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Ready to exploit Colombian tightening gas market

Canacol Energy 13 January 2021 Outlook
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Canacol Energy

Operations update and outlook

Oil & gas

13 January 2021

Price

C$3.69

Market cap

C$666m

C$1.36/US$

Net debt (US$m) at 30 September 2020

329

Shares in issue

180.6m

Free float

67%

Code

CNE

Primary exchange

TSX

Secondary exchange

BVC

Share price performance

%

1m

3m

12m

Abs

(9.8)

7.9

(18.0)

Rel (local)

(12.0)

(0.6)

(21.4)

52-week high/low

C$4.63

C$2.82

Business description

Canacol Energy is a natural gas exploration and production company primarily focused on Colombia.

Next events

2020 drill programme

Ongoing

Analysts

Ian McLelland

+44 (0)20 3077 5756

Elaine Reynolds

+44 (0)20 3077 5713

Canacol Energy is a research client of Edison Investment Research Limited

As we look across the E&P investment universe, few companies potentially offer greater asymmetric risk/reward upside compared with Canacol. The company is playing into a tightening Colombian gas market, which should continue to support favourable pricing and longer-term growth plans. However, even with existing pipeline infrastructure and a conservative outlook on exploration and appraisal success, our 2P + risked exploration base case valuation of C$5.87/share represents 59% upside to the current share price, while the downside is protected through existing take-or-pay contracts that suggest a low case based on 2021 take-or-pay contracted capacity (153mmscfd) of C$3.50/share. Under our current assumptions, which include Canacol’s dividend equivalent to a 5.7% yield, we anticipate planned capex and cash dividends to be covered by the company’s existing cash and cash generation.

Ready to exploit Colombian tightening gas market

Year-end

Revenue* (US$m)

Adj EBITDAX**
(US$m)

Cash from operations (US$m)

Net debt***
(US$m)

Capex****
(US$m)

Yield
(%)

12/18

204.5

138.6

94.0

288.1

(75.5)

N/A

12/19

219.5

162.8

108.4

300.3

(84.3)

1.4

12/20e

234.3

195.1

180.1

286.2

(108.0)

5.7

12/21e

228.4

187.2

156.3

307.2

(119.0)

5.7

Note: *Revenue net of transport expense and royalty. **Adjusted EBITDAX is before non-recurring or non-cash charges and exploration expense. ***Cash and equivalents minus short- and long-term debt. ****Forecasts based on 2P production profile.

Focus on exploration to support RLI

With sufficient gas export capacity now in place to support our base case valuation, Canacol’s focus is on converting its 4.7tcf of net unrisked prospective resource into reserves, and in so doing extending the production plateau and supporting a company target reserve life index (RLI) of eight years. 2021 exploration capex will be the largest in Canacol’s history.

Exploration programme and dividend fully covered

With our end-FY20 net debt forecast of 1.6x EBITDA, Canacol is positioned to progress with its 2021 exploration programme in addition to shareholder returns. Under our base case scenario, the recently announced US$98–140m investment and the US$28m dividend are covered by existing cash and cash generation for the coming years. We anticipate that from 2022 free cash flow (FCF) will cover cash dividends. However, in 2021, the company will have to resort to existing cash.

Valuation: RENAV at C$5.87/share

Our base case valuation stands at C$5.87/share and assumes the world will return to normal in 2022, with gas sales resuming to pre-COVID-19 levels. With fixed gas prices for the medium term and 624bcf 2P reserves, the downside exposure to this valuation is limited to exploration success and decreased gas demand. In a scenario where exploration adds zero value, core NAV stands at C$3.62/share. Conversely, utilising existing infrastructure to the maximum suggests an unrisked upside valuation of C$7.78/share, while the expansion case currently being progressed could increase the upside valuation to C$9.17/share.

Investment summary

Supporting Colombia gas market as national supply diminishes

Canacol offers investors a pure play on the Colombian natural gas market, a market expected to move into gas deficit in 2024 in the absence of LNG imports. Canacol is a key component of national demand, currently holding a c 20% market share. High exploration and appraisal success rates (historically above 80%) and c 4.7tcf of unrisked prospective resource should enable RLI expansion. Low well costs at less than US$5m, excellent reservoir quality and high unconstrained flow rates combined with largely fixed gas pricing (we estimate a realised price post-transport of US$4.39/mcf for FY21) contribute to a company that has material FCF generation potential after investment in new well inventory and shareholder returns.

Valuation: Prospective value in addition to 2P reserves

Canacol currently trades at a c 31% discount to our 2P NAV, with the market only ascribing full value to its 2P reserves but not to the risked prospective resource. Our risked NAV of C$5.87/share (C$6.57/share using a 10% WACC relative to our base case 12.5%) includes an estimated five-year exploration drilling programme with 800bcf unrisked prospective resource and assumes a post-3D commercial success rate of 45%. We also look at valuation scenarios based on a sustained 235mmscfd and 345mmscfd plateau, which stand at C$7.78/share and C$9.17/share respectively. Since January 2020, Canacol’s share price has decreased by c 13%, while its peer group of North American E&Ps with South American operations has declined by 52%. We believe Canacol’s outperformance relative to its peers is due to its limited exposure to downside and current commodity price volatility, its low levels of debt and high netbacks.

Financials: Fixed-price gas contracts provide visibility of FCF

Canacol sells c 80% of its gas based on fixed-price contracts, with realisations forecast to average c US$4.50/mcf post-transport in FY20. This leads to an Edison estimated EBITDAX of c US$195m for the year. After maintenance capital required to replenish and grow Canacol’s reserve base and shareholder returns in line with the new policy of a quarterly dividend of US$7m, we believe management will direct capital to growth opportunities through the drill bit and debt reduction. Under our base case scenario, we estimate that Canacol will have enough cash to cover 2021 planned activities and the drilling programme, as wells as to reduce its debt by US$12m and pay a yearly dividend of US$28m. However, the dividend would not be fully covered by FCF in 2021, with Canacol having to resort to its existing cash. For the future years, once natural gas demand returns to pre-COVID levels, we estimate the dividend to be fully covered by FCF. Canacol expects a decrease in net debt/EBTIDA in the coming years. We estimate FY21 net debt/EBITDA at 1.7x, in line with company expectations.

Risks and sensitivities

We see the key risk as infrastructure access. Canacol is reliant on Promigas pipeline infrastructure to transport its gas to end-users. While an unforeseeable event limiting gas transport capacity would have a material impact on cash flows, this is mitigated by the fact that pipeline availability has been in excess of 95% since operations began and through comprehensive business insurance. Other key risks include Colombian geopolitical risk and exploration success rates. A minor valuation uncertainty includes unit operating expense. In the short term, rising production over a predominantly fixed cost base should ensure unit opex falls. This is likely to be offset by higher unit royalty rates as production shifts to higher royalty paying licences such as VIM-5.

Colombia proving to be a resilient economy

According to the World Bank, Colombia’s economy is the fourth largest in Latin America, as measured by gross domestic product, behind Brazil, Mexico and Argentina. The country has experienced unprecedented growth over the last decade. Petroleum is Colombia's main export, accounting for more than 45% of its exports. Industries like shipbuilding, electronics, automobile, tourism, construction and mining have grown dramatically over the past 20 years. However, most of Colombia's exports are still commodity based.

Foreign investment in Colombia has become a major catalyst for its economic development. In 2019, foreign direct investment inflows increased by 26% to US$14bn, with c 32% invested in the oil and mining industries, while 21% was allocated to financial and professional services and 11% to manufacturing. 2020 was expected to be a turning point for the oil industry, with an increase in investment of more than 20%. However, this target is now unlikely to be met, given the current oil price as a consequence of the impact of COVID-19 on demand. Nonetheless, the Colombian government remains committed to the continuing development of private enterprises.

