88 ENERGY LTD88energy.com/wp-content/uploads/2016/06/88E-Initiation-Report... · compelling and despite the current low commodity price ... The Company received a fee for these

Research Note

RESEARCH NOTE – PATERSONS SECURITIES LIMITED 1

All information and advice is confidential and for the private information of the person to whom it is provided and is provided without any responsibility or liability on any account whatsoever on the part of this firm or any member or employee thereof.

88 ENERGY LTD

POPPING THE CORK ON ICEWINE

Investment Highlights

88 Energy (88E) is a junior oil and gas explorer that has accumulated a significant acreage position across the Central North Slope, onshore Alaska and has partnered with a highly experienced and well recognised partner in Burgundy Xploration. The project (Project Icewine) is well located, near vital infrastructure, providing a cost advantage in terms of both exploration and ultimate production should that prove feasible. The above project attributes, combined with the attractive fiscal terms currently offered by the State of Alaska, make the prospect compelling and despite the current low commodity price environment and project specific risks we initiate coverage with a Speculative Buy recommendation.

Significant acreage position in under explored region - 88E holds

a 78% working interest (WI) and operatorship in 272,422 gross acres across the Central North Slope, onshore Alaska. Exploration across the region has been limited compared to the Lower 48, despite the discoveries of the giant Prudhoe Bay and Kuparuk River fields. The reason for the limited exploration work performed to date is its remoteness and the fact that there is a thick layer of permafrost covering the area, which has historically made seismic imaging difficult. However, with new technology, the latest seismic imaging should prove more effective.

Exploration thesis and Icewine#1- The primary objective in acquiring

the acreage is an untested, unconventional liquids-rich shale play in a prolific source rock, the HRZ shale (Brookian Sequence). This is the same source rock that co-sourced the Prudhoe Bay Oil Field Complex (the largest oil field in North America). Post completion of drilling at Icewine#1 the core samples taken and analysed have shown that preliminary test results have been positive. During the core evaluation, oil / condensate was observed leaching from the HRZ core and testwork confirmed liquid rich gas throughout the HRZ shale. HRZ core samples were analysed for Total Organic Carbon (TOC) and all results indicated an average value of 3.5% which is favourable in comparison with other North American shale plays. Tests on porosity indicate the upper end of the 10-12% expectation, and permeability was several times greater than the effective cut-off in all core samples tested. The final thermal maturity analysis indicates that the Icewine#1 well is in the crossover between the volatile oil and condensate window as expected. Finally, early observations on the rock mechanics and fraccability are reported to be encouraging.

Attractive fiscal terms - In an effort to encourage exploration activity

in order to ultimately promote an increase in oil production in Alaska and maintain the financial viability of the Trans Alaskan Pipeline System (TAPS), the State Legislature passed the More Alaska Production Act (MAPA) in April 2013. The Act effectively eliminated the progressive production tax on oil production and replaced it with a flat rate of 35%. In addition, companies like 88E operating above 68 degrees North latitude would qualify for a combined cash rebate on exploration of 85% for all qualified expenditure until 31 December 2015, reducing to 75% for the period ending 30 June 2016, and 35% thereafter.

Catalysts - We consider the remainder of the test results and analysis

from the completion of the Icewine#1 well, when interpreted in conjunction with the yet to be acquired and interpreted seismic data, to be short term catalysts. A further short term catalyst is the anticipated release of the Independent Resource Report which is expected to include the newly acquired acreage and results from the Icewine#1 well. Success in these efforts could act as a catalyst for a farm-in partner or potentially a buy-out..

18 February 2016

12mth Rating Speculative Buy

Price A$ 0.023

RIC: 88E.AX BBG: 88E AU

Shares o/s m 3,16

Free Float % 92

Market Cap. A$m 72.65

Net Debt (Cash) est. A$m 9.6

3m Av. D. T’over A$m 0.54

52wk High/Low A$ 0.047/0.006

Analyst: Jason Chesters, CFA

Phone: 08 9263 1144

Email: [email protected]

Disclosure: Patersons Securities assisted in raising A$866k at A$0.01/share in November 2015 as part of a larger A$3m Placement and also assisted in raising a combined A$1.165m as part of a larger A$12m Placement at A$0.01/share in two tranches in July and August 2015. The Company received a fee for these services.

