Calima Energy · 2019. 10. 25. · Calima Energy Position in prolific Montney formation Calima’s...

Australia│Equity research│November 30, 2018

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Calima Energy Position in prolific Montney formation

Calima’s core asset is a 100% interest in 72,000 net acres in the liquids-rich Montney formation in British Columbia, Canada.

We estimate an indicative valuation on Calima in the range of A$0.09-$0.30ps, based on a range of transaction multiples applied to its Montney acreage.

Initial drilling and production testing is planned, with a 3-well drill program to get underway in December. A stage 2 development is also proposed for late 2019 that would see Calima’s operations connected via pipeline to the market.

If successful, the initial program would demonstrate the productivity of Calima’s acreage for both gas and liquids.

Key risks for Calima are focused on the early stage of development of its large acreage package.

Long-term opportunities for Calima focus on potential development scenarios or monetising of its interests. This is boosted by the current significant arbitrage that exists between local AECO and seaborne LNG prices, which we expect will attract significant investment and growth in Canada’s gas market.

Key focus on the Montney Calima’s core focus is on the 72,000 net acres it holds in the Montney formation in British Columbia. In August 2018 Calima took its interest in the acreage to 100% through the acquisition of its two joint venture partners TMK Montney and TSV Montney. We observe rising interest in the Montney with growing prospects for significant LNG development in Canada. We expect this prospectivity is supported by the substantial improvement in oil and LNG market fundamentals. Calima also holds interests in Namibia and the Saharawi Arab Democratic Republic.

Why the Montney? The Montney Basin is Canada’s most active hydrocarbon basin. A Government study from back in 2013 estimated remaining reserves in the Montney of 449 tcf of gas, 14.5 billion barrels of NGL’s, and 1,125 million barrels of oil. With current economics in the Montney primarily driven by liquids, we see long term potential for a material improvement in local gas prices aided by significant LNG developments on the west coast of Canada. In anticipation of the expected uplift, we have observed rising transaction multiples across the Montney. These transactions have mostly ranged from C$2,000 to C$5,500 per acre, compared to Calima’s current equivalent EV implied multiple of C$750 per acre.

December drill program Post its recent A$25m equity raising, Calima is planning on undertaking a 3-well drill program and extended production test, set to get underway in December. The program will include: 1) one vertical pilot well aimed at calibrating stratigraphy and collect core samples, and 2) two horizontal wells to test productivity from 2,500m horizontal sections after being completed and put on extended production testing.

Possible scenarios Early in its development, we see a range of possible scenarios for Calima. If drilling proves Calima’s acreage has a high liquids yield then shorter term production scenarios could be unlocked, while demonstrating gas production would in our view boost Calima’s long term corporate appeal (in particular to potential LNG developers looking to boost future gas reserves ahead of staged developments of proposed LNG operations).

COMPANY SNAPSHOT

Reuters/Bloomberg: CE1.AX / CE1 AU

Market cap: US$51.0m

A$69.7m

Current price: A$0.05

Average daily turnover: US$0.04m

A$0.05m

Current shares o/s 1,393.0m

Free float: 100.0%

Adrian Prendergast

T (61) 3 9947 4134

E [email protected]

DISCLAIMER:

Morgans Financial Limited (Morgans) does not formally research this company. Investors should consider this note as general commentary only. Before making any investment decisions, an investor should speak with a financial adviser to determine what best suits their personal circumstances. FOR AUSTRALIAN DISTRIBUTION ONLY, NOT FOR INTERNATIONAL CLIENTS.

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Position in prolific Montney formation

Background

Company overview

Calima’s core focus is on 72,000 acres in the prolific Montney formation in British Columbia, Canada. In August 2018, Calima took its interest in the Montney project to 100% through the acquisition of joint partners TSV Montney and TMK Montney.

The Montney Basin, Canada’s most active hydrocarbon basin and straddles the Alberta and British Columbia border. A joint study between the (Canadian) National Energy Board, British Columbia Oil and Gas Commission and the Alberta Energy Regulator in 2013 estimated remaining reserves of 449 tcf of gas, 14.5 billion barrels of NGL’s and 1,125 million barrels of oil.

While Calima’s Montney interests is its core focus, the company also has a 50% interest and operatorship of four offshore PSCs in the Saharawi Arab Democratic Republic, and an interest in offshore Block 2813B in Namibia.

Key risks

Without existing drilling or production, key risks for Calima remain around its reliance on external capital. There also remains drilling and execution risk given the current early stage of development on Calima’s ground. Another typical risk, the company’s future potential earnings are sensitive to oil and gas prices.

Calima’s sensitivity to future gas prices is also increased by the reliance on improving pricing conditions versus prevailing prices. While we have confidence this will occur, the extent and timing of the improvement may differ to an extent where it impacts the investment case for Calima.

