Touchstone Hits More Gas while Transglobe Bags a New Deal

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The information contained herein is accurate to the best of the author’s knowledge, but the material and interpretations contained herein should be independently verified by any party using this information as part of any research, editorial, or decision making process. Any views expressed here represent the author’s opinion only, and as such readers should do their own research and come to their own conclusions if they are using the opinions contained herein as part of any larger due diligence process. The author may have long or short positions in the companies mentioned and may be buying or selling in the market depending on which way the wind is blowing at any given moment. Opinions are subject to change without notice. Prospective resources, predictions, comparisons, financial projections, and extrapolated metrics are, by their nature, subjective and interpretation dependent. The topics covered are highly speculative and involve a high degree of uncertainty and risk. Speculative companies can and do go to zero. By using this site, you agree that the author(s) and Hydra Capital is/are not responsible for any damages incurred by the use of the presented materials. Anyone reading these blog posts should know that they are the author’s thoughts and opinions, which are not to be confused with or construed as research reports.

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, POE.V, and TGL.TO

At some point, I’ll write a longer note on my broader market thoughts, but generally speaking they haven’t changed. I like materials (especially copper and nickel) and energy in pretty much all forms, with a shot of gold on the side in select stories where I think there’s value. The U.S. dollar index is under pressure and the reflation trade appears to be “on”. The market is full of liquidity these days and it’s looking through to the other side of COVID and it’s liking what it sees. Pent up demand, massive inventory restocking, infrastructure investment, and stimulative fiscal and monetary policies globally all bode well for materials and energy. It could be quite a party once the COVID cuffs come off. For those who would still poo-poo oil, my thinking on that sector is coming around to being quite bullish given the massive disconnect between energy stock valuations and the actual outlook for oil supply/demand in 2021 and beyond. If you haven’t noticed, the energy world has changed… and this time when prices are ripping higher as the world goes on a post-COVID party boat cruise, the big energy companies will be much slower to respond with supply. Things like dividends and debt repayment are now more important than production growth. Capital will be more constrained and cautious… and there’s less of it to go around because right now cash flows are still depressed. The psychological impact of what energy companies have just gone through will leave a mark on any oilman and that will keep capital budgets conservative for a while. Eventually, the whisky might start flowing and we drown ourselves in oil again, but first the boom. Anyone who’s been around oil for a while knows that the oil market is defined by boom and bust cycles, and we just went through a big bust. Like yin and yang, the boom will follow. EV’s? Yes, I know, they’re coming; but not in high enough numbers, and not soon enough in the emerging market economies that are going to rip higher on the back of a lower USD and higher commodity prices (never mind in the developed nations as economic activity ramps back up). For perspective, and I’ve said this before, the global EV fleet (every EV made to date) currently displaces around 1 million barrels per day of oil demand… that’s out of a market that is 100 times that size and has grown pretty much every year outside of ones like the one we just had. If the global EV fleet doubled next year (which it won’t, it might go up 50%), you might offset another 1 million barrels per day of demand, with no account for the existing natural demand growth in emerging economies. Given the current supply imbalance (we are cutting through OECD inventories at a good clip now), it’s looking like the world will be “obviously” behind the curve on oil production by mid-2021. The market is always looking ahead though… and if they are already ripping the cruise lines, Vegas, and airlines, how long do you think it will be until they start ripping oil again? Oil is dead? No, not yet… it’ll have one more chance to remind the world of its critical importance to our society. At least that’s my two cents on the topic…

First off, Touchstone (TXP.TO, last at $2.20) released results from its Cascadura Deep well, logging a total of 1,315 feet of pay across several zones within the Cascadura structure, including some new ones. Due the abundant high-pressure gas up-hole, the company just didn’t have the horsepower to drill to the targeted total depth, but when you have to stop drilling a hole because you’ve got too much gas pay to deal with, that’s technically not much of a problem from my vantage point. Bottom line, some more molecules were added today with much thicker pay in the well relative to the discovery well. The result doesn’t change my view much and I actually trimmed some stock today, simply from a portfolio management standpoint, as this has become a giant position for me after ringing the bell on it in May. I think that no matter what happens from here on out, TXP is on a path that ends with it either (a) being bought, or (b) generating free cash flow like crazy once the Cascadura-Chinook field is on stream. At this point I really just don’t have the information required to even ballpark where TXP sits in terms in terms of resource potential but Cascadura seems to be heading towards the higher end of the reserve report range and Chinook seems to be on the same general spectrum (i.e., “hundreds” of BCF) in terms of size potential. Chinook should be tested soon (testing is expected to start later this month) with results perhaps in late December or January, by my best guess. I’m still waiting for a gas sales agreement with NGC and to see Coho on stream, but all in good time I suppose. Royston will still be hanging out there as the next Big Target for H1 2021 (Q1?) to keep the market’s speculative juices flowing and remember that Cascadura Deep is still on the table, including the potential relationship of that deepest target to the gas pay found in the lowermost zone at Chinook (which would add even more scale). Overall, it sure seems like TXP is going to get to a TCF at Ortoire, so it’s all going to come down to commercial terms and optimal production rates to determine what it’s worth, so I really want to see those commercial terms just as much as more gas molecules at this stage… though the molecules are most welcome anytime.

Coming back to oil, I recently found myself looking for cheap oil and ending up doing some dumpster-diving with Pan Orient Energy (POE.V, last at $0.72) in Thailand and TransGlobe Energy (TGL.TO, last at $0.83) in Egypt. Both companies showed up as being absurdly cheap and I guess I was in the mood to relieve some tax loss sellers (I presume), of their stock. A win-win for all involved, right? Christmas really is the most wonderful time of year, in more ways than one.