An investment in this company should be considered speculative and note assumptions employed are contingent on broader market conditions remaining buoyant. These can change at short notice. Recommendations are current at the time of publication.

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18 February 2016 88 Energy Ltd



EXECUTIVE SUMMARY

88E has accumulated a significant acreage position across the Central North Slope, onshore Alaska and has partnered with a highly experienced and well recognised partner in Burgundy Xploration. The project (Project Icewine) is well located, near vital infrastructure, providing a cost advantage in terms of both exploration and ultimate production should that prove feasible.

The Company has completed its first exploration well (Icewine#1), and has completed a substantial part of the evaluation of the core samples taken, with favourable results so far. 88E awaits the completion of the core evaluation and analysis, and has an exciting forward exploration program ahead in 2016.

The above project attributes, combined with the attractive fiscal terms currently offered by the State of Alaska, make the prospect compelling and despite the current low commodity price environment and project specific risks we initiate coverage with a Speculative Buy recommendation.

OPERATIONS

88E holds a 78% working interest (WI) and operatorship in 272,422 gross acres across the Central North Slope, onshore Alaska (Figure 1). Exploration across the region has been limited compared to the Lower 48, despite the discoveries of the giant Prudhoe Bay and Kuparuk River fields. The reason for the limited exploration work performed to date is its remoteness and the fact that there is a thick layer of permafrost covering the area, which has historically made seismic imaging difficult. However, with new technology, the latest seismic imaging should prove more effective (This has been proven with the recent Repsol discoveries).

Figure 1: Location of acreage

Source: 88 Energy

The initial acreage position was acquired in November 2014 when the Company entered into a binding agreement with Burgundy Xploration (Paul Basinski) to acquire an 87.5% WI in 98,182 gross contiguous acres onshore Alaska. The acreage package was made up of the successful bid for 89,542 acres in the November 2014 State lease sale for the North Slope of Alaska and supplemented by an existing acreage position (8,640 acres) held by Burgundy Xploration (Burgundy). The primary term for the leases is 10 years with no mandatory relinquishment and a low 16.5% royalty (made up of 12.5% State royalty and a 4% vendor royalty).




The agreement entered into with Burgundy made provision for the increase in WI held by Burgundy to 22% post the spud of the first well on the project. This provision has subsequently been met with the spud of the Icewine#1 well and 88E therefore currently holds a 78% WI.

On 19 November 2015, 88E through its 100% owned subsidiary, Accumulate Energy Alaska Inc and its joint venture partner Burgundy was confirmed as the highest bidder on a further 174,240 acres at the North Slope Areawide Bid Sale. The new acreage acquired brought the total acreage position to the current 272,422 contiguous gross acres (212,489 acres net to 88E).

The primary objective (Figures 2 & 3) in acquiring the acreage is an untested, unconventional liquids-rich shale play in a prolific source rock, the HRZ shale (Brookian Sequence). This is the same source rock that co-sourced the Prudhoe Bay Oil Field Complex (the largest oil field in North America). 88E and its JV partner believed that the thermal maturity of the HRZ in its acreage should lead to a high liquids vapour phase play (subsequently proved in core analysis). It is further believed that the geologic circumstances have likely resulted in enhanced porosity in the HRZ shale member. Average Alaskan shale play porosity across the HRZ shale is around 13%, which compares favourably with average shale porosity of 5% and the prime Eagle Ford acreage porosity of 10%. Further potential exists in the shallower conventional Brookian petroleum system within the Hue shale, as well as the deeper Kuparuk sands (Kingak shale) and the Ivashuk Formation (Shublik shale). It should be noted however, that the deeper shales hold a risk that they could potentially be overcooked and therefore in the gas window across some portion of the Project Icewine leases, which would result in a stranded resource due to a lack of available infrastructure to bring the product to market.