The Montney straddles the border between British Columbia and Alberta, in Canada and

Figure 1: Montney Location

SOURCE: MORGANS RESEARCH, COMPANY

Drill and development program

Stage 1: Dec 18 to Mar 19 – Extended test (C$22m)

Calima plans on constructing a winter access road, and drill three wells (1 vertical well to calibrate stratigraphy recover core samples, and 2 horizontal wells to flow test (aimed at testing productivity and liquids yield).



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Figure 2: Planned stage 1 drilling

SOURCE: NATIONAL ENERGY BOARD CANADA, MORGANS RESEARCH, COMPANY

Stage 2: Nov 19 to Feb 20 – Production (C$30m)

During the following drill season (winter), Calima is planning on drilling three additional production wells and a pipeline (C$9m) connecting its wells to nearby infrastructure. Once the pipeline is complete Calima plans on connecting all five horizontal wells.

Figure 3: Overview of Calima Montney leases and planned work




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Why the Montney?

The Montney reservoirs are siltstones encased in shale source rocks, and has been compared to a tight sandstone play more so than a pure shale play. The Montney is one of the thickest unconventional reservoirs in North America with a gross thickness of up to 300 meters. Importantly the mineralogy is predisposed to excellent ‘fracability’ allowing hydrocarbons to flow at greater quantities delivering a higher probability of strong single well economics relative to other North American plays.

The Montney benefits from a combination of attractive production economics, and low cost to acquire, driving strong interest in asset acquisitions recently.

Figure 4: Montney relative economics


The economics supporting the Montney is driven by prolific production rates of gas, and also the high liquids content. Additional factors driving strong economics include:

- Shallow depth. Generally



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Alberta natural gas prices are at a more than 30 year low, with Henry Hub – Alberta gas differentials trading at the widest margins in almost a decade.

Figure 5: North America gas prices – Alberta vs Henry Hub

SOURCE: National Energy Board Canada, Iress, Company Reports, Morgans

Flaring and venting of gas is regulated in both Alberta and British Columbia. For these reasons, many operators in the liquids rich windows will continue to produce gas and market gas at sub-economic pricing, in order to produce the associated liquids which currently drive the play’s economics. Condensate and light crude are well priced and often receive a premium to WTI in Alberta, with condensate and light crude used to dilute heavier oil sands product to assist with transportation.

Canadian natural gas production has grown over recent years, as pipeline infrastructure has opened up some capacity constraints in the prolific production areas of Alberta and British Columbia.

Figure 6: Canadian marketable natural gas production (mmcf/d)


Export potential for Montney gas

Significant investment into pipeline infrastructure is expected over the coming decade with the difference in heavily discounted Montney gas and that of higher export gas prices creating incentives for investment for the industry to open up and expand Montney gas supply. This will materialise in the form of increased pipeline export capacity linking the Montney to Eastern Canada and Northeast USA, and also the potential for LNG export lines onto the West Coast of Canada.

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Figure 7: Montney gas export capacity additions Figure 8: Montney gas export capacity additions map

SOURCE: COMPANY SOURCE: COMPANY

Cheap gas prices helping LNG economics

With local gas prices trading around ~US$1/GJ in BC and Alberta, versus Asian export markets currently receiving US$12/GJ, there exists an opportunity to arbitrage these price differentials with LNG on the West Coast of Canada. The most significant proponent of this is LNG Canada, a joint venture company comprised of subsidiaries owned by Royal Dutch Shell (40%), PetroChina (15%), Mitsubishi Corporate (15%), and KOGAS (5%). Petronas have taken a 25% interest in the project, which is interesting given it is a majority shareholder of Progress Energy which holds acreage adjacent to Calima.

LNG Canada is proposing to build an LNG export terminal in Kitimat. The facility will consist of LNG liquefaction and storage facilities, marine terminal facilities, two cryogenic LNG transfer pipelines and supporting facilities and infrastructure. The North Montney Mainline, when constructed, will take LNG Canada’s gas directly to their dedicated LNG terminal, and will end just ~20km south west of Calima’s acreage.

Initially two large LNG trains (processing units) with capacity to produce 6.5mtpa each of LNG will be built, with an option to expand the facility to four trains in the future, for a total estimated production capacity of 26mtpa (million tonnes per annum).

Further LNG projects include Kitimat LNG (Chevron/Woodside JV), Woodfibre LNG, and Jordan Cove LNG.



