Sharp Credit – Credit News – Credit Information
Touchstone Exploration ( PBEGF ) is a small oil and gas production and exploration business based in Canada, with all production operations in Trinidad, which were entered in 2010 when it acquired the WD-8 development block. As of February 2019, production rates are around 2,300 bopd This is up from 1,375 bopd average in 2017 and 1,729 bopd average in 2018, hence showing a steady increase.
This research regular refers to Touchstone’s latest website presentation :
Current production assets (we think easily covers the current market value)
Touchstone had a successful new drilling program of 11 wells costing US$11m (range US$0.6m to US$1.4m each well often depending on depth) during 2018 and bringing on about 1,000 bopd of new production (circa 10-15% decline on the existing 1,500 bopd at start of year 2018). The range of production appears to be 20-300 bopd from the 11 wells, with the later ones being high graded and some of the former lower producers being commitment wells. It’s worth noting CEO Paul Baay having commented,
” we do not have any more commitment wells, we have met all of these under our contract, so we can really high-grade now and drill where we want to rather than being dictated to a point to where some of the contracts required us to drill.”
It’s worth noting that approximately 20 wells account for 70-80% of group production with many of these being recent wells. In total, they have around 250 producing wells onshore in Trinidad. Management have improved their geological understanding recently and drilled up to 1,500ft deeper to 7,500ft, which has often resulted in better production rates from previously unproduced horizons.
For 2019, they have so far commented on 4 planned new wells with likely start in May, if each well averages 100 bopd and they drill a further 2-4 later in the year, it’s possible year-end 2019 production could easily reach 2,800-3,000 bopd type range for exit production on conventional assets. Note at production 90 per day and U$70 oil price new wells payback in around 13 months (see table P11 in presentation and pasted below). For 2019’s program, management are carefully watching capex levels (budget US$1m for each normal well) and are keen to get the first 2 Ortoire exploration wells drilled (see later in note) without stressing overall total capex levels. Hence, there is some holding back of conventional drilling where they did none during 1Q2019, for instance, preferring to build up some further cash. Management have consistently said a 3,000 bopd type level should provide enough cash flow to self-sustain further drilling on assets and netbacks climbing (2018 level U$34.58) as fixed cost recovery over group costs improves. In a non-constrained capital situation, management have said they’d like two rigs drilling and 20 wells a year costing circa $20m (US$) and adding circa 2,000 bopd to production levels, we are a little way off this currently, but it could be within reach over the next 2 years.
In our eyes, the current enterprise value of ~US$50m (market valuation of US$35M and net debt circa US$14M, which will improve in Q1) can be attributed to these conventional assets and a 2019 likely increase in production towards 3,000+ at year end. It’s the Ortoire exploration potential that could provide multiple times upside to the shares.
Source Touchstone presentation
Note table includes an assumed 15% discount to Brent for Touchstone sales. However, recently, they have been selling with a smaller discount e.g. in March, the discount was 7.4%.
Exploration program (we think provides the multifold upside potential)
The Ortoire Block has contained 70 previous wells since the 1950s, but a lot of this information has never really been pulled together cohesively until very recently.
The GLJ Ortoire prospect report January 2019 is referred to in tables below.
Well 1: COHO-1, Gas targets. ( pg 14-15 in company presentation )
Spud date is expected in June 2019 with circa 35 days drilling time to depth 8,500 feet. Costed at circa US$3m, but including quite a bit of contingency and testing. It’s only modestly deeper than some of the production wells. Touchstone is well experienced in drilling elsewhere on the island, although it is using a higher spec more powerful rig in this instance. It is twinned with previously drilled Corosan 1 well in 2001. This previous well tested positive for gas, with best 2 results in TEST#3 of 5760-68′(8′ NOS) 4.4 MMcf/d and TEST#4 of 5500-16′ (16’NOS) 3.7 MMcf/d. If combined that amounts to 8.2 MMcf/d of gas. In boed, that’s circa 730 and 620, so if combined, it is circa 1300 boepd, an excellent flow rate. Note that the previous owners had just discovered Carapal Ridge where testing came out at 100 MMcf/d and circa 0.5TCF resources, so they were happy to ignore well Corosan 1 at the time. Using 3D seismic and other information, management are aiming for a more crestal location at target depth for the prospect. Assuming this is successful, it would likely result in a greater pay zone and most likely a higher flow rate all being well, the old well found 60ft of hydrocarbon pay. They have also decided to modestly deepen this well to target a second prospect that could be of a similar type size. This second prospect has not been drilled before and hence is pure exploration. It also has not been included in the GLJ report published in January, so represents pure upside optionality. The shallower prospect is sized at 45-112BCF, no sizing for the deeper one. Once drilled, the rig will be moved off to the second prospect and approximately 60 days of testing will follow with hoped for full data in September.
