Trinity Exploration & Production - A Taste of Trinidad

http://www.trinityexploration.com/


With the continuing pick up of oil and gas companies across the sector (which should in turn lead to a narrowing of discounts), it makes sense to try and pick up relatively cheap companies when they are trading towards their lows. Trinity Exploration & Production (LSE:TRIN) is a company that matches that requirement. The Trinidad based company experienced drilling disappointment earlier in the year, and this combined with stagnant production rates has led to the share price underperfoming during 2014 so far. However, Trinity offers an attractive mixture of production and exploration on comparatively cheap metrics to peers, even if it does not have the same speculative appeal as those such as Leni Gas & Oil (LSE:LGO). The wide discount that Trinity trades at should narrow as the rest of the year progresses. The stock currently trades at 105p, and with around 95 million shares in issue, is valued by the market at an undemanding £99.5m.


From a technical perspective, there is not a great deal to add to the comments within the chart. The shares are still in a horizontal zone where there is little in the way of prevailing movement. However, one notable point is that the reaction to the well result in early 2014 was overcooked, and it unquestionably did not merit a decline in the share price amounting to approximately 33%. There is very strong support at 100p having re-bounded from these levels very well on three distinct occasions, and that is no surprise given the undervaluation of Trinity. The most recent bounce in April say the stock rise circa 20% in a number of days. This is easy to explain. Investors on the sidelines were waiting for a buying opportunity once the downtrend had arrested. Once the initial bounce was made, these investors bought in, thus driving a considerable rise. However, the stock has dropped off in recent weeks and currently rests at 105p, within a short-term horizontal range below 110p. I would say that there is excellent downside support at 100p in the short-term and medium-term, yet medium-term upside to around 135p alone (from a trading perspective). The risk/reward is therefore attractive. Trinity also has a decent spread of between 1% and 3%, albeit liquidity can be low during certain trading sessions. Therefore, with the Petroneft stake taken, I have limited the original investment to 50% of the portfolio. I will seek to invest the rest at a later date.

One of the positive aspects of Trinity, is the very respectable shareholding list. This is categorised in two ways. Firstly, there is excellent institutional support: Legal & General hold 15.7%, Threadneedle/Ameriprise hold 5.1% and Regent Pacific hold 4.1%, among others. Secondly, there is excellent board backing, which means that they are well aligned to that of the interests of private investors. Chairman Bruce Dingwall holds 6.1% of the stock, NED Anthony Brash (and family) hold 5.2%, NED Jon Murphy holds 5.1% and NED Finian O'Sullivan holds 3.8%. From this viewpoint, Trinity ticks the right boxes.

As alluded to earlier, part of the reason for reviewing Trinity at the current point in time, is that there are finally clear signs of improvement within the oil and gas sector. Numerous small cap stocks have risen materially in recent weeks and numerous mid-caps are showing indications of stability. This could well be linked to various takeover approaches that have come to light in recent months - the possible takeover of Heritage Oil for £924m is one of the key ones, and is a sign that the market is willing to launch takeover bids at the right price. However, that said, the valuation being put on Heritage is rather low. Other sales bids include that of Chad based Caracal Energy (LSE:CRCL) by Glencore Xstrata for £807m, or that of Salamander Energy's (LSE:SMDR) 40% core asset sale in Thailand for £166m. These transactions are all putting upward emphasis on oil and gas stocks, and combined with positive results lower down the market cap chain, there is growing sentiment. Indeed, the weak oil and gas and mining sectors are core reasons why I do not believe the current market rally is close to ending. These should start to pick up over the next 12 months and that means that picking oil and gas stocks near the base of their cycle can be rewarding.

Oil prices have eased over the past year as African/Middle East tensions have calmed, but over the period of oil prices rises, they underperformed, so there is much catching up to do. In particular, there are two types of company that should be most interesting - those with large undeveloped asset bases that are being progressed towards development, and those who are mid-tier producers. Trinity most closely fits the second criterion.

The current structure of Trinity was formed when it reversed into the previously listed Bayfield Energy in early 2013. This saw the enlarged company take the AIM listing and form a leading domestic player in Trinidad. The company operates in the secure jurisdiction of Trinidad, although it does have a smaller, less important asset in South Africa, which came with the Bayfield merger. Trinidad itself is a mature oil producer - the oil basins within the country are extensions of the prolific Venezuelan basin, which has led to oil production of over 3.5 billion barrels, and gas production of over 23 TCF.