COVID-19 has triggered the deepest global recession in decades and the outcome remains uncertain. The World Bank’s June 2020 forecast envisions a 5.2% contraction in the global economy in 2020 and estimated that economic activity in Latin America will plunge by 7.2% in 2020 as commodity prices deteriorate, with all economies contracting with the exception of Guyana, where the offshore oil industry is developing rapidly. Colombia’s economy is expected to contract less than its neighbours at -4.9%. The Colombian government announced a sizeable fiscal package of c US$3.7bn to provide additional resources for the health system, and subsequently provided fiscal support to businesses, including the deferral of tax collection in selected sectors, lower tariffs for strategic health imports, and special lines of credit and loan guarantees for firms in selected sectors or those that have been severely affected by the crisis.

Colombia has a track record of prudent macroeconomic and fiscal management, evidenced by uninterrupted economic growth since 2000. The country’s economy is proving resilient even during the pandemic and government policies continue to emphasise the development of private businesses and the implementation of best economic and social practices to attract overseas investment in Colombia. This made it possible for the country to join the Organisation for Economic Co-operation and Development (OECD) in April 2020. Prior to the pandemic, Colombia’s progress made in competitiveness and fiscal policies, led to it attaining investment-grade ratings from Standard & Poor’s, Moody's and Fitch.

Exhibit 1: Colombia’s GDP since 2020

Exhibit 2: Year-on-year GDP percent change

Source: World Bank, Edison Investment Research

Source: World Bank, Edison Investment Research

Exhibit 1: Colombia’s GDP since 2020

Source: World Bank, Edison Investment Research

Exhibit 2: Year-on-year GDP percent change

Source: World Bank, Edison Investment Research

The World Bank expects a rebound in Colombia’s economy in 2021–22, provided the pandemic is short-lived. The low interest rate environment, facilitated by the central bank, is expected to boost growth in private consumption to the extent that COVID-19 containment measures can be eased. It is also expected to facilitate a gradual rebound in investment as major infrastructure projects resume.

Natural gas as part of Colombia’s energy transition strategy

Historically, Colombia’s energy mix has been dominated by coal and oil, with a combined share of c 75%, with the balance coming from hydroelectricity, natural gas and non-conventional sources of renewable energy such as biofuels and firewood. However, the country has been working to establish a modern regulatory, institutional and market framework to diversify its energy matrix. The president of the oil and gas regulatory agency, Agencia Nacional de Hidrocarburos (ANH), Armando Zamora, believes natural gas has a key role to play in Colombia’s energy security and in its energy transition, as the country aspires to reduce emissions by 20–30% by 2030, with natural gas contributing c 20% to the energy mix by 2050 under Unidad de Planeación Minero Energética’s (UPME) ‘Nuevas Apuestas’ scenario. The scenario is in line with Paris Agreement targets.

In 2020, Colombia registered substantial progress in energy transition, ranking 25th (34th in 2019) among a total of 115 countries, according to the Energy Transition Index carried out by the World Economic Forum. The Energy Transition Index also highlights that Colombia is classified as being one of the leading countries as it has a well-functioning energy system and high preparedness for transition, the two main components that the measurement evaluates.

Exhibit 3: Colombia energy mix

Source: IEA, Edison Investment Research

Over the past decade, Colombia produced c 1,000mmscfd, with maximum production registered in August 2013 at c 1,200mmscfd. In 2016 and 2017, gas consumption was reduced due to higher hydrological inputs to the national electricity system, but picked up again in 2018.

Colombia’s natural gas production used to be mainly located in the Caribbean coast from La Guajira. However, these fields have been diminishing their contributions. As can be seen in Exhibit 4 below, the fields of Los Llanos and Valle Inferior del Magdalena (VIM), where Canacol’s fields are located, have been increasing their contributions in recent years, while those of La Guajira are gradually declining.

Exhibit 4: Evolution of the national natural gas supply in recent years by basin

Source: UPME, Edison Investment Research

According to the most recent reserves information provided by the ANH, as of 31 December 2019 Colombia’s natural gas 2P reserves stood at 3.8tcf. Reserves have been gradually decreasing since 2012 and the ANH estimated a reserve life index for the country of 9.6 years from the end of 2019 (on a 2P basis). Around 60% of these reserves are located in the Llanos Orientales basin, followed by VIM and La Guajira.

Exhibit 5: Colombia 1P and 2P reserves

Exhibit 6: Colombia year-end 2018 reserves per basin

Source: UPME, Edison Investment Research

Source: UPME, Edison Investment Research

Exhibit 5: Colombia 1P and 2P reserves

Source: UPME, Edison Investment Research

Exhibit 6: Colombia year-end 2018 reserves per basin

Source: UPME, Edison Investment Research

Natural gas demand steadily increasing

Colombia’s electric energy mix is made up of hydrogeneration (c 77%) and thermos-generation plants, with the system heavily reliant on rainfall for electricity generation. Hence, natural gas demand in Colombia is directly affected by natural phenomena such as El Niño. El Niño refers to atmospheric events related to the warming of the sea in the central-eastern area of the Pacific Ocean. During an El Niño event, the surface waters in the central and eastern Pacific Ocean become significantly warmer and the usually dry regions of Peru, Chile, Mexico and the south-western US experience rain and snow. However, the wetter regions of the Brazilian Amazon, Colombia and the north-eastern US plunge into months of long droughts. The 2015–16 drought led to rainfall dropping by 40% in Colombia, leading to severe hydrological drought, which persisted until March 2016. Climatic variabilities determine the reliability of the national supply of electricity and, consequently, of the demand for natural gas. Because Colombia’s natural gas demand can be sensitive to El Niño, ANH takes this into consideration and fluctuations can be observed in its forecasts.

Exhibit 7: Colombia natural gas demand

Source: UPME, Edison Investment Research

We highlight that Exhibit 7 above was based on estimated demand prior to COVID-19 and the pandemic impacts on natural gas consumption. Based on what we observed in 2020, in the event the pandemic persists, a decrease in demand is expected in the near term as countries’ economic activity remains constricted by lockdowns.

Colombia moving towards deficit in natural gas supply

The supply-demand balance of natural gas in the medium term prepared by ANH points to a national level deficit of natural gas in 2024.

Exhibit 8 below presents production in 2019–25e and the country’s projection of demand as published by the Ministry of Mines and Energy. In this scenario, the country could move into deficit from 2024, although these forecasts and the timing of the expected deficit are subject to variations from unpredictable events, such as El Niño.

Exhibit 8: Colombia’s natural gas supply and demand

Source: UPME, Edison Investment Research

In its efforts to avoid what could be an imminent gas deficit crisis, the Colombian government has been studying a range of solutions, with LNG imports at the top of the list. The government commissioned its first LNG terminal on its Caribbean coast in December 2016. This is a floating storage and regasification unit (FSRU) located in Baru, and the government is now studying the option for a second facility in the Pacific. This would provide flexibility of import sources (eg cargoes from the US can serve the Caribbean terminal while a Pacific coast terminal could, for example, receive cargoes from Peru). On 30 June 2020, UPME relaunched a bidding process to design, construct and operate a new LNG facility and a pipeline in Buenaventura, on the Colombian Pacific Coast. However, imported natural gas comes at a cost, traditionally indexed to US Henry Hub pricing. We estimate that a landed cost of US$5.0–6.0/mcf at Cartagena based on a Henry Hub price of US$3.00/mcf would be achievable, for example if we were to adjust Japan spot LNG prices for transport from the US to Colombia (rather than Japan).

Exhibit 9: LNG pricing versus Canacol realised price post transport

Source: Edison Investment Research. Note: *Adjusted for shipping costs to Colombia rather than Japan.

In Exhibit 9, we can observe that in 2020 LNG prices were depressed globally and were lower than Canacol realised prices. However, this reflected the oversupply of LNG when most economies were in lockdown due to COVID-19. Henry Hub and LNG prices have since recovered to pre-pandemic levels, helped by some bounce back from the pandemic and also by seasonal winter demand. Higher LNG prices are expected in the future as a normalisation of demand from LNG offtakers is observed and production of US-associated natural gas declines with lower oil production, resulting in higher Henry Hub gas prices.

Canacol sells gas under fixed-price gas contracts, from one to 10 years duration with long-term contracts typically of five- to 10-year duration, including inflation clauses. Based on current contracted volumes, our forecasts for average realisations (post-transport) are shown in Exhibit 10 below. These are based on company guidance and as provided in Canacol’s last published reserve report. This forms the basis of our medium-term price forecasts for Canacol, beyond which we use US$5.50/mcf and 2.5% inflation.

