Fun with Touchstone Numbers

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Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long TXP.TO

With nothing but time on my hands these days, I’ve had a lot of time to think about a lot of stories; some new, some old. I got to Touchstone Exploration last night (TXP.TO, TXP.L, last at C$0.55) and realized that I really hadn’t appreciated just how asymmetric the risk-reward has become, based on some fairly simple math.

Here’s the punchline in one image that shows the impact to my view of value based on a range of outcomes for Chinook and Cascadura Deep, which I expect will be the next two wells into TXP’s Ortoire block. What follows below just explains the rationale. All numbers in my scenario analysis table would reflect gas volumes net to TXP’s net interest:

My math journey starts with Aventura in 2004, when it was bought by BG Group for C$228 million. Aventura had a similar discovery onshore Trinidad to what Touchstone has drilled at Cascadura (just to the west of TXP’s lands) and it had the well on long-term production test when BG made its bid. Digging through past filings, Aventura’s net 2P reserves at the time were 300 BCF, meaning that BG paid C$0.76/mcf for the 2P reserves. The natural gas price in Trinidad at the time was US$1.10/mcf and the CAD/US fx rates were similar to what they are today so I’m not going to worry about forex changes.

Today, the gas price onshore Trinidad is in the US$3.00/mcf range, so clearly gas molecules are worth more now than they were in 2004… let’s call it 150% more. So in a takeout, if gas was valued at C$0.76/mcf in 2004 when the gas price was US$1.10, I’d feel comfortable saying it was worth C$1.50/mcf today (i.e., the 2004 price plus 100%). Maybe a little less, maybe a little more, but that’s what I’m going to run with…

It’s important to note that Trinidad is currently short 400-500 million cubic feet per day of natural gas supply and has industrial customers running plants well below capacity as a result (for example, Nutrien (NTR.TO, last at $48.42), recently shut down/scaled back ammonia production due to lower ammonia demand and lack of natural gas feedstock).

So what does TXP have on its hands “today” at Cascadura? Well for one, they do not have any 2P reserves, but that’s because the work hasn’t been done yet. I’m thinking about hockey today, so I’ll just say that when it comes to the market, you want to be skating towards where the puck is going, not where it is currently. So where is TXP going? What’s the size of Cascadura as it stands today? I’ve run math on that before based on assumed areal extent and reported pay interval thicknesses, which I’ve laid out in at least one earlier post, and my current view is that Cascadura is likely to fall in the 200-300 BCF recoverable range as a start. Recall that TXP is an 80% interest holder here (Heritage, the state oil company, is the 20% partner), so TXP’s net gas in the 200-300 BCF case is 160 BCF to 240 BCF. The middle of that range is 200 BCF (net), so that’s what I’m going to run with here. That defines the leap of faith that I’m taking here and it’s important to know that it is an assumption, but assumptions are necessary in speculation… and I think that my assumption is based in reality given the information that’s been made available. Soon enough, I won’t have to guess at all, as TXP is expected to get some kind of initial gas volume estimate prepared after it pulls the Cascadura-1ST downhole pressure recorders and integrates that data with the geophysics (Cascadura is covered by 3D seismic). Bottom line, for now, I’m running with 200 BCF net to TXP as a base case at Cascadura here (i.e., “Cascadura as is” in the above table) and then looking at what else is in the hopper in terms of upside.

If I’m running with C$1.50/mcf in the ground for gas (as detailed above), TXP’s 200 BCF (my assumption) at Cascadura could be worth $300 million. That’s $1.65/share. The stock is trading at $0.55; and that’s just on what I think is already “in the bag” at Cascadura. To be clear, TXP still needs to get Cascadura tied in, but the gas will require minimal processing (no H2S) and it’s only a 3-kilometre tie-in to a main gas pipeline with capacity, so I don’t expect a lot more capital (i.e., dilution) for TXP to get to the stage where Aventura was when BG made its bid.

