Canacol Energy is guiding to FY20 realised natural gas sales of 170–197mmscfd (cf 143mmscfd in FY19) as gas demand is picking up in Colombia while quarantine measures are lifted. The low case scenario assumes that spot sales (normally c 20% of the total) are not reactivated in 2020, and the high case scenario assumes they are reactivated in August 2020. We estimate a mid-case scenario of realised natural gas sales of 183mmscfd for the year, with sales in line with the last two weeks of May 2020 as reported by the company. Drilling operations have also resumed and the 2020 programme remains Canacol’s largest ever, despite a slimmed down programme from 12 to nine wells and lower capex for the year of US$108m. The company recently announced that it is maintaining its quarterly dividend of C$0.052/share. Our 2P + risked exploration NAV has decreased by 7% to C$6.55/share, reflecting the impact of lower gas sales demand in Colombia due to the COVID-19 pandemic.
Gas demand increasing
Canacol expects FY20 production to reach 197mmscfd, assuming spot demand increases and stabilises through July and August 2020. Even if demand does not return at this pace, management still guides to full year production of 170mmscfd based on its take or pay contracts. Realised contractual gas sales for the latter half of May were 181mmscfd. Meanwhile, an unusually dry winter and low reservoir conditions have increased demand for gas for thermoelectric power plants.
Exploration drilling from July 2020
After drilling the Nelson-14 and Clarinete-5 development wells, quarantine measures resulted in a two-month delay to the 2020 drilling programme. Drilling is due to restart in June with Pandereta-8, while a second rig is now expected to begin drilling in July at the first exploration well in the 2020 programme, Porro Norte-1.
Valuation: RENAV at C$6.55/share
Our base case valuation of Canacol stands at C$6.55/share. The company trades on an FY20e P/CF of 2.5x, lower than its Canadian peers on 3.3x and its peer group of North American E&Ps with South American operations on 2.8x. Canacol’s share price has only decreased by c 20% since January 2020, while its peer group with South American operations fell by 55%. The company has proved resilient due to its limited exposure to commodity price volatility, low levels of debt and high netbacks, and recently announced that it is maintaining its quarterly dividend at C$0.052 per share.
Colombian demand returns: FY20 guidance 197mmscfd
In Q120, Canacol realised record natural gas sales of 201.5mmscfd, up from 122mmscfd in Q119, primarily due to completion of the Jobo to Cartagena 100mmscfd pipeline in July 2019. This was interrupted by a country-wide shutdown between 26 March and 27 April in Colombia due to COVID-19, during which period there were virtually no gas sales.
Manufacturing and construction activities resumed on 27 April across the whole country and all remaining sectors re-opened on 1 June, except in Bogota, Cali and Cartagena where restrictions were lifted on 15 June 2020. Demand is therefore expected to increase and stabilise during July and August 2020 and under this scenario Canacol is guiding to full year production of 197mmscfd, with guidance of 170mmscfd in the event of spot demand not returning. Around 80% of Canacol’s annual sales are on take or pay contracts, with management estimating that these volumes account for c 162mmscfd. The balance is interruptible or spot sales. In the near term, gas demand is expected to rise, due to hydroelectric reservoirs being at a 20-year low following an unusually dry winter.
The company is planning to increase capacity further, with a 100mmscfd pipeline to Medellin expected on-line by H224 subject to signing the negotiated sales contract with a major utility, EPC contractor selection and financing. Potential future growth projects include the requirement for 30mmscfd from December 2021, subject to revision due to COVID-19, at the El Tesorito power plant, 7km south of Canacol’s facilities, and c 25mmscfd capacity in the Jobo/Cartagena/ Barranquilla pipeline between 2020 and 2022 if interruptible market demand is strong.
2020 drilling programme resumes
Canacol had been planning to drill 12 wells in 2020, including nine exploration wells. However, having successfully completed drilling of the Nelson-14 and Clarinete-5 development wells, the remainder of the drill programme had to be put on hold on 26 March as a result of the quarantine measures taken to limit the COVID-19 pandemic. This also meant that the anticipated arrival of a second rig was delayed until July 2020 and, taken together, these measures resulted in a downward revision to the 2020 programme, with Canacol now expecting to drill nine wells in 2020, five of which will be exploration wells. Despite this, the exploration programme is still the largest exploration investment in Canacol’s history.
The company’s success rate remains high, with an ongoing exploration and appraisal success rate of 83% delivered through the continued application of its amplitude versus offset (AVO) methodology.
The Pioneer 53 drilling rig was reactivated on 24 May 2020. It has since completed the Clarinete-5 development well and is now being mobilised to the Pandereta-8 development location, where it is expected to spud in the third week of June 2020, taking around five weeks to drill and complete. Clarinete-5 encountered 309ft of net gas pay in the primary Cienaga de Oro (CDO) reservoir and was tested at a rate of 43mmscfd. The well has now been tied into permanent production.
The first well to be drilled by the second rig is expected to be exploration well Porro Norte-1 in VIM-5. The well will target a four-way anticline with fault dependent upside and will assess the presence of gas in multiple stacked targets including the CDO but also the Porquero and Tubara sandstones.
Prospective resources audit: 4.7tcf
In April 2020, Canacol provided an update to its prospective resources, based on an independent audit carried out by Gaffney, Cline & Associates (GCA) as of 31 December 2019. The report evaluated and estimated conventional natural gas prospective resources for 162 prospects and leads across all six of the company’s Lower Magdalena Valley exploration blocks and the recently acquired VMM-45 and VMM-49 exploration blocks in the Middle Magdalena Valley basin. The company aggregated the individual prospective resources to a gross unrisked mean of 4.7tcf, up from 2.6tcf as of 31 December 2017. Risked mean resources increased from 0.95tcf to 1.38tcf.
Valuation
Our 2P valuation incorporates discounted cash flows, reflecting monetisation of the company’s existing reserve base, adjusting for overheads, net debt and decommissioning provisions to arrive at a NAV. We also look at two additional valuation scenarios that include incremental reserves over and above 2P. Here we include ‘maintenance’ capex (largely 3D seismic, exploration and development wells and tie-in costs) required to add reserves to sustain a production plateau. Our DCFs utilise a standardised discount rate of 12.5%, but we provide sensitivities to this key assumption later in this note. Key model inputs for our valuation scenarios can be found in our initiation note published on 14 May 2019.
We have updated our forecasts to reflect Q120 results and incorporated the impact of COVID-19 on Canacol’s realised gas sales. As the company announced on 3 June 2020, realised contractual gas sales from January to May 2020 averaged c 180mmscfd, with Q120 sales of 201.5mmscfd, April 2020 sales of 136mmscfd and May 2020 sales of 158mmscfd. We assume a conservative 2020 annual sales scenario of c 183mmscfd, a mid-case scenario compared to the company’s guidance range of 170–197mmscfd. We assume that realised gas sales will remain in line with the second half of May of 181mmscfd, resulting in average realised gas sales of c 186mmscfd for Q320 and Q420. Given current uncertainty and a possible second wave of COVID-19, we decided to take a conservative view for our base case as we continue monitoring the market. Changes to our valuation also include management’s updated 2020 capex to US$108m to reflect the interruption in drilling activities during Colombia’s quarantine period. We also decrease our natural gas price assumption, net of transportation, from US$4.80/mcf to US$4.58/mcf to reflect lower demand for spot cargoes. The Q120 realised price net of transportation stood at US$4.54/mcf. Our base case valuation currently stands at C$6.55/share, reflecting a 7% decrease on our previous valuation of C$7.02/share.