My thesis on POE is very simple. After blowing its brains out drilling exploration wells in Indonesia (which cost me some money personally), POE has just been chipping away at its onshore oil pools in Thailand. The market cap is circa $38 million and the company has $30 million in positive working capital, meaning the market is valuing its assets at $8 million. What are the assets? A 50.01% interest in a small oil field currently doing 1,800 bopd net to POE with net 2P reserves in the 1.8 million barrel range. The net after-tax NPV5 and NPV10 of those 2P barrels is $49 and $44 million respectively. The net 3P NAV (~3.8 mmbls) has an NPVAT5-10 range of $94 million and $79 million respectively. Remember that these assets are currently valued at $8 million. Also consider that those reserves volumes and values were determined (a) before POE established that it had an active water drive in its L53-DD oil field (which helps recovery factors and thus oil reserves) and (b) before POE renegotiated its sales contracts, significantly decreasing (nearly eliminating) the company’s realized discount to Brent on its oil sales. Add in the water injection that POE says will save $2.4mm/yr in operating costs and I think POE’s NAV is going to go up in early February, after which I think there’s a good chance that POE looks to sell the asset and re-invent itself. POE has consistently sold assets in Thailand at values far in excess of what might be possible in Western Canada and I think that’s important to remember. Even if POE could get to 0.5x NAV, and assuming that I should be thinking more about something closer to their 3P 2019 numbers than their 2P, then I could see a pretty easy 50-75% of upside in POE before I have to think about its valuation again. I realize that’s not that exciting, but I’m okay with that. I think my risk-reward is highly skewed and I’ll see what happens. By February, maybe oil will be cool again. It’s a small position for me, but I like the bet.

Wow, TGL was a bit of a windfall this morning, even if it it did close on its ass (i.e., near the lows of the day for those not familiar with that lingo). I’ve followed TGL for a long time. It’s a well-established operator in Egypt and the proverbial Rodney Dangerfield of international oil stocks. The company is conservatively managed and operates very professionally given its size. It had just started paying a dividend before COVID hit. I’ve witnessed TGL go into the ditch and rise to life many times since I’ve followed it, but today something happened that I believe truly changed everything for the company. TGL has only 72.5 million shares outstanding and no less than 24.4 million of them traded hands today. That’s insane. Why the sudden interest? In two words. Contract renegotiation. TGL has talked for YEARS about the hope that one day it could consolidate its Eastern Desert oil concessions into one new concession agreement with better fiscal terms and financial incentives for more intensive development… and today they got it. Before today, TGL’s reserves were truncated/hampered by project life and economics that were prohibitive to TGL investing in enhanced recovery schemes (like waterflooding and horizontal drilling in existing fields). There are huge volumes of oil in place (OOIP) on TGL’s lands, so increasing the recovery factor on those barrels yields big volumes of reserve potential without having to go looking for it. To that end, TGL flagged some 59 million barrels of contingent resources that it will now consider for potential development under its new concession agreement. Of those 59 million barrels that this new agreement puts into play, the company has already technically matured 20.5 million barrels to development-pending status, which I believe should translate into their reserves once the new concession agreement is ratified. Keep in mind that brownfield development/modernization is a huge push in Egypt right now, so this is a win-win for all involved. Also keep in mind that TGL’s Egyptian reserves in these concessions before today was 26.3 million barrels; so calling this deal transformational would not be an overstatement of its significance. You know what else is transformational? The fiscal terms. The estimated impact on netbacks is significant. At $40, $50, and $60 Brent, corporate netbacks are set to increase by US$5-7, US$7-9, and US$9-11 per barrel respectively. That’s on top of prior netbacks of US$2.50, US$6.10, and US$8.30 per barrel at those same price levels, resulting in “new” netbacks of US$7.50-9.50, US$13.10-15.10, and US$17.30-$19.30 per barrel at $40-50-60 Brent (Brent is currently over $48/barrel, with some bold forecasters calling for $60 in H2 2021). Those netback numbers sure seem better, right? Oh, and this deal is retroactive to February 2020, which means that TGL should (may?) be able to offset the $15mm upfront bonus payment, at least partially, through higher netbacks on the oil it has already sold over the last 9 months (that’s an interpretation on my part, though not integral to the case I’m making here). In the following 5 years, TGL is to pay the Egyptian government $10 million per year as part of the contract renegotiation. It’s an elegant way of letting both players split the much bigger pie that results as a product of the new deal. At current production rates, the cash-flow impact of those bonus payments is about $2.50/barrel, but I expect production rates to go up by at least 30% in the next year, so that $2.50/barrel probably drops to less than $2/barrel in short order. When you stack it all up, it looks like a very good deal and my bet is that it’ll show up big-time in the updated reserves values when they come. So what’s it worth? TGL has 72.5 million shares out and an enterprise value (EV) of about CDN$42 million (US$32 million) at its closing price today, so I’m simply going to say that I think it’s worth quite a bit more. I’ve ignored the company’s Canadian assets, which are not worth zero by a long shot (especially South Harmattan), because I just don’t have the time to dissect them right here and right now. If I assume Egyptian volumes increase to 14,500 bopd, which I don’t think is even remotely a stretch, and run it at $60 oil, I get little giddy with the numbers, but they’re too preliminary to print. I may be missing something in my cursory review, but on the back of today’s news, TGL now looks like one of the cheapest oil stocks that I’ve come across in recent memory (and I thought it was cheap before the news). Keep in mind that my view is very preliminary here, but I’m trying to get a handle on this so that I can prepare-to-compare my thinking with what the analysts say about it tomorrow; or perhaps I should say, analyst. Charlie Sharp at Canaccord U.K. is the only one covering the story that I know of, so I hope to see a note out of him tomorrow, or early next week, once he’s had a chance to run this through a proper model.

That’s a long note for something that was supposed to be quick. Happy hunting.