<![CDATA[Hydra Capital Partners Inc. - HYDRA BLOG]]>Fri, 23 Feb 2018 14:20:36 -0800Weebly<![CDATA[Steady as She Goes at Altura Energy]]>Fri, 23 Feb 2018 20:35:20 GMThttp://hydracapital.ca/hydra-blog/steady-as-she-goes-at-altura-energyBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long ATU.V)

Last night, Alberta oil minnow Altura Energy (ATU.V, last at $0.35) released an operational and reserves update and there were no surprises. Production and reserves both grew nicely and the company continues to position itself for a ramp-up in development activity in 2019. Reserves increases of 45% to 71% across PDP, 1P, and 2P categories were largely driven by success in the company's emerging Leduc-Woodbend play (referred to as "LW" in the rest of this note) and production per share growth came in at 22% year-over-year. Importantly, the company expects to be able to generate enough net operating income for the next three years to fully internally fund the development of its reserves over that time period. As expected, the company continues to evaluate the LW play, with initial production rates from its third extended-reach horizontal (ERH) well to be discussed in its March 22, 2018 year-end report. The 2018 capital budget was set at $15 million... 60% of that goes towards drilling and tie-in activity with the remaining 40% going towards infrastructure and other non-drilling activity.

The company reported a 2P (proven+probable) all-in net asset value of $0.73/share ($0.44 on a 1P basis), so at 35 cents, I would say that Altura represents pretty good value in a story with so much organic growth potential in front of it. My investment thesis here is really based on two things: 1) the 400 million barrel in-place LW oil pool that I think could represent a 40-80 million barrel recoverable opportunity and 2) management. I meet a lot of management teams and Altura's stands out as being one of the most methodical, competent, and non-promotional teams that I have come across. Put an asset like LW in front of a team like this and you have yourself a recipe for a real winner. It'll take a little more time to see how it all plays out, but the setup is there... all I need is for LW to continue to deliver and the first 2 ERH wells have been encouraging (see well profiles in the latest slide deck, linked here).

On the negative side, this is a small cap Canadian energy company (the market hates Canadian energy right now) with exposure to Western Canadian Select (WCS) pricing, but the WCS differentials have been coming in lately and I don't mind going where others won't when it comes to the market. In different a market, ATU would be trading at twice the price that it is currently and the market would be trying to shove money down the company's throat to develop LW faster. That's not ATU's style though. This is a team devoted to "per share" metrics (i.e., production, reserves, net present value) and capital efficiencies, so they will stick to their knitting until they are comfortable with what LW can deliver. Macklin is another nice piece of business as well, but in my mind Leduc-Woodbend is the moonshot. At 4 wells per section, ATU outlines 112 potential drilling locations there. Take that to 8 wells per section and you're looking at 224 wells. At a currently estimated 256,000 boe (2P) recoverable per well, the numbers add up quickly and could very well be of interest to many Canadian independent producers down the road.

I think I've said it before, but usually when someone suggests looking at a circa 1,000 boepd Canadian junior producer my first instinct is "pass", but in this case I've made an exception. I think that once the company is comfortable with Leduc-Woodbend's potential, the sale of a non-core asset(s) at the right time could give ATU a cash injection that would allow the company to take LW to the next level... and change the market's view of the growth profile here overnight. For now, all I have to do is sit and wait. I'll check in on the story in another month when the year-end results are released.

<![CDATA[Revisiting Identillect Technologies]]>Tue, 20 Feb 2018 16:19:55 GMThttp://hydracapital.ca/hydra-blog/revisiting-identillect-technologiesBy: Nick Chen

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long ID.V)

A note today from our very own Nick Chen:

I had the chance to catch-up with Todd Sexton of Identillect Technologies (ID.V, last at $0.20) a couple of weeks ago, as he made his way over to Toronto to receive an award for being one of the top 50 Venture stocks on the TSX and shoot a related video. I took that opportunity to arrange a few meetings for Todd with some of my favorite brokerage firms. This is still a relatively unknown name to Canadian institutions, so getting a few firms to hear the Identillect story was my focus.
Identillect is a publicly-listed company which produces an award-winning email encryption platform delivering end-to-end encryption across all email platforms (Outlook, O365, Gmail, Hotmail, mobile, etc.); one of the few providers enabling cross platform encryption. In addition, they are a new entrant in the blockchain application space, with their first commercial product aimed at eliminating man-in-the-middle attacks, wire fraud, and provide audit capabilities across many industries but none hit harder than the real estate industry.

I’m glad I walked around with Todd and his assistant Camelia to a few broker meetings, in addition to hosting an investor lunch for the company.  It gave me a deeper understanding of the opportunities and distribution process in selling its email encryption solution. I started investing in this company in October of 2016, and for me that’s a long time to be involved in a small cap company. Only a few companies in my portfolio are considered long-term investments and this is one of them. I’ve had numerous calls with Todd over that timespan, visited his office in California and met him in person a bunch of other times. I feel I have a good handle on what’s going on at the company, and always feel better about my investment after talking to Todd.

Here are a few things that I learned:
  • Identillect’s competitive advantage is its ease of use for the recipient (near-instant login process, no registration needed), ease of install (hours to install vs weeks for competitors) and low subscription price.
  • They should reach profitability in 2018, but this will depend on the company’s approach to managing growth versus achieving profitability. What is more important? ID is in a land-grab situation in the email encryption business, so spending to attain a larger subscriber base (with very low churn, i.e. 5%) with high recurring revenue is not the worst idea.
  • Net cash burn to the company is roughly $55,000 US per month.
  • The reseller channel is where I think the company could make its greatest gains. Providing 20% of margin to resellers is not a problem when all sales from this channel only costs the company very little just support. Remember, Identillect just signed a JV agreement with Qubechain, which is training its 100 salespeople to sell Delivery Trust. I expect more reseller deals to be signed.
  • The company has begun white-labelling its Delivery Trust platform and has at least one client using this version. This is a good sales pitch to potential customers wanting to offer their clients a personalized email encryption solution.
  • The incoming General Data Protection Regulation (GDPR) will affect all companies in the 27 nations of the EU, as well as all companies doing business with these firms. This is slated to come into effect in May of 2018, so we should see increased data protection spending right now (which the company is currently seeing). ID has a small percentage of users in Europe but plans see a expansion in the EU as ID will market more aggressively in this area going forward.
  • Canada’s Personal Information Protection and Electronic Documents Act (PIPEDA) is due to change, and many believe this will be as stringent as GDPR; yet another catalyst for Identillect and the sector.
  • Identillect was endorsed by the Arkansas Bar Association in January, which has 7,000-member firms. They are the only encryption company to be endorsed by a state bar, and they plan to follow up with a marketing plan to the other 49 state bar associations.
  • Next step is to translate the website into 9 more languages to open sales to new regions
  • I believe one of the greatest challenges they face is getting the message out to consumers about their product as they are competing with companies with larger marketing budgets. It will take time and money to change this and create more awareness.
  • I believe they are on the cusp of landing larger orders. I am not sure when we should expect these as I think they are not sure as to the length of time it takes to land deals north of 5,000 as they have not done it at this point. However, seeing one of these deals would be a nice surprise.

Let’s discuss Identillect’s foray into the blockchain space; they are building solutions for real world problems. Identillect with the help of Qubechain, has created a private Ethereum-based blockchain application which eliminates wire fraud in the real-estate transaction industry.  Real-estate wire fraud was a $19 million US dollar problem in 2016. This number grew to almost $1 billion just a year later. The problem has to do with man-in-the-middle attacks, which can trick escrow agents into sending money to a hackers account instead of the account of the home seller. This is a big enough problem even the FBI is looking for a solution. With the help of his two employed PhD cryptographers (of which there are only 50 in the United States not working for the government) Todd was able to solve this problem. Hashing the email data in the blockchain, adding in two-factor authentication, and ensuring the sending data exactly matches the receiving data eliminates the way hackers are getting in-between transactions. There was a good discussion at the lunch presentation on private keys and public keys, and who controls what keys, but I don’t want to mis-speak so I won’t get into any details on that. I will follow up with Todd though and make sure I understand how they are keeping the keys safe and keeping hackers out.
The company announced last week the product is now commercial ready, so after an initial marketing period we should start seeing sales. Todd has spoken at multiple escrow agent conferences in the past, so another speaking engagement should be in the works to stimulate interest. Identillect has a multiple real-estate clients using Delivery Trust (such as Century 21); logical first adopters of this new technology.

Identillect is in a good spot to create blockchain applications related to audit trail and email transmissions. Todd had mentioned 90% of business transactions are happening over email. If that is indeed the case, I think Identillect’s approach to finding email focused blockchain applications could be it’s ultimate calling card. 

Given the company’s small size ($20M mkt cap) with multiple growing lines of sales, and profitability just around the corner, I think this is a small cap stock worth owning.  As always, I’m open to receive feedback and criticism. That’s how we all get smarter and become better investors!

