Trinity Exploration & Production - Expanding the Portfolio

http://www.trinityexploration.com/


It is sometimes the case that one news announcement is sufficient to change the investment dynamic of a company such that it needs to be reviewed, and changed if warranted. Indeed, I only looked at Trinity E&P (LSE:TRIN) last month when trading at 105p, and concluded: "....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." I also commented that "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." Today Trinity announced the acquisition of a gas asset offshore Western Trinidad and provided an update on production across the portfolio - has that changed the investment dynamic? Trinity currently trades at 91p, which means the company is valued by the market at £86.3m.

This article is a follow-on from the below post. For full context and information, read this article first:
http://www.theel1tetrader.com/2014/06/trinity-exploration-production-taste-of.html


The technical situation for Trinity is very much premised on trading over the next few sessions. Whilst the technical position is now at oversold levels, the share price marginally breached 92.5p support as a result of auction trades today. If the share price bounces from current levels, then the technical position would look strong for a double bottom although that requires a break out of the downward channel, which currently has a ceiling around 98p. Volumes over the past few weeks have been relatively low, although there were a few large buys today following the news. As before, management are well aligned in terms of material holdings and are well experienced, which is a strong positive.

One slightly peculiar point to recognise is that there have been a significant number of very small trades (Less than 50 shares so less than £50) being traded over recent weeks, and these have largely all been on the sell side and processed as 'AT' trades. Whilst the reasoning behind the number of trades is unknown, it has put pressure on the share price as the price has tended to tick down on these auction trades, whereas perhaps larger trades have not have the same impact. Looking at the trade list, a single 1 share was traded mid-afternoon today, there were seven sub-50 share trades yesterday, one on the 15th, two on the 14th and a further fifteen in the two preceding weeks. It is something to be aware of, but these are highly unlikely to be genuine trades, especially since they are all processed as automatic trades.

There have been two major announcements today, and I'll start by covering the Q2 operations update. The company reported:
- Lower overall production at 3,613boepd during the quarter
- Current production higher at 3,750boepd, which is nearly all oil
Within the portfolio:
- West Coast production higher at 612boepd vs. 547boepd in Q1
- Onshore production marginally lower at 2,023bopd vs. 2,153bopd in Q1
- East Coast production lower at 978bopd vs. 1,278bopd in Q1 as a result of a failed well pump. The pump has since been restored with the current run-rate for the Trintes field of circa 1,200bopd

Of course, a fall in production is never good news, and it means the year-end exit run-rate will be towards the lower end of the previous expectations (i.e. between 3,800boepd and 4,000boepd). However, the production during the quarter was largely because of the failed pump, which has since been rectified. Therefore, perhaps the more disappointing news revolved around the B-9X well not flowing oil from the O sands as previously hoped. Instead, they just flowed gas from that package, which will have implications for other future wells in the immediate geology. However, B-9X encountered several intervals, so that plan is to cut back and produce in the 'M' sand instead where there is 85ft of net oil sands. Despite that fallback being in place, production rates are expected to be lower than previous expectations at between 75bopd and 130bopd, which ultimately makes the well relatively immaterial in terms of the overall portfolio. Nonetheless, it should help reach the company's guidance range.

Aside from that, the company received regulatory approvals for six new infill wells onshore, with a further 6 wells in the approval pipeline, and announced forward plans for the next couple of years. The 'J' type well has been pushed back to Q4 2014/Q1 2015, although the company revealed that an operator on an adjacent licence had experienced considerable success with a horizontal well, flowing 1,200bopd and that they had passed on the data to Trinity. That well remains a key catalyst for the share price moving forward as it could add materially to current group production rates. Alongside that development, the company will progress newly acquired assets and will also seek to progress the important TGAL-1 discovery made last year. FDP is still targeted for Q1 2015.

CEO Monty Pemberton said, "Despite technical challenges during the first half, our operational team has shown determination, and the development of the portfolio remains on track. We look forward to the second half and the next operational phase. The Trinidadian basin is entering a new phase, and a growing, nimble company like Trinity, established to capitalise on this change, is an exciting place to work. As demonstrated by the acquisition of Block 1a and 1b that we announced today, Trinity's strategy is bearing fruit and our team continues to review a number of other business development opportunities."

However, it was very much the asset acquisition that was the important announcement. Whilst it helped offset some of the negativity regarding certain issues above, it was not immediately clear what the acquisition means for the broader group, other than a step-change in scale and a clear signal of intents to grow the company.

The acquisition sees Trinity purchase Centrica Energy's 80% stake of the Blocks 1A and 1B, offshore Western Trinidad. The headline consideration for the acquisition is $23m, which equates to around £13.5m plus any fees incurred since the start of the year - it will be funded through an undrawn $20m debt facility and existing cash resources. Whenever a major resource company sells one of their stakes in an asset, is it absolutely crucial to understand why they sold it, and there must be a reason that stacks up positively. After all, if anyone knows the value of an asset, it is likely to be the major company offloading, hence why recent asset purchases such as that of BP's Eriskine interest by Serica Energy (LSE:SQZ) came under scrutiny. If the asset was that good, how would a small or medium tier company be able to get access to it?