Exhibit 10: Canacol contracted gas prices – FY19 reserve report

Five-year gas price forecast

2020

2021

2022

2023

2024

Canacol 2019 reserve report (US$/mmBtu)

5.38

5.56

5.84

6.16

7.59

Edison forecasts (US$/mcf)

4.50

4.39

4.61

4.73

4.85

Source: Canacol Energy, Edison Investment Research

Colombia’s largest independent natural gas producer

Canacol Energy was launched as a private company in February 2008, initially involved in the exploration of oil assets onshore Colombia with the Capella field discovery and acquisition of the Rancho Hermoso Field in the Llanos basin. The acquisition of Shona Energy in December 2012 provided a gas leg to Canacol, leading to a series of successful gas discoveries in the Lower Magdalena, Colombia. Continued consolidation of gas assets, exploration success and licence awards enabled Canacol to amass a leading onshore position in the basin, making the company a key supplier of gas along the Caribbean coast. Canacol’s year-end 2019 2P reserve base of 624bcf equates to an RLI of 8.0 years based on gas sales of 215mmscfd (current installed export capacity). While current contracts are typically five to 10 years in duration and underpinned by existing reserves, Canacol is looking to add to its reserve base to provide the basis for expanding production capacity and extending existing gas contracts.

Exhibit 11: Canacol 2P gas reserve growth (bcf)

Source: Edison Investment Research, Canacol Energy

Positioned for growth

Canacol holds a large resource base covering eight blocks and 1.4m acres and has consistently used best-in-class technology to de-risk its resource potential. The company holds gross unrisked mean prospective resources of 4.7tcf (independently assessed in an audit carried out by Gaffney, Cline & Associates (GCA) in 2020), and has set itself a target of maintaining its 2P reserves life for more than eight years and to have at least a 200% reserve replacement ratio. To achieve this, the company has a conveyor belt strategy to steadily drill 162 individual prospects and leads to convert resources to reserves. This strategy is driven by an exploration and appraisal drilling success rate of more than 80%, which is underpinned by Canacol’s use of Amplitude Versus Offset (AVO) analysis of 3D seismic data.

Exhibit 12: Canacol acreage

Source: Canacol Energy

In late 2019, Canacol expanded its existing acreage in the Lower Magdalena Valley with the award of the conventional exploration contract VIM-33, while also establishing a new core area in the Middle Magdalena valley with the award of two blocks, VMM-45 and VMM-49. All the blocks were awarded at a 100% operated interest and have increased the company’s acreage by 29% to 1.4m net acres. The extension into the Middle Magdalena Valley will allow Canacol to continue successfully exploring to replace declining production from the mature fields of the Llanos basin. The GCA audit included the prospective resources across these new blocks.

VIM-33 sits more than 100km to the east of the company’s current producing area. It covers an area of 155,310 acres and will require the acquisition of 62km2 of 3D seismic and one exploration well during the three-year Phase 1 of the contract. VMM-45 covers 12,442 acres and requires geological studies to be carried out and one exploration well, while VMM-49 requires the acquisition of 200km2 of 3D seismic and three exploration wells.

2020 drilling programme continuing successfully into 2021

Canacol started 2020 aiming to drill 12 wells. However, with COVID-19 restrictions this was paired back to eight wells, as shown in Exhibit 13. Six of these wells were drilled with two being carried over into 2021, namely Siku-1 and Flauta-1.

Exhibit 13: 2020 wells

Well

Well-type

Rig Pioneer 53

Nelson-14*

Development

Clarinete-5*

Development

Pandereta-8*

Development

Pandereta-4*

Appraisal

Siku-1**

Exploration

Rig Pioneer 302

Porro Norte-1*

Exploration

Fresa-1*

Exploration

Flauta-1**

Exploration

Source: Canacol Energy. Note: *Wells drilled/underway. **To be drilled in 2021.

The Nelson-14 and Clarinete-5 2020 development wells were completed and tied into production and, after a delay due to the COVID-19 outbreak, the Pandereta-8 development well was tied into the manifold, ready for production, having tested at a final rate of 15.3mmscfd. The first exploration well in the 2020 programme, Porro Norte-1, is currently suspended, waiting to be tested. Pandereta-4 and Fresa-1 were drilled in late 2020, and Canacol has yet to report on the results of both these wells.

Exhibit 14: 2020 drilling locations

Source: Canacol Energy

The first exploration well of the 2020 programme, Porro Norte-1, was spudded in July 2020 by the Pioneer 302 rig and reached total depth (TD) of 11,810 ft in August. The well sits in the north of VIM-5, away from the core gas field area, and was targeting multiple stacked targets in a four-way anticline structure. The well encountered 24ft of potential gas pay within the Cicuco limestone of the Cienaga de Oro (CDO), a new play type on the VIM-5 block. The well was suspended and will be tested with a workover rig at a future date.

Exhibit 15: Porro Norte-1 map

Exhibit 16: Porro Norte-1 seismic cross section

Source: Canacol Energy

Source: Canacol Energy

Exhibit 15: Porro Norte-1 map

Source: Canacol Energy

Exhibit 16: Porro Norte-1 seismic cross section

Source: Canacol Energy

The Pioneer 53 was mobilised to drill the Pandereta-4 appraisal well in late October 2020 and was designed to target the western extension of the CDO in the Pandereta field. The well targeted CDO sandstones in a fault-dependant closure down dip and 500m laterally displaced from Pandereta-1, and investigated a significant gas show related to the fractured basement in Pandereta-1.

Exhibit 17: Pandereta-4 depth structure

Exhibit 18: Pandereta-4 seismic cross section

Source: Canacol Energy

Source: Canacol Energy

Exhibit 17: Pandereta-4 depth structure

Source: Canacol Energy

Exhibit 18: Pandereta-4 seismic cross section

Source: Canacol Energy

Fresa-1 was also drilling in October 2020. Located in VIM-21, the well was testing a fault dependent closure c 1.2km south of the Arianna field and close to the company’s Jobo facility.

Exhibit 19: Fresa-1 fluid factor extraction with intra CDO depth contours

Exhibit 20: Fresa-1 seismic cross-section

Source: Canacol Energy

Source: Canacol Energy

Exhibit 19: Fresa-1 fluid factor extraction with intra CDO depth contours

Source: Canacol Energy

Exhibit 20: Fresa-1 seismic cross-section

Source: Canacol Energy

Five wells carried into 2021

In December 2020, Canacol announced its capital guidance for 2021, which included the planned wells for the year (Exhibit 21).

Exhibit 21: 2021 planned wells

Block

Well

Well-type

Esperanza

Milano-1

Exploration

Fragata-1

Exploration

Canahuate-4

Development

Nelson-9

Development

VIM-21

Aguas Vivas-1

Exploration

Cornamusa-1

Exploration

VIM-5

Saxofon-1

Exploration

Corneta-1

Exploration

Pifano-1

Exploration

Siku-1

Exploration

Flauta-1

Exploration

Oboe-2

Development

Source: Canacol Energy

Canacol plans to drill 12 wells in 2021, the bulk of which will be exploration, with nine exploration wells and three development wells. Five wells in the programme will be carried over from the original 2020 programme as a result of COVID-19 related operational delays: Milano-1, Cornamusa-1, Oboe-2, Flauta-1 and Saxofon-1, while Siku-1 was added to the programme in September 2020 and has also been shifted into 2021. The company estimates that this programme will cost c US$66m. A further US$23.5m has been identified for the testing and tie-in of successful exploration wells.

Canacol also plans to carry out two large 3D seismic programmes to identify and delineate gas prospects for future exploration drilling. The Redoblante survey will acquire 469km2 across the VIM-5 exploration block, and the Mayupa survey will acquire 186km2 across the SSJN-7 exploration block.

The first wells to be drilled in the 2021 programme will be Flauta-1 and Oboe-2. The 302 rig is currently mobilising to VIM-5 to drill the Flauta-1 well, which is an analogue of Clarinete-1 and will target potentially stacked charged CDO sandstones in a three-way fault-dependent closure.