<![CDATA[Valeura Energy: So Now What?]]>Tue, 20 Feb 2018 08:00:00 GMThttp://hydracapital.ca/hydra-blog/valeura-energy-so-now-whatBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

It’s been an exciting couple of weeks. With Valeura Energy’s (VLE.TO, last at $6.01) long awaited resource assessment outlining unrisked net resource potential of 3.2 TCF to 20 TCF, the market briefly took Valeura’s share price over $8, which was a little glimpse of heights that would have seemed like a dream only a few months ago. Shortly thereafter, Valeura arranged a heavily oversubscribed financing at $5.70 that will yield proceeds of C$60 million (less brokerage fees) when it closes in early March.  While that financing came at a healthy discount to the prior day’s volume weighted average price (VWAP) of $7.13, it represented a key event for the company as it gives Valeura enough cash to fund the Yamalik-1 tie-in and the upcoming three well delineation program with plenty of cash to spare (VLE pays for only two of the upcoming wells). With future wells expected to cost around US$15-20 million in the delineation/pilot phase, Valeura will likely have the cash to fund an additional drilling program in 2019 if it’s still around, which I highly doubt. The bottom line is that the market now knows that 1) the size of the prize is gigantic, and 2) Valeura has all the cash it needs to take this project all the way through to proving commerciality. Little Valeura is all grown up.
So now what? With the stock trading off about a dollar over the last several trading sessions, I can already see market psychology rearing its head. When stocks go up every day, greed runs rampant. When stocks go down (and do remember that even the best stocks go up and down) fear and doubt start to creep in. Fear and greed. Confidence and doubt. I’ve been there and done that many times over the years. “How low will it go?” “Dang, I should have sold it all at $8 and re-bought it lower.
“Am I a buyer, or a seller? If so, at what price(s)?” These are the kinds of things that run through people’s minds at times like these.
In my mind, it all comes down to this simple question... Are you a trader, or not? Only individuals can answer that question for themselves and most people have day jobs that preclude them from paying close enough attention to effectively trade a stock like this. Some people are sitting on massive profits on this story and those tend to be some of the most loyal shareholders, as they have been following the story all the way along, but even they are likely not immune to taking profits. It’s perfectly natural to see a stock pullback after a run like Valeura has had as long-term retail holders trim oversized holdings while institutional investors take their place. 
To put things in perspective, if you own something like IBM, watching the trading day to day or hour by hour would be like watching paint dry, but when you own VLE, it’s like watching a horse race. You’ve followed the horse for some time, you are confident in the ability of the jockey, and the horse looks favoured to win by all measures. Even if the horse is ten lengths ahead coming down the backstretch, emotions will still run high because anything can happen. To take it a step further, imagine that in this horse race, you can place new bets right up to the second before the horse crosses the finish line, and the location of that finish line is somewhat unknown. That, in my opinion, is the psychology that people need to master with a stock like Valeura. The prize is there to be had, but the tickets aren’t free and the price of those tickets is constantly changing based on the whims of the crowd and incremental data. It’s incredibly difficult to stay level-headed through all of the noise.
Some market commentators might call this natural market auction process “hot air”, but I would argue that would be the view of someone who hasn’t done any work on a story like Valeura and doesn’t understand the concept of risked value. What exactly is “hot air”? What does that even mean in a real sense? It’s a fine cliché, but hardly useful when it comes to discussing something real like the expected value of a project that represents a real possibility of generating billions of dollars of wealth creation. What should Valeura be worth today? What’s priced into the stock for the BCGA? Anyone who thinks that speculation is not a natural part of the resource market has learned nothing from its history, particularly when dealing with assets with world-class potential like this one. 
At $6, Valeura’s enterprise value is about C$440 million. Remember that resource report from DeGolyer and MacNaughton? 1.6 TCF is the net risked recoverable prospective resource based on the data from eight wells around the basin. It’s already been cut in half to account for D&M’s assigned risk factors. To put it another way, if the Thrace Basin BCGA is as big and as economic as it looks to be, there is a 90% chance that there is at least 3.2 TCF of recoverable gas net to Valeura. What would that 3.2 TCF be worth? As I outlined in a recent note, my discounted cash flow model suggests that the US$1 billion/TCF general rule of thumb holds up pretty well here. So, to get right down to it, the market is currently valuing Valeura at only 25% of DeGolyer and MacNaughton’s risked P90 case (C$440 million divided by C$2 billion), or at around 12.5% of the unrisked P90 case (implied C$4 billion). Then consider that the market is assigning just a 4% chance to the possibility that Valeura sees its Pmean (average) case (10.1 TCF net recoverable) realized. Now, I’m not saying or suggesting that someone would ever pay $10 billion for Valeura, but I don’t have a hard time seeing how a supermajor would love to take a shot at this if it only cost them the current price of around $6/share because the prize could eventually be worth $10 billion to whoever gets to develop this asset.
For anyone that’s not convinced, look no further than this article on what Exxon paid less than 6 months ago for one exploration block offshore Brazil. The price paid was  about US$690 million. That is not a typo. That is US$690 million of cold hard cash for a “prospective” offshore exploration block with no discovery on it… just mapping that suggests it might be oil-bearing. Exxon also paired up with Petrobras to buy another offshore Brazil exploration block for US$370 million. Combined, that is over US$1 billion paid for two exploration blocks in Brazil’s offshore based purely on their geological prospectivity and wells there aren’t cheap. Individual deepwater exploration wells can easily run $50-100 million each with long (and capital intensive) project development timelines in the event of discovery. Did Exxon pay for “hot air”? Obviously not. That’s real, hard cash, paid simply for the opportunity to explore for hydrocarbons in an area that’s believed to be highly prospective. It’s fine to be unaware of what the supermajors will pay to get exposure to the mega-scale projects that they need to move the needle, but it doesn’t change the fact they do. In that light, the Thrace Basin BCGA starts to look pretty good, doesn’t it? In D&M’s unrisked Pmean (average) case, 10.1 TCF is roughly equal to 1.6 billion barrels of oil equivalent net to Valeura. I guarantee that is big enough for any supermajor to care about.
Look, not a lot of assets can attract the interest of a supermajor (or capture the imagination of the market), but this is one of them, which is what brought Statoil to the table in the first place. The scale is too big to be ignored and an asset like this is far too rare to let it get away. As I’ve said before, supermajors have an insatiable appetite for projects that can take and return massive amounts of capital and be monetized within a reasonable time period. The Thrace Basin BCGA checks every box you can think of in terms of desirable project attributes: infrastructure, location, market, scale, pricing, logistics, drilling costs, access to services, site access, fiscal terms – you name it – the Thrace has it all.
At $6/share the market currently implies that Valeura a 1 in 8 chance of this being 1) big, and 2) economic. First, this project practically covers an entire sedimentary basin (1,600 square kilometres) and has an established range of prospective resources from D&M, so I’m not worried about its size. As for the economics, with some 300-350 metres of gas-condensate pay at Yamalik-1, over 100 metres of core cut in the reservoir, and four flow tests all exceeding pre-determined threshold levels, I think there is very little reason to believe that it won’t perform like analogous plays in North America, but that is the fundamental remaining uncertainty.
So, in a word, this “bet” now comes down to one aspect in my mind: productivity. When Valeura and Statoil start drilling wells down to 5,000 metres later this year (July-August) to prove up even more gas pay at depth, that will just be the icing on an already ridiculously large cake, but the real question is, "What does a full production well look like and how do these wells flow over 30- and 90-day periods?" Given that reservoirs like this are governed as much by physics as they are geology, once you had even a 90-day flow rate you could probably generate a population of type curves that would allow anyone to quickly model the project with a relatively high degree of confidence. Sure, there will be variability throughout the project area, but remember that BCGA’s are coveted because they take hydrocarbon charge risk right off the table. In a BCGA, every pore in the rock, every pore throat, every fracture, and every microfracture will be full of gas. The only question is where you drill for the best reservoir and the best productivity and the project has full 3D seismic coverage to steer the drill program.
And is management being overly promotional about all of this? I think not. Allow me to quote from the February 6th press release:
“… we recognize that we are in the early phases of exploration. More drilling and testing will be required to prove that the gas will flow at commercial rates and to refine the large uncertainty around recoverable gas and condensate." 
What the company does have is a resource assessment from an independent world-renowned petroleum engineering firm that has established a range of potential recoverable gas-condensate resources. Degolyer and MacNaughton has estimated a 70% chance that the prospective resources will in fact be discovered/delineated with additional drilling and a 74% chance that the resources will be commercial to develop. Those are extraordinarily high odds for a project at this stage of development and those odds are driven by the technical and economic attributes of the play that I have highlighted in detail before. In the offshore Brazil example, Exxon might be lucky to see a 20-25% chance of geological success on an exploration well, and that's saying nothing about potential economics.
At the end of the day, the stock market is a market in every sense of the word, it is an auction, held six-and-a-half hours a day where the prices of goods (stocks) vary on a daily basis based on the laws of supply and demand. By looking through the noise you are left with the facts, and that’s where the details matter. Once you know the details, what might look like hot air to a casual observer is perfectly reasonable to others when evaluated relative to the mega-project pool in which the supermajors operate. It all comes down to the market's level of understanding with respect to the asset and the industry.
There is no substitute for doing your own work when it comes to a story like this. Some have asked the right questions while others have not, and that’s what makes a market. I can assure you that the supermajors of the world are able to critically evaluate a play like the Thrace Basin BCGA and when/if they move on a project like this is the billion-dollar question. Only time will tell... and the waiting can be the hardest part.