That is the question that has to be asked regarding Trinity's purchase especially since a lot of money has previously been pumped into the asset. The blocks contain four gas discoveries with total gross 2C resources of 268bcf of gas, which reduces to 215bcf when looking at the net share to Trinity. That is a very respectable resource, although in isolation via a single drill, may not be economic. It boosts Trinity's contingent resource base by a very material 42% and equates to a purchase cost of £2.68/mmboe, which appears good value. Moreover, the field is fully appraised with a total of six wells drilled across the blocks (plus 3D seismic), and in fact it is ready for economic exploitation once initial infrastructure CAPEX is expended - Trinity is targeting first gas from the asset in 2017/18.

That's good, but what about the economic viability of the resource? The asset is located in shallow water, which assists with development, and the plan is to undertake a phased development programme whereby the Iguana discovery is phase 1, and Zandolie and Anole are phases 2 and 3 respectively. These can be tied back in to Iguana, which will all be connected and tied back to onshore markets where there is major infrastructure already in place. The blocks are circa 20km from the Western Trinidad coast, and more importantly 25km from one of Trinity's existing development areas, Brighton. Gross CAPEX for first gas is expected to be $160m or £94m, which highlights how big a development this is relative to the market cap. However, once a gas sales agreement and final development plan have been agreed upon, then the company should be able to gain access to substantial debt facilities that should cover the majority of requirements. What makes the asset particularly interesting is that it carries a cost recovery pool of $220m, which would greatly improve operational cash generation during production. An internal rate of return is touted as reaching as high as 50%, which would make the asset particularly attractive to financiers once a few hurdles have been passed. The development is planned to be accelerated although a gas sales agreement and final development plan are targeted within 12 to 18 months, so before the end of 2015.

There are two last points to consider for the investment to be viable. The first revolves around geological factors. In the case of 1A and 1B, porosities are very good at between 20% and 35% and that means that possible production rates are highly material compared to Trinity's size. Management have noted that they expect a production plateau (i.e. post initial production rises) of 64mmscfd net to Trinity, which is even more relevant when accounting for the cost pool that will remove tax payments for a lengthy period of time. To put it into context, that is roughly 10,700boepd. The last point is that there must be a market for the gas at an attractive sale price. Trinity notes that "Trinidad's domestic market requires additional natural gas supply due to excess demand, as such market risk is minimal". Although gas prices are modest, averaging between $3.5/mcf and $4.0/mcf, forecasts are for a widening demand-supply gap, and that could put upward pressure on the domestic gas price in future years. Of course, factoring that into forecasts is unwise at the moment, but there is plenty of potential demand for the gas.

That is all well and good, but the question over the motivation for the sale has still not been answered. Importantly, it is possible to identify reasons for the asset sale. As background, Centrica has been operating in Trinidad and Tobago for a number of years through a central office at the Port of Spain, Northwest Trinidad. The company has several oil and gas assets to the North including a block called NCMA-1 and Block 22, although the Blocks 1A and 1B are geographically far away - further down South. The A1 and B1 blocks were actually owned by Petro-Canada who largely spent well over $200m on the blocks completing the extensive exploratory work. Petro-Canada then merged with Suncor, who later sold their portfolio of Trinidad interests, including the Northern assets, to Centrica in 2010, for a total consideration of £246m in cash. Despite that large commitment, progress from Centrica has been nothing short of underwhelming with several development-ready projects, including A1 and B1, simply not being developed nearly as quickly as anticipated.

There are several possible reasons for that, which can be drawn from past Centrica documents. One of them includes Centrica wanting to establish an LNG or CNG project in Trinidad in order to service the global markets - that was potentially a way to access higher gas prices overseas. However, a sustained fall in gas prices post-2009 is likely to have played a significant role in hampering that effort. Indeed, a past asset book from 2011 notes that the company was "awaiting development of the gas market". More recently Centrica noted that "The fields are close to existing onshore infrastructure and negotiations are ongoing with local gas buyers to commercialise the resources on these PSC blocks." Ultimately, the sheer length of time that Centrica has sat on these blocks, plus more Northern blocks, suggests that Trinidad is not their core focus, and that was confirmed just last month when the company announced that it was to try and auction off its assets there for £250m, just £4m ahead of the initial purchase price. This was not a single development either, as Centrica is trying to divest of non-core assets, which also include Texan power stations and gas-fired plants in the UK. There is thus no block-specific reason why the blocks were sold off and it was probably a case of rationalising their portfolio and re-investing the proceeds into North America.

So why has Trinity been able to pick up the asset? The asset is seemingly too small for majors, even though resources have been discovered. 215bcf net over four prospects is not a significant development for any international oil and gas company, who tend to seek out multiple TCF at favourable economics. The two blocks do not fit that bill at all. That makes the blocks a strategic fit for Trinity, as the resources are very significant to the market cap, yet are too small for majors to be interested in. Furthermore, a lot of smaller oil and gas companies with worse access to funding would not have been able to stump up the initial fee, let alone be able to commit to the gross CAPEX required to develop the project through to first gas. Trinity has an obvious niche within the Trinidad market, that positions it well to exploit opportunities that are either of too large, or too small a scale for other companies such as Leni Gas & Oil. It is the high production levels that give Trinity that flexibility, and also their strong relationship with Citibank.