Exhibit 22: Flauta-1 fluid factor extraction superimposed with Upper CDO depth contours

Source: Canacol Energy

Meanwhile, the Pioneer 53 is currently mobilising to the Oboe-2 development well. Both Flauta-1 and Oboe-2 are expected to spud in the third week of January. The company intends to keep the Pioneer 53 and 302 rigs under contract throughout 2021 in order to deliver the 2021 programme.

Siku-1 will target the CDO in an undrilled fault north of the Clarinete field and east of the Oboe field.

Exhibit 23: Siku-1 fluid factor extraction at Lower Attic

Exhibit 24: Siku-1 seismic cross-section

Source: Canacol Energy

Source: Canacol Energy

Exhibit 23: Siku-1 fluid factor extraction at Lower Attic

Source: Canacol Energy

Exhibit 24: Siku-1 seismic cross-section

Source: Canacol Energy

Management

Charle Gamba – president & CEO: Mr Gamba founded Canacol Energy in 2008. He has held a variety of technical and management roles with major and mid-sized international oil companies, with the majority of his professional career focused on E&P in South America. Prior to creating Canacol, Mr Gamba was vice president of exploration for Occidental Oil & Gas based in Bogota, Colombia. In his eight years with Occidental, he lived and worked in Ecuador, Qatar, Colombia and the US, working in a variety of technical and management roles. He has also worked for Alberta Energy Company in Argentina and Ecuador, and for Canadian Occidental in Australia, Canada, and Indonesia. He started his career as a geologist with Imperial Oil in Calgary, and holds an MSc and PhD in geology.

Jason Bednar – CFO: Mr Bednar is a chartered accountant with more than 18 years of direct professional experience in the financial and regulatory management of oil and gas companies listed on the Toronto Stock Exchange, TSX Venture Exchange and the US Stock Exchange. He has been the CFO of several international oil and gas exploration companies, most notably the founding chief financial officer of Pan Orient Energy Corp, a South-East Asian exploration company which, during his tenure, grew organically to operate 15,000bbl/d and reached a market cap of C$700m. He has previously sat on the board of directors of several internationally focused E&P companies, including as past chairman of Gallic Energy. Mr Bednar began his career in the chartered accountancy firm of Brown Smith Owen in 1993 before moving into financial controller roles at oil production companies. He holds a Bachelor of Commerce degree from the University of Saskatchewan.

Ravi Sharma – COO: Mr Sharma joined Canacol in October 2015. He is a reservoir engineer with 30 years of oil and natural gas experience in the Americas, Middle East, Russia, Australasia and Africa. He has held progressively senior management roles at major E&P companies worldwide, most recently head of production & operations with Afren where he was responsible for production, development and operations activities in West Africa. Prior to this, he was global petroleum engineering manager for BHP Billiton Petroleum. Mr Sharma also held the position of worldwide chief reservoir engineer for Occidental Oil & Gas. He holds a BSc and MSc in mechanical engineering from the University of Alberta.

Mark Teare – SVP exploration: Mr Teare joined Canacol Energy in early 2009. Previously, he was at AEC International and EnCana where he held a series of senior management positions in Ecuador and Brazil. Over his 30-year career, he has had extensive experience with a number of senior international Canadian energy companies operating in North America, South America and Australasia. He holds an MSc in geology.

Sensitivities

Generic sector risks are as follows:

Commodity price: as with all companies operating in the upstream oil and gas sector, returns are driven by underlying commodity prices. Canacol is not immune, with the bulk of the company’s gas sales leveraged to contracted gas prices. Over 80% of gas is currently contracted, with average pricing after transport of c US$4.50/mcf.

Supply chain: upstream project returns are driven by a combination of commodity price, project operating and capital costs and fiscal regimes. An important consideration is the availability and cost of equipment and personnel.

Political: risks are largely specific to the country of operation. The Colombian oil industry continues to be affected by pipeline attacks, with reports suggesting that 71 attacks occurred on oil pipelines in 2019. The 770km Caño Limon is a top target for bombings and has suffered several attacks this year, according to Ecopetrol. In most instances, operators find alternative routes for production and exports. Gas pipeline attacks appear to be far less common, and Canacol has not experienced any outages due to such events.

Company-specific risks are as follows:

Fiscal/country risk: Canacol’s operations are geographically concentrated. On a standalone basis, the company is exposed to changes in fiscal terms and perceived country risk. Fiscal terms are viewed as compelling relative to other comparable jurisdictions, with low royalty rates and tax offsets.

Geological: Canacol is focused on a proven basin with proven play types and high historical exploration and appraisal success rates across its core area (VIM-21, VIM-5, Esperanza and SSJN-7, VIM-19, VIM-33). Geological risk is typical of an exploration-biased independent E&P, but reduced through the company’s historical success and ability to tie AVO anomalies to gas-bearing sands.

Financial: Canacol is well financed with Edison-estimated net debt of US$287m at end FY20 and net debt/EBITDA of 1.6x. Forecast net debt is expected to fall as the company generates FCF from higher gas sales. Fitch rates Canacol’s senior secured bonds at BB- and Moody’s at B1.

Major shareholders: Cavengas has a c 18.1% stake in Canacol Energy, which is represented by two board seats. Canacol sees Cavengas as a long-term shareholder with which it has a close working relationship. The second major shareholder of Canacol is Fourth Sail Capital with c 16.6% participation.

Valuation

In this section, we look at three DCF-based valuation scenarios. Our 2P valuation incorporates discounted cash flows reflecting the monetisation of Canacol’s existing reserve base, adjusting for overheads, net debt and decommissioning provisions, to arrive at a NAV. We also look at two additional valuation scenarios that include incremental reserves over and above 2P. Here we include ‘maintenance’ capex (largely 3D seismic, exploration and development wells and tie-in costs) required to add reserves to sustain the production plateau. Canacol guides 2021 production at 153–190mmscfd, with the low end of the range accounting for FY21 take-or-pay contracted capacity and the high end of the range assuming that interruptible gas sales improve as natural gas demand recovers from the impacts of COVID-19. We estimate FY21 gas sales at 171.5mmscfd. Canacol also provided guidance for its 2021 investment programme ranging from US$98m to US$140m, dependent on how demand for gas materialises during the year. We estimate FY21 capex at US$119m.

Our DCFs utilise a standardised discount rate of 12.5%, but we provide sensitivities to this key assumption later in this note. Key inputs for our valuation scenarios are shown in the table below.

Exhibit 25: Valuation scenarios and inputs

2P
base case

235mmscfd
sustained plateau

345mmscfd
sustained plateau

Plateau production* (mmscfd)

235

235

345

Gas monetised (bcf)

624**

1,829

1,882

Additional gas recovered above 2P (bcf)

0

1,205

1,258

Life of field average opex (US$/mcf)

(0.28)

(0.32)

(0.32)

Life of field average capex (US$/mcf)

(1.18)

(0.86)

(0.88)

Realised price post-transportation 2021*** (US$/mcf)

4.39

4.39

4.39

Source: Edison Investment Research. Note: *Production profiles provided later in this report. **2P of 624bcf at year-end 2019. ***Realised price post-transport for fixed-price contracts at US$4.50/mcf FY21. Prices escalated by 2.5% thereafter.

Exhibit 26 below shows our estimates of NAV per share, at varying scenarios, compared with the current share price. We include an additional scenario (risked exploration NAV) that adds the estimated value of risked prospective resource (800bcf risked at 45% commercial chance of success) to our 2P base case. 800bcf broadly equates to a five-year programme of around eight wells per year, with an average target size of 20bcf. We assume a 45% chance of commercial success. The market appears to be undervaluing Canacol’s 2P reserve base and its prospective resource, despite historically high exploration and appraisal (E&A) success rates, currently at 84%.

Exhibit 26: Edison valuation scenarios versus share price (base case at 12.5% WACC)

Source: Edison Investment Research. Note: Priced at 18 December 2020.

Base case: 2P valuation plus risked prospective resource

In our 2P valuation case, we use reported year-end 2019 reserves of 624bcf. Our 2P valuation assumes a relatively short production plateau of 235mmscfd sales (based on 205mmscfd of 215mmscfd maximum pipeline capacity and 30mmscfd of natural gas allocated to El Tesorito 200MW Power Plant) prior to terminal decline, assuming minimal incremental drilling beyond planned development wells and zero value for acreage and prospective resource.