<![CDATA[Cash is King: Valeura Scores $60 Million Financing]]>Thu, 08 Feb 2018 13:10:15 GMThttp://hydracapital.ca/hydra-blog/cash-is-king-valeura-scores-50-million-financingBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

Barely a day after Valeura Energy (VLE.TO, last at $6.27) showed the potential for a massive 10.1 TCF (mean case) of net recoverable gas in its Thrace Basin BCGA project, the company has secured a C$60 million bought deal financing led by Canadian-based GMP FirstEnergy and Cormark Securities. A bought deal financing is just what it sounds like, the underwriters have agreed to fund the company to the tune of $60 million (less fees of course). No marketing is required. The financing is being done at a price of $5.70/share, which is a pretty sweet deal for the institutions buying the deal given that yesterday's VWAP (volume weighted average price) was $7.13. I expect demand for this deal will be high given the very attractive pricing. For those wondering about the very odd trading action yesterday, here's your explanation... the market sets the price on financings like this, and it has spoken. From here, it should be smooth sailing with this financing overhang out of the way and I'm pleased that the money came in the door for the company so quickly. It shows that the market is behind this story, even if it's just the sharpest tacks that have caught on at this point.

This financing gives Valeura a huge cash injection and ensures that the company has the capacity to fully fund its share of the upcoming three well drilling program, the tie-in of the Yamalik-1 well, and then some. It shows the supermajors that Valeura now has the ability, capacity, and wherewithal to move this project ahead, which may make them move faster in terms of buying out the company, which is what I think the endgame is here. It's easy to push around an unsupported, unfunded junior energy company, but Valeura is flexing its muscle here and now has the financial capacity to de-risk the project even further.

I'm usually not prone to quoting myself, but yesterday I wrote:

"So, the way I see it, the supermajors that are surely circling this story have a choice: 1) pay something based on a modest discount to P90 net risked value today ($22-25/share), or 2) let VLE and Statoil tie-in Yamalik-1 in Q2 and drill their planned 3-well program in Q3 at which point the unrisked fair value very likely goes up by 100%, to somewhere around $45-50/share. ​Note that these are not to be considered as "price targets" as that's not something that I do... I'm just illustrating what the math suggests from a rule-of-thumb valuation method and don't expect this to happen overnight. My illustrations are meant to highlight the fact that Valeura has serious potential from these levels and, as it turns out, my rule-of-thumb compares quite well with my full discounted cash flow model..."

And that's how I see it now. Valeura now has the cash to make the classic Dirty Harry "Go ahead, make my day..." call with the drill bit and the supermajors who would love to own it have to decide whether or not they let the market see any more test and/or drill data from the project before they acquire it. Over 100 metres of core was cut in the Yamalik-1 well and based on the recovery factors assigned by DeGolyer and MacNaughton in the resource report, the reservoir quality appears to be excellent. Taking it a step further, I've only seen recovery factors like that in the very best known tight-gas resource plays out there, which gives me even more confidence in the model I laid out yesterday. None of that will be lost on Valeura's potential suitors.

Valeura has captured a (giant) strategic asset, in an unreal location, and is a tiny company when it comes to the global energy scene; and now it has all of the cash it needs to add a whole new layer of value to the company. The clock is ticking for the supermajors out there, and I can think of no less than four of them for whom this project would be highly desirable based on specific aspects of their businesses that the Thrace Basin project would compliment. I can think of a dozen more for whom it would be a fantastic piece of business. With that much potential for competitive interest, Valeura's time as an independent junior energy company may be limited,  but with some $70 million in the bank once the deal closes (assuming the over-allotment is exercised), Valeura now has all the time in the world to let it play out.

Tick tock.

<![CDATA[Valeura's Thrace Basin Prize Weighs in at Double-Digit TCFs]]>Tue, 06 Feb 2018 08:00:00 GMThttp://hydracapital.ca/hydra-blog/valeuras-thrace-basin-prize-weighs-in-at-double-digit-tcfsBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

This evening after market close, Valeura Energy (VLE.TO, last at C$6.05) released the results of the first-ever independent resource assessment of the newly discovered Thrace Basin basin centred gas accumulation (BCGA) and it did not disappoint. This assessment was carried out by the same firm that does Statoil and Saudi Aramco's reserves reports. By all measures, it appears to be the largest gas discovery I have seen in the hands a junior for a very long time. You can, and should, link to the full press release and read it in its entirety here (it is a very detailed and balanced description of the project) before reading further.
DeGolyer and MacNaughton, a renowned Texas-based petroleum consulting firm with an 80-year history and offices around the world, estimates an Unrisked Mean Prospective Gas Resource of 10.1 TCF (net recoverable to Valeura's interest). The P10 (high) unrisked estimate was pegged at 20 TCF net recoverable, with a P90 (low) unrisked estimate of 3.2 TCF net recoverable. These are gigantic numbers. Even after applying economic and geological risk factors to get to a "discounted" number, the P90-P50-P10 prospective resource ranges from 1.6 TCF net-risked-recoverable (P90) to 10 TCF net-risked-recoverable (P10), with a Mean (mid-case) estimate of 5.1 TCF net-risked-recoverable gas. These numbers are nearly triple what I had been estimating on my own. I had previously (quietly) hoped for a P50 case of around 3.75 TCF net recoverable based on what I thought was fairly aggressive math. I believe that the difference is mostly due to higher recovery factors than those in my initial estimates (that speaks to reservoir quality). In any case, more gas is good, and my best-guess type curve has been adjusted to account for that. Oh, and there are 236 million barrels of condensate and NGLs estimated in the (mid-case) Net Unrisked Mean Estimate. It's funny when 236 million barrels of liquids almost seems like a footnote, isn't it?

For those wanting me to cut right to the point, the most simple rule of thumb that was used when I worked in the oil industry some 15 years ago (back when gas was US$5+ per mcf in North America), was that a TCF of gas was worth about a billion U.S. dollars "in the ground" in an acquisition scenario. That was not for reserves, that was for an undeveloped play that was generally understood and had shown commercial potential. Using that real of thumb, the lowest reasonable fair value I can arrive at for Valeura is US$1.6 billion, or around C$25/share (based on 79.5 million shares out fully diluted). If I assume 10% share dilution from these levels, maybe it's more like C$22/share. Now, on a takeover, a buyer isn't just going to step in and pay "full" price, but we're only talking about the P90 net risked number here. If we were talking about this actually going into development (i.e., risk factors removed) that potential value goes to US$3.2 billion net to VLE's interest based on the P90 (most conservative case)... that's around C$45-50/share. If I use the P50 numbers (mid-case), the values become ludicrous, even the net-risked P50 suggests US$5 billion is on the table... try out the per share math on that (hint, it is around $70/share). So, the way I see it, the supermajors that are surely circling this story have a choice: 1) pay something based on a modest discount to P90 net risked value today, or 2) let VLE and Statoil tie-in Yamalik-1 in Q2 and drill their planned 3-well program in Q3 at which point the unrisked fair value very likely goes up by 100%, to somewhere around $45-50/share. ​Note that these are not to be considered as "price targets" as that's not something that I do... I'm just illustrating what the math suggests from a rule-of-thumb valuation method and don't expect this to happen overnight. My illustrations are meant to highlight the fact that Valeura has serious potential from these levels and, as it turns out, my rule-of-thumb compares quite well with my full discounted cash flow model that I get into later in this (long) note.

As I mentioned, DeGolyer and MacNaughton is the firm that Statoil uses as its reserves auditor it and also happens to do the reserves reports for Saudi Aramco, so getting a prospective resource estimate from a firm like this adds a huge degree of credibility (i.e., validation) to the story. The resource report represents an independent and extensive review of the potential scale of the opportunity in the Thrace Basin. From here on in, it's just about delineation, economic projections, and development... so if there was any doubt before, there can be no doubt now – the Thrace Basin BCGA has arrived and it has arrived in a major way. As Valeura prudently points out, the play is in its early stages, but as you'll see below, all of the signs are pointing towards the Thrace Basin putting Turkey (and hence Valeura) on the energy map of the region.

