(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)
Testing at Yayli-1 Continues with 128 metres of Gas Pay on the Table, but Patience is Required
Last night, Valeura reported what was probably the most anticlimactic news of the year so far in my universe. While I thought testing of the overpressured section of the Yayli-1 well would be completed by now, equipment limitations mean that the testing has only just begun. Fortunately, the market has taught me over the years that patience is a virtue... and Valeura's update does nothing to detract from my thesis on the company -- I believe VLE's valuation is underpinned by its shallow gas reserves and potential while providing exposure to company-maker BCGA potential. I haven't had a chance to catch up with management yet this morning, but I plan to have a call with them today, after which I will fill in any additional details that seem worthy of note.
So far at Yayli-1 (where Valeura drilled roughly 400 metres of overpressured section earlier this year), the company has recovered just over half of the frack fluid from an initial 13 metre thick fracked zone in the overpressured basin floor fan (tight sand) section. The company is bringing in a larger coil tubing unit that will allow for faster frack fluid clean up in this and future tests. You see, when you frack a well, fluid and sand is pressured up to the point in the wellbore that it cracks the rock in the selected interval and rushes into the formation (rock). When that pressure is removed at the end of the frack job, the pressure of the formation pushes the fluid out, but the sand remains behind, lodged in the induced fractures in order to keep them open as conduits for the gas to get out of the rock. That fluid then needs to be lifted out of the hole first so that the gas can then flow, ideally as quickly as possible. "Producible" gas and condensate have been noted thus far, which is positive, and is about what you would expect from a vertical frack that has only recovered 55% of the frack fluid. For those of you thinking that this was "the" release that would make or break the BCGA (basin centred gas accumulation) concept, think again. Once a larger coil tubing unit is brought in later this month to facilitate frack fluid clean-up, Valeura will likely flowback and frack three separate intervals... so it will probably be sometime in Q2 before results are out.
Tom Petty is a wise man... the waiting really is the hardest part. Talk about a lack of fireworks! However, I will say this... for the first time Valeura has referred to 128 metres (420 feet) of "pay" in the overpressured Yayli section. That is twice what I had in mind and is twice what a lot of Montney wells in Alberta would have. Of that 128 metres, Valeura has only perforated and fracked 13 metres of it so far, and gas and condensate have started to flow as the well continues to flow back frack fluid as part of the testing process. Could Valeura have foreseen the need for a larger coil tubing unit? Perhaps, but then again they are literally defining the shale gas movement in Turkey at the moment, so I'm willing to cut them some slack. Moveable/producible gas at this stage is a reasonable step forward.
The Bati Gurgen-1 (3.4 mmcf/d test rate) tie-in is behind schedule, but imminent, and all other aspects of the quarter and reserves were generally uninteresting. Reported 1P before-tax NPV10 is $0.71/share and 2P before-tax NPV10 is $2.02/share. Netbacks were steady in the $44-45/boe range (Valeura is probably one of the only companies on the planet with netbacks like that these days) and year-end cash was approximately C$7 million, with no debt. I would point out that VLE trades at less than its 1P (proven) NAV, which is fairly conservative given what's on the table in both the shallow and the deep. Have a look at slide 17 of the company's corporate presentation (linked here) to see what has been defined so far in terms of targets on just a portion of the Banarli block.
No 2016 capital budget or production guidance was given as the company is waiting on Yayli-1 results and Bati Gurgen-1 well performance before making any projections, but I think that something in the 2,000 boepd range as a reasonable expectation for a 2016 exit rate. That would translate into gross cash flow of around $25-30 million annualized, which puts VLE's current valuation at just a little over 1x EV/CF (most energy companies in Canada are currently trading in the 8-12x EV/CF range). Farm-out discussions are continuing for the deep gas at both Banarli and on Valeura's JV lands to the south and there is increased chatter regarding Turkish shale gas development potential in the press.
More patience is required, but in my mind the value backstop is clearly defined via the shallow gas development and reserves volumes, which makes for a pretty good risk-reward when looking for a moonshot like a BCGA on Europe's doorstep.
I would expect further updates from Valeura in due course in terms of the Bati Gurgen-1 tie-in, farm-out discussions, and Yayli-1 testing. Valeura has also made applications for two additional exploration licenses adjoining the Banarli concession which are currently under review... Valeura is not thinking small here.
***Supplemental Update*** (March 9, 2016)
As promised, I had a chance to catch up with Valeura management today with respect to details regarding the Yayli-1 testing program details. Recent market action reeks of a combination of 1) the lack of market efficiency in small cap stocks where technical details matter, 2) impatience, and 3) people allowing a stock chart to influence their sentiment towards a story.
First off, no one likes a delay in much-anticipated news -- the Yayli-1 test results in this case. However, the delay in this case is for a very good reason. When VLE fracked the first zone (a 13 metre interval at 2,865 metres depth) in the well, the coil tubing unit (picture a giant garden hose) they had on site had only 1,800 metres of capacity, which means that when it was run into the hole, the bottom of the tubing was more than 850 metres from the top of the tested interval. That means that in order to clean out the frac fluid post-frack, the company was trying to pull the fluid column 850 metres up a 5 1/2" inch casing string before it got to the base of the tubing where it could be pumped out of the well, thus freeing the gas below to flow. Now, typically when you do a frack you want to recover the frack fluid as fast as possible so that the formation uses all of that frack energy to establish gas flow as opposed to using that energy to push a bunch of fluid up the wellbore to your tubing string dangling way up hole. Having said all that, even in spite of having to overcome this fluid column, the zone that was tested at Yayli-1 still flowed gas and condensate to surface. That on its own is quite a feat. I could probably make the case that today's news has actually confirmed that VLE has proved the BCGA concept at Banarli. Rather than continue to mess around with the too-small coil tubing unit, VLE sent it packing and has a bigger one on the way to site as I type this. That unit should be on site by the end of the month.
So what does that mean for the additional pending frack(s) and test(s) at Yayli-1? Well, when Valeura goes back to test its next zone (which is going to be quite a bit thicker than the one that was just done) it will do so with a bigger coil tubing unit (i.e., more "hose") that can reach all the way down to the interval of interest. This should result in a much faster clean-up of the frack fluid used in the well completion process, with less energy used by the formation to push fluid up the wellbore, and more energy used to push gas out of the formation and establish flow, which is what you want. All things considered, I would expect that to translate into a much more prolific test. If I'm right, it will only strengthen VLE's potential to farm out its deep gas play to a willing partner who understands what tight gas development is all about, which would probably be all the "validation" that the market craves.
As indicated in the press release, the Bati Gurgen-1 well should be onstream shortly which will meaningfully and immediately increase VLE's production and cash flow.
So how much longer do investors have to wait? My best guess says that a little over a month from now, I may be discussing where I went right or wrong in my analysis of this information as we digest the next batch of Yayli-1 test data.
The bottom line is that today VLE is just as close to BCGA success as they've ever been... the market just doesn't seem to know it yet. I remember a similar situation with Alpha Minerals in December 2012 when that company released its first set of assays... Alpha's news confirmed the presence of basement hosted uranium at what looked to be potentially economic concentrations (12.5m of 2.5% U3O8) and yet the market sold the stock off hard that day, only to eventually see future holes confirm the presence of a world-class uranium deposit at Patterson Lake South. I'm not saying that this is necessarily the case with VLE just yet, but history often rhymes and there are some real similarities here in my mind. Much anticipated news has failed to meet "market expectations", but when I look at what Valeura has said about confirming the presence of moveable gas and condensate from the first (sub-optimal) test at Yayli-1, I can't help but wonder if it's deja vu...
Time will tell.