Arrow Exploration - The Low-Cost Producer Positioned for Significant Growth in the Llanos Basin

• Arrow Exploration is a junior oil & gas company focused onshore in Colombia's Llanos Basin
• The company has had exploration success in the Carrizales Norte Tapir blocks, nearly doubling its 2P reserves from 8 to 12 million barrels
• Arrow plans to drill a new horizontal well every 3 weeks in 2024 and is projecting significant production growth from 3,300 bpd to 4,000-6,000 bpd
• The company has an attractive fiscal regime, paying only 12% royalties and no taxes while reinvesting capital
• With a $45M capex budget funded by cash flow, Arrow expects to exit 2024 with $13-15M cash and is trading at <2x cash flow, a discount to peers

Low Cost, High Growth Value Creation in the Llanos Basin

Arrow Exploration (LSE:AXL, TSX-V:AXL) presents a compelling investment opportunity as a rapidly growing junior oil producer in the prolific Llanos Basin of Colombia.

Arrow's business strategy focuses on expanding oil production from some of Colombia's most active basins, including the Llanos, Middle Magdalena Valley (MMV), and Putumayo Basin. The company's asset base is predominantly operated with high working interests, and the Brent-linked light oil pricing exposure, combined with low royalties, yields attractive potential operating margins. Arrow's 50% interest in the Tapir Block is subject to the assignment of such interest by Ecopetrol SA.

With a proven track record of exploration success, attractive fiscal terms, and fully-funded growth plans, the company is poised to deliver strong production growth and shareholder returns.

Reserves Growth

A key pillar of the Arrow investment thesis is the company's ability to grow its reserves base through low-risk exploration and development activities. In 2023, Arrow made a significant discovery in the Carrizales Norte block, which CEO Marshall Abbott says "adds significantly to reserve value."

This discovery, combined with reserves in the Tapir block, allowed Arrow to nearly double its 2P reserves from 8 million barrels at year-end 2022 to approximately 12 million barrels by mid-2023. Abbott elaborated:

"We had a year-end Reserve report about this time last year, it's mandated by the regulator in Colombia. We submitted that CPR last year, I believe it was 143 million 2P value... and then in May/June we had the significant discovery at Carrizales Norte. We thought it would be viable to do a midterm report on that exploration success... When you group them together it's about 270 million 2P at 10% in dollars."

This reserves growth provides a solid foundation for Arrow's future development plans and production growth targets. With the majority of its 2P reserves now likely in the "development pending" category, the company is well-positioned to convert these barrels to production over the coming years.

Interview with Chief Executive Officer, Marshall Abbott

Production Growth Potential

Building on its exploration success, Arrow is embarking on an ambitious development program to grow production from current levels of approximately 3,300 barrels per day (bpd). The company has a board-approved capital budget of US$45 million for 2024, which is expected to be fully funded by operating cash flows.

The development plan incorporates both vertical and horizontal wells, with Abbott noting that a vertical well will be drilled "every 3 weeks for the rest of the year", complemented by a horizontal drilling campaign beginning in the next few weeks. Horizontal wells are expected to produce at initial rates of 1,000-2,000 bpd (gross).

"The intention here from an operational perspective is we're going to drill this horizontal well, it will take about 3 weeks to drill and get on stream," Abbott explained. "We want to monitor the behavior and performance of that particular well. While we're doing that, we're going to drill vertical wells into the same reservoir."

With this combination of vertical and horizontal development, Arrow is targeting an exit rate between 4,000-6,000 bpd for 2024, representing potential growth of 20-80%+ versus 2023. Abbott emphasized a focus on balancing growth with reservoir management:

"From an exit rate, we always have a goal of being able to double the previous year. I think we're going to be a little more conservative than that... We'll be well north of 3,500 barrels a day and somewhere south of 6,000 barrels a day."

While this production target is below a "direct double" to 6,600 bpd, it still represents an attractive growth trajectory that should translate to strong cash flows and shareholder returns.

Attractive Fiscal Regime

A key competitive advantage for Arrow is the favorable fiscal regime in Colombia, which allows the company to retain a high proportion of revenue while reinvesting in growth. Abbott highlighted the key fiscal terms:

"Keep in mind that we're only paying a 12% royalty here, so at $80 Brent we're cash flowing between $55 and $60 a barrel. And we take no transportation risk - we have buyers lined up at the wellhead to take our crude and we get paid a month in advance...From a tax perspective, as long as you're spending money there is no applicable tax."

This fiscal structure provides Arrow with a distinct advantage compared to many North American producers. The company's high netbacks support an efficient recycling of capital to fund further growth.

As Abbott noted, "it would be very difficult to find prospects that are going to deliver a thousand barrels a day in a conventional sense [in Canada]. We don't frack these wells, all we do is drill and perforate. If I was able to find one of those in Canada, I'd be paying a 40% royalty."