This is a project with world-class scale, in a location that is nothing short of surreal. I get into more detail below, but the distance from this discovery to Istanbul (a city of 14 million people who use gas as their primary power source) is about the same as the distance from New York to Philadelphia. The economic and strategic potential (and the massive potential value) of this project is among the best I have ever seen in the hands of a junior energy company. The asset is located at the literal crossroads of energy trade between Asia, the Middle East, and Europe and represents one of Europe's only options for alternate supplies that could decrease its dependence on Russian gas imports.
Basin centred gas accumulations (BCGAs) are coveted for their pervasive gas saturation and regional extent, and the scale of the opportunity as outlined today is simply massive. Once you’re in a BCGA, everywhere you drill the rocks will be gas bearing. In light of that, this prospective resource estimate carries a lot of weight given the continuous nature of a resource play like this. There are eight wells (yellow dots in the map below) that have penetrated the BCGA and confirm this interpretation; Yamalik-1 just happens to be the first modern well where these rock formations have been tested below 3,000 metres with modern completion methods that have been proven to unlock resources just like this in a number of plays in North America. Below I’ve included a diagram from the US Geological Survey that should help visualize what a BCGA is for the uninitiated.
Valeura’s licences are outlined in yellow over top of a map of the BCGA in the map below. The play as mapped covers some 400,000 acres and Valeura is the majority acreage holder in the basin. Valeura and Statoil have modern 3D-seismic coverage over the entire Banarli license. The yellow dots on the map below represent the eight wells that at least penetrate the top of the BCGA cell, as evidenced by the significant pressure increases and pervasive gas saturation seen below ~2,500-2,700 metres depth in each of them.
It’s one thing to make a big gas discovery, but it an entirely different thing to find one of this size that can be commercialized so quickly. I’ve written extensively about just what I think makes this project so attractive (link to my last note here) and I’ll refresh here on some of the points I’ve made before for the benefit of those just finding Valeura for the first time.
First and foremost, Turkey currently imports 99% of its gas needs and the vast majority of the country’s electricity (>50%) is generated from natural gas. A recent article quoted Turkey’s November 2017 natural gas imports at about 6.4 BCF per day, so there’s plenty of market there. Even if the Thrace Basin project was flowing 1 BCF/d that would meet less than 1/6th of Turkey’s ever-growing gas needs. Second, the natural gas price in Turkey is currently around US$6/mcf. That pricing reflects the fact that Turkey represents one of the most captive gas markets in the world and has some of the strongest GDP per capita and energy use per capita growth of all OECD countries. You couldn’t ask for a better market in which to make a gas find with this kind of potential and nothing even approaching this size has ever been discovered in the country before. This is what makes a find like this so valuable. Third, Valeura’s area of operations is a 3-hour drive west from Istanbul, Turkey’s largest city with a population of over 14 million people. There are also two ports in close proximity to the project, one in Tekirdag and one in Barbaros so the logistical hurdles that often burden many new discoveries of this scale don’t apply here. The geography of the area is not unlike that around Calgary, Alberta with rolling hills and subtle topography. You can literally drive to the Yamalik-1 well site in a Honda Civic. And to top it all off, the project area is flanked by two large regional gas distribution pipelines, with a third one planned. The fact that the Thrace Basin is on the doorstep of gas-hungry Western Europe is one last bit of serendipity that will not be lost on energy players in (or looking to get into) the region. In short, you simply couldn’t ask for a better location. In fact, I’m not sure that I’ve ever seen a resource of this scale found with such an impressive confluence of project elements.
The project is in Northwestern Turkey and close to Europe:
​It is flanked on two sides by pipelines to Istanbul and export lines to Greece for Europe interconnect with a third pipeline planned. Istanbul is only 150km away. Valeura owns 100% of the existing infield gas infrastructure through which it already produces and sells gas from shallower formations.
Below I've included a map of the Trans-Anatolian gas pipeline (TANAP) that is under construction, as well as the planned Trans-Adriatic Pipeline (TAP), and the previously planned Nabucco pipeline. Nabucco was to be a European gas supply line, but it was cancelled due to the fact that the Europeans had no idea where the gas to fill it was going to come from. It would appear that there may now be an asset in Turkey that they might be interested in (particularly in light of this recent news regarding production issues in Europe's biggest gas field). As you can see, the Thrace Basin BCGA discovery is immediately adjacent to both of the planned Trans-Adriatic and Trans-Anatolian pipelines. Note that this is only a partial discussion of the planned pipeline map taking shape in the region, but those who look further will find that Turkey is an absolutely natural energy hub for the region. In fact, Turkey's geography is a big part of what has made it into the centre of trade and commerce that it has been for thousands of years... and in terms of oil and gas permitting, development, and operations, Turkey is open for business.
​These two ports are within about a 1-hour drive from the Thrace project area. Those are big container ships at Barbaros (i.e., no problem getting equipment in/out and to/from site). The region has an existing, albeit modest, energy sector that Valeura has been operating in since 2011. Access to services is excellent.
​In terms of economic potential, Valeura’s licenses are under a tax-royalty regime with fiscal terms that are as good as anything I’ve seen in the world. Tax-royalty regimes are far preferred over production sharing contracts when it comes to the global E&P scene. Royalties are set at a flat 12.5% and the corporate tax rate is 20%. Combine that with the regional pricing and basically unlimited market and you are looking at an absolutely ideal economic climate to develop a gas resource.
In terms of just what is already known, test results from the four zones tested in the Yamalik-1 discovery well show that the reservoirs spanning some 1300 vertical metres are gas saturated with condensate yields of 20-70 barrels per million cubic feet with no evidence of formation water. The reservoirs consist of massive and interbedded tight sands and silts within a multi-thousand-foot-thick sedimentary package. The reservoirs are significantly overpressured (by nearly 100%) which means that more gas molecules can be packed into in the pore spaces in the rock and that there is a lot of energy wanting to push those gas molecules out. As we’ve just seen, that’s good for big resource numbers, high recoveries, and for productivity potential. The testing that Statoil and Valeura carried out in the Yamalik-1 well showed that the same well completion methods that work in North American resource plays work well in the Thrace Basin with excellent productivity and good sand placement observed in all four tests.
There are multiple, mature, U.S. tight gas plays that serve as excellent analogues for what’s being seen in the Thrace Basin and there is absolutely no reason that these rocks won’t be every bit as impressive as their U.S. counterparts. When you hear about companies exporting North American expertise to foreign jurisdictions, this would make for a prime example of just that. In fact, by using North American plays as examples, very little imagination is needed to extrapolate what full production wells would be expected to look like based on the Yamalik-1 test results… the laws of physics and fluid flow are agnostic to international borders and the reservoir rocks in the Thrace are top-tier.

In my experience, if you are exploring for a tight-gas resource, any time you get a vertical test rate of even just 0.2-0.3 mmcf/d from any particular zone, you will dance a little jig if that zone has any thickness to it. In Valeura's case, the four zones tested between 0.4-0.9 mmcf/d over zones spanning around 140 vertical metres out of 300+ metres of logged gas pay. That should already have people raising an eyebrow. If the company were to drill a horizontal well and land it in any one of the four zones that were tested in the Yamalik-1 well, rule-of-thumb suggests that a horizontal well could test at a rate of 30-40 times those single test rates based on a 30-40 stage completion. That's anywhere from 12-36 mmcf/d for those paying attention. I could go on to talk about (1) the potential for drilling vertical wells targeting thick, naturally-fractured intervals, which in some areas that could see even higher flow rates and (2) the potential for stacking multiple laterals on top of one another, but I don't want to get too far into the weeds here. There's surely some insight to be gained in terms of how the well will perform under longer-term flow tests/production, but (1) that will be known shortly when Yamalik-1 is tied in for long-term production testing, and (2) it doesn't take a rocket scientist to know that a thick, sandy, overpressured gas-condensate reservoir that has attributes very much like other known North American plays is probably going to behave very similarly in terms of flow and decline rates. While it takes some level of knowledge in petroleum geology and/or engineering to make that leap with confidence, I have no doubt that the supermajors of the world have that knowledge in spades. The only question is how long it takes “the market” to realize what’s on the table here, because before today, many people didn't really believe in (or understand) the scale of the opportunity. I suspect that today’s news might go a long way towards rectifying that situation.

