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OTC:ALVOF | TSX:ALV
Operating in Brazil, Alvopetro Energy (OTC:ALVOF) (TSX:ALV) is an upstream producer of natural gas with midstream assets. After several years of development, the company began producing significant amounts of natural gas in July 2020 under an attractive gas sales agreement. The steady cash flow will help fund management’s growth initiatives and future dividends for shareholders.
Alvopetro Energy is producing over 11 MMcf/d from the company’s Caburé natural gas field. This onshore natural gas field is situated in the state of Bahia, north of the city of Salvador, in Brazil. The company also has a developing natural gas project in the Gomo Deep Basin, in the concession Blocks immediately north of the Caburé field. Management has been adept in creating business partnerships to advance its Caburé assets to commercial production.
Currently, the Brazilian Government is promoting investments into the natural gas market in hopes of lowering gas prices by increasing competition and opening the market to other operators. Part of process includes:
• breaking the monopoly held by Petrobras (aka Petróleo Brasileiro S.A, Brazil’s state-controlled oil company; NYSE: PBR), primarily through divestments and
• setting guidelines and incentives for a Novo Mercado de Gás (new natural gas market) program so that natural gas can be more attractively priced and thereby stimulate local industrial activity
Through these actions, the Ministry of Economy expects gas production in Brazil to double over the next 10 years.
Management is focused on creating a platform to develop the natural gas potential of the Recôncavo Basin located in the state of Bahia. Through multiple agreements, strategic infrastructure assets have been constructed, which have enabled Alvopetro to commence commercial natural gas sales from the Caburé Project and to further develop the company’s Gomo natural gas project.
In order to ensure the sale of future gas production at attractive prices, Alvopetro Energy entered into a gas sales agreement with Bahiagás, a major gas distributor in Brazil with a local distribution network servicing the environs of the city of Salvador and 12 surrounding municipalities. Signed in May 2018, the gas sales agreement set an attractive floor price in the contract, along with a firm and flexible delivery volume levels. Through this well-negotiated agreement, Alvopetro’s Caburé natural gas field is now directly connected to Bahiagás’ gas distribution network of Bahiagás a City Gate via a gas treatment facility, both of which Bahiagás constructed for the project.
During the first half of 2020, Alvopetro completed the construction of an 11-kilometer transfer pipeline and a 17.6 MMCFPD gas processing plant. The high-pressure pipeline was completed in January 2020 by Tecmaster, and the gas treatment facility was commissioned in May 2020 under the gas treatment agreement with Enerflex. Alvopetro controls 100% of its midstream business (gas hubs, pipeline and processing facility) and will own the gas treatment facility outright in 10 years for a small payment when the contract expires.
Consequently, by having this midstream infrastructure constructed, the company commenced commercial, high-pressure gas production on July 5, 2020 from the unitized Caburé natural gas field, in which the company has a 49.1% working interest. The gas is delivered (via a City Gate and distribution pipeline owned by Bahiagás) to the industrial area of Camaçari, a major area of natural gas consumption in the environs of the city of Salvador in northeast Brazil.
In July 2020, Alvopetro Energy commenced commercial, high-pressure gas production from the unitized Caburé gas field (which includes portions of Alvopetro’s Blocks 197 and 198) in the Recôncavo Basin and is pursuing natural gas exploration projects 1) on Blocks 182 and 183, just north of the company’s gas processing facility and 2) at a deep tight basin natural gas resource in the Gomo Formation (Blocks 197 and 183), just north of the company’s existing Caburé wells.
Alvopetro has seven existing wells in the Caburé natural gas field, six of which are currently tied-in (2.95 wells net) with one additional development well in the planning stages. Alvopetro’s share of monthly production (December 2020) has risen to 2,032 BOE per day (including associated condensate sales), well above management’s expectations of 1,800 BOEPD. The volume rate of gas sales alone is at 328,500 m3 (11.6 MMCFPD).
A stable production profile is expected through 2028 with increasing EBITDA based on the gas sales agreement with Bahiagás (at an attractive price point above $5.20 per MMBtu). Despite the contracted gas price being over twice that currently realized in North America, Alvopetro’s gas is being sold to the end customer at a lower price than what is available from other producers (primarily Petrobras) in Bahia. Management projects that the company will generate EBITDA of US$17 million in 2021. The cash flow from the Caburé Field will help fund management’s initiatives for future growth and a dividend stream for shareholders.
Gomo Gas Project (Blocks 183 and 197)
Alvopetro is in the process of developing a tight-gas play in the Gomo Deep Basin, which underlies the company’s Blocks 183 and 197. Two wells (183-1 and 197-1) were drilled in 2014. Well 183-1 is in the process of being developed through a production test. The drainage areas around these wells have already been assigned 2P reserves (1.358 MMBOE) by an independent reserve assessment and evaluation consultant. Once 183-1 is declared as commercialized, an 8-kilometer flow-line is expected to be constructed in order to connect the Gomo well to the transfer pipeline in the Caburé gas field.
