As an investor, what I am looking for is to find a difference between perception and reality. This difference is what made me buy Canacol Energy (CAAEF) in late 2012, despite the fact that the stock was in a downtrend, as shown below:
Canacol Energy is an energy producer that has been cashing in on Colombia's and Ecuador's oil and gas resources, by pursuing a mix of conventional and unconventional operations in 5 basins and 6 fields, as I will discuss in the next paragraphs.
Why I Was Bullish On Canacol In Late 2012
In late 2012, I bought Canacol and recommended it twice when the stock was at ~C$3. I also noted that Canacol was one of my favorite oil producers, receiving messages like: "Go buy another turd, this one has been flushed". Apparently, many investors were thinking that Canacol's valuation would continue to go south. Nevertheless, I considered these comments to be unfounded and disparaging remarks, given that Canacol had amassed a huge land position in some of the most promising basins of South America. And I was long big time back then.
1) It was very undervalued at C$3.
2) It became a company with much upside optionality after the completion of the following 3 farm-outs:
B) To Royal Dutch Shell (RDS.A) on VMM-3 for $1,140/acre. In 2012, Shell farmed-in to Canacol's VMM-3 block carrying up to $50 million in work commitments, which consist of all costs for seismic acquisition and the drilling of three exploratory wells.
After these transactions, Canacol had exposure to approximately 334,000 net acres of shale oil potential on five contracts located in the Middle and Upper Magdalena Basins which included VMM 2 (20% WI, 15,000 net acres, Exxon Mobil operator), VMM 3 (20% WI, 17,000 net acres, Shell operator) and Santa Isabel (30% WI, 30,000 net acres).
It is estimated that the oil fairway in the thick Cretaceous La Luna and Rosa Blanca formations is a world-class stacked shale oil play, which is believed to be analogous to the Eagle Ford formation in the U.S. and the Vaca Muerta formation in Argentina. Ranked as one of the most productive source rocks in the world, the La Luna is also the primary source rock in Venezuela's Maracaibo basin, which contains over 250 billion barrels of recoverable oil.
The Middle Magdalena is the oldest producing basin in Colombia, dating back to the 1918 discovery of the giant La Cira-Infantas field complex (900 million barrels). Historically, only the Tertiary section (conventional reservoirs) has been systematically explored and has led to the discovery of ~1,900 MM barrels of oil, 2.5 TCF of gas and over 40 fields. La Luna and Rosa Blanco reservoirs are deeper reservoir prospects than the conventional light oil reservoirs. It is estimated that the recoverable shale and tight gas reserves at 35 tcf and shale oil potential as high as 14 mm boe. The infrastructure is also there, because the Middle Magdalena Valley Basin is crossed by the Oleoducto Central S.A. export pipeline (the OCENSA Pipeline).
As a result, the conventional wisdom was saying to me in late 2012 that Colombia's La Luna and Rosa Blanca could be the next big unconventional shale play with Canacol being one of the main beneficiaries. It is not accidental that the value of the land in the Middle Magdalena Basin has increased from approximately $125/acre in 2011 to more than $3,000/acre, as shown at the latest deal with ConocoPhillips.
The Transformational Catalysts Showed Up In Late 2012 And Continued in 2013
In late 2012, Canacol's production primarily consisted of crude oil and natural gas liquids from its Rancho Hermoso field in the Llanos Basin of Colombia. That was the company's Achilles' heel because the production decline at the Rancho Hermoso field was not offset by other fields until late 2012, when Canacol's diversification started. This diversification was supported by three events:
1) In December 2012, Canacol completed the acquisition of Shona Energy and added producing properties in Colombia and Peru. Through that acquisition, Canacol doubled its 2P reserves and added long reserve life gas fields to the company's existing portfolio of oil reserves.
2) In December 2012, Canacol made a key light oil discovery (the Lambrador discovery) on its LLA 23 block (80% WI) immediately adjacent to the Rancho Hermoso field. The Agueda 1 ST exploration well targeted various reservoir intervals within the Labrador prospect, situated approximately 5 kilometers to the north of Canacol's Rancho Hermoso field. The Agueda 1 ST encountered 70 feet of oil pay within the C7, Lower Gacheta, and Ubaque reservoirs, all of which were productive to the south in the Rancho Hermoso field. A production test of the Lower Gacheta reservoir yielded 1,832 bopd of 28 degree API light oil.