This figure below, modified from an Encana investor presentation, puts some context on the Thrace BCGA relative to a well-known resource play like the Montney in Western Canada. The interval of interest in the Thrace is at least 4,000 feet thick (note the 1,000' scale bar indicated here for the Montney) and could certainly present the opportunity for multiple stacked horizontal wells to maximize productivity and recovery.
In terms of potential value, I’ve been refining a full project model for a few weeks now, but was waiting for the numbers from resource assessment before scaling it to a size that roughly matches the scale of what has been identified. The most important input to my model is the expected “type well” curve. A type well represents what one would expect an “average” well to do over the greater project area. In the course of development, there will be wells that plot both above and below the type well curve, but for the purposes of building an economic model, an average well curve is needed.  Wells in comparable plays can produce at initial rates ranging from 3 mmcf/d to 30+ mmcf/d, with the differences being due to a variety of factors: vertical vs. horizontal wells, more/less natural fracturing, reservoir thickness/quality to name a few. Flow tests and cores taken from the Yamalik-1 well suggest excellent reservoir properties and 3D seismic mapping shows several fault trends (think natural fractures) crossing through the project area. That same 3D seimic survey should also help Statoil and Valeura target regions with superior reservoir quality/thickness as development proceeds.
When it comes to my model, I have based it on a type curve with a 10 mmcf/d IP30 rate with 75% declines after the first year, 30% declines in year 2, and 25% declines in year 3, with 15% declines thereafter. This is consistent with decline rates seen in comparable tight gas plays in North America. My type-curve yields 8.2 Bcfe recoverable per well (6.3 Bcf of gas and 315,000 barrels of condensate at 50 bbls/mmcf) with a NPV10 of about US$8 million per well. That’s a little higher than the type curve I was using a couple of weeks ago, but given that this is a “tight gas” play (i.e. sandstone) as opposed to a “shale gas” play, initial decline rates are likely to be a little more moderate and the reported range of expected recovery factors in the play suggests that wells may have more potential than I initially thought (note: I’ve tested a number of type curves and any reasonable assumption that I plug in comes back as being ridiculously economic). My model uses operating costs of $20/boe, which is probably way too high, but I don’t mind being conservative at this stage. Remember that my models represent my "best guess" at this stage based on the data at hand, but I believe they are well with in the ballpark of what the potential is here.
Over the course of my 20-year project model, around 900 wells are drilled over a 14-year period and 4.97 TCF (gross) and 248 million barrels (mmbbls) of condensate are produced (~2.5 TCF, and 124 mmbbls condy net to VLE). The NPV10AT of this modeled scenario is US$2.45 billion. My model most closely resembles the P90 (low) estimate in terms of scale (my model produces 2.5 TCF net to VLE versus 3.2 TCF net in the resource assessment). That implies an average of 6 rigs working, drilling one well per month, full time for the first 8 years, with 5 rigs working at the same rate for the following 6 years. I realize that the ramp up won’t be instantaneous and that assuming North American rig productivity rates out of the gate may be aggressive, but it’s not that far of a stretch. With two ports within an hour’s drive of the project area, the project is as much about logistics as it is about engineering when it comes to getting set up. The supermajors of the world are logistics experts (comes with the territory) and all of the pieces they need are there to aggressively develop this asset. The required local support network would drive significant economic growth for the region. The project would be material with respect to Turkey’s GDP and current account. In the Mean or High resource cases, the value could be materially higher.
My model reaches a peak production rate of around 1 BCF/day at the end of year 8, with a total of 4.97 TCF of gas (gross) produced over the 20-year period and an after-tax NPV10 of US$4.9 billion (C$6.2 billion). Based on the P90 (low) prospective resource estimate of 3.2 TCF unrisked (net) recoverable, I’d say that my model is probably in the ballpark of what’s possible. At this stage my model is simply meant to frame the scale of opportunity and at US$2.45 billion net to VLE, I’d say that it's a big one – recall that Valeura has around 79.5 million shares out on a fully diluted basis. Even if an acquirer paid C$20/share for VLE, I would argue that they would still be getting VLE for half-price relative to my modeled after-tax NPV10 of around C$3 billion. The one thing that I haven’t included in my model yet is facilities capex (gas processing, compression, etc), but even if I assume a half a billion dollars ($250 million net) in facilities capex, the project is every bit as good, so I’d say I have a lot of margin for error. So after going through all of that, it seems that the $1 billion per TCF in the ground rule-of-thumb seems to hold quite true.
​I’ve included a snapshot of my model outputs below for those who are interested.
So what now? Valeura is currently formulating the 2018 drilling program with Statoil who funds 100% of the costs of a second well into the play in order to complete its 50% earn-in. It appears that three wells are planned starting with the Statoil-funded well in Q3 and I doubt that funding will be an issue given the scale and potential economic value of this gas discovery. The best case for Valeura shareholders would see the company stick around right through to full-scale development, but I just don’t see them making it that far.
Supermajors need projects of this scale to feed their insatiable appetites for quality projects that can take and return massive amounts of capital and the pool of world-class discoveries is constantly shrinking. In light of that, Valeura’s best path forward is to drive ahead at full speed and make it as far as it can (i.e., drill baby, drill) before a major swoops in and takes it out, as I’m certain that I’m not the only one who is going to recognize what makes this project so attractive. When that happens is anyone’s guess, but the data in hand has already painted a picture of this whale of a discovery and whales like this are prized collectibles to the supermajors of the world.

Happy hunting.

<![CDATA[On Valuing Valeura]]>Tue, 23 Jan 2018 04:03:55 GMThttp://hydracapital.ca/hydra-blog/on-valuing-valeruaBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

I see and hear a lot of questions wondering just how much Valeura Energy’s (VLE.TO, last at $4.05) BCGA find in the Thrace Basin might be worth. Analysts and TV commentators are circling around as the chorus starts to grow, and the market is starting to realize that something is about to happen for little Valeura… but many aren’t exactly sure what that means exactly. What’s it worth? It’s one thing to throw a number out there, but I think it’s a lot more useful to consider the whole picture first in order to put things in context. If I said I thought Valeura could be worth $1-2 billion in the eyes of an acquirer, it wouldn’t mean much without being able to appreciate why a buyer might actually be willing to pay that much for this project. Lots of assets have big NPVs, but not all assets are created equal when it comes to their attractiveness as takeout targets. Before anyone can make that leap, I think there are a number of factors that need to be understood. The details really matter here.
First off, in the market’s mind, trying to find a large, scalable, tight gas resource with any kind of proximity to Europe has been the impossible dream for a long time, but based on Valeura’s results at the Yamalik-1 well, it looks like that dream has been realized. The well exhibits all of the characteristics that you would expect in a BCGA. Gas saturation appears to be pervasive throughout the well with no formation water interpreted (on logs or in any of the four flow tests) over the >1200 metre (3,900 feet) interval of interest. The reservoir is significantly overpressured, and the transition zone from normally pressured reservoirs to overpressured ones is consistent throughout a number of historical wells in the basin, suggesting a regional pressure seal at a depth of around 2700 metres (8,850 feet). The geothermal gradient in the basin is elevated, which in this case has pushed source rocks into the gas-condensate window as an extra bonus. The reservoirs are thick, good quality tight sandstones both massive and interbedded character with significant net sand thicknesses. Flow tests have confirmed a gas and condensate column over more than 800 vertical metres (2,600 feet) – with another 800 prospective metres yet to be evaluated at depth. Lastly, the BCGA cell is downdip of the water legs of normally pressured overlying gas fields that exhibit the typical gas-over-water relationship. Much can be found online for those wanting more information of what a BCGA is, but for the purpose of this note, it is enough to say that is that it is a large, continuous gas accumulation, trapped at depth by the laws of physics and petroleum geology. Once you are within a BCGA cell, anywhere you drill the rocks will be gas saturated. As I’ve said before, BCGAs take the question of “Will I hit gas when drilling my well?” right off the table. Let that sink in a little.
Second, you have to appreciate the scale of this BCGA. It covers some 1,600 square kilometres (600 square miles) and Valerua is the dominant land holder in the basin, including licenses covering its deepest and thickest parts. When you look at the map below, which shows Valeura’s blocks in yellow overlain on top of a map of the basin, you have to realize that that’s a lot of area you’re looking at, and every square inch of it is charged with gas and condensate below around 2700-2900 metres (8850-9500 feet) depth. The basin itself is believed to be prospective down to 5000 metres (16,400 feet) with Yamalik-1 proving gas and condensate down to 4200 metres… and the map shows little Valeura’s land position there covering most of it. This is an asset that is big enough to support a massive energy project, where international expertise is on the cusp of unlocking a whole new chapter for the region.

Below I’ve included the latest infrastructure slide from Valeura’s corporate presentation because it’s a pretty key piece of the puzzle. Some people breeze by slides like this because maps are kind of boring to look at and pipelines are just boring lines on already boring map. If you take a minute though, two things really start to sink in. One, Valuera already owns (100%) of its own pipeline network that connects to local gas customers that will take up to 35 mmcf/d. That means that the project, in the lead-up to full development, can actually generate cash flow by selling produced gas during the evaluation stage. That’s a nice feature. Second, and more importantly, there are no fewer than two major regional pipeline systems within spitting distance of the Thrace Basin BCGA. The serendipity of that is incredible, because if the asset was off in the middle of nowhere it would not have the benefit of being adjacent to not one, but two, major trunk lines, with a third one planned. Ordinarily when you find a resource of this scale these days, it takes years and hundreds of millions, if not billions, of dollars just to get infrastructure to it. The infrastructure savings alone should be enough to make a major energy company jump out of its chair here. When it comes to “infrastructure advantage” this verges on what-else-could-you-ask-for territory… and if you want to have a look for yourself, you can probably drive out there in a Toyota Corolla and have a look; access is excellent.