Figure 2 Icewine#1 targeted horizons

Source: 88 Energy




Figure 3 : Icewine #1 cross section

Source: 88 Energy

An Independent Report compiled by Degolyer and MacNaughton for Project Icewine in January 2015 (before the acquisition of the additional 174,240 acres) determined an estimated mean gross unconventional Prospective unrisked oil resource in place across the HRZ, Hue, Kingak and Shublik shales of 492.5 million barrels of oil and a risked mean (assuming a 41% chance of geologic success) of 200.3 million barrels of oil. Of these four shale horizons, the HRZ was deemed to hold the largest resource (mean gross unrisked Prospective Resource of 250.4 million barrels of oil) and is therefore 88E’s primary target. An update to the Independent Report, mentioned above, is currently underway, which incorporates the newly acquired acreage and the results from the Icewine#1 well.

A further advantage that 88E has is that it is advantageously situated close to infrastructure. The Dalton Highway passes through the lease and the location of the first drill pad is just off the Highway allowing for ease of access (Figure 4). Given the harsh terrain and climate, the value of this ease of access should not be underestimated.

Figure 4: Location of Drill pad and nearby infrastructure

Source: 88 Energy




Another infrastructure advantage of the Project is the location of a nearby pipeline providing ease of access to markets for its product. The Trans-Alaska Pipeline System (TAPS) is one of the world’s largest pipeline systems with 1,287km of 48 inch diameter pipe connecting Prudhoe Bay and the Marine Terminal at Valdez (Figure 5 & 6). The pipeline was built between 1974 and 1977, following the discovery of oil at Prudhoe Bay in 1968 and the ’oil crisis’ in 1973. The pipeline has a capacity of around 2 million barrels of oil per day, but current volumes as a result of the decline in production in the region are around 0.5 million barrels per day, therefore indicating the spare transport capacity available.

The TAPS passes through 88E’s acreage near the initial drill pad and is only 35 miles south of Pump Station 1 and approximately 18 miles north of Pump Station 2.

In an effort to encourage exploration activity in order to ultimately promote an increase in oil production in Alaska and maintain the financial viability of the TAPS, the State Legislature passed the More Alaska Production Act (MAPA) in April 2013. The Act effectively eliminated the progressive production tax on oil production and replaced it with a flat rate of 35%. In addition, companies like 88E operating above 68 degrees North latitude would qualify for a combined cash rebate on exploration of 85% for all qualified expenditure until 31 December 2015, reducing to 75% for the period ending 30 June 2016, and 35% thereafter.

The Alaskan State government is in the process of amending these fiscal terms to allow for the transitioning of the credit scheme to a low interest loan scheme. The government has put aside $1.25bn toward the transition fund to pay out the overhang of rebate credits and to initiate the low-interest loans.

Figure 5: Trans-Alaskan Pipeline System route

Source: Wikipedia.org




Figure 6: Trans-Alaska Pipeline System

Source: Peter Bo Rappmund, “800 Miles: Photographing the Trans-Alaska Pipeline,” Places Journal, November 2013.

The Icewine#1 well was spudded on 22 October 2015 using the Kuukpik Rig 5 (Figure 7 indicates the Kuukpik rig 5 on location prior to the spud of the Icewine #1 well). The well was designed as a vertical well with a planned Total Depth (TD) of 11,600 feet. The expected total well cost including a 20% contingency was US$16.9m.

Figure 7: Kuukpik Rig 5 on location prior to spud of Icewine#1 exploration well

Source: 88 Energy / Accumulate Energy Alaska Inc

https://placesjournal.org/wp-content/uploads/2013/11/rappmund-pipeline-5-zoom-1020x573.jpg




Despite a number of delays related to mechanical issues, the well intersected the primary HRZ target at 10,970 feet and the decision was made on 14 December 2015 to pull out of hole at 11,075 feet in order to pick up a core barrel to allow coring of the primary HRZ shale. The drill crew noticed a ‘visible bleeding of gas’ from rock chip samples from the HRZ, as well as ‘persistent oil shows in and above the HRZ interval’. Post the statutory Blow Out Preventer System test, the rig continued to drill the hole to its planned Total Depth of 11,600 feet, which was reached on 24 December 2015. A total of two cores were cut in the HRZ primary shale objective and the underlying Pebble Shale Unit (bottom seal) with an excellent recovery achieved of 97%.

