Moment Of Truth For Falcon Oil & Gas

I have been following Falcon Oil & Gas (OTCPK:FOLGF) for a good few years now, and the next 3 to 6 months will probably make or break the company. I wrote in a previous article here how Hess Corp. (NYSE:HES) pulled out of Falcon's Australia asset (Beetaloo Basin) at the last minute in 2013, but this move may have been a blessing in disguise for Falcon. The reason being that, in 2011 and 2012, Hess invested approximately $80 million in the biggest 2D seismic program in Australia's history. Hess wanted to bring in another partner after the seismic program which would have given Hess a 65% stake in Falcon's acreage. Hess delayed on this decision and eventually asked Falcon for an extension so it could source a third party. Falcon denied the extension request which was seen as a bold move by a junior company with a market cap of just over $100 million compared to Hess' $19 billion+ market cap. Therefore, Falcon ended up with $80 million of seismic data for free. Saying no to Hess in hindsight seems to have been the correct decision considering the interest from other producers and a subsequent farm out deal.

In May of last year, Falcon farmed out a deal worth $200 million with Origin Energy Ltd. (OTCPK:OGFGY) and Sasol Limited (NYSE:SSL). The deal carries Falcon into a nine well drilling program. Furthermore, Falcon retained a 30% ownership in the play (1.38 million acres) and also received a $20 million cash payment up front a few months ago. You can assume that Origin and Sasol would have been able to hit the ground running due to the extensive seismic program that had been already carried out. This asset had been researched thoroughly and was estimated to have 21+ billion barrels of oil and 162 trillion feet of natural gas in total. High expectations from investors have rallied Falcon's shares up to $0.15 a share from $0.09 a share recently. The risk-reward ratio definitely stacks up here in my opinion. Let's discuss some reasons why.

First of all, it has to be an advantage that Origin is involved. This company is Australian and has vast knowledge about how the oil and gas industry works in this jurisdiction. Origin's involvement will lead to more productivity and better deals with suppliers. Origin has a wealth of experience already built up in Australia. Currently, it is a major partner in the Australia Pacific LNG Project which is a $20+ billion project. Falcon's project in the Beetaloo Basin needs Origin for a couple of reasons.

1. The infrastructure is poor in the Beetaloo Basin, even though there is a gas pipeline (probably not big enough to transport big volumes of gas) running through it. Remember that this asset is 600 km south of Darwin so efficiency and productivity on the job will be essential. Origin has experience in this part of the world with regards to rigs. It will need this experience as repairs will be slow and costly.
2. Origin knows the resources are there. The question is, can the company extract oil and gas profitably? This again is where its local geology experts may have an upper hand.

Secondly, although Australia is poised to become the biggest LNG exporter in the world, the industry as a whole in Australia has received bad press due to big oil majors pulling out of projects recently. The most notable one is Chevron Corporation (NYSE:CVX). Eight weeks ago, it pulled out of the Nappamerritrough natural gas project. Chevron is really tightening its finances (due to cash flow problems) at the moment to make sure capex and dividend payments continue to be met. Do I think other oil and gas producers will bail if energy prices remain low? It's a possibility, but there are a few advantages that the Beetaloo Basin has that should keep Origin and Sasol interested for a sustained period of time. However, they undoubtedly will have the right to walk if Phase 1 doesn't go according to plan. But I don't think they will bail because...

1. The shale is on the thick side (over 100 meters in thickness);
2. There is a high degree of total organic carbon (well above the base minimum 2% level); and
3. There is evidence of low clay content shales.

Unconventional plays are not straight forward which is why you need to have as many advantages as possible before drilling starts. I wouldn't read too much into the recent Chevron withdrawal as well as the ConocoPhillips(NYSE:COP) and Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) withdrawals in Australia, as they were mainly a result of the current oil and natural gas price environment. Furthermore, oil and gas prices have risen substantially recently which should give producers more time when performing their drilling procedures.

As I have mentioned above, Falcon has a 30% stake in this project which amounts to 1.38 million acres. Now, if we compare the Beetaloo Basin with the largest horizontal plays in the world (the Bakken and Eagle Ford), here are how the numbers play out (see chart):

Source : oilandgas-investments.com/

Ironically, Hess is one of the 48 producers in the Bakken and is reported to be the most efficient producer thus far. The Bakken in North Dakota is 40% bigger than the Beetaloo Basin and non-producing acreage in this area can fetch $10,000+ per acre. If the Beetaloo Basin becomes commercially viable, then the price of Falcon's non-producing acreage (1.38 million acres) will become very expensive, independent of the volumes of energy found. Since Falcon is not a producer, I believe it will offload this land to the highest bidder and enrich shareholders in the process.

The advantage here over investing in the producers is that Falcon gives shareholders the possibility for substantial upside in a short period of time. I foresee results from these initial wells being released in 4 to 6 months. If they come back positive, Falcon may not be around for Phase 2 next year.

Sometimes in investing, fortune favors the bold. Although I fundamentally agree with dividend growth investing as a proven wealth building strategy, one needs a substantial amount of time and capital to make this strategy a success. I also fundamentally agree with the strategy of investing "$1 to potentially make $5". Falcon definitely offers this possibility. Therefore, I would advise investors (with strict money management) to invest in this stock now. It's a penny stock which brings its own risks such as reduced liquidity and limited historical information on the company. However, Falcon's assets (and interest among oil producers) are what make this company stand out in my opinion. With strict money management, the potential reward outweighs the risk here.