Exhibit 27: Forecast 2P production profile

Exhibit 28: 2P operating cash flows

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 27: Forecast 2P production profile

Source: Edison Investment Research

Exhibit 28: 2P operating cash flows

Source: Edison Investment Research

Given Canacol’s historical exploration success rate across the Esperanza, VIM-5 and VIM-21 blocks plus acreage with a total GCA estimated unrisked prospective resource of 4.7tcf, there is material value in its ability to replace produced reserves and add to behind-pipe reserves.

Exhibit 29: Base case NAV breakdown

Recoverable reserves

Net risked value (@12.5%)

Asset

Country

Diluted WI

CoS

Gross

Net

NPV per mcf

NPV

Per share

%

%

bcf

bcf

US$/mcf

US$m

C$/share

Net debt at end 2019

(300)

(2.08)

SG&A - NPV of 5 years

(90)

(0.62)

Decommissioning provisions

(16)

(0.11)

Cash from assumed exercise of options

62

0.43

Producing assets

Esperanza

Colombia

100%

100%

195

195

1.38

270

1.87

VIM-21

Colombia

100%

100%

58

58

1.96

114

0.79

VIM-5

Colombia

100%

100%

371

371

1.30

483

3.35

Core NAV

624

624

522

3.62

Exploration/development upside

Five-year programme (800bcf gross)

Colombia

100%

45%

800

800

0.90

324

2.25

Total NAV

1,424

1,424

846

5.87

Source: Edison Investment Research. Note: Number of shares: 195.9m includes dilution from all share options.

With fixed gas prices for the medium term and 624bcf 2P reserves, downside exposure is limited to exploration success and decreased gas demand going forward. In a scenario where exploration would add zero value we reach a core valuation of C$3.62/share.

Discount rate sensitivity

A key sensitivity when considering the value of Canacol’s asset base is the discount rate, and within this, the country risk applicable to a company with 100% of cash flows from a single asset in Colombia. We have used a generic discount rate of 12.5% in our valuation. This is in line with that used for funded, cash-generative E&Ps with operations in emerging markets. We provide a sensitivity to this key input below.

Exhibit 30: 2P and risked exploration NAV sensitivity (C$/share) to WACC

WACC

8.0%

10.0%

12.5%

15.0%

2P NAV

4.98

4.32

3.62

3.04

Risked NAV (800bcf risked @ 45%)

7.22

6.57

5.87

5.29

Source: Edison Investment Research

There is potential justification for using a slightly lower discount rate based on Canacol’s current fixed coupon (bullet repayment in 2025) bond priced at 7.25%, with the company fully funded for its share of future drilling expense. Canacol is therefore not reliant on expensive sources of capital such as heavily discounted equity issues or industry capital in the form of farm-outs.

Valuation of prospective resource

GCA estimates c 4.7tcf of net unrisked prospective resource and c 1.4tcf of net risked prospective resource across Canacol’s existing acreage. Typically, for our E&P coverage, we value a company’s 2P reserve base and risk the potential of committed, funded exploration. In the case of Canacol, which has a rolling 3D seismic and E&A programme, we have included 800bcf of unrisked prospective resource (we estimate this would broadly equate to a five-year 3D seismic and drilling programme assuming an average prospect size of 20bcf) and conservatively assumed a 45% success rate. Our assumption is lower than Canacol’s six-year historical rate of over 84% and reflects the fact that prospects move further away from ‘known gas’. Our base case valuation is highly sensitive to assumptions around risked exploration potential and we therefore provide sensitivities to our key inputs below.

Exhibit 31: Risked valuation sensitivity to prospective resource assumptions C$/share

Prospective resource (bcf)

Commercial chance of success (%)

400

600

800

1,000

1,200

1,400

15%

4.00

4.19

4.37

4.56

4.75

4.94

30%

4.37

4.75

5.12

5.50

5.87

6.25

45%

4.75

5.31

5.87

6.43

7.00

7.56

60%

5.12

5.87

6.62

7.37

8.12

8.87

75%

5.50

6.43

7.37

8.31

9.24

10.18

90%

5.87

7.00

8.12

9.24

10.37

11.49

Source: Edison Investment Research

235mmscfd sustained plateau scenario: C$7.78/share

In this scenario, we assume Canacol is able to maintain an annual average rate of 235mmscfd from 2022 (based on 215mmscfd maximum pipeline capacity and 30mmscfd of natural gas allocated to El Tesorito 200MW Power Plant). We cap total recoverable gas at year-end 2019 2P reserves at 624bcf, and fully risked 1.4tcf of prospective resource (in line with GCA’s Pmean estimate). The cash flow profiles below include the cost of ongoing seismic surveys, development and exploration well costs and result in monetised volume of 1,848bcf.

Exhibit 32: 235mmscfd case production profile

Exhibit 33: 235mmscfd operating cash flows

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 32: 235mmscfd case production profile

Source: Edison Investment Research

Exhibit 33: 235mmscfd operating cash flows

Source: Edison Investment Research

For this scenario we arrive at a NAV of C$7.78/share (Exhibit 34).

Exhibit 34: 235mmscfd scenario NAV breakdown

Recoverable reserves

Net risked value (@12.5%)

Asset

Country

Diluted WI

CoS

Gross

Net

NPV per mcf

NPV

Per share

%

%

bcf

bcf

US$/mcf

US$m

C$/share

Net debt at end 2019

(300)

(2.08)

SG&A - NPV of 5 years

(90)

(0.62)

Decommissioning provisions

(16)

(0.11)

Cash from assumed exercise of options

62

0.43

Producing assets

Esperanza

Colombia

100%

100%

565

565

0.91

516

3.58

VIM-21

Colombia

100%

100%

163

163

1.22

200

1.38

VIM-5

Colombia

100%

100%

1,101

1,101

0.68

751

5.21

Core NAV

1,829

1,829

1,122

7.78

Source: Edison Investment Research. Note: Number of shares: 195.9m includes dilution from all share options.

345mmscfd sustained plateau scenario

This represents an upside case with a production plateau of 345mmscfd from 2025 (based on 315mmscfd maximum pipeline capacity and 30mmscfd of natural gas allocated to El Tesorito 200MW Power Plant). As in our base case, we use 624bcf of year-end 2019 2P reserves plus risked prospective resource additions of 1,277bcf. This scenario includes the incremental costs of 3D seismic and exploration and development well costs to sustain this higher level of output.

Exhibit 35: 345mmscfd case production profile

Exhibit 36: 345mmscfd operating cash flows

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 35: 345mmscfd case production profile

Source: Edison Investment Research

Exhibit 36: 345mmscfd operating cash flows

Source: Edison Investment Research

For this scenario we arrive at a NAV of C$9.17/share (Exhibit 37).

Exhibit 37: 345mmscfd scenario NAV breakdown

Recoverable reserves

Net risked value (@12.5%)

Asset

Country

Diluted WI

CoS

Gross

Net

NPV per mcf

NPV

Per share

%

%

bcf

bcf

US$/mcf

US$m

C$/share

Net debt at end 2019

(300)

(2.08)

SG&A - NPV of 5 years

(90)

(0.62)

Decommissioning provisions

(16)

(0.11)

Cash from assumed exercise of options

62

0.43

Producing assets

Esperanza

Colombia

100%

100%

709

709

1.14

809

5.61

VIM-21

Colombia

100%

100%

124

124

1.46

180

1.25

VIM-5

Colombia

100%

100%

1,049

1,049

0.65

677

4.70

Core NAV

1,882

1,882

1,321

9.17

Source: Edison Investment Research. Note: Number of shares: 195.9m includes dilution from all share options.

Relative valuation

Canacol currently trades at a c 37% discount to our NPV12.5 base case scenario valuation of its 2P reserve base plus prospective resources. Relative to Canacol’s peer group, the free cash flow yield in FY21e is high at 10.5%, supporting shareholder cash returns. Canacol trades at a P/CF multiple of 2.7x in FY21e, compared to its large Canadian E&P peers also 2.6x and its North American E&P peers with South American operations on 3.2x. North American E&P peers with South American operations include Frontera Energy, Gran Tierra, Parex Resources, PetroTal and GeoPark. Since January 2020, Canacol’s share price has decreased by c 21%, while its peer group of North American E&Ps with South American operations has declined by 49%.

