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88 Energy Ltd: THE INVESTMENT CASE

88 Energy shares drop, but the sky has yet to fall for the Alaska explorer

Investors will have six weeks of uncertainty before they'll know whether the share price drop was an overreaction.
onshore drilling operation
INVESTMENT OVERVIEW: 88E The Big Picture
88 Energy is shutting the Icewine-2 well for six weeks

Looking at the 40% drop in 88 Energy Ltd's (LON:88E) share price over the last two sessions one might be forgiven for thinking the sky has fallen for the Alaska-focused shale explorer.

The sell-off is illustrative of the panic among investors as the company confirmed it would delay the programme for the Icewine-2 well for a period of six weeks to allow pressure to build and to advance to the well to the production testing phase.

It is a course of action the ASX-quoted company had previously hinted may be necessary, but that warning seemingly went unheeded.

Brendan Long, analyst at WH Ireland, wonders whether the problem with Icewine-2 is well-specific - related its completion and the maiden fracking in the HRZ shale – or does it hint at a systemic problem? To put it bluntly: is the play a bust geologically?

The pre-frack assumption was wrong

Prior to the fracking programme at Icewine-2 well, 88 Energy had thought it was addressing two separate shale reservoir zones. However, a slow rate of frack fluid recovery led the company to believe the two zones were in fact connected.

Since then, the company has continued the process of recovering fracking fluid. By Monday, only 16% had been recovered, and no hydrocarbons were measured.

According to Long, the initial findings don’t bode we;ll for 88 Energy. In a note the analyst said: “The low return of frack fluid is inconsistent with a highly productive well and the lack of oil or gas is surprising.”

Is it just part of a steep learning curve?

It remains to be seen whether the delay is a red-flag against the project, or whether in the passage of time it will be chalked up as part of the learning process in what remains an unchartered shale play.

The project, if it eventually proves successful, remains in its infancy, and plainly the company has much to learn as it tries to unlock an estimated 1bn-plus barrel prize.

The hiatus means the well will be re-opened at the end of August and therefore the results are likely to known shortly thereafter, in sync with the typical post-summer step-up of activity across the market.

The autumn islikely to be significant and pivotal  for 88 Energy.

Icewine-2: the story so far

The company announced the start of a new well programme in April.

The Icewine-2 appraisal well was designed to confirm the geological findings of the first hole, which had confirmed the presence of hydrocarbon bearing HRZ shale.

Success with the Icewine-1 well provided the basis of some big and potentially valuable resources.

That first well had laid out a whole new US shale play and, buoyed by this success, 88 Energy moved quickly to significantly expand its footprint in the surrounding area.

With Icewine-2, the idea was to take the important next steps of fracking and flow testing the HRZ shale. The intention was to prove that the potentially vast oil resource could be accessed and extracted at commercially viable rates. It was a litmus test for the HRZ’s future.

Icewine started well

By mid-May, everything appeared to be going to plan. The company reported to the market that it had completed the drilling phase. The vertical well was drilled on schedule and without incident.

In early June, the company informed investors that it had gained enough insights in to the stress profile and pore pressure of the HRZ shale that it could proceed to the fracking phase. The fracking was designed test whether complex artificial fracture systems could be created within the HRZ via the proposed stimulation.

A June 19 update informed investors that the first of two planned stages of fracking in the Icewine-2 appraisal well had been completed successfully – with 100% of the intended fluid volume injected into the zone.

The next day, it was confirmed that the second-stage was complete after more than 90% of the intended frack fluid injected into the other zone.

But something wasn’t right

By the time that 8% of all the fracking fluid had been recovered, the company came to the conclusion that the two zones were ‘in communication’. It was, therefore, decided that the plug between the two zones ought to be drilled out.

After that, flow-back operations continued.

On June 26, at which point some 16% of fluid had been recovered, 88 Energy managing director Dave Wall said: “Given that we are breaking new ground in relation to the HRZ formation, we need to establish the conditions under which the hydrocarbon cut will return and then increase.

“The stimulation was executed precisely as per plan with over one million lbs of proppant placed into the formation. A little patience is now required as we give the rocks time to show us what they can deliver.”

Time out now planned

Monday's announcement revealed fluid recovery hadn't improved.

“After analysing the performance of the well to date, and comparing to results from other plays, a decision has been made to shut the well in for six weeks to allow for pressure build up and imbibition to occur,” the company told investors.

“Imbibition (or soaking) has proven to be effective in other plays by allowing frack fluid to be absorbed, displacing in-situ water that may be blocking hydrocarbon molecules from being able to flow through the reservoir.”

Following the shut-in period, the well may then be swabbed (a process of mechanically lifting oil), it added.

“Further analyses are required to determine the impact, if any, of the performance of the Icewine-2 well on the probability of success for the HRZ play at the Franklin Bluffs location and over the wider acreage position,” the company said.

The Icewine-2 well will be in ‘time out’ for a period of six weeks.

READ:88 Energy plans to shut-in Alaska well to allow pressure to build

A conventional plan ‘B’

Would all be lost for 88 Energy if the HRZ shale doesn’t produce? No, not quite. It is true that the Icewine wells are responsible for a very significant proportion of the stock’s A$135 million market valuation, and, shale has been the group’s stated priority.

But, the explorer has also identified a meaningful conventional portfolio of prospects.

In late 2016, it told investors that a range of preliminary leads have now been identified as part of its conventional oil exploration programme. It said that the forward work programme will mature prospects and leads, and high-grade the best ones into candidates for future drilling.

Later, in January, the company completed its assessment of Project Icewine’s conventional oil potential. It saw almost 1.5bn barrels of resources across its inventory on Alaska’s North Slope. The resource assessment was based on 2D seismic data.

A total of fifteen exploration leads were identified through the process.

It means there’ll be some alternative options left on the drawing board, should the eventual Icewine-2 results lead to the kind of worst-case scenario to trigger a strategy re-think.

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