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GTE - Gran Tierra Energy Inc


mttddd
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Havent seen a thread on this. GTE is an oil company based in Calgary that focuses on oil in South America. Market cap of ~800 with 400 million cash and more importantly no debt. That said there is no dividend.

 

For a couple years the company was making a bunch of high risk plays in Peru/Brazil and wasnt having much luck. An activist hedge fund (West Face Capital) just came in and replaced the CEO with their choice and are still shaking things up. They are stopping the Peru/Brazil plays and are focusing on Columbia. The new CEO has experience with Columbia and is looking at picking up some assets from the government run oil company.

 

There is obviously a good bit of risk here between oil prices and that Columbia isnt exactly a low risk country but the recent activist shakeup and strong balance sheet I believe make for an attractive opportunity.

 

Thoughts?

 

Disclaimer i am long

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Similar with any other business in the South American region, there are [potentially large] currency risks here. A 300% gain in equity can be erased by a 75% drop in currency. If the govn't ever relaxed FX restrictions then the peso could collapse. Not for me but cool idea.

 

http://www.forbes.com/sites/janetnovack/2014/01/15/travel-alert-dollars-fetch-a-premium-in-black-markets-of-argentina-venezuela/

 

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I think this is one of the more interesting ideas in the oil and gas space. Many junior o&g companies have rallied this year with the rebound in oil especially the ones with a strong balance sheet. GTE has lagged because of their disappointing results in Peru. They were far to aggressive guiding the market to a potential "elephant" discovery. The previous management team's unsuccessful exploration in Peru and Brazil has really tainted the stock but I think investors are overlooking the quality of their Columbian assets and their ability to generate free cash. 

 

In the last 4 years they have successfully grown Columbian production and generated FCF of over $550mm. Unfortunately that money was spent on exploration that was unsuccessful. If the new management team can control the decline at Costayaco, and grow Moqueta they will continue to generate cash that can be used to continue to grow in Columbia. EcoPetrol is the national oil company and they have finally realized that they need help developing the nation's reserves. Farm out packages have just been put to market and represent a new opportunity for GTE to deploy cash and develop a new asset for the business. They are in a great spot with net cash on the balance sheet, a new management team, a CEO that has personally invested in 2mm shares, a core asset that should generate FCF and trading at one of the lowest valuations in the Canadian market.

 

Scwab711- I am not sure I understand the fx risk. GTE revenue is generated by selling oil that is priced in USD. They dont hold pesos. Am I missing somethign?

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Scwab711- I am not sure I understand the fx risk. GTE revenue is generated by selling oil that is priced in USD. They dont hold pesos. Am I missing somethign?

 

First, I have not looked at this at all. Just going by your description. If they operate out of Columbia (and previously, Peru/Brazil), why would you think they do not hold Pesos? Just because financial statements are in USD does not imply all assets/liabilities are denominated in USD. Since they do operate in Columbia they obviously need to pay workers in the local currency (not only is this standard but it's also the law in Columbia; you should really do some research on the FX issues with USD/Peso in Columbia).

 

Risks taken directly from 2014 AR:

Our Business is Subject to Local Legal, Political and Economic Factors Which Are Beyond Our Control, Which Could Impair Our Ability to Expand Our Operations or Operate Profitably.

 

We operate our business in Colombia, Peru, and Brazil, and may eventually expand to other countries. Exploration and production operations in foreign countries are subject to legal, political and economic uncertainties, including terrorism, military repression, social unrest, strikes by local or national labor groups, interference with private contract rights (such as nationalization), extreme fluctuations in currency exchange rates, high rates of inflation, exchange controls, changes in tax rates, changes in laws or policies affecting environmental issues (including land use and water use), workplace safety, foreign investment, foreign trade, investment or taxation, as well as restrictions imposed on the oil and natural gas industry, such as restrictions on production, price controls and export controls. Our production in Brazil was shut in for three weeks in October 2013 as a result of a strike by employees of Petrobras which affected the crude oil receiving terminal we use in the Recôncavo Basin, and we have experienced minor delays in trucking operations due to demonstrations and strikes in our operating area during the year ended December 31, 2014 . We do not know how long any such labor action will last, and if it lasts a significant amount of time, it may affect our ability to meet our production targets.

 

South America has a history of political and economic instability. This instability could result in new governments or the adoption of new policies, laws or regulations that might assume a substantially more hostile attitude toward foreign investment, including the imposition of additional taxes. In an extreme case, such a change could result in termination of contract rights and expropriation of foreign-owned assets. Any changes in oil and gas or investment regulations and policies or a shift in political attitudes in Colombia, Peru or Brazil or other countries in which we intend to operate are beyond our control and may significantly hamper our ability to expand our operations or operate our business at a profit.

 

Changes in laws in the jurisdiction in which we operate or expand into with the effect of favoring local enterprises, and changes in political views regarding the exploitation of natural resources and economic pressures, may make it more difficult for us to negotiate agreements on favorable terms, obtain required licenses, comply with regulations or effectively adapt to adverse economic changes, such as increased taxes, higher costs, inflationary pressure and currency fluctuations. In certain jurisdictions the commitment of local business people, government officials and agencies and the judicial system to abide by legal requirements and negotiated agreements may be more uncertain, creating particular concerns with respect to licenses and agreements for business. These licenses and agreements may be susceptible to revision or cancellation and legal redress may be uncertain or delayed.

