Natural gas has bounced back strongly in recent weeks, gaining 20% from a multi-year low hit in mid-August 2019 to be trading at US$2.56 per million British thermal units (MMBtu). This has given hope to beaten-down Canadian natural gas drillers, which have seen their earnings and hence market values plunge because of natural gas’s prolonged slump. While that has spurred considerable optimism among pundits over the outlook for natural gas producers, there are signs that the outlook for what is known as the clean fossil fuel remains poor. This is because global natural gas supplies are growing at such a rapid clip, they are exceeding demand. That will weigh on many drillers but have little to no impact on Canacol Energy (TSX:CNE).
Leading natural gas supplier
The driller, which five years ago elected to pivot its operations to become a leading natural gas producer in Colombia, has experienced solid growth, despite the fuel’s prolonged slump. For the third quarter 2019, Canacol reported that contracted natural gas sales have grown by 27% year over year, while its natural gas operating netback had climbed by 2% to US$3.86 per thousand cubic feet (Mcf) sold. That gave the driller’s funds from operations (FFO) a healthy lift, seeing it rise by 41%, and EBITDAX shot up by 28% underscoring Canacol’s considerable profitability, despite weak natural gas prices.
The reason for Canacol’s impressive profitability, as underscored by its solid netback, which is significantly higher than any of its peers operating in Canada, is the unique conditions that exist in Colombia’s energy market.
The Latin American nation, which was, up until recently, self-sufficient for natural gas, is suffering from a shortage of the fuel, which forced it to start liquefied natural gas imports in 2017. Aging offshore natural gas fields, which are experiencing rapidly rising decline rates, and a dearth of major discoveries in recent years combined with growing demand for the fuel have triggered a massive domestic shortfall. It is anticipated that Colombia’s demand for natural gas will rise by 33% over the next 13 years, supporting higher domestic prices because of local supply constraints.
As a result, Canacol was able to contractually lock in prices for the natural gas that it produces, which are almost double the North American Henry Hub benchmark. For 2019, the company estimates that its take-or-pay contractual price will average US$4.83 per MMBtu, and it realized an average price of US$4.85 per MMBtu sold during the third quarter. Colombia’s natural gas shortage will continue for the foreseeable future, allowing Canacol to obtain prices will above the North America benchmark for every MMBtu it sells.
That coupled with its copious natural gas reserves with 559 billion cubic feet, considerable exploration success, and growing access to Colombian energy markets because of growing pipeline infrastructure, will lead to higher sales and earnings. Between the end of 2019 and 2023 Canacol expects to expand its natural gas sales by over 47%, which will give its earnings a solid lift.
Canacol finished the third quarter 2019 in solid financial shape. It had US$33 million in cash and long-term debt, including leasing and decommissioning liabilities of US$385 million, which is a manageable 2.5 times EBITDAX.
Foolish takeaway
Canacol has only gained a modest 10% since the start of 2019, despite experiencing solid production and sales growth. This has created an opportunity to gain exposure to a top-quality natural gas producer, which will continue to experience solid earnings growth, despite the fossil fuel’s weakness, making now the time to buy.