The Thrace Basin BCGA is going to be significant asset at this literal energy crossroads between the rest of Asia, Europe, and the Middle East. Gas fields/sources come and go over time, but what should be abundantly clear is the fact that this is a real chip at the regional energy poker table. Given where it is (in a country that imports 99% of its gas on the doorstep of Western Europe), this one should play in the “billions column” of the world financial stage. I say all this because I want it to be clear that this is a large-scale asset worthy of the attention of any (other) supermajor and that it is located in an incredibly strategic and multi-faceted market. Having a several TCF of gas and a couple hundred million barrels of condensate here would be pretty sweet. There’s no question about how or where to market the gas… the markets are already there and are so are the pipelines. It’s almost surreal. You just don’t find assets that have such a dramatic confluence of positive factors very often.
Well, while we’re at it, here’s another thing you have to understand before you can value Valeura. Fiscal terms. In a nutshell, this project has fiscal terms that would look good to any Texas oilman.  It’s a tax-royalty structure with 20% corporate tax and 12.5% royalties. If you don’t know how that stacks up to pretty much any other fiscal regime in the world, I’ll just say that it’s not a stretch to call that “top-tier”. Not at stretch at all.
So, just to recap, this looks to be a multi-TCF gas resource, in a highly strategic region, surrounded by major pipelines, with top-tier fiscal terms, that you can drive to in a Toyota Corolla. Wow, right?
As they say, “But wait, there’s more…”
Turkish BOTAS gas prices are currently around US$6/mcf (C$7.50), which is some of the best pricing in the world. Imagine how much money U.S. gas companies would print at US$6/mcf gas! And if I use a $60/bbl price for condensate, the condensate is worth another $3/mcf at 50 bbls/mmcf. So, to frame it in relative terms, where a U.S. gas company might struggle to make $1/mcf at $3/mcf NYMEX, Valeura would have margins that were around four times that thanks to regional pricing. Adding in the condensate and the project could net ~$6 for every mcf of gas. Thanks largely to the superior pricing in the region, I get a multi-billion dollar NPV for this project. Some of my first back-of-the-envelope assumptions are well laid out in a prior note or those who are interested. I am currently working on a much more detailed model of the project, but I’m going to wait until I can incorporate the resource assessment volumes before finishing it.
What I will include here today though is a type well curve that I’m using. My initial assumptions are run on a 12 mmcf/d IP30 rate with 50 bbls/mmcf of condensate, which happens to achieve payout in about 15 months at US$6 gas and US$60 condensate using an US$8 million all-in well cost. Tight gas wells exhibit steep declines in the first year of production, after which declines moderate for a couple of years, followed by a long flat-ish tail for the remaining life of the well. My recovery per well from my type curve is 7.2 Bcf equivalent, comprised of ~5.5 Bcf of gas and ~275,000 barrels of condensate. Those are just some numbers to think about while the market waits for the prospective resource assessment, after which I will scale-up my model to the appropriate size. My modeled type curve is based on type curves from known U.S. tight gas plays and it appears that the wells could be highly profitable if my assumptions are even close to correct. That's a good sign, because I could make a case that my assumptions may be conservative. Currently I model an NPV/well of around US$6.5 million (100% basis). When you consider the 200,000 acre area (gross) that Valeura deems as being “within” the BCGA, it’s not hard to see that even 500 wells could make for a material piece of business – and that would only cover 20,000 acres at spacing of 16 wells per section (40-acre spacing). Forty-acre spacing may also be viewed to be conservative when compared with a tight gas play like the Pinedale Anticline.

“But Malcolm, I thought I heard somewhere that the rocks in Turkey aren’t good enough for this...”
I can assure you that the rocks in the Thrace Basin have no idea where they are in the world. They are, for the most part, interbedded sands and shales with porosities and permeabilties that are entirely comparable to a number of proven gas resource plays in North America. While they may actually be thicker and of better quality than some of their North American comparables, they are in no way “different” because they happen to be in Turkey. In terms of completions, what works in the North American rocks appears to work well in the Thrace rocks (four zones were tested after being stimulated with slickwater fracs, each with highly encouraging productivities and good sand placement). If you can think of an analogue U.S. tight gas/BCGA play, you can pretty much take those production/recovery/reserve profiles, maybe tweak them a little, and use them to make a ballpark estimate on the Thrace Basin potential, which is what I’ve done above. Development/production wells may be horizontal or vertical depending on the specifics of any given location, but I am confident that they will be just as exciting as their North American cousins.
In my mind, it’s not about whether or not development of this BCGA will be profitable; it’s about whether or not it will be very profitable or insanely profitable. If you look at the factors I’ve been pulling together here, I seriously wonder what else anyone could reasonably hope for in a newly discovered multi-TCF gas resource play. It is nothing short of awesome in every sense of the word and 50% of it is in the hands of a tiny company that almost no one has ever heard of and that even fewer believe in.
I really can’t frame it any clearer than what I’ve done here. I get the impression that some people will ignore the story because “It’s Turkey”, which is somewhat baffling to me given that there’s a population of 80 millon people there with OECD-leading GDP growth, a business friendly environment, and thousands of years of history as a trading/commerce hub. That same country imports 99% of its gas from abroad. 99%!! Could there be a more captive market? But alas, not everyone likes this jurisdiction, but that’s just fine, because there’s honestly not enough to go around if everyone wants a piece.
In summary, I think the Thrace BCGA is a game changer for Valeura, I think it’s a game changer for Turkey, and I think it might even be a game changer for the energy balance in the region. Heck, it might even move the needle for Statoil, an $80 billion juggernaut of the energy industry. When you put it all together, I just don’t see how little Valeura will be able to remain independent through this year. I think that there are multiple parties that would love to take on this piece of business and I think it won’t be very long before the market sees one of them make a move because the Thrace Basin BCGA project is just too good-looking from too many angles already. More time (i.e., drilling) will only make it more expensive and there is already enough data for the supermajors take a shot at it. For them, spending a billion dollars on an acquisition like this would be like you or me buying nice steak dinner and some really nice wine for small a group of friends. It’s not going to dent your pocketbook too badly no matter what happens, and at the end of the day, it’s a heck of a good way to spend your time and money.
Happy hunting.

<![CDATA[Smoke But No Fire (Yet) at Aamurusko for Aurion Resources]]>Thu, 18 Jan 2018 01:08:22 GMThttp://hydracapital.ca/hydra-blog/smoke-but-no-fire-yet-at-aamurusko-for-aurion-resourcesBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long AU.V)

