Africa Oil hosted a conference call with Keith Hill (CEO) to talk through the Twiga South drilling results released Monday morning. The Canadian line of the shares finished down -9% having started the call in positive territory.

Overall, the market should now have a better understanding of the discovery but uncertainties remain , as is typical this early in frontier exploration. The market appears most concerned in two areas, testing flow rates and financing.

The market must wait 4-8weeks to test the flow rates from the upper Lokhone sands in Twiga South. The flow rates from the previous discovery Ngamia will then also be tested.

These rates are important to help determine the commercial threshold for a basin development. Given the reservoir quality encountered to date and the need for more development wells, Citi research would expect a commercial threshold would be around 400m bbls.

Africa Oil is not funded for its 2013 drilling plans. I believe they have sufficient funding following the receipt of the Marathon farm-in proceeds (c. US$32m) until March/April. Our research has previously highlighted Africa Oil will need to raise c. US$200m to fund the full 2013 capex programme. Citi have already assumed the dilution of a US$200m equity raise in our base case NAV of SEK95/share.

The uncertainty around flow rates appears to have significantly changed the markets perception from one of a company with investors competing to fund the company to one of the market questioning if the company can get sufficient funding.

It didn't help institutional sentiment that so many private investors were asking questions on the conference call.

My opinion is these concerns are overdone. Africa Oil has made two out of two oil discoveries and has a significant inventory of prospects to drill. The rewards vs the risks justify further equity financing.



Key points from call:

(1) Twiga South - the well encountered 30m of net pay from a gross 70m section. This level of net pay compares very favourably to wells in Uganda (albeit smaller than Ngamia) and is the second discovery (100% success) in the sub-Lokichar basin.
AOI expects to see a greater net pay section further updip in the Twiga South-1 structure closer to the bounding fault, which was where the Ngamia-1 well was drilled.

The Lower Lokhone reservoir was not seen in this well, but AOI believes this could be seen downdip from the well location. The CPR resource report was mostly based on the Upper Lokhone, which is the primary reservoir along the basin-bounding fault so we dont see resource numbers changing.

AOI believe there is a significant amount of oil in place across the sub-Lokichar basin, but flow rates will be very important to get a better understanding of the quality of the reservoir and the recoverable resources from the Twiga well.

(2) Fractured reservoir play - this is a new play that has not been seen across East Africa. We believe the key question will be the productivity of this play and Tullow/AOI plan to test the deliverability as part of the testing programme on Twiga South.

One of the positives from the Twiga well is that there is further evidence of an active working hydrocarbon system in the region, with hydrocarbon shows across a gross interval of 796m in this section.

(3) Forward programme - In the sub-Lokichar basin (Kenya), the near-term focus will be the testing of Twiga South, which will take 4-8 weeks to complete.

The rig will then move to test Ngamia. Elsewhere, the Paipai well is currently drilling, targeting the Cretaceous rift in Kenya. AOI expects a result before the end of the year.

A third rig will also arrive in early 2013 to drill the Sabisa prospect in the South Omo area in Ethiopia. Once testing is completed on Ngamia, AOI/Tullow will drill further wells in the sub-Lokichar basin - perhaps Kongoni or Kamba.

(4) Balance Sheet - AOI had cash of US$55m in 3Q12 and has now received cash from Marathon of US$32m. As we have highlighted, Africa Oil will need to raise funds for its 2013 capex programme. We have already assumed the dilution of a US$200m equity raise in our base case NAV of SEK95/share.