Assuming success, a 3.5km gas pipeline and some minimal surface equipment can then be installed to take the gas to Shell’s processing facility which has significant spare capacity (sales pricing and processing already agreed). Guidance is for 6 months to do this connection to production, but this includes significant hold up time estimates as no new onshore gas lines have been permissioned for over a decade in Trinidad. If both drilling prospects are successful, they can produce from both of them on a combined basis, which could result in excellent flow rates. It should cost less than US$1m for topside equipment, and management are happy to debt finance this. A total of US$4m investment could pay back in around a month if production started for context. Success here has the potential to nearly double current production for the whole business.
Source GLJ Ortoire Prospec t report January 2019
The above table shows the independent valuation released on January 17 th , 2019, for 2 zones, including the shallow prospect. The high estimate at a 10% discount factor U$102m type value shows what this might be worth if the drilling is a discovery. Note 16,128 (16BCF) is assumed recoverable out of 41-112BCF total prospect range size cited in text above, so that’s based on a 14-39% recovery factor. The valuation has nothing in it for the deeper prospect to also be tested with the first well. There is also a follow-up deeper target that will not be evaluated by this well and could be included in the 2020 drilling program.
So, if drilling is a success on the shallower prospect, that might give a prize of half US$102m (high size estimate used). Owning 80% of this means US$40 m-ish, roughly doubling the market cap. The deeper prospect is verbally sized at about the same size and hence another shot at US$40m on top. But note this is higher risk as we have no previous well to go on here, only the 3D seismic.
Upon success here, it is realistic management would come back and drill a second well in 2020+ that would target the optimum crestal location (for faster production) on the shallower prospect and drill the second deeper prospect outlined in the reserves report and top right on P15 in the presentation.
Well 2: Cascadura-1, Oil targets . ( pg 16-17 in company presentation)
Spud date is expected to be August 2019, using the same rig with similar circa 35 days drilling time to depth 8,160 feet. It is also costed at circa US$3m but including quite a bit of contingency and testing. This is twinned with previously drilled BW-5 in 1950 where the logs show 187ft of net hydrocarbon and 44ft of completed reservoir from which >27,000BoO were produced over around 18 months, or about 150BoO/D a day. The original well had a stuck pipe, so the repeat section wasn’t tested. The new well targets a crestal location, and management believe the original BW-5 well veered off course somewhat when originally drilled, and hit on the shoulder, giving a much thinner net pay (see P 17 top right). This could add over 200ft of extra net pay if it’s a correct prognosis. They are also targeting a new, deeper, and potentially larger prospect in a stacked repeat formation. Again, this deeper target isn’t included in any valuation work previously done and is only based on 3D seismic.
Depending on results and flow rates management could choose to FRAC either prospect to improve recovery flow rates, with the likely cost of US$1m and for a 3x-5x production uplift. Any natural flow rate in the 500-1,000 type range would be an excellent result and clearly not need fracking.
Source: GLJ Ortoire Prospect report January 2019
This valuation has two shallower prospects included; the one being drilled, and another based around BW-7 and BW-7X side-track. Both of these found significant Hydrocarbon pay (see pg 16 in presentation). Hence, this well exposes shareholders to about half the valuation work in the table for the shallower prospect. The deeper prospect isn’t considered but is verbally described as bigger, and hence, if successful, would give a very significant valuation uplift. Hence, half of U$109m (midcase size used) is U$55m+ and 80% ownership results in U$44m to shareholders upon success. The deeper prospect is described as larger, so should give this again on top if successful.