Tonight after the close, Aurion Resources (AU.V, last at $1.63) reported results from its maiden drill program at the Aamurusko gold project in the Central Lapland Greenstone Belt, Finland. For those hoping that Aurion would hit the motherlode on its first swing at the plate, the results reported will likely leave you wanting. With 21 holes drilled in the initial 3,500 metre program, Aurion found quartz veining with gold on the 13th hole and then drilled 8 more holes (all finding quartz veining) before shutting down for Christmas to wait for assays and interpretation of the drill hole data. The best result reported was 10.1 g/t Au over 1 metre in hole AM170015. While these are not the kind of results that will get casual observers excited, make no mistake about the fact that they nonetheless represent good “smoke” in the hunt for the source of the high-grade boulders seen at surface in the Aamurusko project area. Zones of quartz veining up to 20 metres wide were intersected in core with individual quartz veins up to 6.3 metres wide (all downhole widths).
Calling it “smoke” might seem like an exploration cliché to some people (I know, I know, “I didn’t come for smoke… show me the fire!”), but it really is important to keep perspective on what realistic expectations should be at this stage. While there is nothing more exciting that the first long, rich, “discovery hole” in any exploration project, when you’re early on a story that hole can seem to take a while to hit… and that’s because there’s a lot of work that goes into hitting that first zinger. When you actually objectively look at what’s been reported, Aurion has revealed a very key piece of the puzzle with just 3,500 metres of drilling. With only 21 holes likely costing a little over a million dollars (that assumes $300/metre all-in costs, which should leave plenty of room for error on my part), Aurion was able to find multiple gold-bearing quartz veins in bedrock with geochemistry and textures that closely resemble the boulders seen at surface. If you put your explorationist hat on, that’s a pretty good start, because finding gold in quartz veins in bedrock that closely resemble the very same quartz boulders seen at surface is a very key deliverable from this initial drill program. The case for worrying that the boulders all came from somewhere off the property can be pretty much thrown out the window now. That’s a big deal. There are literally hundreds of gold-bearing boulders at surface at Aamurusko and the thesis that they very likely came from the property is now supported by actual drill holes (with quartz veining, comparable geochemistry, textures, and gold in them) as opposed to only relying on their blocky (i.e., not rounded due to transport) shapes. To put it another way, the odds of the boulders at surface not being related to the gold-bearing quartz veins now found in the underlying bedrock are essentially zero in my view… and being able to make that leap is what made a very pretty penny in a story called Alpha Minerals few years back.
Forgive the digression, but I think it may be useful for the uninitiated. For those who are unfamiliar with the story of Alpha Minerals, it was not so unlike the story of Aurion. The Alpha story goes something like this… Alpha had identified a high-grade uranium boulder field in Saskatchewan on the margin of the Athabasca Basin. The next closest mine was some 60 kilometres away and the source of the boulders was unknown. No uranium deposits had been found in the immediate area, mostly due to lack of methodical exploration, not lack of geologic prospectivity. In the last 4 holes of a 28-hole drill program (the company's second or third pass in the area), Alpha identified pitchblende (uranium mineralization) in core and assays were pending. The stock went from 10 cents to around $2.20 before assay results came back and I was long a fair bit of stock as I’d been buying it all the way up. When the assays came back, the company reported an intercept of 12.5 metres of 2.5% U3O8. The results were not “hot enough” for some investors and I watched the stock fall from $2.00 to $1.40 the next day. I racked my brain. The company had just drilled a very intriguing intercept that was not the “motherlode” that the market was hoping for, but the result had clearly derisked one of the main aspects of the story, which was, “Where did those boulders come from?” And yet, there the stock was, down 30% as the result wasn’t “good enough” for short-term traders to make their fortunes overnight. The data had never been more supportive, but results had failed to live up to market expectations. What was I to do? Unwilling to be shaken from my “no-way-those-boulders-aren’t-related-to-this-find” conviction, I actually bought more stock that day and in the days and weeks following. Not long afterwards (only about 2 months later) Alpha was already out drilling on its follow-up program and started hitting thick high-grade holes… and the rest is history. Once they were “in it”, Alpha just kept hitting, and hitting, and hitting, and the chart was “up-and-to-the-right” for the next 10 months after that, after which Alpha was taken over by its partner, Fission Uranium, at a little over $6 per share.  That was some sweet vindication and some even sweeter profit.
I don’t recount the Alpha story here to say or suggest that history will repeat here. I’ve seen plenty of programs come up empty handed over the years, but short-term sentiment is a funny thing. When expectations are high and not met, people will sell stocks like they’re going out of style even though the data is more supportive of the initial thesis than ever before.  It’s an evil bit of market psychology and it is extremely difficult to see through/think rationally in the face of an irrational/impatient market, but that is literally what makes a market. Now look, it would be amazing if I had a crystal ball, but barring that I can only look at Aurion’s results in the same light as I did Alpha’s. There are 632 boulder samples with grades and textures that suggest there’s at least one gold deposit at Aamurusko somewhere, and the project is in a very compelling overall geological setting that should be expected to yield some large gold deposits (remembering its geologic similarities to the ~75 million ounce Timmins camp, for example). So, when you get right down to it, I think that the critical question that everyone has to answer for themselves is this:
What are the odds that the gold-bearing quartz veins found in Aurion’s maiden drill program are completely unrelated to the hundreds of gold-bearing quartz boulders at surface?”
That’s it… and I really do think that’s the main thing that Aurion holders need to ask themselves on the back of these results, because drilling has already started up again (first targeting a prospective structural bend indicated by the just released drill hole data) and with somewhere around $20 million in cash (thanks largely to 9.9% holder Kinross, who “gets” the prospectivity of Aamurusko and the exploration process) Aurion has plenty of swings at the plate (i.e., time). Gold-bearing quartz veins are far from common occurrences and to find them in bedrock under an area littered with similar looking boulders is a pretty big step in the right direction. If Aurion had its back against the wall with out any backers or money, sure, run for the hills, but with no need for financing in the foreseeable future, Aurion has nothing but time to find the source of those boulders. With its cash on hand, I estimate that Aurion could probably drill 50,000-60,000+ metres without raising another dollar from the market. Given that the most recent program was just 3,500 metres, with only the last 8 or 9 holes in structure, I think it’s safe to say it’s early days. Remember that Aamurusko is a blind target (the bedrock is covered by rocks, trees, and dirt) and drilling more holes is the only way to find the source of the high-grade boulders. 
As I said above, I think that the odds of the quartz veins now found in core not being related to the quartz boulders at surface are about zero. I also know that it will be a long time before Aurion needs to think about needing any more money. It’s only a question of time and perseverance and I have a great deal of confidence in the perseverance of the Aurion team. All Aurion holders need to make their own decisions on news days like this, because no one has a crystal ball. In Alpha’s case, things worked out very well for me and a big part of that was being able to look at the initial drill results and put them in context relative to what the available data was at the time. That means that I was either smart, or lucky… or maybe a little of both.
When I look at the following excerpt from Aurion’s August, 2017 press release (linked here), I find that it puts things in context a little. This is a large area and Aurion has barely even scratched the surface with its drilling so far. Of particular note, only around 20% of the boulder samples outlined below graded greater than 1 g/t gold. In that light, Aurion has actually done pretty well on its first time out. Gold systems are organic things (i.e., expect variability during “the hunt for the source”) and the drill results reported today should leave little doubt that Aurion is in the right neighbourhood, but has yet to find the high-grade. Here’s a rehash of the boulder results from August of last year that generated so much excitement in the first place:
To date Aurion has received assays from 632 rock samples including the 2016 samples and samples from the June 2017 sampling campaign. The average of these samples is 26.7 g/t Au with 68 assaying greater than 31 g/t Au, 97 assaying greater than 5 g/t Au and 131 assaying greater than 1 g/t Au. Assays from several hundred more rock samples collected throughout the Aamurusko corridor and elsewhere on the Risti property are pending.
The quartz vein blocks range from 0.1 m to >3 m wide, trend NE-SW and are hosted by quartzites and polymictic conglomerates of the Kumpu Group and mafic volcanics of the Sodankyla Group. The conglomerates are interpreted to be unconformably in contact with the mafic volcanics.
The sampling has now extended the main Aamurusko trend to 1.4 km NE-SW. The southern-most sample assayed 2520 g/t Au. Further extension of this trend is hampered by deep overburden cover. The prospecting and mapping thus far has now identified several discreet quartz vein block trends within a greater than 2.5 km wide east to west corridor. Again, the limits of this corridor are constrained by overburden cover.”
My math pegs the Aamurusko target area at around 3.5 square kilometres. I’d hardly say that 21 holes are going to evaluate more than a collective postage stamp within that prospect area. Once again, context is important in the early days when data is scarce.
None of my ramblings here are intended as advice, because I’m a firm believer that everyone needs to make his or her own decisions. All I’m doing here is stepping back and taking an objective look at the data, the company, the cash, and the thesis all in light of my own personal experience in similar situations in the past. Patience can be a very tough power to wield in a market where there’s a new opportunity every five minutes and the market measures you on a daily basis. Over time, I’ve consistently found that if I can truly assure myself that my risk level in a story is decreasing, not increasing, the market usually follows suit. That’s not to say that there won’t be fits and starts, but at the end of the day if the data stays supportive and there’s enough cash to keep going, then it’s onwards and (hopefully) upwards. At any given time, if you can look through what’s screaming in your face in the moment (the share quote) and see the bigger picture, that’s a decent step towards not being an emotional trader. Some people may sell with the hopes of “buying back lower” at a later time, others may throw their hands up, sell, and move on, and others still will use this as an entry point on a story that they always liked, but previously didn’t like the valuation.
Aurion has already started a follow-up drill program that will continue to chase the source of the high-grade boulders in the underlying bedrock and with approximately $20 million in the bank; the company is very well-financed for the task at hand. Some people may prefer not to stick around and wait it out, but Aurion’s share price has already pulled back some 50% from its September highs, so a lot of steam has already come out of the stock and it’s hard to know how long the market will focus on these results (i.e., the rear-view mirror) before starting to look at the road ahead again. Those people with years of experience in the sector and a long-term view are likely to be relatively unfazed by the results of a 9-hole sample of a system whose scale is measured in kilometres, while those with shorter time horizons in mind may take the opportunity to chase marijuana or blockchain stocks, or whatever the flavour of the day may be. I have seen and been in both sets of shoes over the years. All I can say is that discovery is a process that takes time, with the key to success being found in the technical capabilities of the team, the financial capacity to execute a significant amount of drilling, and of course a little bit of luck. Aurion has the first two of those in spades, so holders can take some comfort in that... and a lot of people say that you make your own luck with positioning and hard work. With significant quartz veining already identified, Aurion is hitting the ground running with the follow-up drill program that’s currently underway.
Having been to site, and having seen the sheer number of high-grade boulders literally sitting at surface at Aamurusko, I’m now even more convinced that those boulders didn’t fall out of the sky or come from very far away. With that in mind, and with Aurion already getting sniffs of gold-bearing quartz veins with some of the final holes of the 2017 program, I still think this represents an excellent exploration target worthy of the attention from the majors that it’s getting (e.g., Kinross). With gold prices up 9% over the last year, Aurion’s timing could end up being quite good as the market is still hungry for gold exploration stories with needle-moving potential. When pre-drill expectations are as high as they were for Aurion, the company was almost in an impossible position, but cooler heads will prevail (as they always do) in the coming days and weeks as the company continues drilling at Aamurusko. There’s a lot of story yet to be written and I think there’s still a good chance that this story has a happy ending… maybe not today or tomorrow, but when it comes to exploration drilling, timing is the hardest part.
Happy hunting.
<![CDATA[Gas is Good: Valuera Solidifies BCGA with Fourth Test]]>Thu, 28 Dec 2017 12:07:06 GMThttp://hydracapital.ca/hydra-blog/gas-is-good-valuera-solidifies-bcga-with-fourth-testBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

Valeura Energy (VLE.TO, last at $4.83) has released results from the fourth of four planned tests at the Yamalik-1 well in Thrace Basin, Western Turkey. Results continue to demonstrate pervasive gas and condensate saturation within the well, now spanning over 800 vertical metres. Pervasive gas saturation like this is precisely what you would expect from a BCGA and, well, you know the saying -- if it walks like a duck and it quacks like a duck...