Most of this exploitation was completed by majors such as BP, rather than independents like Trinity, so this has meant that the basin is considered mature and highly developed. There are positives and downsides to this. The positives are that there is considerable infrastructure in place, and a fairly sound set of regulations. The negatives are that, in theory anyway, the most lucrative oil has been extracted. That does not necessarily play out in reality, and there has been considerable scope for independent companies to 'pick up what is left behind'. To put that into numbers, fields as large as 20-50mmbbls of oil and 250-500bcf of cash are left behind as they are simply not large enough for the majors. On the other hand, they are very economical and potentially extremely valuable for independents.

The extraction of the most lucrative reserves has meant that Trinidad's oil production has been in decline for the past decade, from producing around 140,000bopd in 2005 to just above 80,000bopd in 2013. The government is keen to reverse this trend, and that can be seen by the increase in capital allowances secured in 2013 - Trinity was at the forefront of this lobbying process. This has seen Trinity's payback on certain wells reduced by around 40% and internal rate of returns boosted to over 50%, from previously sub-30% levels. Natural industry interest has also started to rise again, after BHP Billiton (LSE:BLT) farmed into 2 deepwater blocks owned by BP, earlier in 2014.

Trinity operates 11 licences across Trinidad, which means that it has full control over expenditure and forward plans. These licences are spread across three main zones:
- West Coast = A shallow-water offshore area to the West of Trinidad's mainland. Trinity has a 70% working interest in the PGB area and a 100% working interest in the Brighton area
- Onshore = An onshore area located in West Trinidad. Trinity has a 100% working interest across a broad range of producing areas
- East Coast = An offshore area to the East of Trinidad's mainland. This contains the Galeota field where Trinity has a 65% working interest. Trinity has a 100% working interest in the Trintes field in this area having converted state-owned Petrotrin's 35% working interest to an overriding royalty agreement in October 2013. This gives greater flexibility to Trinity, but importantly demonstrates the strong ties with the government

The company is a full-cycle company as it operates assets from those that are in early development, to those that are in steady production. It is similar in some ways to that of another company, Leni Gas & Oil, which also has a core Trinidad focus. Leni's assets are onshore however, and thus have lower drill costs. Their strategy is to conduct infill drilling at their Goudron asset, which has already demonstrated very good flow potential, albeit only at an initial production level. Leni's market cap has soared more than three-fold in recent weeks as production rates and pay zones have exceeded expectations - this underscores that there is a very real business opportunity to be had through operating in the 'mature' yet 'under-exploited' areas within Trinidad.

Crucially, the business is being led by a highly experienced management team, which has enjoyed very credible success. Chairman Bruce Dingwall was one of three founders of Venture Petroleum in 1996, which listed on the LSE in 2002, before being taken over in 2009 for $2.2bn. Non-executive director Finian O'Sullivan founded Burren Energy, which floated with a £175m market cap in 2003, before being acquired by Italian major ENI in 2008 for £1.7bn. Amid a raft of other experience is CEO Joel ('Monty') Pemberton, a Trinidadian who joined Trinity in 2005 as the Chief Financial Officer, before becoming Chief Executive Officer in 2009. The company should be able to draw on this experience moving forward, and combined with the strong shareholding alignment, should see the company continue to work for its shareholders and minimise any future dilution.

Indeed, already since listing, the company has grown its reserves by over 50% and production is also up, albeit at a much slower rate that initially envisaged. Internal company targets were for production of around 5000boepd by the end of 2014/early 2015, whereas the latest released production rate totalled 3978boepd - practically all of this production was oil, which achieved a sales price of around $91.6/bbl. Immediately it is clear to see that the company has a very profitable operation in progress. Despite that, the missed targets led to weakened sentiment and a relatively weak start post-merger. Interest from retail investors has failed to build up since then.  The production was split 55% Onshore, 29.3% East Coast, and 15.7% West Coast during 2013.

There were good reasons for this decline though, as several operations inherited from Bayfield Energy were improved. New boats were acquired to replace the old ones (which led to downtime), the drill rig was upgraded and this required it to be brought to shore, and new gensets were brought in to help resolve power supply issues. These should put the company on a firmer footing moving forward. To add to this, there were a couple of other issues including wells declining faster than expected, and an important well suffering from medium-term waxing issues. All this considered, the current production rate is excellent for the market cap under consideration, especially since the production is all oil. Comparable companies with similar production rates tend to have lower sales prices or a large proportion of gas. The production range for 2014 exit has been estimated at between 3800boepd and 4500boepd dependent upon the productivity of a new 'J-type' well, which the company will drill later in the year.