3) The third catalyst came from the company's portfolio in the Middle Magdalena Basin. On October 31, 2012 Canacol announced that the Mona Arana 1 exploration well on its VMM2 E&P contract located in the Middle Magdalena Basin had encountered 85 feet of net potential oil pay within the conventional Lisama sandstone reservoir. More good news showed up in January 2013 when Canacol announced that the Mona Arana 1 well had encountered 230 feet of potential net oil pay within the deeper Cretaceous La Luna Formation. A subsequent test of the interval in produced 1,242 bopd in January 2013.
When I recommended Canacol at C$3 in late 2012, I also quoted the reasons for the company's upside potential. Both the drilling results from the Middle Magdalena Basin and the results from the LLA 23 Block where Canacol made two key discoveries (Labrador, Leono) in 2013 were included in my list. It was obvious that this success would have a meaningful impact on Canacol's production and reserves. However, the market remained blind for some time. It took the market more than six months to greet these key events warmly and push Canacol's valuation to higher levels. The market's myopic focus lasted until August 2013, when Canacol's stock broke the resistance at $3.5 and started an uptrend.
Meanwhile, an additional transformational catalyst showed up in late 2013. In December 2013, the Labrador discovery was coupled with a Leono 1 discovery that encountered 133 feet of net oil pay within 4 different reservoirs. After a series of production tests, Canacol announced a few weeks ago that the Barco reservoir flow tested at a gross rate of 1,863 bopd and the Gacheta reservoir flowed at a stable gross rate of 1,869 bopd.
Canacol believes that the thickness of the net oil pay section at Leono 1 is approximately twice that of Labrador, and rivals that of Rancho Hermoso, making Leono a major development project in calendar 2014. The Leono find in central Colombia's onshore Llanos Basin could add as much as 10,000 bopd, according to the company's CEO who estimates that total output of 15,000 bopd is "a low-side type of guidance" for next year.
Canacol has guns blazing on multiple fronts. It owns 25 Blocks located in the Lower Magdalena Basin (conventional gas), the Middle and Upper Magdalena Basin (conventional and unconventional oil), Llanos Basin (conventional light oil), Caguan - Putumayo (conventional heavy oil), and the Libertador-Atacapi oil fields in Ecuador, as shown below:
In January 2014, Canacol expanded its position within the developing shale oil play in the Magdalena Valley of Colombia to over 545,000 net acres. The company acquired an 80% WI in each of the COR 4 and COR 12 Blocks located in the Upper Magdalena Basin of Colombia. These two Blocks are located adjacent to the company's existing COR 39 and COR 11 Blocks and are prospective for both shallow conventional oil exploration targets within the Guadalupe sandstone reservoirs, and deeper non-conventional oil exploration targets within the thick Cretaceous La Luna shale. The acquisition of these two Blocks gave Canacol the second largest shale position in Colombia after Ecopetrol (EC), the state oil company.
Production Growth Is Here To Stay
Thanks to the discoveries at LLA-23 (Labrador field, Leono field), the VMM2 Block in the Middle Magdalena Basin and the acquisition of Shona Energy, production has been on the ascent since early 2013. Canacol's natural gas comes primarily from the Esperanza field, located in the Lower Magdalena Basin. Here is a summary of this production growth during 2013:
Average Production (boepd)
7,800 (~60% oil)
8,000 (~60% oil)
10,120 (~70% oil)
9,642 (~70% oil)
10,550 (~70% oil)
Canacol plans to spend net capex of $150 million in calendar 2014 on drilling, workovers, seismic, production facilities, and pipelines in Colombia and Ecuador, and anticipates net average production before royalties of between 11,500 and 12,500 boepd, which represents a 30% to 40% increase from average 2013 production of 8,796 boepd. The production split for 2014 is expected to be approximately 70% oil and 30% gas.
The company plans to spend approximately $117 million net capex on its activities in Colombia, and approximately $33 million net capex on its activities in Ecuador.
For 2014, the company will focus on:
1) Building out production from the Leono and Mono Arana oil discoveries in Colombia and from the Libertador - Atacapi fields in Ecuador in order to continue to deliver strong production growth.
2) Continuing to de-risk its extensive shale oil position via the flow testing of the La Luna shale in the Mono Arana 1 well and additional new drills on the blocks in the Middle Magdalena Basin to increase the value of the 250,000 net acres Canacol controls in this play.