Additional Exploration Potential
Management has identified oil & gas prospects across the company’s Brazilian concessions, which comprise 23,527 acres of land. Alvopetro plans to drill two of these exploration prospects (183-B1 and 182-C1) during 2021. Both of these wells are natural gas prospects in close proximity to Alvopetro’s natural gas processing unit (Unidade de Processamento de Gás Natural or UPGN).
Blue Sky Potential – Additional Natural Gas Exploration Prospects
Management is dedicating a portion of the company’s operational cash flows for the investment in additional upstream opportunities in Brazil. With the intermediate-term goal of increasing daily gas volumes at its UPGN, management is focusing its initial efforts on natural gas prospects in close proximity to that facility.
In the small cap, junior exploration and production company segment of the oil & gas sector, investors look for assurance that management can effectively execute its strategy. In order to be successful, the management team of a junior oil & gas company needs the technical, development, regulatory, operational and financing experience to navigate the necessary steps of exploring a prospective field (seismic interpretation, regulatory approvals, environmental permitting etc.), conducting production tests (to determine gas reservoir performance), effecting production planning, arranging supporting infrastructure and implementing operational procedures.
Alvopetro Energy has a leadership team with a proven track record that has delivered in the past. Several members of Alvopetro’s management team (COB, CEO, CFO, VP of Asset Management and Exploration Manager) was also part of management of Petrominerales (TSE: PMG), which was developed into a 40,000 BOPD producer in Colombia and which was acquired for CDN$1.6 billion (US$1.55 billion) by Colombia's largest private oil producer, Pacific Rubiales Energy Corp. (TSE: PRE) in 2013. While operating Petrominerales, management acquired a 5% stake in a pipeline, signaling management’s insight into the importance of equity ownership in midstream assets. In addition, John Wright, COB of Alvopetro, was the CEO of Pacalta Resources, which was developed to a 40,000 BOPD producer in Ecuador and subsequently sold to Alberta Energy for CDN$973 million in 1999. To be sure, Alvopetro has the natural gas assets and management experience to walk the same path again.
Management’s vision is to make Alvopetro Energy a leading independent upstream and midstream gas company in Brazil. Phase 1 consisted of becoming commercial producer of on-shore natural gas producer in the state of Bahia in Brazil, which was achieved in July 2020. The cash flow from the production is expected to help fund additional developmental initiatives and return a healthy dividend to shareholders.
Based on the development of the company’s Caburé’s P2 reserves, management has forecasted an EBITDA profile at the floor price in the sales agreement with Bahiagás (light green bars in the above chart). In 2020, it is estimated that the company has generated EBITDA of US$7.5 million, most of which has been either utilized to reduced debt or added to working capital. For 2021, projected EBITDA is US$17 million, including the impact of forecasted G&A expenses. In 2021, almost all of the projected EBITDA is anticipated to be consumed by capital expenditure (grey bar), debt principal repayment (light blue bar), interest costs on debt (dark blue bar), a UPGN fee to Enerflex for the gas facility (yellow bar) and taxes (red bar). By the end of 2022, it is assumed that the entire amount of debt will have been repaid, and thereafter, between 2023 and 2029, a cumulative amount of CDN$0.74 per share would be available for shareholders.
Also, over the same time period, CDN$1.09 per share (or US$82 million) would be available for investment in upstream projects (in the Gomo Deep Basin Project and/o in additional exploration prospects) and, at the discretion of the Board, other uses of cash flow, e.g. acquisition of some of the expected divestitures by Petrobras in the Recôncavo Basin, additional dividends to shareholders, share buybacks etc. Management is also considering the renegotiation the company’s existing credit facility (in order to lower interest costs), along with extending the maturity of the company’s debt, which would permit more funds generated from operations to be allocated to acquisitions, exploration and dividends.
Management’s medium-term objective (or Phase 2) is to maximize the capacity of both the transfer pipeline and gas treatment facility up to full capacity (500,000 m³ or 17.657 MMCF per day), which would increase the company’s EBITDA to US$31 million from US$17 million at the floor price.
The capacity of Bahiagás’ City Gate is 2.00 million m³ (70.6 MMCF) per day, and management would like to capture as much as a 50% share over the long term. Toward that end, Phase 3 consists of increasing reserves to support that higher level of production through 1) exploration drilling in 2021 and 2) the additional development of the Gomo natural gas project.
Commercial production from the Caburé natural gas field began on July 5, 2020. Alvopetro’s interest in daily sales volume, including condensate, quickly rose to a level of over 1,856 BOE and has increased slightly every month thereafter. Sales volumes have exceeded management’s initial production forecast of 1,767 BOE/D, which was projected to generate EBITDA of $7.5 million.
Due to the nature of the Caburé natural gas field, a flat production profile is expected with little maintenance capital being required on this conventional gas reservoir. Current production is being derived from three wells of the existing seven wells with all remaining wells expected to be in production in 2021. Typically, the production profile of a natural gas well declines steadily after the initial month of production, particularly in unconventional tight gas plays that have short transient flow periods. Management’s projected production profile (below) portends a relatively flat trajectory over the first eight years of operation.
The P/S valuation range for comparable small-cap, producing oil & gas companies is between 1.86 and 9.75. Utilizing comparable analysis, the target price for Alvopetro Energy is $1.08 per share, which is based on an expected second quartile price-to-sales multiple.
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