If there was anyone who still doubted that this might not be a BCGA, I think that this should pretty much seal the deal for them. Yamalik-1 has now proven gas and condensate in four separate test intervals, all of which are outside of any kind of structural closure. Log interpretations, pressure data, hydrocarbon saturation, and lack of moveable formation water all continue to demonstrate exactly what one would expect from a BCGA.  Rates from any one of the four reported tests would make any tight gas developer salivate. For context, many a Canadian Montney field has been discovered based on a single vertical 
test rate of 0.2-0.3 mmcf/d and Valeura has now reported four tests in four separate intervals ranging from 0.4 to 0.9 mmcf/d (all at restricted rates and all only partially cleaned up).

This latest test flowed at an average (stabilized) restricted rate of 0.4 mmcf/d with 30-50 barrels per million of condensate over the final 24-hours of a 41-hour test. The continued presence of condensate is a continued massive bonus. Based on the results of the third test, I had wondered if perhaps the condensate yield would taper off in intervals higher in the well, but that doesn't appear to be the case. Yesterday, a friend of mine asked me about the potential value of the condensate in the Thrace BCGA relative to the gas, so I ran some quick numbers and was surprised by what I found. In terms of net cash flow, at a condensate yield of 50 bbls/mmcf, the value of the condensate is roughly equal to the value of the gas, which makes this BCGA even more valuable that I had originally thought. In my prior NPV calculations, I had simply ignored the condensate value, but with condensate in all four tests now, that is likely to be grossly conservative.

In terms of the test rate, being higher (shallower) in the well, the porosity and permeability in the fourth zone are very likely higher than that in any of the previously tested zones and as a result, the frack fluid flowback is likely to be somewhat slower than that seen in the other zones (the frack fluid is able to penetrate deeper into the formation in better rock) so I wouldn't read too much into that. Once the well is tied in for a long-term production test and clean-up, the market will get a handle on what the well is actually capable of producing without the limitations of time and the surface testing equipment. In the meantime, Valeura is going to see about performing an aggregate commingled test of all four zones by drilling out bridge and flow-through plugs in the well with a coil tubing unit that they currently have on site. There are some limitations imposed by the configuration of the testing equipment that may or may not allow for the commingled test, but it's not overly material in either case. As I've said before, anyone that tries to get hung up on any individual test at this stage is sadly missing the point with respect to just what this BCGA represents. I recently read a classic quote from Warren Buffett stating that "the market is incredibly efficient at transferring money from the impatient to the patient", and I've found that to be quite true over the years...

With Yamalik-1 proving the BCGA concept and showing rates that far exceed any pre-drill expectations, the path ahead couldn't be more clear. There are scenarios where vertical and/or horizontal development could yield flow rates that would make any tight gas developer jealous and the pricing, strategic location, and fiscal regime in the Thrace are absolutely first class. You can have the best resource in the world, but if it is too remote, has poor fiscal terms, or is in a market with poor pricing it can be all for not. Valeura and Statoil have quite the opposite on their hands in the Thrace and I think the other supermajors of the world know it. As these energy behemoths scour the globe in search of projects that provide the alignment of scale, fiscal terms, and location the Thrace BCGA must look very, very attractive. With the resource assessment expected in late January and with Valeura marketing to institutions in mid-January, the story is getting set for the "great handoff" whereby Valeura's retail investors start getting replaced by institutional ones who will recognize the sheer magnitude of what's on the table here. The big wildcard that remains is how long Valeura, a tiny junior company that most people have never heard of, will be allowed to play alongside Statoil in the Thrace Basin sandbox where the potential will soon be casually measured in the trillions of cubic feet. 

Valeura's story in the Thrace is still only just beginning with the big unveiling to a much broader audience set to happen in January when, for the first time, the world will see the scale of what's on the table here. I suspect it will make headlines from Istanbul, to Oslo, to Calgary and it will be only then that Valeura will have made its transition from obscurity to the mainstream, at which point the next stage of the journey will begin.

Happy hunting.

<![CDATA[Valeura Energy Scores a Hat Trick at Yamalik-1]]>Mon, 18 Dec 2017 13:29:39 GMThttp://hydracapital.ca/hydra-blog/valeura-energy-scores-a-hat-trickBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long VLE.TO)

Valeura Energy (VLE.TO, last at $3.05) has released results from the third of four planned tests at the Yamalik-1 well in Thrace Basin, Western Turkey. I said pretty much all I have to say for now in a note from last week, but obviously this test result continues to add to be body of evidence that Valeura and Statoil have a BCGA on their hands here. To summarize the results, I will quote directly from the press release here:

"Two slick-water fracs were carried out in Test #3 to access approximately 26 metres of indicated net gas pay over a depth interval from 3,488 to 3,635 metres. The well was produced for a total of 37 hours. Over the final 24 hours of stable flow, the well was produced at an average restricted rate of approximately 0.9 million cubic feet per day ("MMcf/d") of natural gas. This rate compares to the final 24-hour rate of 0.8 MMcf/d in both Test #1 and Test #2.
Condensate production in the range of 20 to 30 barrels per MMcf was observed in Test #3. The condensate measurement is subject to considerable uncertainty given the nature of the testing protocol and the short duration of the testing."

Measured condensate yields appear to be a little lower than the first two tests, but continue to confirm the liquids potential of the BCGA cell and are a very welcome bonus for a play that I don't think anyone was expecting any condensate from to begin with. The presence of gas and condensate has now been proven over some 650 vertical metres, with the expectation that gas saturation should be pervasive throughout the interval below the regional pressure seal. With aggregate (restricted) rates from the first three tests now totalling 2.5 mmcf/d, Yamalik-1 continues to surpass all pre-drill expectations. Slowly but surely the market is waking up to what's taking shape here and industry is usually a few steps ahead, so it will be very interesting to see how this plays out for Valeura over the coming weeks and months.

<![CDATA[Altura Energy Quietly Beats Expected Type Curves on ERH Wells at Leduc-Woodbend]]>Fri, 15 Dec 2017 00:24:46 GMThttp://hydracapital.ca/hydra-blog/altura-energy-quietly-beats-expected-type-curves-on-erh-wells-at-leduc-woodbendBy: Malcolm Shaw

(Disclosure: The following represents my opinions only. I am not receiving any compensation for writing this article, nor does Hydra Capital have any business relationship with companies mentioned in this post. I am long ATU.V)

Altura Energy (ATU.V, last at $0.41) released a corporate update tonight that includes a 2018 capital budget and initial production rates from its first two extended reach horizontal wells at its 400 million barrel OOIP Leduc-Woodbend project. For anyone not familiar with the story, I would refer you to my prior note linked here. The only thing that I wanted to see in this release was the initial production rates from the ERH wells and I'm quite pleased with what's been reported tonight. I will be putting this position on autopilot from here on out. Altura has updated its corporate presentation, but I've saved a slide from the old presentation to show how the first two ERH wells are plotting relative to initial expectations. See below for the 03-02 and 13-14 well production rates 45 days after coming onstream plotted on the company's previous expected type curve plot:
It's early days, but the initial results from the well results are clearly encouraging. With a huge drilling inventory, massive oil-in-place numbers, and an absolutely first-class management team, I see Altura as a wolf in sheep's clothing. Management is far from promotional, but is very, very capable of organically growing this company to multiples of current levels if given time. If you take the corporate cultures of Peyto, Storm, and Vermillion and mix them together into a junior with a ton of growth potential you've got yourself Altura Energy. Leduc-Woodbend is a big asset in a small company, but it looks like something that Altura is going to grow into if these first two wells are any indication of what that field can do. Sometimes stories don't require a lot of explanation and I think this is one of those situations. Patient money should do very well here and if oil prices run, it would only serve to speed up Altura's inevitable rise.