The second reason why the company is languishing at low levels is the recent exploration failure announced in February. The failure was at the $17m El Dorado well drilled within the East Coast PGB area. The well boasted a high chance of success yet failed to find commercial net pay. 'Significant' sands were found, but net pay only totalled 13ft and the lack of a trap indicated that oil had migrated through the area. It was consequently plugged and abandoned.

It is easy to overlook previous success though. In December, the company made a very substantial discovery in the form of TGAL-1 in the West Coast area where they have a 65% working interest. The well penetrated all 5 of its target zones, encountered high-quality oil bearing sands with a net oil column of 541ft. Initial original oil in place estimates are for 50-115mmbls, gross. Development planning has commenced with the company moving towards a field development plan by Q1 2015. The discovery de-risked a wider area around the Galeota Ridge anticline, which include prospects such as 'Carolina' and 'Thais'. Gross contingent resources for this area are 45mmbbls, with prospective gross resources of 144mmbbls. Whilst TGAL will require funds to develop (most probably debt funding given the company's cash flow), it is a very important asset that should carry material value when online.

Monty Pemberton commented: "In 2013 Trinity was the third most active driller in Trinidad and our TGAL discovery was the only successful exploration well in Trinidad during the year. This discovery reaffirms our confidence in the Galeota block and the key priority is to develop a cost efficient development plan within the shortest possible time frame. Our continued focus on improving drilling performance is beginning to yield positive results and we expect to see further benefits over time.
The Trinidad upstream industry continues to evolve and Trinity is pursuing various business development opportunities to further growth the Company in line with the existing business model."
 
In late May, the company also announced success at its B-9X infill well within Galeota. The well encountered 331ft of net oil sands, albeit it was terminated early due to unexpectedly high formation pressures near the lower target zones. Unfortunately, this did leave the lower horizons untested, albeit the well was a commercial success. B-9X was strategically positioned in a crestal position such that it should unlock upside in surrounding untapped areas. Expected initial production rates are for between 200bopd and 300bopd - it should be brought into production towards late June or early July. To follow this up, there are two planned wells. The first is B-13X, which will be a horizontal well, and the second is B-18 J-type well. The J-type well will test a new well design, which is expected to increase production rates from around 250bopd to 500bopd. It is essentially a well that extends along the horizontal payzones, exposing more of them to the wellbore, thus increasing production - a technique that management notes has worked well in Brunei. Success would de-risk later production at both TGAL and the wider Trintes field. There is consequently a clear case to be made that the recent share price downturn has been exaggerated without merit.
 
The South African asset is very much a sideshow. Located in shallow water, Trinity owns 100% of the Pletmos inshore exploration block. The block inventory has 6 prospects with a total of 2.7TCF net unrisked in potential. A farmout has been initiated to try to sell down interest ahead of either a 2D seismic survey or exploration well. Despite there being several independent oil companies nearby, I attribute little value to this asset until the farmout proves otherwise - it should consequently be treated as non-core. The potential resource is good, but the asset remains very early-stage, and there are relatively tight time constraints given the obligations need to be met by April 2015.
 
Trinity also ticks another box in terms of its 2P reserves, which stand at 49mmbbls on the last reading. The table below shows a rough comparison for Trinity versus its London-listed competitors.


The ten companies shown all have 2P reserves and meaningful production at their assets. Computing the underlying value in each case (see note at the bottom), and then comparing it to the 2P reserves and production rates shows the undervaluation that Trinity suffers from. The company has a particularly low Underlying Value/BOE at £2.12, which is lower than all of the comparators except Petroneft Resources (previously reviewed with this a core reason for the Buy tag), and Gulfsands Petroleum (which operates in Syria where its asset is effectively 'stuck'). It is almost certainly the case that Trinity has a lower UV/BOE compared to Nighthawk Energy as well. In addition, the company has the highest Boepd per £million UV on offer, at 38.27. In other words, the company produces 38.27 barrels per £million of its UV - the higher the better. Whilst the list is not comprehensive (for example, I have excluded Exillon Energy which has massive 2P reserves and large production flows, because of the extremely high risk it carries), the comparison with the closest comparators is very favourable. Of course, this list does only represent a static point in time, and production at both Leni and Caza is rising quickly, but the margin of difference is statistically significant. It is not that the other oil and gas explorers are overvalued, rather Trinity is materially undervalued.

