Introduction & disclaimer
Hello! I'm back with my second report, this time featuring a natgas company. As previously, the opinions stated here are my own and I am still a greenhorn when it comes to investing, I may make mistakes or have misunderstandings about the companies I discuss. Before getting into the report I'd like to take my time to review the performance of the company which I previously wrote and article on since the time of posting. My previous report featured gold & silver developer Integra Resources, where I explained what I saw as the potential for a 4-bagger. That post was made on 27 December, 2021. The TSX share price was at C$2.70 at the time, and now the price is C$1.80, a -33% performance in about three months. Hardly a 4 times return on investment! In hindsight, I believe I made two crucial mistakes in my assessment. One, I underestimated the effect inflation would have on project economics as the market disliked the lukewarm results of the PFS. Two, much of the analysis relied on the company being able to more than double its current resource base and succeed in its exploration efforts, which I now look back on in embarrassment. So I was too hopeful for the short term results of the PFS, and I didn't take into account the costs (time, money, exploration risk) of reaching the lofty exploration goals I had set for the company. Do I still believe the company could more than double the current resources, I would say yes I still do think that it's possible although that is a mere speculation on my part, not tangible value that I can actually rely on as an investor. I do admit I made a great mistake in my assessment and let speculation cloud my judgment, and as a result I made a bad investment (in other words I was WRONG). This is something I will learn from: inflation is not to be underestimated when it comes to development stage projects, and speculative exploration prospects are not tangible value for the share price and will take a very long time and millions of dollars to define into a resource & feasibility stage.
As was the case last time, I will happily listen to comments, thoughts and constructive criticism from anybody willing to chat with me. Please share your opinions with me, I'll take it to heart and learn from it.
Now onto the report!
DISCLAIMER: This is not financial advice. I may or may not currently own shares of this company, and I may sell a position at any point without warning. Please do your own due diligence and invest at your own risk. I am not a paid advertiser or promoter. I'm not a geo or any sort of professional. Do your own due diligence and take what I say with a grain of salt. Question everything and form your own opinion, this report is only meant to share my own due diligence with You, the reader.
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Imagine
Imagine a natural gas project off the coast of Morocco, just south of Spain, that could produce natural gas at 70MMscf/d initially. Imagine hundreds of billions of cubic feet of contingent resources and trillions of cubic feet of prospective resources. Imagine a recent appraisal well success that vastly exceeded expectations and greatly derisked other prospects. Imagine selling the gas via an existing major pipeline to the European market, where the current price of natural gas is about $38.8/mmBtu. Imagine a company valued at only $150M that owns 75% of this asset.
The truth is, you don't have to imagine. This is reality.
Chariot Ltd (LSE:CHAR), along with the government of Morocco, is the lucky owner of this phenomenal asset. The Anchois Project is located about 40km offshore to the West of Morocco within the Lixus Offshore license, which in turn is inside the Rissana Offshore license that was awarded to Chariot on 28 February this year. Another 30km eastwards from shore is the Gazoduc Maghreb-Europe pipeline that connects Algeria to Spain.
The Anchois-1 discovery was made back in 2009 by Dana Petroleum but the discovery was left abandoned likely due to the undeveloped gas market in Morocco at the time. The results of the appraisal resulted in 307Bcf 2C contingent resources and 116Bcf 2U prospective resources which added up to a total of 423Bcf 2C+2U recoverable resources. The appraisal well hit 55m of net gas pay and average porosities between 25% and 28%, the well was drilled at a 388m water depth. At the time of the discovery Morocco's natural gas market was half as small as it is today (~20Bcf annual consumption at the time, ~45Bcf today) and the discovery was abandoned.
Chariot was awarded the Lixus license in 2019. Upon being awarded the project, the company went on to identify five satellite deposits, Anchois N; W; NW; SW; and WSW, which an independent report estimated included 588Bcf 2U prospective resources in addition to the 423Bcf 2C+2U resources identified previously. On 7 September 2020, Chariot announced a significant resource upgrade at Anchois after 3D seismic data reprocessing, resulting in 361Bcf of 2C resources from the A & B sands previously appraised in 2009, and 690Bcf 2U resources from C, M, and O sands below the A and B sands. Previously only the C sand had been recognized. The Anchois resource increased from 423Bcf 2C+2U to 1,051Bcf 2C+2U -- a 148% increase. Including the prospective satellite deposits the total resources at Anchois increased by 284% to 1,639Bcf.
The appraisal
On 15 December 2021, Chariot commenced drilling at Anchois with the intent of drilling another appraisal well to confirm the findings of the first appraisal well and in order to test the prospective sands below the A and B sands. The drilling program also included re-entry to the previous well in order to assess the integrity of the well, test the productivity of the A sand and to provide a future production well for the development of the field. The new appraisal well, Anchois-2, would also become a future production well.
