Natural gas has surged in recent weeks because of stronger-than-expected seasonal demand, localized shortages in East Asia, and growing consumption of the fossil fuel by the electricity industry. This has failed to buoy many natural gas producers, including Canacol Energy (TSX: CNE), which has seen its market value slump by almost 19% for the year to date. While the long-term outlook for natural gas remains muted, this has created an opportunity for investors.
Now what?
Canacol is an upstream natural gas producer focused on gas exploration and production in the Latin American nation of Colombia. It reported some solid third-quarter 2018 results, which — along with local shortages of the fossil fuel — makes it an attractively valued investment for contrarian investors seeking to diversify their portfolios.
Canacol’s third-quarter production shot up by 33% year over year to 21,978 barrels daily. Most of that output was weighted to natural gas because of the drillers focus on becoming a leading Colombian producer of the fossil fuel. That strategy has seen Canacol’s natural gas reserves expand at a rapid clip to 113 million barrels of oil equivalent, which, before income taxes, have a net asset value (NAV) of US$1.4 billion. This equates to $10.29 per share, which is almost three times greater than Canacol’s share price, highlighting the considerable potential upside that exists.
A pleasing aspect of Canacol’s third-quarter performance is its solid operating netback. Even after declining by 4% compared to a year earlier, it was still a notable US$22.04 per barrel of oil equivalent produced, which is higher than many natural gas producers operating solely on North America. An upstream oil and gas driller’s operating netback is an important metric used to measure the profitability of its developed and producing assets.
While the average realized price for each barrel of oil equivalent sold rose by 6% year over year to US$32.74, Canacol’s third-quarter netback was lower than the equivalent period in 2017 because of a sharp increase in production and transportation expenses. Those higher operating expenses can be attributed to additional fixed costs at new gas fields that came online over the last year.
Canacol’s solid netback and increased production saw a significant improvement in its bottom line for the third quarter. The driller reported net income of US$12 million compared to a net loss of US$1.5 million a year earlier.
Canacol’s production should keep expanding at a decent clip. It is focused on achieving 230 million square cubic feet per day of production via the expansion of its gas-processing facilities at Jobo and by tying in the Pandereta, Canahuate, and Chirimia wells by December 2018.
The company also plans to drill nine wells as part of its gas exploration and development drilling program and will commence with the first well in mid-December 2018. Given the company’s high-drilling success rate, it is likely that it will report further hydrocarbon discoveries, which will support Canacol’s plans to expand 2019 production by 90% year over year.
What makes Canacol a particularly compelling investment is that because of domestic natural gas shortages in Colombia, it has established a contracted well-head price of US$4.85 per thousand cubic feet of gas (mcf) sold. This is substantially higher than the North American spot price, thereby giving Canacol a financial advantage over its peers operating solely in Canada and the U.S. It also helps to insulate its earnings from the wild swings in oil and gas prices witnessed since the start of 2018, thereby increasing the stability of Canacol’s earnings.
So what?
Canacol is heavily undervalued by the market, and much of that can be attributed to an overbaked perception of risk because it is focused on operating in Colombia. It has, however, a long-proven history of being able to unlock considerable value from its assets located in the Andean nation.
Furthermore, the implementation of a peace agreement between the government and largest guerrilla group the FARC in 2016 has bolstered domestic security. When this is considered in conjunction with Canacol’s copious long-life gas reserves as well as its solid netback, substantial drilling success rate, and strong third-quarter results, there is every sign that the stock will soar in coming months.