The intercept of the HRZ shale was some 500 feet deeper than originally expected and therefore the data from the well will be used, along with yet to be acquired seismic, to reinterpret the future drilling program. Despite this, the preliminary test results from the core analysis have been positive and reduce the risk that the that the hydrocarbons are overcooked. During the core evaluation, oil / condensate was observed leaching from the HRZ core (Figure 8) and testwork confirmed liquid rich gas throughout the HRZ shale. HRZ core samples were analysed for Total Organic Carbon (TOC) and all results indicated an average value of 3.5% which is favourable in comparison with other North American shale plays. Tests on porosity indicate the upper end of the 10-12% expectation, and permeability was several times greater than the effective cut-off in all core samples tested. The final thermal maturity analysis indicates that the Icewine#1 well is in the crossover between the volatile oil and condensate window as expected. Finally, early observations on the rock mechanics and fraccability are reported to be encouraging.

Figure 8: Light oil and condensate observed leaching from core

Source: 88 Energy

The forward plan is to finalise the rock mechanics and fraccability tests, and the finalisation of an integrated petrophysical analyses. The Company also expects completion of the Independent Resource Report in the next few months.

88E intends to acquire new seismic which would give it coverage of all of its Western acreage which, together with its data from Icewine#1, should give vital information for the forward exploration program, particularly the planning of the Icewine#2 well (potentially a horizontal well with a multi-stage frac). The total expected net cost of acquiring the seismic data is US$3m. Seismic acquisition is currently planned for March/April 2016.




CORPORATE AND CAPITAL STRUCTURE

88E is dual listed on the ASX and on AIM and has 3.16bn shares on issue (post the recent 20 November 2015 Placement of 300m shares to raise A$3m and the allocation of 442m shares to raise A$4.43m at A$0.01/share from the Share Purchase Plan). The Company has 413.7m listed option with a strike price of A$0.02/share and an expiry date of 2 March 2018, and also has 151.6m unlisted options at varying strike prices and expiry dates (the majority at prices between A$0.014-0.021 expiring in 2018).

88E had a cash position of A$9.6m as at 31 December 2015. In addition, 88E has access to a US$50m debt funding facility with Bank of America (provided against the security of the Alaskan State government exploration rebate scheme (MAPA)) and has drawn down the first portion under this facility and had an available balance of US$42.1m as at 31 December 2015. The Company estimates cash outflows for the March Quarter 2016 of A$3.3m including A$2.5m net equity contribution toward exploration and evaluation (i.e. excluding the drawdowns on the debt funding facility). Looking further ahead, we expect the Company to pay around US$3m for the seismic acquisition and US$5m net payment for the additional acreage acquired, both payments due within the next six months. These payments would result in a shortfall in funding required and could potentially lead to a further share placement.

Top current shareholders include:

Hargreaves Lansdown (Nominees) Limited <15942> 5.27%

HSDL Nominees Limited 5.17%

Barclayshare Nominees Limited 4.85%

Hargreaves Lansdown (Nominees) Limited <VRA> 4.35%

Hargreaves Lansdown (Nominees) Limited <HLNOM> 4.27%

TD Direct Investing Nominees (Europe) Limited <SMKTNOMS> 4.22%

The top 20 shareholders hold a combined 54.17% of the equity in the Company.

VALUATION

While it is premature to attempt a valuation on 88E based on any potential cash flows, it is possible to obtain an early gauge of potential value based on comparative transactions in the region. It should be noted that some of the earlier transactions were conducted during a period of substantially higher oil prices, but nevertheless provide an indication of potential value.

In March 2011 Repsol farmed into 494,000 acres (approximately 60km north-west of 88E’s acreage) from Armstrong Oil & Gas Inc to obtain a 70% WI by spending US$750m over a number of years. In November of that same year, Great Bear Petroleum Operating LLC (Great Bear) farmed out a 25% WI in its 500,000 acres (immediately to the north of 88E’s acreage) to Halliburton for two wells and the acquisition of seismic, which cost an estimated US$60m.

