Parex Resources: A Risk-Reward Reassessment After The New Oil Find In Colombia

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About: Parex Resources Inc. (PARXF), Includes: EC, GPRK
by: Laurentian Research
Summary

Parex struck oil in a northern fault block of the Andina field, Capachos Block, Colombia, expanding the extent of the field and adding to production capacity.

The discovery adds to yet-to-book reserves and puts the company on solid ground to achieve its full-year 2019 goals, both further adding to the upside.

The ongoing stock buyback may provide a cushion on the downside.

The stock is believed to continue to offer a favorable risk-reward profile in the back half of the year.

Parex Resources is one of the top picks of Laurentian Research for its proprietary Live TNRH Model Portfolio.

What

On June 10, 2019, Parex Resources Inc. (PXT.TSX)(OTCPK:PARXF) reported that it had struck crude oil in the Andina Norte-1 exploration well in the Capachos Block, Llanos Basin, Colombia.

Andina Norte-1 is located in the northern part of the Capachos Block, which Parex operates with a 50% working interest while state company Ecopetrol S.A (EC) holds the remaining stake (Fig. 1). The well was drilled to a total depth (known as TD to the oil patch) of 18,852' and encountered oil-bearing reservoirs in the Une and Guadalupe formations.

Fig. 1. The Capachos Block and Andina Norte-1 exploration well therein, shown with Parex assets in Colombia, modified from source.

The primary objective, the Guadalupe reservoir, was completed following cement remediation and production testing. The well tested flowing at 2,785 bo/d and 4.3 MMcfg/d under natural flowing conditions with a wellhead pressure of 1,420 psi.

A secondary objective, the Une Formation, tested flowing at 621 bo/d, 446 bw/d, and 1.5 MMcfg/d.

So What

Oil had been previously struck in the Guadalupe and/or Une formations in three different fault blocks in the same structure (Table 1; Fig. 2).

Table 1. Objectives in the Andina structure, Capachos Block. Source.

Fig. 2. A structural map of the Andina structure, showing locations of Andina-1 and Andina Norte-1 discoveries in the Capachos Block. Source.

Andina Norte-1 targets the northern fault block, with objectives in the Une, Guadalupe, and Mirador formations (Fig. 3). The successful production tests now confirm the northern fault block is also oil and gas-bearing, thus extending the extent of the field. I look forward to the company adding a meaningful chunk of new reserves outside of LLA-34 in the coming reserve booking season; I would not be surprised if the company books an additional 10 MMboe or more of 3P reserves in the Capachos Block.

Fig. 3. A cross section of the Andina structure, showing the Andina Norte-1 exploration well targeting a separate fault block from Andina-1 and Andina-2 wells, modified from source. Andina-2, an appraisal well will be drilled on the same pad of Andina Norte-1.

The company expects to produce from the Guadalupe Formation in the Andina Norte-1 well. As for the Une pool, a secondary objective, the company looks to conduct remediation to isolate the water production before putting it on production.

The company is currently producing 2,550 bo/d net to its working interest from the Capachos Block. I reckon oil production out of the block will probably be doubled once Andina Norte-1 (and Andina 3) is brought onstream. In addition, the Phase 1 gas processing facility is expected to be on-line in 2Q2019 to enable natural gas production from the field.

The company attaches considerable importance to the Capachos Block, hoping to diversify production away from the GeoPark (GPRK)-operated Llanos 34 Block (or LLA-34 for short), which it has a 55% interest. The one-two punch of Andina-1 and Andina Norte-1 certainly gives the company confidence in its diversification strategy.

Now What

Parex has been quietly delivering operational results:

  • The company indicated that it would average 52,000 boe/d in the 2Q2019, up 23.7% from that in the same quarter one year ago (Fig. 4). Both LLA-34 and the Andina Norte wells are expected to drive production growth in the 2H2019. To me, a 20% year-over-year production growth as guided toward by the management (Table 2) appears to be a cinch.

Laurentian Research maintains a database of operational and financial results to aid his in-depth research. This chart is generated from that database. Fig. 4. The quarterly production profile of Parex. Source: Laurentian Research.

Table 2. The 2019 guidance of Parex. Source.

  • In 2019, the company has a 46-well program which serves as a source of near-term catalysts (Table 3). The success of Andina Norte-1 as part of that program will lead to new reserve additions, thus increasing its intrinsic value. And those 21 wells in the so-called SoCa area, which includes its flagship LLA-34, will be the main driver for production growth.

Table 3. Parex's 2019 drilling program. Source.

  • As production grows, the company will also benefit from operating cost reduction; the recent commissioning of the flowline from LLA-34 to Oleoducto de los Llanos (aka, ODL) is supposed to lower the operating cost in LLA-34 by at least $1/bo, possibly adding some $15 million per year to the bottom line (see here and here).
  • The company guided toward $260 million of free cash flow for full-year 2019, which may be on the conservative side in my opinion (Table 2).

Since the entry of the Live TNRH®Model Portfolio into Parex at year-end 2018 on the back of our in-depth research on the company, the stock has performed satisfactorily with a 50% gain (Fig. 5). The slower pace of advance of the stock as of late may have sent some shareholders to the sidelines. While the profit-taking is understandable given the macro uncertainty going into the back half of the year, I think money may be left on the table by staying on the sidelines.

TNRH's timely entry into Parex gives us a 50% gain so far! Fig. 5. Stock chart of Parex, modified from source.

It is important to remember the company has 4.55 million shares yet to repurchase as part of its ongoing stock buyback program. The company began the normal course issuer bid, on December 21, 2018, intending to repurchase 15 million shares or 10% of the public float. As of June 7, 2019, the company has only bought back 10.45 million shares. The ongoing share repurchase will support the share price on the downside.

On the other hand, the afore-mentioned operational catalysts may drive the stock upward in the near term. Therefore, I reckon the company still offers a risk-reward profile in favor of the perspicacious shareholders.

Disclosure: I am/we are long GPRK, parxf. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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