Exhibit 38: Share price performance of Canacol and its peers since January 2020

Source: Edison Investment Research, Refinitiv. Note: Prices as at 7 January 2021.


Exhibit 39: Peer group valuation table

Market cap

(US$m)

EV

(US$m)

P/CF
FY20e
(x)

P/CF
FY21e
(x)

EV/EBITDA
FY20e
(x)

EV/EBITDA FY21e
(x)

FCF yield
FY20e
(%)

FCF yield
FY21e
(%)

Net debt/
EBITDA FY20e (x)

Net debt/
EBITDA FY21e (x)

Div yield FY20e
(%)

Production
FY20e
(kboed)

Prod growth FY20e
(%)

EV/kboed
FY20e
(US$m/kboed)

Edison estimate - Canacol

492

821

2.23

2.69

2.92

3.49

18.8%

10.5%

1.02

1.30

5.7%

41.2

94.4%

19.9

Canacol peer group

680

953

(5.05)

3.20

6.73

4.20

-8.6%

13.4%

1.62

0.77

2.6%

32.5

34.7%

31.2

Frontera Energy

680

953

(5.05)

3.20

6.73

4.20

-8.6%

13.4%

1.62

0.77

2.6%

32.5

34.7%

31.2

GeoPark

275

621

1.72

1.52

3.60

3.51

6.2%

-2.2%

0.43

0.42

12.7%

47.9

-9.0%

13.0

Gran Tierra Energy

774

1,419

5.13

5.47

7.29

6.28

-5.9%

5.7%

1.74

1.50

0.4%

40.6

1.8%

35.0

Parex Resources

151

884

2.29

1.08

11.80

4.73

-30.9%

28.7%

8.02

3.22

0.0%

22.6

25.7%

39.0

PetroTal

2,037

1,685

7.09

4.94

6.28

4.42

7.8%

10.3%

(1.47)

(1.04)

0.0%

46.5

5.4%

36.2

Canada

164

158

(41.50)

2.96

4.68

2.03

-20.1%

24.4%

(0.60)

(0.26)

0.0%

4.8

149.6%

32.6

Junior E&P<30kboed

2,031

3,482

3.38

2.56

6.03

4.84

-0.2%

5.8%

2.95

2.47

1.8%

124.4

6.7%

20.5

Cardinal Energy (Alberta)

180

376

3.18

2.27

5.90

4.83

-1.0%

1.4%

3.76

3.17

1.0%

20.6

7.6%

18.1

Crew Energy

82

281

2.33

1.63

6.61

4.82

10.1%

42.2%

4.04

2.95

2.8%

18.2

-1.3%

15.4

Kelt Exploration

74

344

2.32

1.10

6.90

4.62

-41.0%

-40.4%

5.43

3.63

0.0%

21.7

24.1%

15.9

Obsidian Energy

305

270

6.63

5.28

5.94

5.04

-22.6%

-5.3%

6.40

5.42

0.0%

24.4

-28.6%

11.1

Pipestone Energy

63

430

1.06

1.10

3.88

5.25

68.0%

5.0%

4.00

5.40

0.0%

25.4

-10.1%

16.9

Storm Resources

108

244

3.21

1.29

5.53

2.60

-48.9%

-25.8%

3.29

1.55

0.0%

15.8

61.6%

15.4

Surge Energy

207

311

4.63

2.56

6.33

4.19

1.8%

9.0%

1.95

1.29

0.0%

23.2

17.5%

13.4

Tamarack Valley Energy

90

411

1.80

1.81

5.81

5.60

13.5%

10.1%

4.70

4.53

5.7%

18.0

-1.2%

22.9

TORC Oil & Gas

291

455

2.68

2.64

4.56

4.58

3.1%

6.6%

1.58

1.59

0.0%

21.7

6.5%

21.0

Yangarra Resources

522

797

5.48

3.99

7.62

6.59

4.0%

5.8%

2.29

1.98

1.8%

25.8

-2.2%

30.8

Intermediate E&P>30kboed

57

222

1.65

1.28

5.79

5.01

2.5%

6.7%

3.93

3.40

0.0%

12.1

9.3%

18.3

Advantage Oil & Gas

706

1,256

3.31

2.54

5.71

4.63

-2.9%

7.4%

2.32

1.91

2.3%

62.1

7.3%

20.7

Baytex Energy

258

446

2.95

1.80

4.53

2.88

-15.9%

13.2%

2.23

1.42

0.0%

45.1

6.8%

9.9

Birchcliff Energy

380

1,813

1.53

1.39

5.30

5.16

9.1%

17.5%

4.15

4.04

0.0%

80.5

-7.0%

22.5

Canacol Energy

399

1,093

2.69

1.50

7.55

4.01

-20.9%

23.5%

3.60

1.92

1.8%

76.4

3.3%

14.3

Enerplus

525

824

3.27

3.76

4.32

4.07

8.2%

4.4%

1.72

1.62

2.6%

30.8

12.0%

26.7

Frontera Energy

783

1,121

2.98

2.78

4.00

4.05

2.5%

4.0%

1.39

1.41

2.8%

90.6

-5.2%

12.4

NuVista Energy

275

621

1.72

1.52

3.60

3.51

6.2%

-2.2%

0.43

0.42

12.7%

47.9

-9.0%

13.0

Paramount Resources

178

760

1.53

1.39

5.11

5.15

-12.3%

-5.4%

3.32

3.36

0.0%

50.0

1.3%

15.2

Parex Resources

582

1,226

5.33

2.43

7.97

5.09

-14.4%

6.7%

3.29

2.10

0.0%

67.7

16.3%

18.1

Peyto Exploration & Development

2,037

1,685

7.09

4.94

6.28

4.42

7.8%

10.3%

(1.47)

(1.04)

0.0%

46.5

5.4%

36.2

Whitecap Resources

414

1,326

2.19

1.42

6.53

5.04

-9.1%

2.5%

4.26

3.28

2.1%

79.5

9.2%

16.7

Large E&P>100kboed

1,929

2,899

5.07

5.03

7.61

7.55

7.0%

6.7%

2.54

2.52

3.0%

68.0

47.5%

42.6

ARC Resources

7,546

12,740

3.87

3.06

6.86

5.24

5.9%

10.1%

2.78

2.30

2.2%

411.4

4.0%

24.3

Canadian Natural Resources

1,781

2,458

3.60

2.99

6.67

4.72

10.5%

11.2%

1.91

1.35

3.7%

158.8

2.2%

15.5

Crescent Point Energy

31,507

49,704

7.57

5.14

11.58

7.39

4.5%

9.3%

4.02

2.56

3.8%

1,158.6

6.1%

42.9

Ovintiv

1,417

3,418

2.12

2.52

4.25

5.79

13.4%

8.1%

2.90

3.95

1.7%

121.1

-9.2%

28.2

Seven Generations Energy

4,490

11,651

2.52

2.18

5.26

4.99

-0.4%

8.0%

3.16

3.00

1.6%

535.9

-3.4%

21.7

Tourmaline Oil

1,800

3,421

2.81

2.58

7.58

4.45

7.6%

10.5%

3.45

2.02

0.0%

182.7

-0.2%

18.7

US

4,282

5,787

4.62

2.93

5.82

4.09

-0.5%

13.5%

1.26

0.89

2.2%

311.0

28.6%

18.6

RoW

4,925

6,770

1.44

4.02

6.70

5.11

7.7%

16.8%

1.98

1.75

0.3%

86.7

14.1%

91.5

Average

4,448

7,182

3.53

3.88

6.60

5.18

2.2%

9.1%

2.71

2.22

1.5%

191.4

9.7%

37.8

Source: Edison Investment Research, Refinitiv. Note: Prices as at 7 January 2021.