In May 2013 Rampart Energy (now Pilot Energy) farmed into Royale Energy’s 50,000 acres (to the north-west of 88E’s acreage). Rampart acquired a 75% WI for an upfront cash and scrip payment and a carry through a specific work program, which could be estimated at a total value of US$40m.

In November 2014, Great Bear was awarded four blocks immediately to the north of 88E’s Icewine acreage. Great Bear bid US$212 per acre for these blocks.

In July 2015, Otto Energy acquired a 40% stake in Borealis Petroleum for US$4m (part of an US$8m raising by Borealis) and has the right to participate in further funding rounds up to the full amount raised. At present, Otto Energy has paid US$14m towards its stake in the investment. Borealis, in turn, has a staged entry of 8% and 10.8% WI in the Great Bear acreage. The total cost of the deal is US$20m and Borealis also has the option to farm into 22,804 gross acres that includes the existing Alkaid-1 well for a further US$25m.

The look-through valuation range per acre on the above (and other) transactions is US$212-US$2000. Given the geographic position of 88E’s acreage is further south of the above transactions and further up the slope, and given the current low oil price environment, we consider a conservative start point for determining value to be at the lower end of the indicated range. However, further exploration success could unlock substantial value and crystallise a farm-in (or buy-out) partner at a substantially higher value. Figure 9 indicates the




potential impact on value to 88E, based on various price points per acre. In the table we have assumed two thirds of 88E’s acreage to be prospective. Based on the initial encouraging test results and the potential value accretion from success, we initiate coverage on 88E with a Speculative Buy recommendation.

Figure 9: Valuation range based on acreage value

Gross Acreage

Net Acreage

Prospective acreage (2/3)

Value/acre Value (US$) Value (A$) Assuming FX 0.7

# of shares Value/ share (A$)

272,422 212,489 141,659 250 35,414,833 50,592,619 3,159,028,372 0.016

272,422 212,489 141,659 300 42,497,800 60,711,142 3,159,028,372 0.019

272,422 212,489 141,659 350 49,580,766 70,829,666 3,159,028,372 0.022

272,422 212,489 141,659 400 56,663,733 80,948,190 3,159,028,372 0.026

272,422 212,489 141,659 450 63,746,699 91,066,713 3,159,028,372 0.029

272,422 212,489 141,659 500 70,829,666 101,185,237 3,159,028,372 0.032

272,422 212,489 141,659 550 77,912,633 111,303,761 3,159,028,372 0.035

272,422 212,489 141,659 600 84,995,599 121,422,285 3,159,028,372 0.038

272,422 212,489 141,659 650 92,078,566 131,540,808 3,159,028,372 0.042

272,422 212,489 141,659 700 99,161,532 141,659,332 3,159,028,372 0.045

272,422 212,489 141,659 1000 141,659,332 202,370,474 3,159,028,372 0.064

Source: Patersons Securities

We note that 88E estimate a break-even oil price for the project of US$52/bbl, which, compared to the current Brent oil price of around US$33/bbl, results in it being uneconomic. However, taking a slightly longer term view and assuming exploration success, it is not difficult to envisage that the project could invoke significant interest from a major.

CATALYSTS

We consider the remainder of the test results and analysis from the completion of the Icewine#1 well, when interpreted in conjunction with the yet to be acquired and interpreted seismic data, to be short term catalysts. A further short term catalyst is the anticipated release of the Independent Resource Report which is expected to include the newly acquired acreage and results from the Icewine#1 well. Success in these efforts could act as a catalyst for a farm-in partner or potentially a buy-out.

BOARD OF DIRECTORS

Michael Evans – Non-Executive Chairman

Mr Michael Evans (Non-Executive Chairman, appointed 9 April 2014). Mr Evans is a Chartered Accountant based in Perth and has extensive executive and board level experience with publicly listed companies in the natural resources sector spanning 30 years.

Michael was the founding Executive Chairman of ASX oil and gas explorer FAR Limited, a position he held from 1995 until his resignation in April 2012. Under Mr Evans’ stewardship, FAR established and built up an extensive international oil and gas portfolio spanning Africa, North America, China and Australia – with industry partners including Amoco, Shell, BHP, BP, Exxon, CNOOC, Woodside and Santos, amongst others. Mr Evans is currently the Non-Executive Chairman of ASX-listing TNG Limited.

