TTE - Frontera's Latest News From Guyana Confirms Buy Rating

2023-07-03 22:16:06 ET

Summary

• Canadian oil producer Frontera Energy's shares are heavily undervalued by the market due to an overbaked perception of risk.
• Latest drilling results from CGX Energy, a subsidiary of Frontera, in the Corentyne Block offshore Guyana confirm the presence of light oil and gas condensate.
• Despite the costs and risks associated with developing offshore oil discoveries, Frontera Energy appears heavily undervalued after making what is potentially a transformational find.
• The Wei-1 discovery has the potential to be a powerful catalyst for Frontera with the company offering potential upside of up to two-and-a-half times its current share price.

Canadian intermediate oil producer Frontera Energy ( OTCPK:FECCF ) ( FEC:CA ) is being buffeted by headwinds because its key oil operations are located in onshore Colombia. The Andean country’s first leftwing president former guerilla Gustavo Petro has promised to ban hydraulic fracturing and cease awarding contracts for hydrocarbon exploration. Those developments coupled with a softer outlook for crude oil have been responsible for Frontera’s price plunging 8% for the year to date. The recent announcement of an oil discovery in the Corentyne Block offshore Guyana, where Fronters has amassed a significant presence, makes now the time to review the driller’s prospects for what is labeled as a transformational opportunity. This is particularly the case after assigning a buy rating in my June 8, 2023, update on Frontera .

Latest news from Guyana

Frontera holds a 68% non-operated working interest in the Corentyne Block offshore Guyana with the remaining 32% held by the operator CGX Energy ( OTCPK:CGXEF )(OYL:V). The Canadian small cap driller also owns a controlling 76.97% of CGX, giving it a consolidated interest in the Corentyne Block of 92.64% conferring all of the contractual obligations of operating the block onto Frontera. The Corentyne Block has the potential to be a key piece of petroleum real estate in offshore Guyana.

The northern segment of the Corentyne Block is contiguous to the prolific Stabroek Block where global supermajor Exxon has made over 35 high-quality oil discoveries and endowing it with more than 11 billion barrels of oil resources. Exxon ( XOM ) has two operational FPSOs on the Stabroek Block which are pumping around 400,000 barrels of oil per day from the Liza oilfield, which has been called the world’s most exciting frontier field.

It is believed the petroleum fairway within the Stabroek Bock runs through the northern segment of the Corentyne Block into neighboring Block 58 offshore Suriname where partners TotalEnergies and Apache have made five commercial discoveries.

The latest drilling results from CGX certainly support that view. During May 2022, CGX announced the discovery of oil at the Kawa-1 wildcat well. According to Gabriel Alba chairman of Frontera and co-chairman of CGX:

“The Joint Venture is pleased to announce that it has successfully discovered light oil in the Santonian and Coniacian and gas condensate in the Maastrichtian and Campanian at the Kawa-1 exploration well, offshore Guyana,...”

The driller encountered 228 feet of net oil pay distributed across the Maastrichtian, Campanian, Santonian, and Coniacian zones. Further analysis and testing confirmed that the Kawa wildcat well successfully found light oil in the Santonian and Coniacian and gas condensate in the Maastrichtian and Campanian intervals.

That discovery laid the groundwork for CGX to proceed with the Wei-1 exploration well which was spudded in January 2023 and completed by mid-June. The troubled Wei wildcat well which suffered from equipment outages is located nearly seven miles northwest of the Kawa-1 exploration well, also discovered oil. CGX released a statement at the end of June 2023 saying:

“The Wei-1 well encountered 210 feet of hydrocarbon bearing sands in the Santonian horizon.”

Nevertheless, it is important to note that as per the CGX press release because of a series of incidents during the drilling of the Wei well oil samples were not obtained, and evaluation of that discovery is ongoing.

Prior to that announcement, CGX stated on June 13, 2023 , that the well had encountered 71 feet of net oil pay in the Maastrichtian and Campanian intervals.

The company also asserted in that initial report that the presence of hydrocarbons had been confirmed in the primary targeted in the Santonian interval. CGX went on to state:

“Results from the Well are consistent with pre-drill expectations. The Well has confirmed the Company’s geologic and geophysical assessment of the block.”

This was all confirmed by the June 28, 2023, press release, discussed earlier. The Wei discovery is particularly important development for a range of reasons, which affects not only CGX and Fronter abut also other players in Guyana’s massive offshore oil boom.

The significance of the discoveries

CGX’s oil discoveries have important implications for Guyana and Suriname’s offshore oil booms. They support claims by analysts that the hydrocarbon fairway passing through the Stabroek Block offshore continues into the northern portion of the Corentyne Block and then into neighboring Block 58 offshore Suriname. This is a particularly important development because Block 58, which is operated by TotalEnergies ( TTE ) with a 50% working interest and the remainder held by APA Corporation ( APA ), is believed to have similar potential to the prolific Stabroek Block.

CGX’s discoveries bode well for Spain’s Repsol ( OTCQX:REPYY )( OTCQX:REPYF ) which is the operator with a 37.5% working interest in the Kanuku Block which is contiguous to the Corentyne Block. Repsol has struggled to make commercial oil discoveries on Kanuku and currently constructing a roadmap for the next steps concerning the block where Tullow ( OTCPK:TUWLF )( OTCPK:TUWOY ) holds a non-operated 37.5% and the remainder is held by TotalEnergies.