 

Recently, in the Department of Putumayo in Colombia where we operate, despite a company’s compliance with legislative requirements for prior consultation of communities and minority ethnic groups and the receipt of the necessary permits to drill and operate, new ethnic groups have been threatening, and in some cases using, the Judicial Branch of the Government, Superior Court of the Judicial District of Mocoa (the “Local Court”) to require that they be consulted, and thereby obtain benefits from companies operating in the Department of Putumayo as a result of those consultations. The Local Court has the ultimate jurisdiction to determine, upon a writ for protection or tutela, by an ethnic group (i) whether there has been a violation of a fundamental right to prior consultation by act or omission of a public authority or individual and (ii) whether the ethnic

 

 

group is legitimate. If the Local Court determines that there has been a violation and the ethnic group is legitimate despite receipt by the company of its proper governmental permits, the Local Court has the power to invalidate a company’s permits and force the company to cease operations immediately until such time as the company can successfully appeal to the Supreme Court to overturn the Local Court’s decision or prior consultations are completed and the permits effective once again.

Property right transfers, joint ventures, licenses, license applications or other legal arrangements pursuant to which we operate may be adversely affected by the actions of government and judicial authorities and the effectiveness of and enforcement of our rights under such arrangements in these jurisdictions may be impaired and, if we are faced with a tutela, our operations in the area(s) governed by a Local Court’s order may be shut down for a period of time thereby causing significant harm to our business in Colombia.

 

Recently in Brazil, environmental regulations related to fracture stimulation drilling have been under review by national agencies. In December 2014, the ANP issued an injunction specifically related to properties in the Recôncavo Basin covered by Bid Round 12. This injunction placed a moratorium on unconventional activities on the Bid Round 12 blocks, all of which were unconventional exploration targets, until such a time as policies governing unconventional activities are finalized. Blocks REC-T-129, REC-T-142, REC-T-155 and REC-T-224 were granted in Bid Round 9, for which there has not been a similar injunction; however, we expect that the ANP’s injunction may limit our ability to receive permits in the short-term for our blocks with unconventional exploration targets. We acquired Blocks REC-T-86, REC-T-117 and REC-T-118 in Bid Round 11 and these blocks may be affected by the same or a similar injunction as the one placed on blocks acquired in Bid Round 12. Until this situation is resolved, the expansion of our drilling operations in Brazil may be limited which would harm our business in Brazil.

 

Almost All of Our Cash and Cash Equivalents is Held Outside of Canada and the United States, and if We Determine to, or Are Required to, Repatriate These Funds, We Could Be Subject to Significant Taxes.

 

At December 31, 2014 , 87% of our cash and cash equivalents was held by subsidiaries and partnerships outside of Canada and the United States. This cash is generally not available to fund domestic or head office operations unless funds are repatriated. At this time, we do not intend to repatriate funds, but if we did, we might have to accrue and pay taxes in certain jurisdictions on the distribution of accumulated earnings.

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To clarify why I am so concerned with FX risks in this specific case. In both Venezuela and Columbia there is significant USD FX activity that is conducted illegally. USD trades at ~40% - 75% higher illegally then at the "official" FX rates. This means that if Columbia ever lost control of their "official" FX rate then the currency would depreciate considerably and likely take all capital gains with it. Right now Columbian citizens are assuming the currency is worth ~40% less then current FX rate (so you should multiply your GTE IV by 60% or less to be conservative).

 

I don't think this should be an issue but there is also a history of nationalizing foreign-held assets of national importance (oil or sugar [or cocaine; but these companies are rarely publicly traded :)]). You should look up some cases of nationalizing foreign assets. They generally compensate the owners but at extremely low rates without opportunity for arbitration or appeal and certainly without prior notice. Finally, I don't think Columbia has the issue currently and GTE is Canadian, but there is also a history of ownership disputes where US companies in China/Venezuela/ect has lost ownership of their assets even though they have a documented history of title because they are US entities (person or company).

 

You should really treat any stock purchase the same as if you were to personally run the company. This includes understanding the local laws. In the case of Columbia, you really can't ignore this step as there are significant risks.

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I would hold to a contrary view regarding the FX risk.  Weakening of the local currency is usually beneficial for oil companies who hold their cash in dollars.  Gran Tierra noted they benefit from a declining currency as it makes their deferred taxes shrink on a dollar basis.  If the whole balance sheet was held in a foreign currency, and it is not, then changes hurt the assets as well as the liabilities.

 

I would agree with the rest of what Schwab posted.  You do have expropriation/nationalization risk, and it is important to understand local laws, but I would not fear a decline in the local currency. 

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I would hold to a contrary view regarding the FX risk.  Weakening of the local currency is usually beneficial for oil companies who hold their cash in dollars.  Gran Tierra noted they benefit from a declining currency as it makes their deferred taxes shrink on a dollar basis.  If the whole balance sheet was held in a foreign currency, and it is not, then changes hurt the assets as well as the liabilities.

