(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)
When I saw the headlines couple of weeks ago citing the downing of a Russian bomber in eastern Turkey by Turkish F-16's, I was surprised that someone had actually stood up to Russia's sometimes "loose" interpretation of sovereign airspace. Turkey presents a pretty clear-cut account of the events, but at the end of the day, the only detail that mattered was the fact that a Turkish plane had shot down a Russian one… the Russians would not be pleased. As a NATO member, Turkey is unlikely to see any real military retaliation, but the threat of economic consequences could prove to be far less benign. Almost overnight, Russia responded by shunning Turkish exports of billions of dollars worth of fruits and vegetables, (maybe) putting a major gas pipeline project on hold, discouraging Russian tourist traffic to Turkey, and slowing the construction progress of a Turkish nuclear reactor build-out. The real kicker though? Gas supplies. As I've pointed out before, Turkey imports 99% of its gas needs… and 55% of its imports come from guess who? That's right… Russia. To put it further in perspective, the U.S. EIA reports that Turkey relied on natural gas for roughly 40% of its electricity generation as of 2012. Today that number is reportedly closer to 48%. It's no surprise that headlines regarding energy price increases are already showing up… it doesn't make for a comfortable situation heading into winter if your largest gas supplier is, ahem, "unhappy" with you. Therein lies the silver lining though… it is now glaringly obvious that Turkey has been too dependent on gas imports for far too long. It's time for the Turkish government and the market to wake up and do something about it.
The current row with Russia very plainly highlights the fact that it's time for Turkey to, 1) start developing domestic gas supplies and 2) start building increased gas storage capacity. The potential is there. Turkey is slightly larger than Texas and has very good geologic potential for both gas and oil depending on what part of the country you're in. The country has decent domestic distribution infrastructure, multiple regions of historic and current drilling activity, one of the best fiscal regimes in the world (12.5% royalty and 20% corporate tax), and one of the world's longest histories of trade and commerce. It ranks 18th in terms of global GDP, so we're talking about a real market here. I would be shocked if there are not dozens of companies looking at how to get into Turkey's gas market at the moment. I would be equally shocked if the Turkish government has not already started to reach out directly to the E&P industry in search of investment. At the very least, I would think that now might be a good time for the government to direct funding towards organizations like Turkish Petroleum (aka TPAO) so that they can drill high-impact plays either alone or in partnership with the handful of existing local operators. Even if the Turkish government directed $2 billion towards domestic energy projects, that would be less than 0.25% of GDP. In light of the fact that agriculture and tourism are likely to be hurting in the near-term at the very least, a little bit of stimulus in the energy sector might not be a bad idea… and hey, who knows, Turkey might just unlock its massive domestic gas potential in the process.
Regular readers will know where I'm heading with this... Valeura Energy (VLE.TO). I believe VLE is an undervalued gas producer in what I believe to be one of the best local gas markets in the world. Gas in Turkey sells for around $10/mcf, so while most other companies are being buried by low oil and gas prices, Turkish gas producers (a rare breed) just keep trucking along. At Friday's close of C$0.46, Valeura has a market cap of roughly $27 million, which puts it at about 1.5-1.6x EV/CF (2015, net of $10 million positive working capital, no debt) and the company is currently in the midst of a drill program on its 100%-owned Banarli concession in the Thrace Basin… a proven gas producing region in far-western Turkey, far from the troubles in the east. VLE's contingent resource potential on its JV lands alone is 652 BCF (2C). Again, that is 652 BCF (2013 presentation link here). If this gas was in Alberta, it would've been drilled 15 years ago by someone like Canadian Natural Resources or EnCana… this is classic shallow gas in multi-stacked gas-charged sands in areas of proven historic and current production. Granted, this 652 BCF I'm quoting is a contingent resource estimate from a few years ago and should not be confused with reserves, but anyone who understands what happened in Alberta shallow gas over the last 15 years will understand the potential on the table. After all, that's a $6.5 billion prize right there. So why hasn't it been developed? One word… capital. VLE and its partner simply haven't had the capital to chase these huge contingent resources, despite the fact that they have proven the economics of shallow gas wells to be very favourable, yielding IRRs in the 80-100%+ range. To me, VLE is like a race car waiting to be driven… add a little gas (capital) and the potential is there. The current situation with Russia is just a classic catalyst for capital inflows into Turkey's energy industry, full stop. Turkey isn't going anywhere. It is a key NATO member, it's Russia's only real maritime link to the Mediterranean, and it is the southern gateway to Europe. Wake up Mr. Market, the stars have aligned and they have spelled out "INVEST IN TURKISH GAS" in the sky.
This leads me to my next point… Valeura's multi-TCF shale gas potential. I have written on it before, so I won't belabour the point here, but I would point out the following… For roughly $20 million, VLE could likely drill and complete two wells to effectively test the shale gas potential below 2,700 metres on its 100%-owned Banarli block. Historical data clearly shows that below 2,700 metres, the sand and shale formations in the area are over-pressured and have exhibited extensive gas shows during drilling. All of the ingredients are there for a basin-centred-gas-accumulation: a thick sedimentary section, proven gas generation, reservoirs, source rocks, and evidence of a regional pressure seal. When I think about all of the high-risk offshore wells that are drilled around the world every year for costs in the $20-100 million range, I think it's just a matter of time until someone steps up to the plate to test the shale gas potential at Banarli. In the meantime, I'll wait and see if the company can boost its cash flow through success in the ongoing shallow drilling program.
The path for Turkey and investors is plain as day. Direct capital towards exploring for and developing domestic gas supplies, as well as domestic gas storage projects. The signs couldn't be any clearer... Turkey is presenting a pretty sweet case for gas.