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sterling comment on chinguetti 27.07.2006 oilbarrel.com

Sterling Energy Remains Bullish Despite Production Problems At Chinguetti
2006 had been shaping up to be a record year for Sterling Energy, with the first six months of the year delivering production volumes 150 per cent higher than the first half of 2005. Given booming commodity prices this promised to deliver a cash bonanza to the AIM quoted E&P. But problems at the Chinguetti oilfield offshore Mauritania have thrown a cloak of uncertainty over these bright prospects, although the company is keen to stress that the project will still meet its projected financial returns.

Over the first half of the year, Sterling was producing more than 25 million cubic feet of gas equivalent per day (cfge/d). The company’s US assets contributed 7.8 million cfge/d with gas prices averaging US$7.25 per thousand cubic feet, which is a nice little earner. What’s more, the first two three cargoes from the newly onstream Chinguetti oilfield and the income from its royalty interest agreement netted Sterling more than US$32 million.

But the production problems at Chinguetti, which started operations in late February, have tarnished what was one of the jewels in Sterling’s portfolio. The field should be producing 75,000 barrels per day gross but output is running at around half that due to problems with a number of production wells and gas handling equipment. The operator, Woodside of Australia, is taking steps to resolve the problems and will drill infill wells over the course of 2006/early 2007 to shore up production numbers.

In a pre-close trading statement ahead of its interim results on September 22, Sterling said the current studies and operations underway at Chinguetti will “help to clarify the optimum future production levels and will enable estimates of Chinguetti and other Mauritanian reserves to be updated later in the year�.

A spokesman for Sterling said the Chinguetti issue was not a major cause for concern. “The increased oil price has offset the problem with the production,� he said. And speaking last month at the AGM chairman Richard O’Toole said that despite the current difficulties the company remains “confident that the project will meet our projected financial returns�.

Even so, investors hate this kind of uncertainty: production problems can sometimes herald far more fundamental issues with the reservoir and its ability to perform over the longer term. Regular communications about the current remediation programme and its implications will go some way to alleviate these jitters - this is particularly the case for those companies that are far more exposed to Chinguetti than Sterling, which has what amounts to an 8 per cent interest in the project.

The good news for Sterling followers is that this canny company is exposed to future upside in Mauritania but not to the costs and risks of funding the necessary development work. This is because of the royalty agreements inherited from its December 2003 £40 million acquisition of Fusion Oil & Gas. These agreements give Sterling a cash bonus of US$1-2 million for each development approved over 50 million barrels plus a sliding scale royalty that depends on the oil price and whether the state oil firm, Societe Mauritanienne Des Hydrocarbures (SMH), backs in for its 12 per cent of the project. In the case of Chinguetti, this royalty calculation worked out at 5.28 per cent.

Sterling has a sliding scale royalty interest in the Tiof discovery, which could be declared commercial by year-end. Tiof would be developed in phases, with the first phase drawing on between 40 and 60 million barrels of oil resulting in production of 50,000 bpd by 2009 - yet Sterling does not have to pay a penny towards these development costs but will still enjoy a slug of the production. The Mauritania partners are also eying the Tevet, Labeidna and Banda oil discoveries as potential satellite tie-backs to Chinguetti - again at no cost to Sterling, which retains a royalty interest in the resulting production.

However, Sterling is likely to seek greater exposure to future Mauritania developments by repeating the funding deal it struck with SMH for Chinguetti. The company raised cash on the UK equity market in order to provide the Mauritanian government with the cash it needs to fund its share of the Chinguetti field development costs (to date some US$96 million of the US$130 million letter of credit has been drawn). In return Sterling was awarded what amounts to an 8 per cent economic interest in the field. This was quite a coup for the AIM firm but this time round Sterling is likely to face more competition as other firms will be keen to shake hands with the oil authorities in this newest producing nation.

In the meantime, Sterling is keeping busy elsewhere. It has recently spudded the Trehan-1 well onshore Southern Louisiana in the States, the first of four planned exploration wells in the US over the second half of the year. It also holds a 3 per cent royalty interest in the 150 million barrel Colin prospect now drilling offshore Mauritania and will largely be carried through three exploration wells in Gabon and Equatorial Guinea. In addition, work is underway on the 4,000 km of 2D data acquired offshore Madagascar and, the company says, the initial results give cause for optimism.