Total and Santos Deadline Looms: Melbana Aims for Full Buy In

The deadline for petroleum heavyweights Total and Santos to decide whether to buy into Melbana Energy’s (ASX:MAY) WA-488-P permit offshore northwest Australia has been extended by the pair’s request: by November 4, Total and Santos must notify Melbana if they wish to acquire an 80% interest in the permit, in return for jointly funding the Beehive-1 exploration well.

That deadline is just one week away and could be a game-changer for the small cap oil explorer.

However, Melbana has also been busy in Cuba, having recently received approval for amendments at its Block 9 Production Sharing Contract (Block 9 PSC) in this under explored, yet highly prolific region.

CUPET, the national oil company of Cuba, has now received the necessary approvals and informed Melbana that it is in good standing with respect to all of its Block 9 PSC obligations.

Melbana is now in deep discussions with prospective farm-in partners, and has also commenced the process of seeking to extend the various drilling, environmental and other permits and access agreements it currently holds to allow for a two well drilling program commencing the second half of 2020.

We expect a busy period for Melbana and several catalysts to play out sooner rather than later, so let’s catch up with...

Share Price: $0.01 (as at 29 October 2019)

Market Capitalisation: $19 million

Here’s why I like MAY:

Independent oil and gas company Melbana Energy (ASX:MAY) holds a world-class portfolio of upstream oil and gas assets in Cuba and Australia.

In Cuba, Melbana wholly owns both the Block 9 Production Sharing Contract (Block 9 PSC) covering 2,344 square kilometres onshore on the north coast of the country, and the Santa Cruz oil field, also on the north coast.

Melbana’s home-country projects are headlined by the wholly owned WA-488-P exploration permit located in the Bonaparte Gulf region of northwest Western Australia, in which Melbana has identified the giant Beehive prospect, considered one of the largest undrilled hydrocarbon prospects in Australia.

It is here in Australia, where the action is about to ramp up.

Total and Santos deadline looms large for Melbana shareholders

Melbana initially struck a farm-in option agreement over the WA-488-P permit with French petroleum major Total and Australian oil and gas producer Santos in December 2017. Under the deal, Total and Santos each hold an identical option to take a 40% interest in the WA-488-P licence area (shown below), if they agree to meet 50% of the cost of fully funding the first well in the licence area, the Beehive-1 exploration well. Total and Santos can individually or jointly exercise those options.

As part of the agreement, Total and Santos funded the Beehive 3D Seismic Survey, which was completed in August 2018, having been extended by about 100 square kilometres (about a 16% increase in coverage) to incorporate the newly identified lead (Egret) encountered by the survey, which is partially within the boundary of WA-488-P.

If Total and Santos exercise their options, Melbana would retain a 20% participating interest and be fully carried for the Beehive-1 well. Initial negotiations set a deadline of 2 October 2019 for Total and Santos to notify Melbana if they wish to acquire a direct 80% interest in the permit, but at the pair’s request, Melbana has extended this deadline to 4 November 2019.

Melbana announced in October that it had agreed to a request by Total and Santos to extend by one month the expiry date of the WA-488-P options. At the time, both companies confirmed that they have completed their technical assessment of the Beehive prospect and that both needed extended time to finalise their commercial analysis and seek internal approvals.

Total and Santos now have until 4 November 2019 (just a few days to go) to notify Melbana whether they will exercise their options (the options themselves expire on 4 December 2019.)

If the option is exercised, drilling is anticipated in the second half of 2020. Melbana has estimated the cost of the well to be in the US$40 million–US$60 million range (A$58.8 million–$88.2 million at the current US$0.68 exchange rate.) If the option is exercised, Melbana will be fully carried on all costs incurred from the time the option is exercised until 90 days after the rig is released after drilling this well.

In effect, there are three “cases” to consider for Melbana.

The “best case” is that both Total and Santos exercise the option, and between them take 80% ownership of WA-488-P, and fully fund Beehive-1.

The alternate case is that only one of Total and Santos exercises. If on 4 November 2019 either Total or Santos informs Melbana that it will not exercise its option, the other party automatically gets the right to buy 80% of the licence area, for funding 100% of the Beehive-1 well. In that case, that party has one month in which to make that decision.