Given the secure operating environment of Trinidad and the respectable oil price achieved, applying a conservative blended £5/boe price would be reasonable in Trinity's case. This fetches an asset value of £245m for the proven and probable (2P) assets alone - factoring in the net entitlement values, it is likely closer to £200m. That is still twice the current market cap. In fact, looking at Caracal's takeover, it was valued at a UV of £770.5m. Caracal had production of 11,799bopd and 89.8mmbbls in net working interest 2P reserves. The UV/BOE value for that transaction amounts to £8.58, with a Boepd/£m UV of 15.3. If that same UV/BOE is applied to Trinity, the value of the reserves amounts to circa £420m. Of course, this is not realistic given that Caracal had far superior 3P resource numbers of 194.3mmbbls. It is trading on comparably low asset value and production metrics. Broker Jefferies has previously commented on Trinity saying that the sector average is closer to $21/boe (£12.5/boe). That would place Trinity on a valuation of £612.5m, which looks too high to me, but yet again signals that the current multiple put on the company is very low. These numbers tally with the broker targets, which are all much higher than the current share price. Jefferies has a 190p target price, RBC Capital has a 200p target and Investec has a 250p target.

The one aspect that Trinity lacks is speculative appeal. The outlook for 2014 consists of workovers at West Coast and infill drilling at East Coast, along with the J-type well. In addition, at the Onshore asset, drilling is currently suspended pending the resolution of discussions with the Ministry and state-owned Petrotrin, aimed at removing drilling inefficiencies. Is that likely to send shockwaves through the market? Most probably not. In early 2015, all eyes will be on TGAL, which has the potential to increase the company's net reserves by more than 50% at the top end of the range. Assuming a conservative 30% oil recovery and the bottom end of the range in terms of OOIP, there is potential for 9.75mmbls to be added to the 2P reserves, or an additional £29.25m at a cautious £3/boe (30.9p/share).

There are of course some core catalysts within that schedule, and there is the chance of M&A within Trinidad that could provide upside, but there is no one standout event. CAPEX is also set to slow in 2014, but that is actually positive since 2013 was categorised by high levels of spending, with $31.4m spent on development wells and $18.2m spent on infrastructure upgrades. 2014 spending plans are for $6m in infrastructure spend, $8m in production drilling and the $7m already spend on El Dorado. Given that revenues in 2013 jumped to $12.8m, with EBITDA of $34.8m and a cash inflow of $17m, the period of consolidation should be welcomed. On another metric, the company is trading on an EV/EBITDA of less than 5. The company is not strained for cash given that there is a $25m debt facility with long-term partner CitiGroup available, and because there are strong cash flows from operating activities. $5m of the facility was drawn upon in January.

It is for these reasons that Trinity E&P presents a tempting investing case around current levels. The share price has retreated since failure at El Dorado, which is justified, but the scale of the fall shows that investors have over-reacted and failed to understand the bigger picture at Trinity. The company has a robust financial base, with a credible management team, excellent production flows, and a 'cheap' 2P reserve base, with potential for that to grow as the 3P is de-risked. Certainly within Trinidad as a whole, the company is well placed to keep up along its growth profile, and there is every chance that could be assisted through either asset purchases of further M&A opportunities. As the oil and gas sector continues its recovery, it is likely that Trinity will recover from its chronically low valuation over the next 6-9 months. With strong share price backing (100p support) and an undervalued business, Trinity offers a taste of the Trinidad oil and gas sector, at a price that is particularly attractive.

3 comments:

  1. I strongly agree. Trinity exploration has been on my watchlist since the Bayfield days and I have been waiting for the right moment to purchase. I missed that moment in August last year as the share price ran very little towards fair value, but I have been gobsmacked by the fall from grace. 105p looks a very nice entry point. I share your rhoughts on Exillion too. They have half a billion in 2P and almost 20k in production but is uninvestable. Russia and large russian stakeholders and a board overhaul makes ot a barge pole stock for me. Why did it not get a takeover offer if it was so cheap? The sale process failed. Makes a mockery of AIM that one does and so does Ruspetro. 2 barepole stocks. PTR and TRIN hve their own positives

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  2. Thanks El1te, very good indeed

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  3. Good work as usual. Thanks for the effort you put into the reviews as they help many investors. There seems to be a seller on the books but not a heavy one and they will be erased in a few days. Trinity looks a long run winner

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