Canacol’s production reports always generate work in the HCC offices because their business is never simple. Through the first half of 2012, most of their revenue-generating production was so-called “Tariff” which was essentially was a services contract where they pumped oil for another company at a set fee per barrel. This was a low-netback business that the company has been deemphasizing, expecting it to be only about 11% of its business in 2013. As the graph shows, they also report figures before royalties, a not uncommon practice but one we do not agree with and normally try to adjust for.
However their guidance for 2013 mixes Ecuadorian and Colombian production and we lack information on Ecuador to be able to adjust. The tariff production is also before royalties since presumably royalties are the responsibility of the end client and not Canacol. So to avoid mixing apples and oranges (or in Colombian terms apples and pears) we will use their Before Royalties comparisons. As a reference, we estimate Canacol’s average royalty rate on its Colombian non-tariff oil to be 19%.
Canacol also did not split its 2013 oil production guidance between Ecuador and Colombia. But in 3Q12 Ecuadorian revenue was minimal. So we assume that all 3Q12 non-tariff oil was Colombian and (absent explicit guidance from Canacol) that 2013 growth will be zero. With this assumption, Colombian non-tariff (i.e. normal) production will be about 37% of the total, Ecuador non-tariff production about a 1/5, Colombian gas about 1/3 and tariff production the balance at 11%. Ecuador’s contribution would be lower and Colombia’s higher if we assume the Colombian tariff production shifts to non-tariff instead of just disappearing as we have assumed here.
Total production will be up 56% over the disastrous 3Q12 figure thanks to Ecuador and the Shona (gas) acquisition which closed late December of 2012. Oil production will be up 4.4% but non-tariff oil production will be up at least 50%. Non-tariff oil production would be at its highest level ever – the previous peak was 4,422 bd in 4Q11.
The company says CAPEX will be US$67M split 46:21 between Colombia and Ecuador, suggesting we are not seriously over-estimating Ecuador production. They plan to drill 8 exploration wells in Colombia.
CEO Charle Gamba said "In 2013 the Corporation will focus on 1) building out production from recent oil discoveries on LLA23 and VMM2 and increasing production levels from the newly acquired Esperanza gas field in Colombia via new sales contract, 2) continuing to increase production from our Libertador-Atacapi oil field in Ecuador, and 3) execute a significant oil focused exploration program in Colombia targeting both conventional light and heavy oil, and unconventional light oil.”
Bottom-Line: Canacol was the worst-performing stock amongst Colombia-focused companies with significant production. More importantly than making our analysis complicated, the tariff business made it hard for investors to benchmark the company against its peers, making the shift to non-tariff production essential. Natural declines at Rancho Hermosa and the public order challenges of the 3rd quarter of 2012 made a difficult situation worse. The Shona deal should give a boost as will growth in Ecuador. Our assumption that Colombian non-tariff production will be stable needs a leap of faith that the company can get environmental permits for the wells it needs to drill to keep the oil flowing. That process will ultimately determine if the company’s plans succeed.