Based on this business plan, Canacol estimates to hit 15,000 boepd by 2015 and 50,000 boepd by 2020, as shown below:
According to the latest quarterly report for fiscal Q1 2014, Canacol recorded net income of $3.0 million compared to a net loss of $7.2 million for the comparable period. Adjusted funds from operations for fiscal Q1 2014 increased 73% to $24.3 million compared to $14.1 million for the comparable period.
The average operating netback for fiscal Q1 2014 increased 65% to $39.33/boe compared to $23.85/boe for the comparable period, as the company's production shifted towards its higher netback light oil production from the LLA-23 block in Colombia and the Libertador - Atacapi fields in Ecuador.
As of February 2014, Canacol's net debt (including convertibles) is $97.4 million. The company's market cap is approximately $630 million given the stock lies at ~C$7 currently, and the enterprise value is approximately $725 million. Canacol's proved and probable reserves are 34.7 MMboe (including Shona's acquisition) with a long reserve life or 12 years.
Due to the ongoing consolidation in the Colombian energy patch and the acquisitions of Petrominerales and C&C Energia, there are not many publicly traded intermediate producers in Colombia and Ecuador.
The peer group includes Gran Tierra Energy (GTE), Parex Resources (OTC:PARXF) and Petroamerica Oil (OTCPK:PTAXF). Both Gran Tierra and Parex are intermediate producers whose most of their production is coming from Colombia and Ecuador. Petroamerica Oil is a junior oil-weighted producer with strong production growth y-o-y and properties only in Colombia.
Is Canacol overvalued, undervalued or fairly valued compared to its peers? To find this, let's see the following calculations:
1) Per EV/Production: Let's check out the table with the first key metric:
Gran Tierra Energy
21,500 (96% oil)
10,550 (70% oil)
18,000 (100% oil)
6,414 (98% oil)
2) Per EV/2P Reserves: Now let's check out the second table below:
Gran Tierra Energy
3) Per EV/EBITDA: Let's take a look at the third table below:
2013 EBITDA (*)
Gran Tierra Energy
(**): For FY 2014
As shown above and given that a significant part of Canacol's production is natural gas, Canacol does not currently have compelling metrics compared to its peers.
The Catalysts For 2014
As mentioned above, the focus for calendar 2014 oil production growth is on high netback oil primarily from the Labrador, Leono, Mono Arana, and Libertador-Atacapi fields. However, the following wildcard initiatives can lead to a significant upleg in case their results are fruitful:
1) The Shallow Lisama Reservoir And The 6 Well Drilling Program At The VMM2 Block: The shallow Lisama reservoir was tested for a period of 28 days and produced at a gross average rate of 1043 bopd and 271,000 cfpd of gas. Thanks to these results, Canacol and Exxon Mobil have approved an up to 6 well appraisal drilling program to delineate and develop the shallow Lisama discovery.
The appraisal program consists of the drilling of up to 6 wells and the construction of production facilities related to the appraisal and development of the Tertiary aged Lisama discovery at Mono Arana. The first appraisal well, Mono Arana 2, was spudded on December 10, 2013 and Canacol's petrophysical analysis of the open hole logs indicated that the well encountered 244 feet measured depth of oil pay in 2 conventional sandstone reservoirs within the Tertiary Lisama Formation.
Canacol is currently awaiting the results of the 5 remaining appraisal wells to define the size of this significant oil discovery. The next appraisal well, Mono Arana 5, was spud on January 17, 2014 and will be drilled to a depth of approximately 7,078 ft to test the oil potential of the Lisama reservoir approximately 1.1 kilometers to the northwest of the Mono Arana 2 appraisal well.
2) The Deep La Luna Formation At The VMM2 Block: In addition to the shallow drilling program at the Mono Arana discovery, production testing of the deeper Cretaceous La Luna Formation within the Mono Arana 1 well commenced in December 2013. We will know more from this front by Q3 2014.
3) The Deep La Luna Formation At The VMM3 Block: Shell will drill the Picoplata well by Q2 2014, targeting the promising La Luna and Rosa Blanca formations in Middle Magdalena Basin. Canacol has 20% WI in this Block.
