TRLEF - Trillion Energy: Growing Into A Deferred Energy Crisis

2023-03-31 10:01:12 ET

Summary

• The natural gas pricing environment in Europe and Turkey has softened, due to the mild winter, but still remains at favorable levels.
• Trillion Energy is executing its development program with 4 already producing wells and is expected to add one more every 30-45 days.
• Trillion is trading at a deep discount to its 2P reserves value, while exploration prospects may add additional gas to the reserves.

Back in November 2022, I presented the case for Trillion Energy (TRLEF) as the company was entering production stage. Now Trillion has 4 producing wells and is expected to be bringing one more every 30-45 days. Meanwhile, the SASB program was expanded to include 20 wells, instead of 17, as 3 additional opportunities were identified. The staggered development program has the potential to self-fund itself, eliminating the need for additional capital raising. The updated reserves report indicates expanded resource base and improved economics. The estimated after-tax NPV of the 2P reserves indicates share price of US$0.78 on a fully diluted basis, indicating more than 160% upside to the current levels.

The natural gas pricing environment in Europe

After the Russian invasion in Ukraine and the blow-up of the Nordstream-2 pipeline, Europe has limited its exposure to the previously biggest natural gas source - Russia. At the same time, the EU continues to push its green agenda and member states are sticking with closing fossil-fuel extraction fields on their territory like the Groningen gas field in the Netherlands. Initially, all these factors caused a perfect storm for natural gas prices, which went parabolic as Europe was in a full blown energy crisis. However, the combination of unusually mild winter , lower LNG demand from China, due to the lockdowns, and reduced consumption due to some industrial facilities closing down, helped Europe to weather the storm. Subsequently, natural gas prices collapsed from their highs, but still remain at historically elevated levels.

Going forward, I don't think that the chances of Europe repeating its 2022/3 winter luck are high. Two mild winters in a row seem unlikely and China already abandoned the pandemic-related restriction, therefore demand is expected to pick up. The current easement of prices may also lead to increased industrial demand. At the same time, Russian supply is not coming back as deeper and deeper red lines are drawn in the EU-Russia relationship. Due to those factors, I believe high prices will eventually return later this year.

The case of Turkey

While Turkey is not in the EU, it imports the vast majority of its natural gas from outside sources. LNG is part of the import mix and the close proximity to Europe causes correlation of the natural gas price in Turkey with that in Europe. Not surprisingly, since the beginning of the year, the state-owned utility Botas has begun cutting prices . For March, 1mcf costs around US$17.60, compared to US$30/mcf in the end of 2022. Still, this is much higher than prices in the US, so any producer that has exposure to the Turkish market is well positioned to benefit. Such is the case of Trillion Energy.

Trillion Energy recent developments

As I've covered the company before, I'm not going to present the Trillion story again, but instead will focus on the new developments. The firm is executing its staggered development program for the SABS gas field and as of 29 March , 4 wells are producing and is expected to be adding one more every 30-45 days. In a recent interview, the CEO - Arthur Halleran revealed that the first wells were put into production with rates of 3.5-4/MMcf per day, more towards the lower band. However, the latest well - Guluc-2 was put into production at a rate of 6.0MMcf/day. Assuming 17MMcf/day total production rate of the operating assets and a price of US$17/mcf, after accounting for the 49% working interest of Trillion, the company should be able to generate about US$4.4M/month.

This appears sufficient to self-fund the remaining part of the SASB development program. Meanwhile, the company released an updated reserves. The report reveals 141.8% YoY increase in 2P reserves to 48.6Bcf. However, according to the recent interview of the CEO, the Guluc discovery is not included in the reserves report, so the company plans to publish and updated reserves version as of 31 January, which will include that well and is expected to give another boost to reserves. The increase in resources will allow the company to flatten the previously projected steep decline in the production curve and to extend production towards the second half of the decade. At the same time, the company is identifying more prospective areas for exploration within the SASB gas field, which may boost reserves and useful life further.

Valuation discussion

To get a sense of the valuation of Trillion, I used for reference the 2022 reserves report. It indicated after-tax NPV of US$344.4M of the 2P reserves.

Looking at the capital structure of Trillion, while it has 383.9M shares as of 31 January, it also has over 106.5M warrants, most of which are exercisable at a price of US$0.33. There are also 7.5M options. For that reason, I'll assume fully diluted share count of 500M shares and proceeds from the exercise of the dilutive instruments of US$35M.

* Based on author's own assumptions

Based on these assumptions, I estimate the fair price of Trillion at US$0.78/share, implying more than 160% upside potential. As far as upside triggers, every new well that is put into production successfully makes the case for the company stronger. However, I believe that if natural gas prices remain at current levels or even go higher later this year, Trillion may be in a position to initiate some sort of capital return program towards the end of 2023.

Risks

Political risk

Trillion's main asset is based in Turkey, which is in the bottom half in terms of economic freedom, according to the ranking of the Heritage foundation. The country is experiencing high-inflation and government intervention in the economy is not uncommon. However, in the case of Trillion, the fact that Turkey is a natural gas importer is a positive. Because of that, imposing price caps doesn't make sense, as exporters will simply avoid the market. On the contrary, Turkey is trying to increase its energy independence and companies like Trillion that increase domestic production are in a good position. I don't expect the upcoming elections in Turkey to change anything regarding Trillion as well.

Operational risk

Bringing wells into production is an engineering exercise. So far, the company is 4/4 wells. However, in February, the company experienced some minor technical and logistical issues, which resulted into the Guluc-2 well being put into production a month later than anticipated. Still, management proved to be flexible and moved the rig elsewhere in the meantime, so the actual delay to the drilling program ended up being negligible.

Natural gas prices risk

This is probably the most serious risk to Trillion as natural gas is the primary source of revenue. As discussed in the beginning of the article, I see a favorable natural gas price environment in Europe and Turkey to persist in the mid-term.

Conclusion

Trillion Energy offers investors exposure to the high natural gas price environment of Turkey. The company has been successfully executing its development program and putting wells into production win 4 already operation ones. Trillion has managed to considerably increase its proven and probable resource base during the past year. At the same time, the company is trading at deep discount to the indicated after-tax NPV of its 2P reserves. I estimate the fair price at US$0.78, implying more than 160% upside potential from current levels.

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