Canacol Energy — Canacol maintains drilling pace into 2022

In 2022 Canacol will focus on delivering a 12-well drilling programme, with an emphasis on exploration wells, as it targets a reserves replacement ratio (RRR) of more than 200%. To achieve this, the company will move beyond the VIM-5, VIM-21 and Esperanza licences for the first time and drill three wells in previously undrilled blocks. Exploration activities, including seismic, will contribute to the bulk of 2022’s capex, which is estimated to be US$172m–US$209m (cf to US$108m in 2021) and will be fully funded from existing cash and 2022 cash flow. The budget will also allow over US$7m in quarterly dividends. The company anticipates gas sales between 160mmscfd and 200mmscfd, with c 80% of sales being take-or-pay under the high-end guidance. Longer-term Colombian gas demand is expected to grow at a rate of 2–3% per year.

Management will also focus on progressing the Jobo to Medellin pipeline project by selecting a contractor and submitting the environmental licence by the end of Q122, and contracting an additional 45mmscfd of take-or-pay contracts by the end of Q322. The pipeline will increase the company’s sale capacity by 100mmscfd when it comes online at the end of 2024.

Eight gas compression units will be installed across Canacol’s gas fields in 2022, which the company estimates will increase recovery factors between 8% and10% and reduce field-level opex. We note the guidance for EBITDAX for 2022 implies there is an increase in corporate level operating costs (SG&A and other opex). See valuation and financials section below for impact of guidance on our forecasts.

The company is also committed to strengthening its ESG strategy and will provide its short- and medium-term carbon emission reduction targets, together with a projected timeline for achieving net-zero emissions, in H122.

Canacol has delivered its planned programme of 12 wells in 2021, with the final well, Clarinete 6, reaching total depth in mid- December. The major success of the programme was the Aguas Vivas-1 discovery, which was followed with two appraisal wells, and the company will integrate the results from these wells with existing 3D seismic to assess the extent of the accumulation. We expect these three wells will make a significant contribution to the company’s reserves replacement this year. Of the remaining five exploration wells drilled, two wells, San Marcos-1 and Siku-1, successfully encountered commercial hydrocarbons while three wells did not encounter commercial hydrocarbons. Flauta-1 and Milano-1 were plugged and abandoned, while Corneta-1 has been cased and suspended as a future water disposal well. This brings the company’s exploration and appraisal success rate for 2021 to 62%, somewhat below its average success rate over 2016–2020 of 90%.

The final exploration well in the 2021 programme, Siku-1, encountered 33 ft of net gas pay in the primary Cienaga de Oro (CDO) reservoir and is expected to be tied into production in early 2022.

The 2022 drilling programme will look to maintain the pace set in 2021 with a programme of up to 12 wells, and will continue Canacol’s focus on exploration, with up to eight exploration wells and four development wells planned. Three of the exploration wells will target previously undrilled blocks, two in the Lower Magdalena Basin and one in the Middle Magdalena Basin, and the programme will start in the third week of January with the Toronja-2 development well. The majority of the wells will target prospects defined on 3D seismic, supported by the amplitude versus offset technology that has accounted for the company’s historical exploration and appraisal success rate of 79%. In total, 470km of 3D seismic will also be acquired across the VIM-5 block as Canacol looks to identify further gas prospects for exploration drilling.

Canacol holds a 100% operating position in the VMM-45 E&P contract in the Middle Magdalena Basin covering 611,00 net acres. The conventional gas play here is deeper than in the Lower Magdalena Basin and the wells take longer to drill and are more expensive (at c US$15m/well). The company is expecting to drill one well in VMM-45, in Q222, and it will take five months to drill, test and complete. The Pola-1 well sits less than 10km from the Transportadora de Gas Internacional (TGI) pipeline, which transports gas from Ecopetrol’s declining mature gas fields to the interior of Colombia. The pipeline has c 260mmscfpd of spare capacity, so any discovery can be quickly commercialised.

In the Lower Magdalena Valley, the company plans to drill Dividvi-1 on the VIM-33 E&P contract (100% working interest) and Natilla-1 on the SSJN-7 E&P Contract (50% WI). Dividvi-1 will target the CDO reservoirs that produce in the nearby Arjona and El Dificil gas condensate fields. The well can be tied into the TGI pipeline c 50km to the east in the case of success. Natilla is the largest of 10 prospects identified in SSJN-7 on 3D seismic acquired by Canacol in 2021.The Natilla-1 well will target gas in the CDO and Porquero sandstone on an exploration fairway between the company’s gas fields c 60km to the south and the Frontera operated La Creciente gas fields c 30km to the north.

We update our valuation to reflect management guidance for 2022 (adopting the midpoint of the range), its preliminary expectations for 2021 and Q321 results.

Canacol expects volumes sales of 183mmscfd in FY21, which is slightly higher than our previous forecast of 180mmscfd, due to increased volume sales over September to December (average of 192mmsfd). We note that 22% of sales in FY22 came from the spot market (interruptible sales) and thus represent sales outside of longer-term contracts. The midpoint of guidance for FY22 is 180mmscfd, which is below our previous forecast of 207mmscfd. The midpoint assumes only 10% of sales come from the spot market. If the same level of sales were made in the spot market as in FY21, the volume sales in FY22 would be c 202mmsfd. We believe Canacol is cautious in its guidance due to the ongoing COVID-19 pandemic. We previously assumed plateau production of 235mmscfd in FY23. We now assume this is achieved in FY24.

Canacol expects EBITDAX (EBITDA excluding pre-licence costs and exploration impairment, stock-based payments and non-recurring costs) of US$197m in FY21, which is slightly above our previous forecast of US$193m. This difference is mostly due to the impact of the increase in revenue due to higher volume sales. The midpoint of guidance for FY22 is US$197m, which is below our previous forecast of US$237m. The difference is due to lower revenue (lower volume sales) combined with implied higher operating costs (SG&A and other opex). We estimate there is an almost 40% increase in these costs and extrapolate the increase across our forecast period.

Canacol expects capex of US$108m in FY21, which is significantly lower than our previous forecast of US$148m. This difference is mostly due to reduced exploration spend in the second half of FY21. The midpoint of guidance for FY22 is US$190m, which is above our previous forecast of US$171m. This difference is mostly due to exploration spend from FY21 deferred into FY22 (and beyond). In aggregate, we increase our capex forecasts over FY22–25 by 2%.

Our core NAV for Canacol decreases from C$3.15/share to C$2.76/share, as a result of the changes to our forecasts for volume sales, operating costs and capex. Our additional 2P reserves decreases very slightly (-2%), giving a total NAV of C$5.65 (from C$6.12 previously). The breakdown of our valuation is shown below.

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, resulting in our valuation of C$5.65/share. At a 10% discount rate, it would increase to C$6.37/share. We provide a sensitivity to this key input below.

Canacol trades at a P/CF multiple of 4.3x in FY22e compared to its Canadian (junior) E&P peers on 4.9x 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; excluding Gran Tierra, which is an outlier, FY22e P/CF for this peer group becomes 3.6x.