The “reversion” case, is that neither exercises its option, in which case Melbana retains 100% interest in the permit, but now owns the 3D Seismic Survey that someone else funded and processed.

In terms of market perception, only one exercising would not be as good as both exercising; although if it were Total exercising and not Santos, the market would likely take greater comfort, given that it is a global petroleum company (and a much larger business than Santos) that could easily handle that well on its own.

If it were Santos exercising on its own, and Total demurring, the market would likely not be as enthused, but would likely still see that as positive, given the US$1.4 billion ($2.2 billion) investment it recently made in northern Australia, in buying the ConocoPhillips assets, including control of the Darwin LNG plant. Santos exercising on its own would likely engender confidence that the South Australian company had a plan for bringing in a partner.

If neither Total nor Santos exercised, there would likely be significant disappointment on the stock market, given that the duo had already favourably completed their technical studies on the prospect: the obvious question would be, ‘Why didn’t they go ahead commercially?’

In reality, companies have many prospects and they internally rank them on a global basis. And in that case, Melbana would be reasonably confident that there was enough interest in the Beehive-1 well, and in northern Australia, for it to strike an alternative farm-in deal. A number of other parties have expressed interest in reviewing the Beehive opportunity, pending a decision by Total and Santos.

Approvals in place to start work in Cuba

Melbana has an established position in Cuba, where its assets are the Block 9 Production Sharing Contract (Block 9 PSC) and the Santa Cruz oil field. Block 9 PSC is world-class exploration acreage, covering 2,344 square kilometres onshore on the north coast of Cuba, 140 kilometres east of Havana, in a proven hydrocarbon system and along trend with the multi-billion-barrel Varadero oil field. The independent expert’s Competent Persons Report, conducted by McDaniel & Associates Consultants (dated 30 June 2018), estimated Block 9 Oil in Place as about 15.7 billion barrels (best estimate) with recoverable prospective resource of 718 million barrels (best estimate).

Block 9 (location shown below) has multiple other producing fields within close proximity, including the Majaguillar and San Anton fields immediately adjacent to Block 9 in addition to the Motembo field, the first oil field discovered in Cuba. Melbana Energy is pre-qualified as an onshore and shallow water operator in Cuba and was awarded a 100% interest in the Block 9 PSC on 3 September, 2015.

The Santa Cruz oil field is located approximately 45 kilometres from Havana, between Boca de Jaruco and Canasí oil fields, and approximately 150 kilometres west of Melbana’s existing Block 9. Santa Cruz is in the northern foldbelt of Cuba, the trend that is responsible for the vast majority of Cuba’s oil and gas production. In December, 2018 Melbana finalised a long-term binding incremental oil recovery (IOR) contract with Cuba's national oil company, CubaPetroleo (CUPET). The contract is subject to standard Cuban regulatory approvals.

In October, Melbana announced that it requested amendments to its Block 9 PSC with CUPET, covering extension of the current exploration sub-period to 1 November 2020, with no change to the commitment to drill one exploration well during this sub-period, and the extension of the exploration period by one year. As well, Melbana would voluntarily relinquish 24.6 square kilometres of its ground (about 1% of the total area), which would reduce the total prospective resource (best estimate) for Block 9 from 718 million barrels of oil to 676 million barrels of oil.

Later in the month, the company reported that these amendments had been approved, and formally documented between it and CUPET. Melbana has received confirmation from CUPET that it is in good standing with respect to all of its obligations under the Block 9 PSC. Melbana is required to drill one exploration well in the current exploration sub-period, expiring November 2020.

You can read about this development in more detail in the following Finfeed article:

In parallel with its discussions with prospective farm-in partners, Melbana has commenced the process of seeking to extend the various drilling, environmental and other permits and access agreements it currently holds to allow for a two-well drilling program to commence in the second half of 2020. This program would test four separate targets, totalling 236 million barrels (best estimate) of prospective resource, the best of which is estimated to have a 32% chance of success, taking information from the independent expert’s Competent Persons Report, conducted by McDaniel & Associates Consultants (dated 30 June 2018).