The discoveries also support the view that there is considerable oil potential contained within Guyana and Suriname’s shallow territorial waters. The former British colony launched a bid round in December 2022, where it is offering 14 blocks with 11 shallow water blocks two of which are contiguous to the Corentyne Block. The government in Georgetown pushed back the deadline for submissions for that auction to mid-July 2023. For neighboring Suriname, the former Dutch colony’s government conferred three shallow water blocks from its 2021 oil auction. Block 5 was awarded to U.S. supermajor Chevron ( CVX ), while a consortium comprised of TotalEnergies and Qatar Petroleum received Block 6 along with Block 8.

Next steps

While CGX’s latest announcement is particularly positive news for it and Frontera, there is a long way to go before the two discoveries in the Corentyne Block will become the transformational developments touted by management. There is considerable work on the Kawa and Wei wildcat wells to be completed before any decision can be made regarding their viability and commercial exploitability. Initially key will be CGX releasing the results of the well wall sampling, wireline logging and flowline resistivity measurements which are used to model the forecast reservoirs.

Once those activities are complete CGX and partner as well as majority owner Fronter must consider whether to drill another wildcat well or move onto appraising the discoveries made to date. This will be a difficult and costly decision because the Wei-1 well cost $195 million to bring to completion compared to the $120 million budgeted. There are considerable risks associated with developing an offshore block to first oil as TotalEnergies experience with appraisal drilling and flow testing in neighboring Block 58. Even after reporting successful flow tests at the Sapakara oil discovery TotalEnergies delayed the $10 billion final investment decision because of conflicting seismic data, poor drilling results and a high gas to oil ratio.

Frontera, which has principally financed the exploration program in the Corentyne Block, is coming under considerable financial pressure. Softer than anticipated oil prices combined with Colombia’s November 2022 tax hikes are impacting earnings and free cashflow from Frontera’s core oil producing operations in the Andean country. You see, Frontera was funding exploration drilling in the Corentyne Block from the cashflow generated by its Colombian operations. Frontera benefited from the 2022 surge in oil prices after Russia’s invasion of Ukraine with it reporting record fourth quarter 2022 net income of $197.8 million and $286.6 million for the full year.

As a result, Frontera’s unrestricted cash at the end of 2022 surged by $32 million, compared to a year earlier, to nearly $290 million. That came on the back of a remarkable 89.5% year over year increase in cash flow from operating activities which was $620.5 million for 2022 compared to $327.4 million a year earlier. This translated into 2022 free cash flow of $237.2 million compared to $140.4 million for 2021, allowing Frontera to significantly boost 2022 and 2023 capital spending.

However, for 2023 Frontera expects free cashflow, generated by its Colombia and Ecuador operations, to be $50 million to $75 million if Bren average $80 per barrel for the year. Aside from that being a steep decrease compared to 2022 there is every indication that Brent will not average $80 per barrel for 2023. U.S. EIA data shows that Brent averaged $79.77 a barrel from the start of 2023 to the end of June, with the agency’s latest forecast predicting the international benchmark will average $79.54 per barrel for 2023. This indicates Frontera may not be able to generate the considerable free cashflow needed to finance appraisal drilling in the Corentyne Block.

For CGX and Frontera to engage in a costly appraisal drilling and flow testing campaign as well as conduct further seismic studies and reservoir modeling, they will need to find additional capital. Indeed, with the Wei exploration well costing nearly $200 million and the need to drill at least 2 appraisal wells, this will be a costly exercise with the potential to require $400 million to $500 million of capital. For that to occur, CGX and Frontera will likely need a farm-in partner with deep pockets, which will obviously dilute Frontera’s working interest in the Corentyne Block.

There is growing pressure from the majority owner of Frontera Toronto based Catalyst Capital, which owns around 41% of the company, to realize a profit by selling its position in the driller. Earlier this year Frontera was restructured into three businesses discussed in depth in my June 8, 2023, article. These are an onshore upstream oil exploration and production operation in Colombia and Ecuador, a standalone Colombian midstream business and an offshore exploration operation in Guyana. That makes it far easier to sell aligned parts of Frontera or even the entire company.

As far back as April 2023, it was rumored that Citigroup had been tapped to explore a potential sale of all or part of the business. The apparent lack of interest in buying Frontera either in part or full along with leftwing President Petro seeking to ban hydraulic fracturing and end awarding new exploration contracts is weighing heavily on the driller’s market value.

Key risk

The factors discussed make it more difficult for CGX and Frontera to find an appropriate farm-in partner for the Corentyne Block with no major energy company willing to risk significant capital when such uncertainty exists. For these reasons, CGX and Frontera will likely need to go it alone for the appraisal stage of the Kawa and Wei wells, placing greater financial pressure on both drillers at a crucial time. The interest of big oil companies will only be piqued once appraisal drilling and flow testing has proven that there are commercially viable reservoirs of quality crude oil with a long lifespan to exploit.

If the neighboring Stabroek Block, where Exxon has identified over 11 billion barrels of oil resources, and Block 58, where TotalEnergies has found at least 525 million barrels, are any indication then there are likely large commercially exploitable reservoirs in the northern portion of the Corentyne Block. For that to be established, CGX and Frontera must find a means of financing the appraisal drilling, flow testing and other related activities to delineate the scale of the discoveries and quality of the reservoirs as well as crude oil found.

Bottom line

The Wei-1 oil discovery is a powerful catalyst that will drive Frontera's stock price higher if the exploration well lives up to the potential identified thus far. This is a much needed catalyst for a company which has been beaten-down by the market for the sharp increase in geopolitical risk associated with Colombia. It is for this reason that Frontera's after-tax 2P net asset value or NAV, as calculated in my June 8, 2023, article, of $21.57 stands. This is two and half-times greater than the current market value, indicating that not only is there considerable upside ahead for investors but also a wide margin of safety.

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