Financials

Before COVID-19, Canacol generated strong netbacks per unit of production at a reported FY19 US$3.82 pre-tax, with cash flow from operations at US$108m. Despite the impacts of COVID-19 on natural gas demand in the first half of 2020, the company was able to maintain healthy netbacks of c US$3.60/mcf. Over our forecast period, royalties on a unit basis increase from US$0.66/mcf in FY19 to US$1.00/mcf by FY25 as production shifts from lower royalty paying blocks to VIM-5. This is partly offset by operating costs, which are largely fixed as they are spread across a growing production base.

Exhibit 40: Netbacks (2P scenario)

2019

2020e

2021e

2022e

2023e

2024e

2025e

Realised price post-transport (US$/mcf)

4.76

4.50

4.39

4.61

4.73

4.85

5.50

Royalty (US$/mcf)

0.66

0.76

0.74

0.81

0.85

0.88

0.97

Opex (US$/mcf)

0.28

0.25

0.26

0.27

0.27

0.28

0.29

Pre-tax netback (US$/mcf)

3.82

3.49

3.39

3.54

3.60

3.69

4.24

Production (mmscfd)

142.6

171.2

171.5

203.3

235.0

235.0

175.6

Source: Edison Investment Research

Our 2P case forecasts a material reduction in net debt and gearing, assuming returns to shareholders remain in line with current levels of US$7m per quarter. Excess cash is, in our view, likely to be directed to expanding the company’s footprint through the drill bit.

Exhibit 41: Pre-tax netbacks US$/mcf (2P scenario)

Exhibit 42: Gearing and net debt/EBITDA (2P scenario)

Source: Edison Investment Research

Source: Edison Investment Research

Exhibit 41: Pre-tax netbacks US$/mcf (2P scenario)

Source: Edison Investment Research

Exhibit 42: Gearing and net debt/EBITDA (2P scenario)

Source: Edison Investment Research

We expect an EBITDAX of c US$195m in FY20 and US$187m in FY21 as we model lower average realised gas prices (US$4.50/mcf in 2020 vs US$4.39/mcf in 2021), even though our FY21 gas sales estimate remains relatively in line with FY20 at c 171.5mmscfd. The company expects net debt/EBTIDA of 1.7x in FY21, in line with our estimates. Under our current assumptions, the FY20 cash dividend stands at 67% of FCF. However, in FY21 we anticipate Canacol will have to utilise existing cash reserves for shareholder distributions. We anticipate that FCF will again start covering cash dividends from 2022 onwards, assuming the world recovers from COVID-19 and demand returns to normal, as can be observed in Exhibit 42.

Exhibit 43: Canacol’s dividend sustainability

Source: Edison Investment Research


Exhibit 44: Financial summary

 

US$m

 

2017

2018

2019

2020e

2021e

Year-end December

 

 

IFRS

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

 

156.6

204.5

219.5

234.3

228.4

Cost of sales (opex)

(25.0)

(28.9)

(17.1)

(15.6)

(16.4)

Gross profit

131.6

175.6

202.4

218.7

212.0

General & admin

(26.5)

(28.2)

(29.0)

(24.2)

(24.8)

Share based payments

(11.6)

(8.5)

(7.9)

(8.1)

(8.3)

Exploration expense

(27.1)

(13.7)

(3.0)

(3.0)

(3.1)

EBITDA

(54.3)

86.1

151.9

183.3

175.8

Adj EBITDAX

 

 

130.2

138.6

162.8

195.1

187.2

Depreciation

(35.8)

(44.2)

(54.3)

(61.2)

(61.2)

Operating Profit (before amort. and except.)

 

 

(90.0)

41.9

97.6

122.1

114.6

Intangible amortisation

-

-

-

-

-

Exceptionals

-

-

-

-

-

Other

-

-

-

-

-

EBIT

(90.0)

41.9

97.6

122.1

114.6

Net interest

(26.3)

(34.5)

(32.9)

(29.4)

(28.9)

Profit Before Tax (norm)

 

 

(116.4)

7.3

64.7

92.7

85.7

Profit Before Tax (FRS 3)

 

 

(116.4)

7.3

64.7

92.7

85.7

Tax

(32.4)

(29.2)

(30.5)

(15.0)

(31.7)

Profit After Tax (norm)

(148.8)

(21.8)

34.2

77.7

54.0

Profit After Tax (FRS 3)

(148.8)

(21.8)

34.2

77.7

54.0

Average Number of Shares Outstanding (m)

175.2

177.2

178.3

181.0

180.6

EPS - normalised (c)

 

 

(84.95)

(12.32)

19.21

42.95

29.92

EPS - normalised fully diluted (c)

 

 

(84.95)

(12.32)

19.21

42.95

29.92

EPS - (IFRS) (US$)

 

 

(0.85)

(0.12)

0.19

0.43

0.30

Dividend per share (c)

-

-

0.05

0.21

0.21

Gross margin (%)

84.01

85.87

92.19

93.34

92.83

EBITDA margin (%)

84.01

85.87

92.19

93.34

92.83

Operating margin (before GW and except.) (%)

(57.49)

20.48

44.48

52.11

50.17

BALANCE SHEET

Non-current assets

 

 

499.8

580.3

620.8

664.5

719.2

Intangible assets

43.9

39.6

53.9

116.8

181.7

Tangible assets

383.4

480.4

506.1

486.9

476.6

Investments

72.5

60.3

60.8

60.8

60.8

Current assets

 

 

196.7

124.7

133.3

144.7

112.4

Stocks

0.6

0.3

-

-

-

Debtors

50.4

68.2

69.6

69.6

69.6

Cash

39.1

51.6

41.2

52.7

20.3

Other/ restricted cash

106.6

4.6

22.4

22.4

22.4

Current liabilities

 

 

(86.3)

(69.3)

(97.8)

(97.8)

(97.8)

Creditors

(86.3)

(69.3)

(89.6)

(89.6)

(89.6)

Short-term borrowings

-

-

(8.2)

(8.2)

(8.2)

Long-term liabilities

 

 

(371.0)

(430.3)

(413.5)

(410.8)

(398.8)

Long-term borrowings

(294.6)

(339.7)

(333.4)

(330.7)

(318.7)

Other long-term liabilities (inc. decomm.)

(76.4)

(90.6)

(80.1)

(80.1)

(80.1)

Net assets

 

 

239.1

205.4

242.7

300.6

335.0

CASH FLOW

Operating cash flow

 

 

65.3

94.0

108.4

180.1

156.3

Capex inc acquisitions

(106.0)

(75.5)

(84.3)

(108.0)

(119.0)

Financing expenses

(21.2)

(36.0)

(29.5)

(30.0)

(29.7)

Equity issued

(1.9)

(3.7)

2.1

-

-

Dividends

-

-

(7.1)

(28.0)

(28.0)

Net cash flow

(63.8)

(21.2)

(10.4)

14.1

(20.3)

Opening net debt/(cash)

 

 

184.4

255.5

288.1

300.3

286.2

HP finance leases initiated

-

-

-

-

-

Other

(7.4)

(11.4)

(1.9)

0.0

(0.0)

Closing net debt/(cash)

 

 

255.5

288.1

300.3

286.2

306.5

Source: Edison Investment Research, Canacol Energy accounts. Note: *Edison revenue forecast net of royalties and transport expenses; Canacol reports revenues net of royalties before transport expenses.

Contact details

Revenue by geography

2650, 585 8th Avenue South West
Calgary, Alberta, Canada, T2P 1G1
CA
+1 403 561 1648
www.canacolenergy.com

Contact details

2650, 585 8th Avenue South West
Calgary, Alberta, Canada, T2P 1G1
CA
+1 403 561 1648
www.canacolenergy.com

Revenue by geography

Management team

President & CEO: Charle Gamba

CFO: Jason Bednar

Mr Gamba founded Canacol Energy in 2008. He has held a variety of technical and management roles with major and mid-sized international oil companies, with the majority of his professional career focused on E&P in South America. Prior to creating Canacol, Mr Gamba was vice president of exploration for Occidental Oil & Gas based in Bogota, Colombia. In his eight years with Occidental, he lived and worked in Ecuador, Qatar, Colombia and the US, working in a variety of technical and management roles. He has also worked for Alberta Energy Company in Argentina and Ecuador, and for Canadian Occidental in Australia, Canada and Indonesia. He started his career as a geologist with Imperial Oil in Calgary, and holds an MSc and PhD in geology.

