Disclosure: The following represents my opinions only. I am long TAO.V (Image credit to NASA)
In outer space, a star is born when a giant cloud of gas and dust collapses under its own gravity. Eventually enough matter, heat, and pressure builds up in the centre of a collapsing disc that hydrogen fusion begins, after which the newly-born star blows away the remaining dust, perhaps to become a point of light in someone’s night sky. If you think about it, that’s not totally unlike the process of a micro/small cap company making the transition from the market fringe to the mainstream. Once in a while, years of relationships, data, persistence, and a touch of serendipity coalesce to make a new story worthy of broader market attention; and I think that’s what I’m witnessing today with Tag Oil’s (TAO.V, last at $0.75) update from its first frack within the Abu Roash F (ARF) formation in Egypt’s Western Desert.
TAO’s proof-of-concept BED 1-7 well has delivered a choked-back stabilized production rate of 140 bopd, a rate which the company’s engineers believe will allow for maximum oil recovery under optimal flowing conditions (at 140 bopd there is a significant fluid column above the ESP). To be clear, TAO could’ve pulled harder on this well if they wanted to, but the BED 1-7 well test is about getting real flow data that can actually be extrapolated to the upcoming horizontal well. The fact that the well is stable at 140 bopd after a month of production suggests that the ARF is indeed acting like its American cousin; the venerable Eagle Ford shale. That is some good company. The Eagle Ford is one of the most profitable oil plays in North America and remains the focus of many of the leading companies in the industry. Heck, even Berkshire’s Charlie Munger grudgingly appreciates the economics of the Eagle Ford. For reference, if you did a single vertical frack in the oil-prone region of the Eagle Ford shale, you might expect an initial production rate similar to what TAO just reported today (in Canada’s Montney, you might get 50-100 bopd). In other words, the test rate reported today from the single frack at the BED 1-7 well is more than enough to extrapolate some eye-catching flow rates in the 15-20 stage horizontal well that will soon follow — which is exactly why I’m willing to bet that TAO will shine even brighter in the months and years ahead.
As of Friday’s close, TAO’s market cap was about US$88 million. When RPS Energy did its resource report on the Abu Roash F formation within TAO’s Badr concession back in November — where TAO has a 100% operated interest — the firm calculated an unrisked after-tax NPV10 of US$423 million based on 20 well locations (with an impressive NPV to capex ratio of 4:1). In recent presentations, TAO management has said that they believe there are at least 40-60 well locations already on the table at Badr (i.e., 2-3x what is in the RPS report), with the potential for even more locations on unevaluated lands where there is less data. Re-read the prior two sentences and let them sink in a bit — the RPS report is just a starting point. RPS modelled a horizontal well as recovering around 1.5 million barrels (unrisked, mid-case), which implies development costs of about US$4-5/barrel (remember that the capex here is just drilling and completion costs, plus a small incremental cost for tie-in to existing infrastructure). Opex is modelled to be around US$6/barrel over the life of the project — this is low cost oil. TAO’s fiscal terms at Badr are attractive given its early-mover status in the ARF play and, as a result, after-tax netbacks are expected to be strong, coming in at around US$30-35/barrel at US$70-75 Brent (Brent crude is US$76.60 right now). Wells would be expected to pay out in months at current oil prices. Bottom line, the ARF looks really good on paper… and the first-month of flow data from the BED 1-7 test, which is the first frack ever in this horizon, means that the RPS report — and the economic analysis within it — isn’t just a fantasy. Drilling of the first horizontal well is expected to start in late July (TAO announced that a rig has been secured) with results in September or October, and if the horizontal delivers as expected, I think that’s when the broader market will really take notice of the story. Right now, you have to be looking in the right place at the right time to notice TAO, but drop a four-digit flow rate on the newswire, with 40-60+ locations in inventory, and sunglasses will be in order. If it’s not already clear from what I’ve said above, I think TAO can multi-bag from here with a little patience.
To me, this is the definition of an inflection point in a junior resource development story. Like gravity, the data is all pulling towards a single conclusion — that horizontal wells in TAO’s Abu Roash F should be highly economic. With 15-20 fracks planned in TAO’s first horizontal (maybe a little more or less depending on the prevalence of natural fractures along the horizontal leg), TAO is setting up for “ignition” when that well test hits the wire. It’s easy for the market to ignore a company reporting a circa 150 bopd flow rate in an international play it has never heard of; but if TAO reports a flow rate in the low thousands of barrels per day (maybe 1200-2000+ bopd?) I think the market will wake up in a hurry. The modelled short payouts and ample spare transportation capacity (about 15,000 bopd) mean that the project would be expected to become self-funding quite quickly, and, while there’s the standard operational risk for future wells, the path forward is not hard to imagine here.
In short, TAO’s Badr oil project is in the process of transitioning from proof-of-concept to actual development; within a rich source rock that is both frackable and areally extensive, just like the unconventional plays that we know so well here in North America. Markets go up and markets go down — and so do oil prices — but for me, this is an event-driven “alpha” situation. History has taught me that when a company like TAO is creating/unlocking value that wasn’t there before — in this case by deploying North American unconventional development technology in a new target formation abroad — that company can substantially outperform both its peers and the market. I saw exactly that with Mr. Badwi’s Rally Energy through the years 2005 to 2007. Back then, Rally had identified the old, overlooked Issaran heavy oilfield in Egypt as a candidate for enhanced oil recovery using cyclic-steam stimulation (CSS) and the company’s early tests showed that its plan to deploy the technology in the field was working. I watched Rally’s reported 2P reserves go from 11 million barrels, to 45 million barrels, and to 92 million barrels in the years 2005, 2006, and 2007 respectively. Oil swung wildly over that time period, but the Rally chart pretty much went up and to the right until the company was bought in September of 2007 for ~CDN$900 million (Rally was valued at just CDN$100 million in July 2005, when Mr. Badwi was brought in as CEO). As they say; history seldom repeats, but often rhymes… and TAO’s proof-of-concept in terms of fracking the ARF sure smells a lot like the early days of Rally’s CSS deployment at Issaran, so here’s hoping. RPS estimates that TAO’s mid-case unrisked contingent oil resource at Badr is around 34 million barrels recoverable; and remember that’s based on 20 wells. Should that well count expand to 40-60+ the scale of the Badr project matches that of Rally, and that’s without considering any future acreage additions in the play… hmmmmm.
I’ve seen lesser companies, with lesser prospects, in far tougher jurisdictions (often with no infrastructure in place), trade for multiples of what TAO is trading at today. That makes me optimistic about what’s in store for TAO’s valuation as the company continues to execute on its plans at Badr. The theme of exporting North American unconventional resource development expertise overseas is both logical and appealing, and Egypt’s long history of hydrocarbon production makes it an ideal jurisdiction for a company like TAO to put an opportunity like this together. The ARF has shown that it fracks well, the early flow data is supportive, the modelled economics are impressive, and there’s no doubt that the oil is there. With all of that on the table, I think that TAO should start to attract a broader audience now. For those who do take the time to look through my telescope at this one, I don’t think it’s at all a stretch to say that TAO’s future is looking bright here; and while star formation is a process that doesn’t happen overnight, once it starts, it’s certainly something to behold…