Canacol Energy Ltd.: Rapid Growth and Strategic Acquisitions in Oil & Gas Exploration

Founded without any producing oil wells, within six months Canacol Energy Ltd. had a discovery. “We started as a private company in February 2008 with no assets,” President and CEO Charle Gamba recalls. “We farmed into an exploration block in Colombia which resulted in a large heavy oil discovery in July 2008 called Capella.” That same year, Canacol Energy Ltd. acquired additional wells.

“We acquired three assets in Colombia from a private Colombian company,” he continues. “We purchased those three assets including two producing fields, which are called Rancho Hermosa and Entrerrios. When we started the company, our focus was to build an exploration and processing company focused primarily on Colombia, which was really a fraction of management’s operating experience. We have a very high level of experience, particularly in Colombia.”

Another acquisition in October 2008 was a reverse takeover of a Canadian public company called BrazAlta Resources. “That gave us 10 blocks in Brazil onshore,” Gamba notes. In 2008, the company also acquired an exploration block in Guyana in which the company drilled a dry hole in the first quarter of 2011.

The company’s initial goal in 2008 that it achieved was to acquire producing assets in Colombia that would provide cash flow and debt financing for additional acquisitions. “From that time on, we’ve picked up a number of other assets,” Gamba points out. Canacol Energy currently has 20 blocks located primarily in Colombia, Brazil and Guyana, of which seven are producing oil fields.

“We are currently netting about 11,700 barrels of light oil daily out of Colombia,” Gamba declares. “That was our average production for the month of May out of Colombia.” The company also has 13 exploration blocks. “We have a very large portfolio of conventional oil prospects we are drilling our way through this year and next,” he continues. “We have exposure to about 1.4 billion barrels of net unrisked oil potential on those exploration blocks. That really is the focus of the company – to drill our way through these exploration projects this year and next.”

Well, Well

Canacol Energy Ltd. has a 10 percent interest in the heavy oil discovery at Capella. “That’s a very large oil field – 220 million barrels of recoverable gross reserves and resources,” Gamba points out. “We made a series of new pool discoveries in the Rancho Hermosa field, which we’ve been very successful at bringing onto full production very quickly to get us to our current net production.”

The company drilled three other exploration wells, all of which were dry holes. “It was producing about 1,800 barrels a day when we bought that field in August 2008,” Gamba remembers. “So we started some appraisal drilling of that field in late 2009 and we discovered two new producing light oil reservoirs in that field. So since that discovery in 2009, we bought the field up.” Currently, the field is producing approximately 25,000 barrels daily of gross production, of which Canacol’s net share is 11,700 barrels daily.

In 2011, Canacol Energy is drilling 44 new wells beginning in July, of which 34 are production wells. In Rancho Hermosa, the company is drilling six wells, and in Capella, it is drilling a total of 28 production wells. The new wells are designed to provide the company’s production target averaging between 10,500 and 11,500 of net oil production.

“That drilling program will help us maintain those levels,” Gamba maintains. The other 10 wells are exploration wells – seven exploration wells are being drilled in Colombia, two in Guyana and one in Brazil. He estimates approximately 750 million barrels of net unrisked oil potential is in those nine wells.

“So obviously, it’s a very big exploration program for us this year,” he emphasizes. The exploration wells are drilled into prospects that are not currently producing. “So there is a lot of uncertainty whether there is any oil there or not,” Gamba stresses. “So exploration wells in general would be categorized as high risk. Whereas with a producing well, you’re drilling into a producing oil field, so the risk is low in terms of not encountering oil.

When a discovery is made, a series of appraisal wells must be drilled to determine the size of the discovery and whether it is suitable for commercial development. If it is, “You go ahead and start a production drilling program to fully explore the reserves associated with the field,” Gamba explains.

Not Gushers

When exploring for oil or natural gas, seismic data is used to generate various maps of the deposit where the fuels might reside and to determine the best location to drill the exploration well. Similar to sonar, in seismic mapping, a vibration is sent out and a series of microphones are laid out on the surface of the area being explored to record the reflection of those vibrations off of different rocky surfaces. Seismic mapping can penetrate much deeper into the earth than sonar.

“Seismic in general is not useful to determine if there is oil or water,” Gamba concedes. “It can see the rocks, but it can’t tell you what’s inside them. You see the space, but you don’t know what’s inside. It could be water – which is the most common – it could be oil or gas, or it could be absolutely nothing there. It could just be solid rock with nothing.”

One of the exploration wells drilled in Rancho Hermosa in 2009 produced 8,000 barrels of oil daily, a very large amount. “Generally, the wells we drill in Colombia, Brazil and Guyana are not what you’d call gushers,” Gamba maintains. “They don’t blow or spray out.”

Good Business Environment

A petroleum geologist, Gamba previously was vice president of exploration for industry giant Occidental Petroleum. He has spent approximately 75 percent of his career in South America working for a number of other companies. “I know the geology of South America quite well,” he asserts. “Colombia is a very attractive country with respect to oil investment. The royalty contracts are very lucrative for companies, and the operating environment is very safe, very stable. There are 150 other oil companies active in Colombia, so the drilling services are very abundant.

“Most importantly of all, Colombia has a very systematic process whereby they have land auctions which are open to the industry,” he continues. “So if you’ve done a bit of work on the geology of an area and you think there’s some potential, you can pick up a piece of land through a public bidding process quite easily. So in 2008 – combined with very good potential for oil in Colombia and the royalty structure – Colombia was a very attractive place to start a small private independent company.”