David Wall – Managing Director

As a leading oil and gas equity analyst for the past six and a half years, Mr Wall brings extensive experience with junior oil and gas exploration companies. His skillset spans asset evaluation across many fiscal regimes / play types as well as corporate advisory / M&A and equity capital markets, having led >$300m in capital raisings.

Prior to his career as an analyst, Mr Wall managed a small team at Woodside Petroleum Ltd that reported to the Executive Committee. This team was responsible for vetting reports from all departments within the business, prior to Board submission, including exploration, development, operations, commercial and M&A.




The team was also responsible for generating the annual budget and providing significant input into the Five Year Plan and the Company Strategic Plan. By virtue of these experiences, Mr Wall brings strong commercial and strategic skills as well as generalist knowledge across all levels of the oil and gas industry. This is complemented by financial markets experience focussed on junior exploration companies. Mr Wall holds a Bachelor of Commerce from the University of Western Australia, majoring in Management and Finance.

Brent Villemarette – Non-Executive Director

Mr Brent Villemarette is a petroleum engineer with more than 30 years of experience in the oil and gas industry, both domestic and international.

His experience spans a wide range of disciplines including exploration, development, operations, marketing, acquisitions and new ventures. He is presently Chief Operations Officer for Transerv Energy, which has assets in the onshore Perth Basin in Western Australia and in Alberta Canada. He has previously been Operations Director for Latent Petroleum, a private oil and gas exploration company co-founded with a small team of industry professionals engaged in commercialising the Warro tight gas field in the northern Perth Basin. He has also held the roles of International Reservoir Engineering Manager for New Ventures with Apache Corporation based in Houston, Texas, Reservoir Engineering Manager for Apache Energy Limited based in Perth, and several senior engineering positions in the US with Apache Corporation and Oryx Energy (formerly Sun E&P).

Stephen Staley – Non-Executive Director

Dr Stephen Staley (Non-Executive Director, appointed 9 April 2014). Dr Stephen Staley has 30 years' of management and technical experience in the European, African and Asian oil, gas and power sectors, including with Conoco and BP.

More recently Stephen was founding Managing Director of upstream start-ups Fastnet Oil & Gas plc and Independent Resources plc and a Non-Executive Director of Cove Energy plc. He is a Fellow of the Geological Society, holds a BSc (Hons.) in Geophysics from Edinburgh University, a PhD in Petroleum Geology from Sheffield University and an MBA from Warwick University.

INVESTMENT RISKS

Investment risks associated with 88E include, but are not limited to, the following key risks:

Exploration and Geological risk – All oil and gas explorers face exploration risk and given 88E’s focus on a relatively unexplored region, these risks require further consideration. In particular, the confirmation of the Company’s theory regarding the thermal maturity of the primary target across its acreage position, the porosity of the shale and the integrity of the seals are all areas of exploration risk. Furthermore, the actual production characteristics of an oil and gas reservoir may differ significantly from initial interpretations and expectations.

Capital expenditure – Exploration activity of this nature is expensive and without a major farm-in partner to fund a large portion of the costs, the ability of the Company to substantially fund its required exploration into the future can be brought into question.

Commodity price and exchange rate risk – the risk that fluctuations in either the commodity price or exchange rate or both, cause the economic prospects of the project to deteriorate.

Liquidity risk – the ability of 88E to pay its commitments in a timely manner. It should be noted that the availability of the Bank of America debt facility, coupled with the proceeds from the recent capital raising reduces this risk, however, significant expenditure is required over the coming 12 months which could place pressure on the Company in terms of funding ability.

Liability risk – 88E has an outstanding contingent liability of US$3.4m to Galp Energy, should its market capitalisation reach US$50m before September 2021. This liability arose as a result of 88E pulling out of the Tarfaya Offshore Block in Morocco.




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88 ENERGY LTD88energy.com/wp-content/uploads/2016/06/88E-Initiation-Report... · compelling and despite the current low commodity price ... The Company received a fee for these