If the results of the Anchois-2 well were favorable, a significant part of the 690Bcf 2U prospective resources from the C, M and O sands could be converted into 2C contingent resources. On 10 January 2022 the company announced the success of the Anchois-2 appraisal well. The discovery was circulated on sites like Maritime Executive and Rigzone, which I how I came to find out about the company. Let's see what the Anchois-2 appraisal well ended up looking like compared to the pre-drill plan above.
The Anchois-2 appraisal well succeeded in the following via preliminary interpretation:
- Intersected 7 gas zones: A, B upper, B lower, C, M upper, M lower and O sands, lower B newly identified
- High quality reservoirs were encountered in all gas sands according to the company
- Proved the extension of B sand to the East of Anchois-1 discovery well
- A sand was not targeted (company intended to evaluate it in the Anchois-1 reentry), however it was encountered and a gas sample was taken at Anchois-2 instead to maintain efficiency
- C, M and O sands were all encountered and materially exceeded pre-drill expectations and no water-bearing reservoirs were encountered
- Hit over 100m of net gas pay -- compare to Anchois-1 well which discovered 361Bcf 2C resources
- Twelve gas samples and over 60 pressure tests taken
- Well now remains suspended for reentry for future production along with Anchois-1
- Further comprehensive analysis ongoing, resource update and detailed data as near term catalysts
Looking at the success demonstrated at Anchois-2, the upside is clear. The appraisal well exceeded the company's expectations and new reservoir sands were encountered. The previous 2U prospective resources that were targeted included the C, M and O sands which totaled 543Bcf in prospective resources when the O sand footwall prospect is ignored. The results show a new reservoir, Lower B sand, which when combined with Upper B included 50m of net gas pay. There is also Upper M which was not originally modeled in the pre-drill plan. The C and Lower M sand seem to have been encountered as planned, while the O sand seems to have been mostly faulted off although the reservoir was encountered. I'm going to speculate that the encountered Lower B, C, Upper M, Lower M and O sand will increase the 2C resources by at least 300Bcf, bringing the 2C resources from 361Bcf to 661Bcf, a 83% increase. Furthermore I expect significant derisking for adjacent prospects offset by faults, satellite prospects and prospects in the newly granted Rissana license. At current European natural gas prices 661Bcf 2C resources would be about $25.6B gross value, and this is excluding the highly prospective resources around Chariot's blocks.
In addition to a third party 2C+2U resource update I'm expecting the company to come out with similarly stellar results as Anchois-1 with regards to porosity and gas quality, and I'm very interested to see how high the gas flow rates are. The company has indicated the potential to produce at an initial rate of 50-70MMscf/d from two or three wells using a conventional subsea manifold operation pictured below. It will take two years from final investment decision to first gas, I expect production to begin in 2024 or 2025. I believe the company will get a debt financing after comprehensive analysis of the drilling program is completed. Chariot has already received two non-binding expressions of interest to finance the development of Anchois from two financing organizations.
The gas market opportunity and fiscal regime
Chariot has the luxury of being in the right place in the right time, developing a high quality late stage natgas asset not only in a country that imports 90% of its energy but also being close to infrastructure that allows for market optionality to sell gas to Europe which is arguably one of the most lucrative markets for natural gas right now and for the foreseeable future. I'm sure I don't have to explain Europe's energy security issues, or that the current price of Dutch TTF benchmark price is nearing $40/mmBtu. A long term price of $20/mmBtu for European natgas is very feasible at least for the next five years in my opinion.
As for the Moroccan natural gas market, it is also very profitable to say the least. Long term prices for natgas in Morocco range from $8 to $11/mmBtu. However, recent geopolitical developments have not only affected Europe. Morocco has for years relied on the Gazoduc Maghreb-Europe pipeline flows for its natural gas needs. In November 2021 Algeria stopped pipeline flows to Spain through Morocco via the MEG pipeline, choosing not to renew a gas supply contract and opting to send the natural gas to Spain via another pipeline and as LNG. Algeria essentially cut ties with Morocco due to long-standing political disputes over the sovereignty of Western Sahara which Morocco claims as its own territory. This is a massive hit for Morocco as the country used to buy and take gas royalties of about 1bcm (35Bcf) a year from the pipeline which used to cover the vast majority of Morocco's gas needs. In February this year Morocco made a deal with Spain for natural gas imports: Morocco now has to buy LNG from the Middle East, get it sent to Spain where it can be regasified (as Morocco has no LNG facilities), and piped south to Morocco via the MEG pipeline as reversed flows. This is a heavy price burden for Morocco and there is great political will and a mouthwatering market for a project like Anchois. I believe the long term gas prices may well be above $10/mmBtu in Morocco for the foreseeable future.
