Last month Echo Energy (LSE: ECHO), the South and Central American oil and gas company, revealed its plans to fund a potentially transformational group of acquisitions in Argentina. As part of its farm-in agreement with a local firm, Company General de Combustibles (CGC), Echo will take a 50pc stake in three concessions and one exploration licence in Argentina’s Austral basin. Two of the projects are already producing oil (1/3) and gas (2/3) and all three offer significant potential upside through additional exploration drilling. 2018 holds a great deal of promise for this company.
The much-anticipated farm-in fails to excite (initially)
For much of 2017 there was a lot of excitement among Echo’s shareholders as to what sort of deal the company would secure to complete its turnaround story. The company’s management team has a strong pedigree and proven track record of success, so expectations were high.
In November Echo announced a conditional farm-in agreement with CGC, a privately owned affiliate of an Argentinian conglomerate. The transaction would see Echo take a 50pc interest with CGC in the Fracción C, Fracción D and Laguna De Los Capones concessions, alongside a 50pc interest in the Tapi Aike exploration permit. The sites cover a total of 11,153km2 across the Austral basin in onshore Argentina and represent the first step in Echo’s South and Central American regional exploration and production strategy, announced in April.
The size of the deal meant that Echo’s shares immediately went into suspension under reverse takeover rules, but by mid-December trading resumed when the company confirmed details of its acquisition and also a placing to raise a net £4.7million at 17.5p per share.
Unfortunately for Echo and the placing participants the immediate market response to this deal hasn’t been positive and the company’s stock now trades at 14.5p, last seen. However, has this created an opening for retail investors?
Echo’s CEO, Fiona Macaulay, is naturally bullish about the scale of the opportunity Echo is pursuing. Speaking to ValueTheMarkets.com, she said:
‘We have a definite first mover advantage in Argentina. There are very few places in the world that equity investors can invest in our sector in this country. We have an excellent local partner and a fantastic team on the ground. With the financing now in place our goal is to seize the initiative here to deliver outstanding shareholder returns.’
The numbers underpinning the new assets seem to back up her words.
Fracción C and Fracción D already have existing gross gas production of approximate 11.2 million standard cubic feet per day (mmscfe/d). Since Echo is entitled to a 50pc share of this production, the acquisition will immediately begin generating income. This is particularly important for the business, as it is not currently engaged in any production.
What’s more, Echo believes there is potential to increase significantly current gross production across these two concessions to over 80 mmscfe/d over a five year period if strong local Argentinian gas prices continue.
Echo and CGC have agreed an 18-month work programme for the concessions, which includes reprocessing Laguna De Los Capones, drilling and testing four exploration wells on Fracción C, and a workover of three wells on Fracción D.
Following this, Echo hopes to begin a second term on the concessions. Here, it plans to expand total seismic acquisition across the concessions to 2000km2 and drill a further eight exploration wells.
Tapi Aike, meanwhile, is an exploration permit, which covers an area of 5,187km2 in the foothills of the Andes Mountains. A Competent Person’s Report has identified 41 leads over three independent plays at the site, with prospective resources of 50-600 billion cubic feet of gas at the best estimate level. The largest two are assessed as potentially containing 3.8 trillion cubic feet and 2.6 trillion cubic feet of gas in place. Three others are expected to potentially contain more than 1 trillion cubic feet of gas.
A total of 14 wells have been drilled in Tapi Aike oner the last 45 years, and – although no commercial discovery has yet been made – Echo believes there have been encouraging signs of the presence of gas. An initial two-year work programme at Tapi Aike has been agreed, comprising a 2D seismic re-procession, 3D seismic acquisition planning and the initiation of 3D seismic acquisition.
If the concession sites and Tapi Aike are as lucrative as hoped, Echo’s shares could trade at a multiple of their current level, but such ambitious plans do not come cheap.
Paying for the work programme
Further to paying $2.5million in November, upon signing the initial farm-out agreement, Echo will have to meet 100pc of the costs of the initial 18 month work programme for the concessions. It will also have to pay a deferred cash payment of $2.5million on completion of this effort. When the costs of developing Tapi Aike are added to this, alongside other fees associated with the acquisition, all in all this is expected to cost the company £26.9million.
Thankfully, Echo has the funds in place to meet these obligations. At the end of October the company had a cash balance of $30million, which it bolstered with the £4.7million from December’s placement. This means shareholders can reasonably expect no further dilution for the best part of 2018, while still being exposed to significant equity upside. Any one of Echo’s drills could prove to be a catalyst for a major rerate in the company’s valuation, which could well put the company’s shares in a sweet spot right now.
This impression is strengthened, when taking into account Macaulay’s incentive package. She has 24million options exercisable at 16.1p, ensuring her interests are heavily aligned with shareholders and those 17.5p placement participants. Of course success cannot be guaranteed, but it is encouraging when a management team has a realizable and lucrative personal target to hit, especially when the market trades at a discount to the exercise price.
Notwithstanding this, Macaulay’s confidence in the business is clear and she believes the market will soon see the true value of early entry into the Argentinian market:
‘We have a really exciting year ahead of us, with lots of anticipated news flow. We will be conducting near field exploration drilling at 4 to 5 locations, any of which could prove to be a catalyst for a significant rerate in our company’s valuation. Our cash balance was already strong and we further bolstered that a month ago, meaning we are full funded for our planned work programme,’ she says
A recent research note from Progressive Equity Research supports her view. Progressive believes that Echo’s acquisition is ‘exciting’ and could ‘have a significant impact on valuation’. It writes that Echo’s entry into the Argentinian market offers significant exploration upside in an overlooked area and points out drilling successes could create further opportunities for the company, in particular in funding future development beyond the initial work programme.
Although the operating environment is not without risk, Progressive notes possible instability in Argentina and macro commodity pricing risk, the broker remains broadly optimistic.
‘The main opportunity for the company is in the exploration upside that is available in the licences that it is farming into. Success with the drill-bit should allow a significant increase in the group’s reserve base and hence potential valuation,’ it said.
‘Investors should be aware that exploration is a high-risk activity. However, this portfolio provides a blend of lower risk from Fracción C & D to higher risk in the Tapi Aike licence. The company has established a significant portfolio of acreage in a prolific oil and gas basin. Having established this initial position in the country, it provides a springboard for adding to this asset base.’
Poised to break into a sprint?
After something of a false start to 2018, Echo appears ready to come charging out of the blocks, hopefully ending the year in a sprint finish. The company has secured a deal, which provides it with both existing production and a lot of scope for exploration upside. This attractive combination promises to deliver plenty of news flow going forward, which is crucial to success on AIM.
Echo is truly throwing everything it has at this deal, firm in the belief that Argentina is currently one of the hottest destinations in the global gas market. The company is targeting a number of potentially exceptional prospects and is funded to deliver its ambitious plan. Whether this results in fundamental returns remains to be seen, but it seems a fair bet at this point that speculation of future success should drive the share price higher from its current. At 14.5p perhaps the market is being overly generous?