Touchstone’s Free Cash Flow Engine: Cascadura Reserves Report Delivers

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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

It’s Christmas in July today as Touchstone Exploration (TXP.TO, last at $0.96) reported its maiden Cascadura reserves estimate overnight… and it did not disappoint. In fact, the reserves numbers beat every estimate I have seen in any TXP reports to date, including my own, which are usually realistic-but-optimistic, so it’s a solid beat all around. The stock is up 17% in London on over 1.5 million shares traded as I type this; about an hour before the North American markets open.

I don’t have a lot of time this morning and I’ve made some straw-man estimates before on what I believe the range of outcomes for TXP could be in a variety of scenarios, depending on what happens with the upcoming Chinook and Cascadura Deep wells (link to it here). What I will point out is that my prior valuation assumptions were based on 200 BCF of net 2P reserves for Cascadura, which turned out to be 234 BCF (plus 6 mmbbls of associated liquids). I don’t think anyone really believed my estimates/assumptions when I posted them, but it’s nice to see some confirmation from a quality firm like GLJ, and I think that today’s reserve report should serve to set a foundation under the stock as the company heads into drilling again over the next “few weeks”. 

Even if I was to use the industry rule-of-thumb of “a buck an M” (i.e., $1/mcf of gas) valuation on Cascadura, I would get to about C$1.25/share (using 183 million shares out) on the 2P estimate. That’s assigning zero value for the Coho discovery, zero value for the company’s oil assets, and zero for any exploration upside. Enough said.

One final point that I always like to talk about when it comes to TXP is the tiny “future development capital” (aka FDC) associated with this reserves estimate. Again, focusing on the 2P (Best Estimate) case, the FDC for Cascadura is only $15.8 million. What that means is that if you put another $15.8 million into drilling development wells (recall that TXP is just 3km from pipe and that it appears that NGC will pay the tie-in costs), you get out a net before tax NPV10 of $519 million. Undiscounted, the net 2P before tax cash flow is $970 million. This is from an incremental investment of less than $16 million. Now, the tax rate in Trinidad is high, so before tax numbers aren’t what you want to hang your hat on, but I think I’ve illustrated my point. This is a situation where very little capital needs to go into the ground to unlock a huge cash flow stream. This is the “wall of cash” that CEO Paul Baay keeps referring to in his interviews. If you’ve ever wanted to understand the concept of free cash flow, TXP is a pretty good example. The cash set to come at them literally dwarfs the capital requirements needed to get it out of the ground and to market. I think that’s a very important distinction when it comes to understanding Touchstone. Holders of a stock like Canacol Energy (CNE.TO, last at $3.76) in Colombia will remember how long, and how much money, it took to get that company’s gas onstream… TXP has the potential to be like CNE on super-fast-forward. I like the set-up here a lot.

I’m out of time, so I’ll just quote a couple of lines from the TXP press release below. It’s a good day for TXP holders and a good day for Cascadura. Here’s hoping for more of those ahead.

Cascadura Reserves Report Highlights

Gross Discovered Petroleum Initially-in-Place (“DPIIP”) is estimated to be between 571.5 Bcf of natural gas in the High Estimate and 241.2 Bcf in the Low Estimate, with a Best Estimate of 398.5 Bcf. Company working interest 3P reserves of 73,190 Mboe (85% recovery of High Estimate DPIIP), 2P reserves of 45,030 Mboe (75% recovery of Best Estimate DPIIP), and 1P reserves of 23,622 Mboe (65% recovery of the Low Estimate DPIIP). Net peak production is estimated to be 22,600 boe/d in the 3P forecast, 15,108 boe/d in the 2P forecast, and 10,266 boe/d in the 1P forecast. Estimated before tax 3P 10% discounted net present value of future net revenues (“NPV10”) of $802.9 million, 2P NPV10 of $519.2 million, and 1P NPV10 of $287.7 million. Net future development costs associated with the development of the Cascadura Assessment Area is estimated at $11.6 million for 1P reserves and $15.8 million for both 2P and 3P reserves. 

James Shipka, Chief Operating Officer, commented:
“GLJ’s independent evaluation of the Cascadura-1ST1 production test results and the subsequent reserves evaluation of the Cascadura Assessment Area confirms the tremendous potential of the Ortoire exploration block. The Cascadura Reserves Report combines both the pressure and flow testing of the Cascadura-1ST1 well with the 3D seismic data which covers the entirety of the Cascadura structure as we now understand it. The team is currently working hard to design the facilities and infrastructure required to bring the Cascadura gas and liquids to market as quickly as possible, and with GLJ estimating there is in excess of 500 Bcf of discovered natural gas in place in the Cascadura area, it is evident that we have a clear pathway to a multi-year development program.”