It was not always that way. “Prior to 2003, the regulatory environment was very strict in Colombia,” Gamba insists. “It favored very large companies. It was controlled by the state oil company, who obviously didn’t want much competition. But in 2003, because Colombia’s oil production was falling quite dramatically from the mid-1990s into 2003, the government decided to attract foreign investment in the oil and gas sector by basically removing the regulatory function of the industry from the state oil company and placing it into a government organization.”

At the same time, Colombia’s regulatory authority also made the terms of investment much more attractive to lure foreign investment. “It’s been extremely successful on the part of Colombia,” Gamba maintains. “Whereas in 2003, only 5 percent of the land was under contract for exploration, we now have a situation where more than 60 percent of the exploration lands are under contract. We’ve had a huge influx of small companies like Canacol. and Colombia’s oil production has also risen.” Canacol is a Canadian-based company, so despite its Canadian-Columbian subsidiary, it is viewed as a foreign investor.

Oil production has nearly doubled from 2003 to the present in Colombia, from approximately 400,000 or 500,000 barrels daily in 2003 to 940,000 barrels daily. “They realized that people weren’t investing in the country because of bad terms,” Gamba points out. “Their oil revenues were declining because of no investment. In 2003, they took those steps which have reversed that trend very successfully.”

Oilfield Services

Although the business climate for oil and natural gas production in Colombia has improved, that still cannot completely overcome the climate itself. South American countries have rainy seasons, and Colombia, Guyana and Brazil are no exceptions.

Although the land on which many of Canacol’s wells in Colombia are located is accessible savannah where cattle graze amid the pump jacks and oil rigs – similar to west Texas – Colombia’s rainy season is different. Its beginning and end depend on the location, but Gamba says it mostly is from May to October.

“You have to plan your activities to make sure everything – all your construction – goes in during the dry season,” Gamba notes. “We build all of our drilling pads and roads in the dry season with berms and elevating. So that when it does start raining, the roads to the leases are above the water so we can drive trucks and drilling rigs.”

Oilfield services are abundant in Colombia, where oil has been produced for almost 90 years. The drill rigs, pipelines, chemicals and major international service companies are all represented in Colombia along with a highly experienced workforce. However, in Guyana, there are no oil and gas services.

“In Guyana, we have to bring everything in from either the U.S., Trinidad or Brazil,” Gamba notes. “Guyana is a complete frontier country. There’s no oil production at all. Guyana is very open to investment. It’s possible to go and ask for pieces of land to be awarded directly to you. It’s probably the most liberal in terms of access to the land, but because there’s no oil production in Guyana, it’s viewed as quite risky.” The country also has a rainy season from May through November. “There’s pretty heavy rains and then it’s dry,” he says.

Because of that risk, in Guyana Canacol did a farm-in. “We entered an existing company‘s block as a partner,” Gamba says. The company did the same for its investment in 10 blocks in Brazil, although Brazil has a well-developed oil industry producing 2.5 million barrels daily.

The size of a block depends on how the government chooses to define it. “The smallest block we have is 5,000 hectares, and the largest block we have is 400,000 hectares,” Gamba notes.

Heavy, Man

A trend Gamba sees in the industry in South and North America is an increasing reliance on unconventional and more risky plays – such as oil and natural gas from shale – and methods that have higher development costs. “Those are becoming increasingly attractive investments, given the fact that conventional plays are becoming more scarce, as most have been discovered,” Gamba observes. “We’re simply running out of conventional plays and having to look at unconventional opportunities. We’re starting to see a trend towards that in South America as countries’ oil production becomes more mature.

“South America in general is less mature than North America, but all of most of the very large conventional opportunities have been discovered or are in production,” Gamba asserts. “If you’re looking for something of a material size of hundreds of millions of barrels of reserves, companies are starting to look at more unconventional opportunities for the simple fact that nobody has explored for those, so those opportunities are possible to encounter.”

Another trend Gamba sees in South America also follows one in North America – an increasing interest in heavy oil, which is used in plastics, fertilizers and road building materials. “Because light oil production is declining, we are also focusing on heavy oil opportunities in Colombia,” Gamba declares. Historically, 90 to 95 percent of production in Colombia has been of light oil.

“People only wanted to find light oil, so therefore, there is a lot of heavy oil potential in Colombia that has not been looked at very carefully in the past,” he asserts. “As a Canadian company, we have access to a lot of heavy oil expertise for exploration and production out of Canada, which is to our advantage in Colombia.” Canacol’s first oil discovery, Capella, contains 200 million barrels of recoverable heavy oil, one of the largest in recent Colombian history, Gamba maintains. “That was something we were very focused on trying to find, and since then, we have acquired a number of exploration blocks with the sole purpose of finding more heavy oil,” he says.

A large amount of heavy oil production had been coming from Venezuela five or six years ago, Gamba says, but with the nationalization of the oil industry in that country, that supply is declining. “We’re seeing commodity prices for heavy oil increasing as refineries are wiling to pay more for heavy oil, as they need to generate these products,” Gamba reports. South American and Gulf Coast refineries traditionally have handled heavy oil from Venezuela.

Light oil – which is used for gasoline, diesel and jet fuel – has been favored in the past because it is inexpensive to develop wells and produces at higher rates than heavy oil. It also requires smaller facilities than heavy oil and it sells at a higher price. Canacol Energy Ltd. plans to optimize production, Gamba says, and with its active exploration program, its goal is to produce 15,000 to 20,000 barrels of oil daily in 2012.

Canacol Energy obtains bits for drilling its exploration and production wells from Baker Hughes along with electrical submersible pumps for its oil wells. “Canacol is very pleased with the high standard of quality associated with our service contracts with Baker Hughes, and look forward to a long relationship going forward with them in Colombia and beyond,” Gamba says. EMI