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“LNG Canada, as the project is called, is stunning in scale. It proposes to eventually ship as much as 28 million tons a year out of Kitimat, the equivalent of 10% of global LNG supply in 2017. It would carve out a new path --the shortest by days --between North America and Asia for super-chilled gas. For Canada, whose energy exports are sold almost exclusively to the U.S. at depressed prices for the lack of a coastal facility, it means unlocking the Montney, a massive formation holding about half the total reserves of Qatar. It would also mean an investment triple the size of Canada’s largest single infrastructure project to date.” LNG Canada Chief Executive Officer Andy Calitz

Figure 9: LNG Canada proposed site

SOURCE: LNG Canada

LNG industry overview

Rebounding LNG prices helping new projects

More than a dozen proposed LNG projects for the West Coast have previously been shelved or discontinued during the last decade, with LNG Canada’s sanctioned project the first major LNG development in five years. This project’s development will provide a useful (updated) case study on how the economics of greenfield LNG developments has progressed relative to other regions.

Many of these now shelved Canadian LNG projects took an especially large hit from the previous oil price downcycle, due to the fact that the majority of recent LNG offtake contracts are priced on an oil-linked mechanism. As a consequence, the significant recovery cycle that has since unfolded in the oil market is indirectly boosting the prevailing fundamentals supporting these undeveloped projects.

Furthermore, the last (and sizeable) wave of global seaborne LNG supply that came online over the past decade failed to sink the global LNG market into an overwhelming surplus. We partly attribute this to the new LNG demand investment across existing and new consuming regions that was encouraged by the boost in supply. Regardless of the cause, the improvement in LNG fundamentals has further boosted the ‘sanctionability’ of greenfield LNG projects.

Queensland LNG boom provides an interesting analogue

The Queensland gas market experienced a similar LNG revolution to the potential one we see in possible in Canada. This occurred after substantial resources were unlocked from coal seam gas in the 2000’s that dwarfed the local market demand. As a result, international LNG groups were attracted to the abundant scale, and relatively attractive gas prices on offer in Queensland.

This triggered a wave acquisitions in Queensland as the LNG developers sought to scale up their gas reserves to support their LNG projects. Prior to this, asset transactions in the local gas market rarely exceeded $1/GJ, even on



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quickly expanding reserve bases. This all changed when BG entered the market buying a 30% stake in QGC’s acreage, in addition to a corporate stake. This was followed by a flurry of activity by buyer’s including:

- Petronas – Santos acreage;

- Total – Santos acreage;

- QGC takeover of Sunshine Gas;

- ConocoPhillips acquisition of 50% of Origin’s acreage;

- BG – QGC takeover; and

- Shell / PetroChina – Arrow Energy takeover

Santos kicked off the first of many acquisitions with Tipperary in 2005, and multiples crescendo’d into 2008 which was initiated by the BG acquisition of QGC acreage

Figure 10: Queensland Coal Seam Gas transaction multiples(EV/GJ (2P reserves)) over time


Domestic players including QGC conducted a series of mergers and takeovers to grow its resource base to a scale required to underpin a long lived multi-train LNG development. Conversely, large multinationals acquired strategic stakes from dominant local acreage holders that also held significant resources and reserves.

The Canadian market is larger than the market on the east coast of Australia, and is also connected to the much larger lower 48 US market. Given the increased depth in the North American market, we don’t expect a response as significant as that witnessed in Queensland in 2008/09. However we do expect significant growth in demand for gas through LNG investment on the Canadian West Coast, and expect this to have a positive impact on the Western Canadian gas prices, and acreage values.

Asset transaction multiples increasing on LNG progress

Calima acquired the bulk of its acreage through an acquisition of drilling rights directly from the Canadian government at the beginning of 2014/15, after geoscience workflow identified liquids rich zones within the emerging west gas play in the Montney. Since this time, land sales have been completed that have extended the prospective area of the Montney beyond the eastern boundary of Calima’s landholding.

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Figure 11: Montney leasing maps over time

SOURCE: COMPANY

As the market has matured, and the prospectivity of the Montney has been proven up through production, a healthy secondary market for Montney acreage has also developed. Asset values in the Montney have experienced an uptick in the last 12 months, in line with the positive momentum in LNG markets, and also improving potential for Canadian LNG. Another recent transaction (not shown below, involved NuVista Energy Ltd acquiring 35,600 net acres for C$625m, and included 9,600 boe/d of production and significant infrastructure).

The most recent transaction was announced in early November 2018, with the merger of Pipestone Oil and Blackbird Energy (C$700m merger). The deal was done at an equivalent C$7,300/acre, coming at a premium to Montney peers at C$5,000/acre.

Figure 12: Montney acreage transaction multiples




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The average transaction multiple of undeveloped Montney land sales during 2018 was approximately C$4,500 per acre, with most deals in the range of C$2,000 to C$5,500 per acre. This compares favourably to Calima’s current diluted EV equivalent to ~C$750 per acre.

Figure 13: Operational timetable

SOURCE: COMPANY



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