88 Energy (ASX:88E): Risky stock, but lots of upside

Set to benefit from the surging oil price

88 Energy Limited (ASX: 88E) engages in the exploration of oil and gas properties in the United States. The company’s flagship project is its 64% working interest in the Icewine project, which covers an area of approximately 486,000 acres located in the North Slope of Alaska.

We wrote on 88 Energy and its potential in our Stocks Down Under publication in January 2021. At that time the stock price was massively hammered as a result of plunging oil prices in the aftermath of the COVID pandemic. But now things are very different for 88E. Oil prices are at levels not seen since 2015 and the company has achieved some significant results with its exploration projects.

 

Energy prices have been booming

The oil price started a quick and consistent recovery following the Corona Crash in March 2020 with prices going well above pre-pandemic levels. This increase in oil price was due to the curtailed investment in the oil industry in the prior years because of environmental concerns as well as the unclear future that investors foresee for the industry as they expect renewable energy sources to largely replace fossil fuels in due course.

The reality, however, turned out to be that the world is still far away from any significant transition to renewable energy sources. Consequently, the low level of investments in fossil fuel resources resulted in supply shortage and strongly increasing energy prices, including oil, natural gas and coal. For these reasons, we are bullish on energy markets in the foreseeable future.

 

Operational progress at the Merlin-1 drives share price

Let’s take a look at 88E’s chart and see what moved the price last year.

 

 

❶ Commencement of Merlin-1 drilling with results expected to come out shortly after.

❷ Commencement of Merlin-1 production hole after surface hole was successfully drilled. A successful share placement at $0.018 to fund its drilling campaigns. The share price consequently makes a quick retracement to this level.

❸ Encouraging results from the drilling campaign.

❹ Umiat Oil Field acquisition and continuation of wireline logging at Merlin-1.

❺ Operational issues at Merlin-1 project.

❻ Upside potential at the Umiat Oil Field.

❼ Merlin-1 well confirms light oil. Appraisal well planned for Q1 2022 at Merlin-2, located to the east of Merlin-1.

❽ Share placement at $0.028 to raise $24m.

❾ Surging oil price brings back attention to the stock.

 

What we can learn from this techno-fundamental analysis is that 88E’s share price moves on the back of the company’s progress with its Merlin wells. Its announcement regarding the timeline for the Merlin-2 appraisal wells (Point 6 on the chart) told the market not to expect much exciting news in the short-term. Accordingly, the share price depreciation started and was further driven by the capital raise on 2 September 2021.

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Momentum is kicking back to the 88E share price

We believe the surging oil price has brought back market attention to 88E. The share price has been able to break the mid-term downtrend (blue line in the chart). According to the latest operations update, drilling of the Merlin-2 appraisal well is on track to commence in February, targeting 652 million barrels of oil. At the current oil price of about US$80 per barrel, the value of the resource would be more than US$50bn. This is a very big number given 88E’s current market capitalisation of just A$600m.

 

We think 88 Energy is worth a punt

88 Energy is optimistic about the results of its Merlin-2 appraisal well because of the encouraging results of the Merlin-1 hole in its proximity. We believe this creates a good speculative opportunity on the drill results of the well, which should be expected in the next couple of months.

An encouraging result can potentially drive the share price up to 10 cents in an initial market response. Obviously, the risk is that the company announces poor drilling results from the appraisal well, which could potentially send the share price down below the recent 2.5 cent support level (the red line) in an initial market response. Obviuosly, issues in operations can also occur as they happened with Merlin-1, while the fluctuations in the oil price are also a risk to the share price of 88E. Although we are bullish on the oil price, a decline in the price is still a possibility.  So, the question is … do you feel lucky?

 

A suggested action plan

Our expectation is that as we get closer to receiving the results of Merlin-2 appraisal well, the speculation demand for the stock will drive the share price. The oil price is also on the rise, which justifies a higher valuation for 88E and therefore a higher share price. Based on this, buy limit orders at lower prices than the current market price are not very likely to get filled. So, buying at market prices and waiting for the results of the well is our suggested strategy to play this trade.

 

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Frequently Asked Questions about 88 Energy

• Where is 88 Energy based?

  88E is headquartered in Subiaco, WA, but its business activities are based in Alaska, US.

• Does 88E pay a dividend?

  No, the company does not pay a dividend. It needs all its capita to further develop the Merlin wells.

• What is the upside potential for 88E shares?

  If the company reports good news around the Merlin-2 appraisal well, we see upside potential to 10 cents per share.