So in my mind, $1.65 is really my “base case” right now. Sure Cascadura might be a little bigger or a little smaller, but this is all just educated guessing anyway, so I think it’s as good place to start as any.

What about Chinook? Well, for those who are really keen, here’s a link to an old TXP presentation that shows a map of the Chinook fault block (aka “Balata West South”) relative to the Cascadura fault block (aka “Balata West North”). Keep in mind that these are old maps and that they were made back when TXP thought that these were oil targets. The maps also grossly simplify the structural situation. If you saw a cross-section through this area, it would be complex, with stacking of thrust sheets in some places, including the Cascadura-Chinook area. My point is that maps like that are just gross approximations of the lay of the land, but they do illustrate that Chinook, all else being equal, appears to be bigger than Cascadura in terms of area. That jives with prior sound bites from past company interviews and forms the basis of my next layer of “option value”.

Let’s say Chinook is just comparable in size to Cascadura (i.e., not bigger, which it seems to be). That would mean that success at Chinook could add another 200 BCF (net) to the project. Those molecules would be just as valuable as the first ones, as more scale simply means a higher production rate plateau here. That’s another $1.65 on the table. What if Chinook is half the size? What if it’s 50 BCF bigger? 100 BCF bigger? There are lot of permutations. All this would be incremental to my $1.65 “base case”. It could also be zero (i.e., they could drill a dry well), so there’s that, but in my view I’m not even close to paying anything for the option anyway.

And then there’s what I’ll call Cascadura “Deep”, which is really not that deep (~2000 feet deeper I believe), but it would be a separate accumulation from what was drilled and tested in the Cascadura discovery well, which had to stop short of the “deep” target due to high-pressure gas wanting to rush out of the hole that they thought was going to be an oil well. I think there’s a very strong case for TXP’s next well after Chinook to be a dual-purpose well at Cascadura. If another well was drilled at Cascadura, targeting the lowermost thrust sheet, it could also drill through the uphole reservoirs that have already been tested. If engineered properly, not only could another Cascadura well evaluate the deeper thrust sheet, but it could also be used as a second production well in the known uphole zones when the project comes onstream in 2021. Stifel GMP have hinted at this possibility in a recent research note and I do like the idea, so I  guess we’ll see.

If I assume that Cascadura Deep is the same areal extent but half the thickness it could still add somewhere on the order of 100-200 net BCF to the picture given that more gas can be jammed into pore spaces at the higher pressures encountered at depth. That adds further to the “free option value” pile. Again, I pay nothing for this upside exposure based on my current view of the project.

So, to sum it up. My base case is that TXP already has a $1.65/share discovery on its hands that the market just hasn’t appreciated yet given the early stage of the discovery.  If Chinook hits, I figure that adds another ~$0.50-2.00 per share of value. If Cascadura Deep hits, it could add another ~$0.50-2.00 per share. If you make goal posts out of all of that (see the table above), the range of potential outcomes that I see ranges from $1.65 to $5.85 per share, and that’s for a stock trading at C$0.55 as I type this.

I started this note by talking about the asymmetry of the risk-reward here and I think I’ve laid that out as clearly as I can. I haven’t even discussed the “biggest” target of them all, Royston, but I don’t think that’s necessary. If either of Cascadura Deep or Chinook hit, I’m piling significant upside on something that I think is already undervalued by nearly 200% and I don’t think I’m stretching on the gas price or my volume assumptions at Cascadura.

My current best guess is that drilling should start up in July, and will start with the Chinook well. Trinidad was very lightly touched by COVID-19 and may apply restrictions to incoming workers, but is likely to “open up” in the near term for oilfield activity (as an imported contractor, I could think of worse fates than quarantining in Trinidad for two weeks before starting a job, as long as the quarantining was done in a suitably comfortable place!).

Does the market really appreciate what’s on the table here? With the stock up just 15 cents from its 40-cent March-puke-out lows, I’d say that it doesn’t. Not by a long shot.

Time will tell.