Trinidad-focused oil and gas producer Touchstone Exploration (LON: TXP) has cash generating assets on the island, but it is the exploration activity that provides the upside for the share price.
The exploration is not the greenfield kind. The wells are near to previous wells drilled by Shell in the 1950s which showed signs of hydrocarbons.
The existing wells will help to finance some of the exploration spending and Touchstone has cash in the bank.
Trinidad has a history of oil and gas production and many oil majors are involved onshore and offshore, as well as other independents.
Drilling has commenced on Coho-1 in the Ortoire exploration area. It is near to the historic Corosan-1 well and the target is gas. This is the first of at least four planned wells.
Touchstone has a 80% working interest in Ortoire and it will fund the full cost on behalf of Heritage Petroleum, which owns the other 20%. The first well will probably cost $3.3m and the second around $3m.
Shore believes that the prospects could add 60p a share to the company valuation, but it is still early days.
The results of the first well could be available in September. Once drilling is completed the drilling rig will be moved to the second drill site.
It is not purely about oil and gas. Touchstone is also bidding on a solar project with a partner. This would involve using spare land related to oil and gas operations to site 30MW of solar capacity.
There are options to fund this without hampering investment in the core oil and gas operations.
In the six months to June 2019, average daily oil production increased from 1,631 barrels to 1,944 barrels. The realised sale price was 3% lower at $58.91/barrel, but lower royalties and operating expenses meant that there was a small increase in underlying income per barrel to $28.20.
Group revenues improved by 16% to $20.7m, although most of the improvement was in the first quarter. Cash generation from operating activities was one-quarter ahead at $4.57m – helped by a working capital boost. This was achieved without drilling any production wells in the period.
In February, Touchstone raised $5m (£3.8m) at 12p a share and at the end of June 2019 it had cash of $7.25m, although net debt was $10m. No debt principal payments are required until the beginning of 2021.
The cash figure barely changed during the most recent quarter, but there will be much higher exploration spending in the second half. Net debt is expected to rise to $11.5m at the end of 2019 and then increase further to $16.2m the following year. That would need additional funding, possibly via another share issue. Successful exploration would make that easier and provide less dilution.
That reflects the heavy exploration and development spending over the next 18 months. Cash generation should cover more than 50% of that spending.
There are plans to change the current tax regime in Trinidad so that oil and gas exploration and investment is encouraged. This would make it easier to fund exploration, but there is no certainty about the timing of any changes.
Shore Capital has reduced its estimate of average daily oil production in 2019 from 2,220 barrels to 1,875 barrels because of the lack of development expenditure so far this year. The broker expects the figure to rise to 2,300 barrels next year after further development expenditure.
There is likely to be a working capital outflow in the second half, so there will not be any more cash generated. Next year, though, operating cash flow is forecast at $7.62m. Further falls in the oil price could hamper this cash generation.
Shore believes that the existing assets have a core value of 26p a share, with upside for Ortoire. That is based on $7 for each barrel in the ground.
At 14.25p a share, Touchstone is valued at £24.3m. That is not dear given the potential cash generation next year and there is also the potential from the exploration on top of that.