Arrow Exploration: Possible 100% Return As Horizontal Drilling Transforms Production

Quick Business Overview

Arrow Exploration is mainly UK listed/traded but also Canada and US listed whilst top management are located in Canada and the bulk of production comes from Colombia. Management have a successful history of building up small oil companies and exiting these in sales to strategic acquirers after several years at high returns for shareholders, and are clear they would like to do this again with Arrow. Current management became fully active in April 2020 and undertook a successful restructuring/turnaround that saved the company, in October 2021 they listed on Aim in UK and raised U$9m of new capital at 5p whilst offering warrants alongside at 9p. At this time production was around 590 BOPD and the new capital was to be channelled into production growth from drilling oil wells mainly in Colombia. This has proven successful over the 2-year period as current production has increased significantly to 2800-3000 BOPD and the balance sheet still has net cash around U$11m. Management aim to take production through 10,000 BOPD in the future, maybe two more years. Management update their presentations regularly on the website, and it contains lots of background information, they also give regular presentations to watch, first example and this more recently.

Assets

Their main asset is 50% share and full operatorship in the Tapir Block situated within the Llanos Basin in Colombia, here their net production sits at circa 2300 BOPD from six current wells located on the Rio Crave Este (“RCE”) field and three current wells on the Carrizales Norte (“CN”) field, both these fields have active ongoing drilling programs to expand production. They recently published an updated reserve report for CN stating 3.92 MMbbls 2P with a NPV10 value of U$143.5m pretax. Arrow year-end 2022 reserve report showed 7.69 MMbbls with a NPV10 value of U$127.3m pretax to give some context. Worth noting, these are all based on vertical wells and the shift to horizontal wells is not included in any reserve reports. For 2023 they have an U$32m capex drilling budget to deliver 10 wells across RCE, CN and a smaller asset called Oso Pardu field. Likely 2024 capex program will be of a similar magnitude (note the market cap is only U$60m, equivalent to around the two years total capex)

Rio Crave Este field

Source Arrow Exploration presentation

This shows existing wells and planned drilling with RCE-6, RCE-7 and RCE-8 all likely drilled by year end 2023 which should expand net production by circa 1000 BOPD or more.

Carrizales Norte Field

The first discovery/production well was only drilled in May 2023, this was a very high chance of success as they had excellent seismic, other nearby well data and offsetting producing fields. It tested 2 successful zones, Carbonera C7 and Ubaque and is currently producing from the Ubaque, the second and third wells extended the field size and also are on production whilst providing the information to the recent reserves report mentioned above. Most interestingly management now think the field is very suitable for horizontal drilling in the future. Roughly speaking a horizontal well should cost around 1.5X a vertical well but produce at 3X initial rate. For CNE management guide a vertical well at 360 BOPD net their 50% (i.e. 720 gross at start) so hence a horizontal should be net 3X360=1080 BOPD.

Source Arrow Exploration presentation

This shows six possible horizontals that management hope to start drilling in January 2024, and they are already improving the pad and infrastructure in anticipation of starting the six back to back horizontals, 600m length each. Guidance is a 2% decline rate per month. We have built the following simplistic spreadsheet assuming each well comes on successfully as discussed.

Click to enlarge

Whilst drilling starts in January this is a 12-month model for first year, hence month 1 might realistically be late February or early March 2024 if drilling starts Jan 1. However, it is a clear attempt to illustrate how a successful six well horizontal drilling campaign in 1H2024 could transform Arrow production numbers. At a U$50 netback this would generate over U$80m for Arrow over the first 12 months. That compares to a net capex for the 6 wells that might cost circa U$30m, showing a very fast payback on their capex.

For context the three analysts following Arrow for 2024 have average production through the year of the following: Auctus 5029 BOPD, Zeus 3840 BOPD and Canaccord 2894 BOPD. Clearly there is currently no assumptions built in for a successful horizontal drilling campaign in 2024, however it could go a long way towards moving Arrow towards management targets of 10,000 BOPD.

Other points to note

Arrow have some producing gas assets in Canada which are clearly worth something. The Oso Pardo licence area has current small production, 2 wells due in the coming months and hopefully at some point in 2024 they will be granted a much larger area extension that management hope to then drill up creating excellent economic value. Future exploration and finding of new fields, management have completed recent 3D over several large areas across the Tapir block and have several prospects worth exploration drilling, more information and firm plans expected in the future. There is also potential exploration success next to the Carrizales field, management have commented on. Worth noting that all the warrants are in the process of expiring, mainly end of October and small amount in November, these are well in the money at 9p, so it’s likely some holders have been selling shares to pay for warrants. This trend/dilution is coming to an end and hopefully with positive near-term drilling newsflow the shares can make positive progress.

Conclusion

Arrow Exploration management would like to be a 10,000 BOPD producer. It appears as though analyst forecasts are well behind management’s ambitions and if they can execute on an early 2024 horizontal drilling program at CN, then Arrow will be closing in on its target moving into 2025. This is all self-funded from the balance sheet and internal cashflow.

There is also other potentially positive newsflow around Oso Pardo licence extension, exploration wells not yet recognised in the valuation. The current market cap is U$60m with net cash of U$11m meaning U$50m Enterprise Value, this is less than 2 years planned capex for context and capex pays back in less than 12 months usually. It also compares to my U$80m cash generated number from 6 horizontal wells over the first 12 months at U$50 netback level. Analyst average EBITDA for 2024 is 77.2m on Bloomberg meaning it’s trading at less than 1XEV/EBITDA projected.

Key risks are clearly Colombia political and oil/gas tax changes could take a turn for the worse at any point. There is also drilling failure risk, arguably that increases with horizontal drilling but so far vertical wells have drilled very well with current management and drilling team in place. There can be blockades of production by protesters and other local disruptions, so far Arrow’s area of operations has been largely unaffected although 200 BOPD are currently offline due to protests. Clearly Arrow shares are a high risk investment proposition and any holdings should be with high risk capital only.

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