In January 2014, Shell announced that it suspended 2014 offshore drilling plans in the Arctic Ocean. Shell's new CEO seems to have different plans in terms of how to boost Shell's profits which dropped 71% in Q4 2013 on a year over year basis.
To date, Shell has invested more than $5 billion in its Arctic drilling projects and spent six years fighting legal challenges from environmental groups worried about the fragile Arctic ecosystem, as well as the climate consequences of burning what Shell has referred to as its "multibillion barrel prize."
As a result, Shell will seek to commit its resources for drilling elsewhere. This place could be Colombia if Shell's results from VMM3 (two horizontal wells) prove to be as successful as Exxon's results from VMM2. Excluding VMM3, Shell will also drill the neighboring VMM-27 Block (two horizontal wells) and VMM-28 Block (two horizontal wells). Shell bought VMM27 and VMM28 Blocks in 2011 for only $129/acre.
Thus it is clear that Shell is ramping up its expansion efforts in Colombia, and the company was among the winning bidders in late 2012 at Colombia's first government auction of oil and natural gas blocks in two years. Shell submitted a high bid of $11.1 million for one of the auction's biggest offshore blocks, adjacent to its existing La Guajira interests in Colombia's Atlantic waters. No Colombian offshore blocks are currently producing oil, but Shell has been completing seismic studies since 2012. According to Kelly op de Weegh, Shell's media relations officer, Shell is targeting areas that have "future potential" in Colombia.
After all, either the enormous and extremely promising La Luna shale formation or Colombia's Atlantic waters could become Shell's next "multibillion barrel prize" in an area which is much warmer than the Arctic Ocean.
4) Further Development Of The Santa Isabel Block: As noted above, the Santa Isabel contract exposes Canacol to a potentially large unconventional shale oil play, as supported by the drilling results on the adjacent VMM2 contract. Canacol has a 30% stake with ConocoPhillips controlling the remaining 70%.
ConocoPhillips drilled recently the first well, the Oso Pardo 1 well, and the results were very promising. Petrophysical evaluation of the openhole logs acquired indicated 60 ft of oil pay within the Lisama sandstones with an average porosity of 25%, and 28 ft of oil pay within two separate Umir sandstones with an average porosity of 16%. Due to some technical problems, the drilling of the deeper La Luna shale was suspended and Canacol subsequently exercised its option to continue shallow operations at Oso Pardo - 1 on a 100% cost basis. The Upper Umir sandstone interval produced at a final stable rate of approximately 205.3 bopd and gas production of 107.54 thousand cubic feet per day.
This light oil discovery in the Umir sandstone was the first discovery on the Santa Isabel contract. This discovery also indicated that there was significant potential within the shallow sandstone section of the block, where Canacol has the right to receive 100% of the crude produced. As a result, Canacol designed a stimulation for the Upper Umir sandstone (shallow section) and will place the well on long term production once the permit has been received.
The Oso Pardo 1 well is located approximately 12 kilometers to the west of the Mono Arana 1 well that Exxon Mobil drilled with very successful results as mentioned above. According to the company's CEO, Shell is going to drill the next well (Morsa well) on the contract in Q2 2014.
Long story short, Colombia is clearly preparing for a shale boom, and Canacol can reap significant rewards in 2014 from its VMM2, VMM3 and Santa Isabel Blocks, as shown below:
Canacol is fully valued currently. Since a bird in the hand is worth two in the bush, I exited Canacol at C$6 a few weeks ago to lock a 100% gain in 12 months and switch to other undervalued stocks.
No matter what I did, I must note that Canacol has made great strides to diversify its reserve and production base. The company's huge exploration position in Colombia of 1.6 million net acres has delivered solid exploration discoveries, resulting in a pretty dramatic increase in production since early 2013. Canacol has managed to "swallow" this expansion without any indigestion symptoms thus far.
Thanks to this diverse and growing production base located in 5 different basins, Canacol has also a range of catalysts that promise to maintain that upward trend. With a number of positive catalysts yet to fully play out, and given the untapped shale resources in Colombia, Canacol could also become an acquisition target, as the company is dancing among majors like Ecopetrol, Pacific Rubiales (OTCPK:PEGFF), Sinochem, Exxon Mobil, Shell and ConocoPhillips. Taking into account this significant potential, a long term investor could add Canacol at the current levels and put it on the shelf, with the hope that tomorrow is going to be a brighter day.