Referring back to the table used in the previous review, we can now update it accordingly. As per the table below, the production rates have fallen, but so has the market cap.


Indeed, the UV/BOE 2P has fallen by over 10% since the initial review, which continues to underscore the relative undervaluation compared to almost all London listed oil and gas companies. The Boepd per £m UV has also improved as the fall in underlying value has exceeded the fall in the production rate. That continues to make Trinity a very attractive proposition. Factoring in the transaction and the take-up of around £13.5m of debt, the UV/BOE returns back to the original £2.12 level, which once again makes Trinity highly attractive on current metrics. The Boepd per £m UV falls by around 13% to 36.13, only marginally below previous levels. That is more than offset by the sharp rise in 2C contingent resources as a result of the positive 36 mmboe influx from 1A and 1B. Indeed, on that metric, the company is significantly cheaper post-transaction than in the two previous scenarios. It is important to remember that the company has very strong underlying operating cash flows (as you would expect) albeit that is being recycled back into funding growth.

In essence, although there were negative aspects to today's announcement, the acquisition of the offshore blocks appears to be a shrewd one, and not one driven out of impatience. The favourable economics and low initial purchase cost (certainly compared to how much was spent on the asset and the resources in question) means that an attractive asset has been added to Trinity's portfolio, and this will assist Trinity in being able to grow from a low-medium tier Trinidad hydrocarbon producer to a mid-cap producer in future years. As noted in the initial review, Trinidad is a prolific hydrocarbon basin with a stable fiscal regime, extensive infrastructure and attractive cost levels. Cash use by Trinity will remain a point of consideration, but with an aligned and experienced management team plus strong cash flows, the company remains on a firm footing, and the acquisition today potentially gives them access to greatly increasing future production rates.

The acquisition of the blocks from Centrica appears positively motivated and has further improved the investment case. A market cap of £86.3m, or a post-transaction UV of £103.8m is undemanding on a reserve, resource and production basis and substantial upside remains in place for investors willing to wait for the market to awaken to the potential. The company's production rates and the asset base continue to provide a firm backing for the current share price, and especially for lower share prices, and that generates a good risk-reward taking a 9-15 month viewpoint - this is not a pure exploration company in any form. I have therefore doubled up the initial 50% slot stake to form a full slot holding for Trinity at an average price of 98p and will look to scale in further dependent upon price movements. I retain my Buy tag on Trinity targeting significantly higher levels on a medium-long term basis.

UPDATE (16/10/14) - I have moved Trinity from Buy to No Rating for a very disappointing aggregate £1,800 loss, of circa 53% on the original stake or circa 36% on the normalised (£5,000) stake. Whilst the assets are still high quality, the current assets/current liabilities situation combined with the declining oil price (which has the potential to stay weak), could cause problems including progress delays and problems in seeking funding. This move has therefore been triggered by the declining oil price

11 comments:

  1. Great review,thanks.I happened to notice the Rns yesterday so put Trinity on my research list

    ReplyDelete
  2. Centrica can clear off. They have done nothing for our beautiful country when we invited them into our land to help us.

    ReplyDelete
  3. Thank you for a very helpful review. This has convinced me to continue holding Trinity.

    ReplyDelete
  4. Nice piece Elite. Can you take a look at AEY. At 6p is sitting at cash level and has the Fyne north sea discovery and the irish licence( with kosmos).

    ReplyDelete
  5. What happened to your updates? I saw there were a couple, with an over-riding one published 10th October, but they have now gone!

    ReplyDelete
  6. Hi,

    The previous updates were for the implementation of a new stake at just above 70p but this was stopped out at 70p in short order. As you note, I had written an overriding update on the basis that the position was closed out at a residual stop at around 54p from last week. That has the basis for the overriding change; However, I learnt over the weekend that the stop failed to trigger hence back to the previous state. I remain watching closely

    El1te

    ReplyDelete
  7. Good stuff, hopefully it's bottomed out as it seems like an excellent buy at this price - further crude price collapse notwithstanding!

    ReplyDelete
    Replies
    1. It would appear that way given the costs incurred just to drill up the portfolio of assets including TGAL-1 and 1A/B, but the question is all about how they can finance the operations. If they can find a solution that is not particularly dilutive, then the share price is highly attractive given that the production revenues are helped by an accommodating T&T tax system. In other words, when the oil price drops, the tax due to the government falls in line. That said, the market is clearly not convinced and if the brent price slips further, there is potential for further downside given the weak technical position. An interesting dilemna - hence the need to watch very carefully!

      El1te

      Delete
    2. So I bought 50,000@47 last Friday but the trade was reported as a sell?? :-(

      Delete
    3. That tends to be the case when there is a stock overhang hence the ask price is low relative to the bid price (in terms of distance from the mid price). As per the update, I regrettably moved the position at circa 47.5p

      El1te

      Delete