be subject to quality adjustments for pricing, and 2) heavier oils tend to be more viscous, which can impact flow characteristics. On a positive note, Pan Orient has stated that the reservoir temperature in the initial tested zone in the L53-DC1 is high, which allowed for the 13.8 degree API oil to flow quite well. Going forward, I would not want to see oil gravities much lower than what was encountered in this zone, though a high reservoir temperature seems to be working in the well's favor (imagine your car oil on a cold winter morning versus a hot summer day). The reasons for variable oil quality can be varied and are somewhat academic, but he main point is to keep an eye on the oil gravity going forward. It is difficult to know how this one well test may impact other zones in terms of oil gravity/quality, as fields can have variable oil qualities in different zones. As a general rule, oil gravity tends to increase with depth (meaning that lighter oils are generally found deeper). Unless, plans have changed (and there is no indication otherwise from the company) the L53-DC2 appraisal well is expected to target deeper reservoir potential in the same fault block in addition to the up-dip extension of the reservoirs found in the L53-DC1 well discussed here.
If you've read to this point, your head may be spinning with details and information, but the bottom line is this: Pan Orient continues to work away at maintaining or increasing production from the last reported rate of 1500 bopd in onshore Thailand while preparing for a high-impact drill program in onshore Indonesia. The first of the Indonesian well program on the company's Batu Gaja block, Shinta-1, is expected to start drilling shortly. Additional detail on prospect sizes, locations, and timelines can be found in Pan Orient's corporate presentation.
With a strong cash balance of over $2/sh, no debt, and approximately $0.50 of cash flow per share at the last reported production rate of 1500 bopd, my thesis on the stock as being a skewed risk-reward opportunity remains unchanged, though recent trading should highlight the potential share price volatility in drill-bit driven companies. While the L53-DC1 new pool testing and appraisal program are in the early stages, I don't believe that the market reaction to the recent L53-DC1 well test is unwarranted given the move the stock has had since early Jaunary. I would expect caution to reign until additional drill and/or test data becomes available, which should be in about two to three week's time.
With the Indonesian drilling program about to begin, I expect Pan Orient to continue to attract attention from experienced market players who have portfolios dedicated to skewed risk-reward situations. Given the size of the exploration targets on the table, any one new discovery has the ability to alter the face of the company and Pan Orient has more than enough money to give investors the time necessary to test at least half a dozen very high-impact targets. The fact remains that exploration wells are inherently risky, but given the number and quality of the targets, investors only need one to hit.