 

I would agree with the rest of what Schwab posted.  You do have expropriation/nationalization risk, and it is important to understand local laws, but I would not fear a decline in the local currency.

 

Don't they have to convert the local currency back to USD/CAN? Assuming they start in USD then the weakening currency is beneficial but most of their cash (and presumably assets) is already held in local currency right? So any further weakening is a direct hit to IV (as priced in USD)?

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I would hold to a contrary view regarding the FX risk.  Weakening of the local currency is usually beneficial for oil companies who hold their cash in dollars.  Gran Tierra noted they benefit from a declining currency as it makes their deferred taxes shrink on a dollar basis.  If the whole balance sheet was held in a foreign currency, and it is not, then changes hurt the assets as well as the liabilities.

 

I would agree with the rest of what Schwab posted.  You do have expropriation/nationalization risk, and it is important to understand local laws, but I would not fear a decline in the local currency.

 

Don't they have to convert the local currency back to USD/CAN? Assuming they start in USD then the weakening currency is beneficial but most of their cash (and presumably assets) is already held in local currency right? So any further weakening is a direct hit to IV (as priced in USD)?

 

It says cash is held at HSBC, and I presume it is in dollars.  I presume that because I did not see any notation saying cash is held in any other currency and converted at period end.  When that is the case there is usually a conversion table provided to help see the impact tot he balance sheet. 

 

My base assumption would be for international sales is that sales are in dollars and costs in local currency.  For local sales both are local currency.  Any decent CFO would keep currency in USD whenever possible.  If I were an investor I would certainly ask to make sure especially with a small cap company.

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Guys should look into the failed case study of Houston American Energy Corporation (HUSA).

 

Brief overview:

  • Company ran a lean overhead structure
  • Owned wells in Texas which were sold for blocks in Columbia
  • These blocks struck pay dirt and were sold to buy into a larger block
  • This larger block was next to a giant 1 billion+ BOE oil discovery
  • A bunch of dry holes were drilled and company is basically BK

 

Company was debt free with tons of cash and it was all for not.  These guys were experts that had a successful track record and they blew it up.

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Guys should look into the failed case study of Houston American Energy Corporation (HUSA).

 

Brief overview:

  • Company ran a lean overhead structure
  • Owned wells in Texas which were sold for blocks in Columbia
  • These blocks struck pay dirt and were sold to buy into a larger block
  • This larger block was next to a giant 1 billion+ BOE oil discovery
  • A bunch of dry holes were drilled and company is basically BK

 

Company was debt free with tons of cash and it was all for not.  These guys were experts that had a successful track record and they blew it up.

 

I see the similarities although I think that just provides a good illustration of the risks when investing. Good management, good balance sheet, good valuation etc are all great but things can still go wrong. Although selling the proven wells to finance additional drilling seems a bit like gambling and I would like to think would lead me to sell my position, although hindsight is 20/20 so who knows! Something to keep in mind for sure but I personally am ok with the risk/return of this investment.

 

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They only convert USD to peso to pay their operating expenses. All capex is in USD and funds are held in USD. If the peso devalues it actually would reduce opex.

 

Source?

 

I would hold to a contrary view regarding the FX risk.  Weakening of the local currency is usually beneficial for oil companies who hold their cash in dollars.  Gran Tierra noted they benefit from a declining currency as it makes their deferred taxes shrink on a dollar basis.  If the whole balance sheet was held in a foreign currency, and it is not, then changes hurt the assets as well as the liabilities.

 

I would agree with the rest of what Schwab posted.  You do have expropriation/nationalization risk, and it is important to understand local laws, but I would not fear a decline in the local currency.

 

Don't they have to convert the local currency back to USD/CAN? Assuming they start in USD then the weakening currency is beneficial but most of their cash (and presumably assets) is already held in local currency right? So any further weakening is a direct hit to IV (as priced in USD)?

 

It says cash is held at HSBC, and I presume it is in dollars.  I presume that because I did not see any notation saying cash is held in any other currency and converted at period end.  When that is the case there is usually a conversion table provided to help see the impact tot he balance sheet. 

 

My base assumption would be for international sales is that sales are in dollars and costs in local currency.  For local sales both are local currency.  Any decent CFO would keep currency in USD whenever possible.  If I were an investor I would certainly ask to make sure especially with a small cap company.

 

Thanks, I appreciate the response, I didn't know what the default assumptions were. Would your response change in anyway if the company were American instead of Canadian?

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I spoke to the CFO.

 

Awesome, thanks.

 

This is one of the few ways to play USD/Peso (Colombian) then, at least that I know of. This could become an overnight double if they ever run out of resources to keep the dollar peg.

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I spoke to the CFO.

 

Awesome, thanks.

 

This is one of the few ways to play USD/Peso (Colombian) then, at least that I know of. This could become an overnight double if they ever run out of resources to keep the dollar peg.

 

Assuming the gov't of columbia doesn't raise taxes on foreign oil companies in some way, which seems at least possible in a scenario where they are out of foreign currency reserves.

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