(Idea) The Market Reaction On New Stratus Energy Is Incorrect
New Stratus Energy, a small position in the HFI Portfolio (3.9%), is selling off by ~18% today on the back of the Ecuador presidential election that took place this Sunday.
I believe that the market is misinterpreting the election results and the sell-off is unwarranted.
But before I delve more into details, if you have not read Jon's write-up on New Stratus, I strongly urge you to do so here.
What's at stake here?
First and foremost, New Stratus is a highly speculative name. The company has a market cap of C$55 million and has no real producing assets and no debt.
Investors buying New Stratus today are banking on the possibility that there will be a deal made with the Ecuador government. New Stratus sued the Ecuador government at the end of 2022 because the government failed to conduct its normal due diligence process in assessing whether or not to extend the producing blocks (16 & 67) for another 20 years.
Over the past several months, there have been growing indications that a deal will be struct. Based on the recent news releases, this is what the terms could look like:
$1.5 billion upfront payment for a 20-year contract for Sacha (block 60). It is currently producing ~77k boe/d.
Sinopec & New Stratus are partners (the mix is expected to be 60-75% Sinopec, and 25-40% New Stratus).
Block 16 & 67 (previous deal with Ecuador) showed an operating netback margin of 35%, but the blocks produced heavy oil versus the light crude from block 60. Operating netback would then be closer to ~47%. At $75/bbl Brent (C$107), operating netback would be C$50.4/bbl.
In a recent interview from the Ecuador Energy Minister, he indicated that a deal would be done by the end of January. But with the deadline so close to the presidential election (Feb 9th), there were likely political forces at play that prevented the deal from going through.
But I think this is where the market is irrational.
Irrational
First, most investors who are buying New Stratus have no idea how the presidential election system works in Ecuador. The only way for Noboa to have won the election on Feb 9 was if he had:
More than 50% of the votes or,
He was above 40% with a 10% greater margin.
According to most polls, this was not a high-probability event. As a result, investors expecting this to be a bullish catalyst were going to be disappointed.
Second, the final result of the first round came in far closer than the consensus expected.
Source: Polymarket
The close race is leading some investors to believe that a deal won't be announced and it will be dragged post the April (final round) election.
But I think this logic is flawed. Because of the tight race, Noboa will want to increase his chance of winning by announcing initiatives in advance. His campaign has been hallmarked by a fight against organized crime, and there have been very few initiatives to bolster the economy or employment. A $1.5 billion payment from Sinopec and New Stratus would be held as a political win and garner more support.
Finally, and I think this is the most important point, the Campo Sacha field is facing natural base declines that won't be resolved through PetroEcuador. You can see the energy minister talking about it himself in this recent news article.
So what's clear to me from this is that there will be a deal announced before the election is held again in April. President Noboa will want to increase his margin of safety via more initiatives before the vote, and with this deal already in the final stages*, it is just a matter of time.
Note*: Ecuador's Energy Minister has already ordered PetroEcuador to transfer block 60 back to the state.