Despite crude rallying sharply in recent weeks, because of renewed optimism over the global economic outlook (the international benchmark Brent is up by 16% for the year to date), oil producer Gran Tierra Energy (TSX: GTE)(NYSE:GTE) has lost a whopping 58%. This has created considerable speculation as to whether it is undervalued and what the future holds for the driller.
Disappointing results
The latest sharp decline in the driller’s value comes on the back of Gran Tierra reporting poor third-quarter 2019 results, where it missed analysts’ estimate for its earnings per share. A key issue that impacted Gran Tierra’s performance was a 9% year-over-year decrease in gross production for the quarter.
This can be blamed on outages at its Acordionero field, where a combination of equipment failures and high natural gas production forced Gran Tierra to shutter production at several wells. Gran Tierra was also forced to shutter operations at its Suroriente block in Colombia’s southern Putumayo Basin because of community protests. These production outages highlight a key risk faced by international oil companies operating in Colombia, where geopolitical risk and community opposition to their operations are ratcheting up at a furious pace.
There has also been a spate of pipeline bombings in the Andean nation since the start of 2019, which have been attributed to either dissident FARC groups who refused to participate in the 2016 peace accord or the last remaining insurgent group the ELN. Those are of significant concern because in Colombia’s rugged terrain, pipelines are the only economic means of efficiently transporting the crude oil companies produce to coastal ports.
The last major attack was the bombing of the Trasandino pipeline in early October, which connects the oil fields in the Putumayo Basin to the Pacific port of Tumaco. Gran Tierra has amassed substantial acreage in the Putumayo Basin, where it is the single largest landholder, underscoring how severely local community as well as security issues and outages of the Trasandino pipeline can have on its operations.
The driller’s third-quarter operating netback, a key measure of operational profitability, also declined sharply falling by 32% compared to a year earlier to US$32.45 per barrel sold. That can be primarily attributed to weaker crude, with the average Brent benchmark for the period declining by 18% compared to a year earlier, and Gran Tierra’s average basket price falling by 22% to US$51.98 per barrel. A sharp 25% year-over-year increase in operating expenses was also responsible for the decline in Gran Tierra’s operating netback.
Those factors don’t bode well for Gran Tierra’s performance over the remainder of 2019 and into 2020, explaining why the stock has been so heavily marked down by the market. That does appear heavily overdone, however, because it now sees Gran Tierra trading at less than a third of its after-tax net asset value, indicating there is considerable upside ahead for investors. The key issue is whether Gran Tierra can convince the market that rising security risks and political tensions in Colombia won’t have a severe a impact on its operations.
Another disappointing development is that Gran Tierra’s debt has increased significantly, growing by 60% year over year to almost US$638 million by the end of the third quarter 2019. This weighs on Gran Tierra’s value by reducing its financial flexibility and igniting concerns over its ability to weather another price collapse.
Foolish takeaway
Gran Tierra has proven a difficult oil producer to like. It has fallen sharply in value, despite crude rallying solidly since the start of 2019 to be trading at a deep discount to the after-tax net asset value of its oil reserves. Nonetheless, it appears very attractively valued, and the degree of perceived risk associated with Gran Tierra appears heavily overbaked, making it a speculative play on higher oil.