Moroccan natural gas demand is increasing. Demand has more than doubled since 2010 according to worldometers.info and the country produced 3.1Bcf while consuming 44Bcf of natgas in 2018 according to the EIA. Last year the country revealed a national roadmap for developing its natural gas market, with the intention of supporting the development of natural gas for industrial and domestic needs as well as electricity production. Morocco wants to offset and eventually replace coal-powered energy production with natural gas. Coal, according to the EIA, supplied Morocco with about half of its energy needs in 2017. Morocco's demand for natural gas is expected to exceed 3Bcm in 2040, which is almost three times as much as current demand. There is great political will to get Anchois into production.
The fiscal terms offered by Morocco are extremely attractive. Morocco offers the first ten years of production absolutely tax free, and only takes a low 3.5% royalty for profits. The royalties as well as rental, training, exploration, production and other expenditures are all tax deductible. After the ten year tax holiday the corporate tax is 31%. As a reminder 25% of Anchois is owned by Morocco. These fiscal terms are excellent and will incentivize aggressive production. The low royalty and ten year tax holiday combined with the high natural gas prices mean that production from Anchois will be extremely profitable.
Simple maths
Now let's get to the maths. I'm going to make a base case assumption using what I believe are conservative prices in order to show the value of the production from Anchois.
Assumptions for the first twelve years after FID and financing:
- $500M initial CAPEX ($375M net to Chariot) debt financed, 8% compound interest
- Two year build, interest compound taken into account: $437.4M debt net to Chariot
- $40M annual debt & interest payments: ~$318M net debt after ten years of production
- 70MMscf/d average annual production (25.55Bcf/year)
- 50MMscf/d sold to Moroccan markets at $10/mmBtu
- 20MMscf/d sold to European markets at $20/mmBtu
- 0% tax
- 3.5% royalty
- $40M annual capital expenditures (exploration, development)
- $20M annual G&A excluding interest
(50,000*$10*365*0.965)+(20,000*$20*365*0.965)-$20M-$40M-$40M
= $217,002,500
$217M * 0.75 = $162.75M
I believe Anchois could, using these assumptions, net about $162.75M annually for Chariot on average during the first ten years of production. The annual production may be higher or lower than 70MMscf/d, initial CAPEX or interest rate may be higher or lower (company estimates $300-500M initial CAPEX so I went with $500M due to high inflation), and the annual expenditures may also be higher or lower than my assumptions. However the project remains robust even when using more bearish numbers. One more bearish scenario with worse assumptions still managed to end up with $61M annual net to Chariot:
60,000*$10*365*0.965-$30M-$50M-$50M = $81,335,000
$81M * 0.75 = $61M
If we totally ignore everything else and just slap at 10x valuation on top of the annual net cashflow the "bull" case would give the company a $1.63B market cap, and the "bear" case would value the company at $610M. The current market cap is about £115M ($150M), implying a +987% increase in the "bull" case and a +307% increase in the "bear" case over the next 2-4 years until full production is reached. And this is just the cashflow, without any value attributed to the asset's derisked multi-Tcf prospectivity, without value attributed to an increase in production after cashflow, without value attributed to Chariot's other hydrocarbon assets in Namibia and Brazil which the company has written off from their balance sheet, and without value attributed to Chariot's "Transitional energy" business where the company has a 500MW pipeline of energy projects around Africa in partnership with Total Eren and Chariot's exclusive rights to develop a 10GW green hydrogen energy project in Mauritania.
I think it's reasonable to assign such high price targets given the quality of the Anchois gas project, the world class fiscal terms and the natural gas markets available to the project -- especially considering that I'm not assigning any value to the company's exploration prospects, potential for increased rate of production, or other assets and ventures.
Prospectivity
To keep it as short as I can, there is over 2.8Tcf of 2U prospective resources at Anchois Satellite deposits and other prospects within the Lixus license closer to shore. The Anchois Satellites should become much more derisked after a comprehensive analysis of the Anchois-2 appraisal well is complete, and they should also be relatively easy to tie into any potential future expansion at Anchois. Chariot's independent best estimate is that there could be almost 4Tcf of gas within the company's blocks. The company already has a large area covered by 2D and 3D seismic at Lixus and Rissana, and the company has already features conceptual production tie-ins in its presentations. The company notes that onshore the success rate is very high for what the company thinks are the same rocks, while the company's probability for geologic success in the offshore blocks is presented to be relatively low. I believe the chances of success for the different prospects will be updated to be higher after all the results from Anchois-2 are out.
Share price and catalysts
Since the gas discovery on 15 December, the share price has performed well. The shares were trading below 8p/share pre-discovery, increased in price after discovery and consolidated back to 8p before moving to make new multi-year highs. Technically speaking, although I am no chartist, I would say this looks like a cup & handle formation and that is typically a very bullish sign that a rerate is on the way. Next major catalysts are final results from the Anchois-2 well and Anchois-1 reentry; resource upgrade; project financing and build start; Chariot's "transitional energy" business ventures in green energy projects around Africa; potentially monetizing the Namibia/Brazil oil assets; and finally production beginning in 2024 or 2025.