Importantly, any success can be rapidly brought on production with a trucking solution and later a short oil pipeline to a nearby gathering facility; again, for a relatively low capex price and very fast payback. Touchstone have government approval for multiple wells from each pad, and it’s also likely that any success here could be rapidly revisited in 2020 with further drilling both for increased production rates and targeting increased resources. To follow the BW-7 and BW-7x previously drilled wells, they would need to set up a different drilling pad location, something perhaps for 2020.
Well 3: Royston, Large Gas target . ( pg 18-19 in company presentation )
This prospect does not have 3D seismic over it, and hence, there is less clarity. However, the previous Lizard Spring well logs from 1965 show an at least 750ft thick gas pay starting at 9,700ft that remains open at depth and Touchstone plan to drill to 11,500ft. The reserve range of 240BCF-960BCF only considers the 750ft thickness, hence anything beyond/deeper than this would likely make the find much larger. Touchstone hopes to drill this late 2019 or 1Q 2020 with a likely cost U$5.5m, including upgrading the access road (budget U$1m) where work should start in August and might take 5-6months. It’s situated 13km from the Shell plant. This prospect looks seismically most like the nearby producing Shell field Carapal Ridge, but perhaps twice as thick. They also have OL2 wells drilled in past further to the south that showed no hydrocarbons, but management think over-weighted mud forced hydrocarbons back into reservoir. This prospect is smaller and higher risk, but an easy follow on target later in campaign should Royston prove successful.
Source: GLJ Ortoire Prospect report January 2019
An unrisked value range of U$109m to U$438m (table above NPV10 best at 10% to high estimate NPV5 at 5%) is clearly exceptionally valuable for Touchstone assuming some drilling success here. There is also the possibility it is larger as this valuation only considers 750ft of pay, and it could be the prospect goes deeper as it remains open at depth from the previous well drilled.
Ortoire drilling conclusion
Each of these 3 prospects is twinned with previously drilled successful wells. The block contains many other prospects (14+) of varying characteristics, which would all be somewhat derisked by any success. Hence, there is an abundance of targets for 2020+, and any significant increase in available cash flow would allow a much expanded 2020 drilling program of 2 rigs or more in operation. The ability to rapidly take any drilling success into production (onshore and cheap with spare processing capacity to hand) would transform Touchstone’s own organic cashflow AND allow then to step up drilling hugely in 2020.
Other points of note
Through 2018 Touchstone produced oil sold at circa 16% discount to Brent, that has improved. Since the refinery has closed and hence subsidisation reduced for 2019, the discount has been more like a 11-12%, and in March 2019, only 7.4%, which should help improve 2019 returns.
Tax situation: the existing Special Petroleum Tax ((SPT)) is considered rather out of date and somewhat punitive. This Newsday article discusses various points of view. Suffice to say for this note that any tax reform could help increase the value of Touchstone’s assets significantly. However, it’s a difficult thing to assess, and we regard it as a somewhat free option at this stage. For clarity, the SPT does not apply to Natural gas production.
Management try to keep debt at around 1.5* cash flow, at year-end 2018, it was 1.8*. Hence, when oil price dipped very low at end of 2018, they suspended drilling, and there was no drilling during 1Q, allowing cash to reduce debt. They pay an 8% coupon on the debt and circa 1% of group turnover. The debt has been extended several times and currently runs until November 2023 (see link for more details), small repayments start January 2021.
They only own 80% of Ortoire block but pay 100% of well costs for first 4 wells, after that Heritage must pay their share.
Wells are completed and produced from the lowest reservoir up and commingling is not allowed between horizons over 500ft apart. Once the completed reservoir is depleted, the well can be recompleted across a new interval.
Equity fund raisings so far have been US$5m (at 11.5p) in December 2017 to help fund 2018 extended drilling campaign and in February 2019, they raised US$6m (at 12p) for the upcoming drilling on the Ortoire block.