Mr Bednar is a chartered accountant with more than 18 years of direct professional experience in the financial and regulatory management of oil and gas companies listed on the Toronto Stock Exchange, TSX Venture Exchange and US Stock Exchange. He has been the CFO of several international oil and gas exploration companies, most notably the founding chief financial officer of Pan Orient Energy Corp, a South-East Asia exploration company, which during his tenure grew organically to operate 15,000bbl/d and reached a market cap of C$700m. He has previously sat on the board of directors of several internationally focused E&P companies, including as the past chairman of Gallic Energy. Mr Bednar began his career in the chartered accountancy firm of Brown Smith Owen in 1993 before moving into financial controller roles at oil production companies. He holds a Bachelor of Commerce from the University of Saskatchewan.

COO: Ravi Sharma

SVP exploration: Mark Teare

Mr Sharma joined Canacol in October 2015. He is a reservoir engineer with 30 years of oil and natural gas experience in the Americas, Middle East, Russia, Australasia and Africa. He has held progressively senior management roles at major E&P companies worldwide, most recently head of production & operations with Afren where he was responsible for production, development and operations activities in West Africa. Prior to this, he was global petroleum engineering manager for BHP Billiton Petroleum. Mr Sharma also held the position of worldwide chief reservoir engineer for Occidental Oil and Gas. He holds a BSc and MSc in mechanical engineering from the University of Alberta.

Mr Teare joined Canacol Energy in early 2009. Previously, he was at AEC International and EnCana where he held a series of senior management positions in Ecuador and Brazil. Over his 30-year career, he has had extensive experience with a number of senior international Canadian energy companies operating in North America, South America and Australasia. He holds an MSc degree in geology.

Management team

President & CEO: Charle Gamba

Mr Gamba founded Canacol Energy in 2008. He has held a variety of technical and management roles with major and mid-sized international oil companies, with the majority of his professional career focused on E&P in South America. Prior to creating Canacol, Mr Gamba was vice president of exploration for Occidental Oil & Gas based in Bogota, Colombia. In his eight years with Occidental, he lived and worked in Ecuador, Qatar, Colombia and the US, working in a variety of technical and management roles. He has also worked for Alberta Energy Company in Argentina and Ecuador, and for Canadian Occidental in Australia, Canada and Indonesia. He started his career as a geologist with Imperial Oil in Calgary, and holds an MSc and PhD in geology.

CFO: Jason Bednar

Mr Bednar is a chartered accountant with more than 18 years of direct professional experience in the financial and regulatory management of oil and gas companies listed on the Toronto Stock Exchange, TSX Venture Exchange and US Stock Exchange. He has been the CFO of several international oil and gas exploration companies, most notably the founding chief financial officer of Pan Orient Energy Corp, a South-East Asia exploration company, which during his tenure grew organically to operate 15,000bbl/d and reached a market cap of C$700m. He has previously sat on the board of directors of several internationally focused E&P companies, including as the past chairman of Gallic Energy. Mr Bednar began his career in the chartered accountancy firm of Brown Smith Owen in 1993 before moving into financial controller roles at oil production companies. He holds a Bachelor of Commerce from the University of Saskatchewan.

COO: Ravi Sharma

Mr Sharma joined Canacol in October 2015. He is a reservoir engineer with 30 years of oil and natural gas experience in the Americas, Middle East, Russia, Australasia and Africa. He has held progressively senior management roles at major E&P companies worldwide, most recently head of production & operations with Afren where he was responsible for production, development and operations activities in West Africa. Prior to this, he was global petroleum engineering manager for BHP Billiton Petroleum. Mr Sharma also held the position of worldwide chief reservoir engineer for Occidental Oil and Gas. He holds a BSc and MSc in mechanical engineering from the University of Alberta.

SVP exploration: Mark Teare

Mr Teare joined Canacol Energy in early 2009. Previously, he was at AEC International and EnCana where he held a series of senior management positions in Ecuador and Brazil. Over his 30-year career, he has had extensive experience with a number of senior international Canadian energy companies operating in North America, South America and Australasia. He holds an MSc degree in geology.

Principal shareholders

(%)

Cavengas Holdings SRL

18.06

FOURTH SAIL CAPITAL LP

16.57

BlackRock Inc

4.38

Dimensional Fund Advisors LP

1.85

Norges Bank

1.2

Elliot Gregory D

0.76

Fiera Capital Europe/Cayman Is

0.62


General disclaimer and copyright

This report has been commissioned by Canacol Energy and prepared and issued by Edison, in consideration of a fee payable by Canacol Energy. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

General disclaimer and copyright

This report has been commissioned by Canacol Energy and prepared and issued by Edison, in consideration of a fee payable by Canacol Energy. Edison Investment Research standard fees are £49,500 pa for the production and broad dissemination of a detailed note (Outlook) following by regular (typically quarterly) update notes. Fees are paid upfront in cash without recourse. Edison may seek additional fees for the provision of roadshows and related IR services for the client but does not get remunerated for any investment banking services. We never take payment in stock, options or warrants for any of our services.

Accuracy of content: All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report and have not sought for this information to be independently verified. Opinions contained in this report represent those of the research department of Edison at the time of publication. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations.

Exclusion of Liability: To the fullest extent allowed by law, Edison shall not be liable for any direct, indirect or consequential losses, loss of profits, damages, costs or expenses incurred or suffered by you arising out or in connection with the access to, use of or reliance on any information contained on this note.

No personalised advice: The information that we provide should not be construed in any manner whatsoever as, personalised advice. Also, the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The securities described in the report may not be eligible for sale in all jurisdictions or to certain categories of investors.

Investment in securities mentioned: Edison has a restrictive policy relating to personal dealing and conflicts of interest. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report, subject to Edison's policies on personal dealing and conflicts of interest.

Copyright: Copyright 2021 Edison Investment Research Limited (Edison).

Australia

Edison Investment Research Pty Ltd (Edison AU) is the Australian subsidiary of Edison. Edison AU is a Corporate Authorised Representative (1252501) of Crown Wealth Group Pty Ltd who holds an Australian Financial Services Licence (Number: 494274). This research is issued in Australia by Edison AU and any access to it, is intended only for "wholesale clients" within the meaning of the Corporations Act 2001 of Australia. Any advice given by Edison AU is general advice only and does not take into account your personal circumstances, needs or objectives. You should, before acting on this advice, consider the appropriateness of the advice, having regard to your objectives, financial situation and needs. If our advice relates to the acquisition, or possible acquisition, of a particular financial product you should read any relevant Product Disclosure Statement or like instrument.

New Zealand

The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (i.e. without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision.

United Kingdom

This document is prepared and provided by Edison for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.

This Communication is being distributed in the United Kingdom and is directed only at (i) persons having professional experience in matters relating to investments, i.e. investment professionals within the meaning of Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005, as amended (the "FPO") (ii) high net-worth companies, unincorporated associations or other bodies within the meaning of Article 49 of the FPO and (iii) persons to whom it is otherwise lawful to distribute it. The investment or investment activity to which this document relates is available only to such persons. It is not intended that this document be distributed or passed on, directly or indirectly, to any other class of persons and in any event and under no circumstances should persons of any other description rely on or act upon the contents of this document.

This Communication is being supplied to you solely for your information and may not be reproduced by, further distributed to or published in whole or in part by, any other person.

United States

Edison relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. This report is a bona fide publication of general and regular circulation offering impersonal investment-related advice, not tailored to a specific investment portfolio or the needs of current and/or prospective subscribers. As such, Edison does not offer or provide personal advice and the research provided is for informational purposes only. No mention of a particular security in this report constitutes a recommendation to buy, sell or hold that or any security, or that any particular security, portfolio of securities, transaction or investment strategy is suitable for any specific person.

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

1185 Avenue of the Americas

3rd Floor, New York, NY 10036

United States of America

Sydney +61 (0)2 8249 8342

Level 4, Office 1205

95 Pitt Street, Sydney

NSW 2000, Australia

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