In close proximity to the Santa Cruz oil field, CUPET reported to Cuban media a significant potential discovery of lighter-than-typical crude oil in an exploration well drilled on the Bacuranao prospect in the northern part of the western region of the island. The discovery was made late in 2017 and has been undergoing long-term testing. CUPET representatives reported that the oil produced from the field has a density of 22° API, which is the highest-quality oil discovered in the area and is encouraging for oil exploration activities in the area. The Bacuranao discovery is in the northern fold belt trend that continues into Melbana’s Block 9 and is in close proximity to the Santa Cruz oil field.

What is going on at Beehive

By any standards, Beehive is a potentially world-class prospect. Located in about 40-metre water depth and defined by a tight grid of high-quality 2D seismic data, it is one of the largest undrilled hydrocarbon prospects in Australia. Geologically, the Beehive prospect is a 180-square-kilometre isolated carbonate build-up of Carboniferous age with 400 metres of mapped vertical relief and a crest at 4,100 metres. Beehive is considered to be similar to the giant Tengiz field in the Caspian Basin (Kazakhstan), which is also a Carboniferous isolated carbonate build-up.

The most recent Independent Expert’s Competent Persons Report, conducted by McDaniel & Associates Consultants (dated 30 June 2018) estimated Beehive Oil in Place as about 1.4 billion barrels (best estimate) with recoverable prospective resource of 388 million barrels of oil equivalent (best estimate), with oil at 299 million barrels. In addition, Beehive is located close to several existing facilities, including the Ichthys LNG project and Blacktip gas field and pipeline, offering several options for future commercialisation.

Operational changes

In mid-July, the company announced its conditional intention to make a takeover offer for 100% of the ordinary shares in Metgasco Limited (ASX: MEL). On the 25 July, Melbana announced its binding intention to make the takeover bid. In between, on the 22 July, Melbana told the ASX that the CEO had left the company, effective 19 July 2019.

Melbana is offering four of its shares for every Metgasco share. The offer has been extended to 15 November 2019. At time of writing, the market is valuing MEL at 4.1 cents per share, versus Melbana’s valuation of 4 cents, based on the MAY stock price of 1 cent.

While the market is applying a premium to Metgasco stock, shareholders are weighing up the possibilities of (1) if MAY were to pull its bid, would the MEL price stay where it is? and (2) a decision by Total or Santos boosts the MAY share price – which would make MAY’s offer for MEL more attractive.

What the analysts are saying

As reported by Finfeed in August, Perth brokerage Hartleys issued a research note on Melbana in August in which oil and gas analyst Aiden Bradley gave a 12-month price target of 2.2 cents on MAY – more than double the current market price of 1 cent, although as with any analyst prediction, this is speculative and potential investors should do their own due diligence.

The main reason for Hartleys’ price target and speculative buy rating can be seen as the looming Beehive decision: indeed, Bradley’s note states that the “main potential positive catalyst and key reason for investors currently to be focused on the stock is the potential for Santos and/or Total to announce that they will drill an exploration well in WA-488-P.”

Bradley goes on to say that “the case for drilling the well is actually quite strong.” Indeed, a decision by Santos and/or Total to drill an exploration well should increase the value attributed to Beehive.

Bradley also notes that in Cuba, Canadian company Sherritt International is nearing the completion of its well in Block 10, and success there could re-rate exploration acreage (including Block 9) across Cuba.

Beehive decision the obvious short-term share price catalyst

The 4 November deadline looms as a potential game-changer for the MAY share price, with clear scope for a spike in the case that both Total and Santos choose to exercise their options; lesser upside if only one does so (with a more positive qualitative perception likely in the case that Total elects to become Melbana’s sole partner; and potential disappointment from the market if neither exercise.

In the latter case, the MAY share price would likely become hostage to news flow regarding any other participant that may come forward as a farm-in prospect. Given the crucial nature of the 4 November deadline for the MAY share price, the result of the Total/Santos deliberations also becomes pivotal to the progress of Melbana’s takeover bid for Metgasco.

So, one day ahead of the “Race that Stops the Nation,” we have the “Decision that Could Send MAY Off to the Races.”