Strong Financial Position

Arrow enters 2024 in a strong financial position, with its $45 million capital budget expected to be fully funded by operating cash flow at current commodity prices. Despite its growth investments, the company anticipates exiting the year with a cash balance between $13-15 million. This provides ample liquidity to manage volatility and potentially accelerate growth plans if warranted by commodity prices and well results.

Importantly, Arrow's rapid growth is not coming at the expense of its balance sheet. The company has no debt and a clean capital structure with strong institutional support. Abbott noted that Arrow's 2023 financing included a "dedicated shareholder base" with 30% from UK institutions and another 30% from high net worth individuals.

Valuation Upside

Perhaps most compelling for investors, Arrow's shares currently trade at less than 2x cash flow based on its growth trajectory - a significant discount to junior oil and gas producer peers. Abbott commented:

"I think when we're actually looking at forward cash flow, we're trading well below two times, which in my career I've never had this much success on the drilling front with such a low cash flow multiple... Overall I think that's going to change in the near future."

As Arrow delivers on its production targets and proves the repeatability of its exploration success, the company's shares could see a significant re-rating towards peer cash flow multiples. Abbott has a goal of increasing market awareness in 2024, noting "we've been rather quiet on the marketing side, now we're going to get a little more aggressive and make sure that the story is out there."

Conclusion

With its high-quality asset base, attractive fiscal regime and fully-funded growth plans, Arrow offers investors a compelling opportunity to gain exposure to Colombia's prolific Llanos Basin. As the company delivers on its operational targets and increases market awareness, Arrow's shares could see a significant re-rating to better reflect its underlying cash flow growth and NAV accretion from exploration success.

Upcoming Catalysts

Looking ahead, Arrow has a busy pipeline of catalysts for investors to monitor in 2024:

• Updated competent persons report (CPR) expected in late March to incorporate year-end 2023 reserves
• Vertical well drilling results across the Carrizales Norte and Tapir blocks
• Horizontal well drilling results beginning in Q2, with productivity monitored over a 2-3 month period
• Exploration drilling at the Baquiano and Mateguafa prospects, which have "significant reserve upside" according to Abbott
• Quarterly production and cash flow updates as Arrow progresses towards 2024

The Investment Thesis for Arrow Exploration

• Proven management team with a track record of value creation in Latin America
• Attractive asset base in Colombia's prolific Llanos Basin with significant exploration upside
• Nearly doubled 2P reserves in 2023 with Carrizales Norte discovery, providing production growth platform
• Fully-funded $45M capital program expected to grow production 20-80%+ to 4,000-6,000 boepd in 2024
• Highly economic wells at $80/bbl Brent generate $55-60/bbl operating netback after royalties
• Favorable fiscal regime with 12% royalties and no taxes while reinvesting capital
• Clean balance sheet with no debt and strong institutional support
• Shares trading at <2x cash flow, a significant discount to junior producer peers
• Upcoming catalysts include horizontal well results, exploration drilling and quarterly opex/production updates
• Undemanding valuation provides attractive margin of safety and upside potential as Arrow delivers operational outperformance

Key Takeaways

Arrow Exploration offers investors a unique opportunity to gain exposure to the prolific Llanos Basin of Colombia. With a proven management team, attractive asset base, and fully-funded growth plans, the company is poised to deliver strong production and cash flow growth in 2024 and beyond.

Despite this compelling outlook, Arrow's shares currently trade at a significant discount to peers at less than 2x cash flow. As the company delivers on its operational targets and increases market awareness, Arrow's valuation could see a significant re-rating to better reflect its underlying fundamentals. With numerous upcoming catalysts and a favorable risk/reward profile, Arrow Exploration presents a timely opportunity for investors to gain exposure to a high-growth junior oil producer.

Macro Thematic Analysis

The outlook for oil prices remains constructive, supported by a combination of steady demand growth, capital discipline among producers, and geopolitical risks to supply. Despite concerns about a potential global recession, oil demand has proven resilient, with most analysts still forecasting demand growth of 1-2 million barrels per day in 2023.

At the same time, the supply picture remains constrained by years of underinvestment in new production, particularly among international oil companies and OPEC nations. This has left global spare capacity at historically low levels, increasing the market's vulnerability to supply disruptions.

In this context, companies like Arrow Exploration that can deliver low-cost, high-margin production growth are well-positioned to outperform. With its asset base in the prolific Llanos Basin of Colombia, Arrow benefits from highly economic wells that can generate strong returns even in a lower commodity price environment.

This combination of low-cost, high-productivity wells and a favorable fiscal regime gives Arrow a distinct competitive advantage. As the company delivers on its funded growth plans, it is well-positioned to generate significant shareholder value in the current macro environment.