Heritage oil may release more blocks for Touchstone to drill on as Heritage are relatively cash constrained, but it’s in their interest for drilling to go ahead. Hopefully, this will just be the capex costs of drilling for Touchstone and not more.
Peer Group Valuation
UK-quoted Columbus Energy Resources is also a Trinidad-based onshore operator quoted on AIM targeting 1,000 boopd at year end 2018. It was loss-making at EBITDA level 2018 and generates small amounts of cash with a much less aggressive drilling campaign. It’s a somewhat subscale company, in our view. They have a market cap of £25m and small net cash balance sheet. This seems quite a bit more expensive than Touchstone’s pure producing assets.
Similarly, Trinity Exploration have onshore and near offshore assets in Trinidad, production averaged 2,871 bopd for 2018 and exit rate over 3,000, so a bit higher than Touchstone. For 2019, they are guiding for a 3,000-3,300 yearly average production rate. They have a nearshore FDP being submitted late 2019 to add significant production by 2022, adding 5,000-6,000 bopd in 2023 with reasonable capex circa U$100m to spend on it (likely to farm out). The current market cap is £62m having raised US$20m equity in 3Q 2018 to clear all debt and provide cash for development of existing assets. Ultimately, they have ~US$15m net cash at moment. Hence, if Touchstone could exit 2019 getting near 2,800-3,000 production you might give it 70-80% of Trinity’s EV, which would be around £35-45m type range.
The two sell-side analysts that follow Touchstone have price targets of 25p and 35p, with only minimal amounts attributable to the exploration program. Both argue the current production assets are worth more than the current market cap and debt together.
The key remains that these 3 upcoming drilling wells are each twinned with previous drilled discoveries which should make them relatively ‘lower risk’ compared to pure exploration drilling. To varying degrees, each single well could transform Touchstone from a little known small ‘also ran’ operator into something much larger. Any two success combination would be off the chart really. This also comes for a small capital outlay on each well and with access to nearby infrastructure, a rapid monetization and cash flow route is available. This is a very rare combination of positive factors in our view. For investors owning the shares at this price, there ought to be relatively low downside medium-term risk. The currently-producing assets cover more than the current valuation, in our view, whilst the upside success case could be a multiple of the current share price. That said, if all 3 wells turn out as failures, then the short-term share price would no doubt suffer. But with a refocusing on the existing production assets, this would hopefully make such a fall somewhat short lived.
Trinidad is ‘updip’ Venezuela in geological terms and only 12km off the coast at nearest point. Been producing oil since 1908 first oil find and has circa 6Bn reserves. Roughly 60,000 BOEPD produced on whole island/around per day, a decline from 140,000 in 2008 and peak in 1978 at 228,000. Petrotin/Heritage (state owned producer renamed) produce about half of this. Been very little drilling onshore in recent years and especially very little beyond 12,000ft has not had the onshore rigs for this depth. Last onshore discovery of note was 15+ years ago with all recent emphasis on offshore sector by the international majors e.g. BP ( BP ), Shell (RDS.A), BHP ( BHP ), and EOG Resources ( EOG ). Plenty of onshore hydrocarbons infrastructure already built but some quite old. Carapal Ridge is only onshore producing gas field, plenty offshore. Petrotin’s refinery closed in 2018 as too old and losing money, whilst only operating at half capacity, it is currently up for sale. No central database of all oil wells drilled/seismic etc. means sometimes information can be hard to come by. Trinidad is the wealthiest country in the Caribbean as a result of its oil/gas assets, Energy makes up circa 35% of the island’s GDP. It’s the 6 th largest exporter of LNG in the world.
Touchstone Exploration online presentation: Paul Baay and James Shipka discuss year-end results and Ortoire exploration programme (TXP)
49 minutes 28 th March 2019 video presentation
Touchstone Exploration – Oil Capital Conference March 2019
25minutes after full year 2018 results, public presentation
See also Ciner Resources: The Key Risk To Monitor on seekingalpha.com
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.