Vermilion Energy Inc.
Q3 2015 Earnings Call Transcript

Published:

  • Operator:
    Good morning. My name is Connor, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy, Incorporated third quarter results conference call. [Operator Instructions] Thank you. Lorenzo Donadeo, CEO, you may begin your conference.
  • Lorenzo Donadeo:
    Thank you, Connor. And good morning, ladies and gentlemen, and thank you for joining us today to discuss our third quarter 2015 financial and operating results. I am Lorenzo Donadeo, Chief Executive Officer of Vermilion. On the call today are Tony Marino, President and Chief Operating Officer; and Curtis Hicks, Executive Vice President and Chief Financial Officer. Before we get started, I'd like refer you to the advisory regarding forward-looking statements contained in today's news release. These advisories described are forward-looking nature, non-GAAP measures and oil and gas terms referred to today and outline the risk factors and assumptions relevant to this discussion. Earlier this morning, we announced our financial and operating results for the third quarter of 2015. We were pleased to deliver record quarterly production and strong financial results that continue to demonstrate the strength of our diverse asset base, despite the prevailing economic environment. Third quarter fund flows from operations at $129.4 million or $1.17 per basic share were in line with the prior quarter, despite a 20% decrease in oil prices from Q2. Our consistent financial performance was largely attributable to growth in production of high netback European natural gas. Production for the third quarter averaged 56,280 BOEs per day, an increase of 9% as compared to 51,831 BOE per day in the second quarter of 2015. This growth was mainly driven by our Netherlands business unit, which placed two very successful natural gas wells on production in the third quarter. The two wells Slootdorp-06 and 07 contributed approximately 4,000 BOEs per day to the quarter's production rate on a combined basis. Also contributing to the quarter-over-quarter production increase was our Canadian Mannville drilling program as well as increased Australian oil production. We were pleased with the Irish Environmental Protection Agency issued its final determination in support of the Corrib Industrial Emissions License on October 8. At the beginning of September, the operator Shell E&P Ireland Limited declared the project ready for service. At this point, the sole remaining requirement prior to commencing gas production at Corrib is the receipt of ministerial consent from Ireland's Department of Communications, Energy and Natural Resources. We continue to expect that the required consent will be received in the coming weeks, with first gas production to follow shortly thereafter. Following startup, production levels at Corrib are expected to rise over a period of around six months to a peak rate of approximately 58 million a day or 9,700 BOEs a day net to Vermilion by mid-2016. Continuing with Europe, in the Netherlands we focused on debottlenecking activities at our Middenmeer Treatment Centre to address facility constraints and enhanced deliverability from the two Slootdorp wells, we placed on production during the quarter. Diever-02, a 45% working interest exploration well that was drilled in 2014 came on production in early November at a gross rate of 28.5 million cubic feet per day or 4,750 BOEs a day. Because of our current pipeline constraints in a multi-well system that Diever-02 produces into, our net incremental production increases from this well is limited to approximately 6 million cubic feet per day or 1,000 BOEs per day. In France, we continued our workover campaign during the quarter and we've been extremely pleased with the continuing strong results from investments made in our Champotran field in the Paris Basin. Productivity from the four well Champotran drilling program, we executed in Q1 of this year, continues to exceed our expectations. Following the conversion of one of wells to a waterflood injector, the remaining three wells contributed approximately 820 barrels per day to the Q3 average production rate. That is 25% higher than we had originally budgeted for the program to be delivering at this stage. In addition, our Champotran field, waterflood program is showing strong results and is delivering highly capital efficient production growth. Response from the waterflood increased production from the field by approximately 300 barrels per day or 10% over the course of the third quarter. With respect to the German farm-in agreement that we signed in July, all joint venture partners have now approved Vermilion as a new partner. As such, the transfer of proprietary geological data that will support Vermilion's exploration activity is currently in progress. We continue to expect that the farm-in transaction will close towards the end of the year, once all government approvals have been received. In Canada, we drilled and participated in 10 gross or 6.9 net Mannville wells during the quarter, and brought 5.5 net Mannville wells on production. Subsequent to the quarter, we production tested our recently completed two-mile Notikewin well that flowed at a highly restricted rate of 10.79 cubic feet per day or 1,780 BOEs per day with casing pressure of 4,700 PSI. Based on available processing and transportation capacity, we expect to put this well on production during Q4 at a rate of between 12 million and 14 million cubic feet per day. This level of productivity would rank this well amongst the top gas wells currently producing in Alberta. Although, we were able to largely mitigate the impacts of the NGTL system transportation restrictions on our Canadian production volumes during the quarter, we continue to have approximately 900 BOEs per day offline through Q3 due to third-party facility constraints. In addition, we expect another 2,400 BOEs a day of productive capacity will become available in Q4, but will remain shut-in until processing capacity is obtained. We're actively working with our partners to address these concerns. During the quarter, we recorded a non-cash impairment charge against earnings of $143 million related to our Saskatchewan assets. This charge stems from the significant decline in crude oil prices that has occurred following our acquisition of the underlying assets in early 2014. This impairment charge does not have any impact on Vermilion's fund flow from operations, capital expenditures or payout. There is also no impact on our future development plans for these assets. In the United States, we completed and began testing the Turner Shurley Sand well that we drilled in Q2 in the eastern Powder River Basin of Wyoming. During the quarter, we consolidated our ownership of this project area to 100% through the acquisition of the remaining 30% interest. The purchase price of US$9.6 million provides Vermilion with an estimated 0.9 million BOEs a day of 2P reserves and substantial contingent resource opportunity as well as an additional 22,000 net acres of land and a nominal amount of incremental production. In early October, we commenced the Australian drilling program at the Wandoo A offshore platform. We expect to complete and place the well on production during the fourth quarter of 2015. We remain on target to achieve our original full year 2015 production guidance of 55,000 to 57,000 BOEs per day, although we consider it more likely that annual production will come in at the lower half of this range. Our ability to maintain this target, which was set in March 2014 and achieved more than 10% production growth in spite of the later than expected start up of Corrib and at a 30% decrease in capital expenditure, reflects the operational strength of our company and its high-quality asset base. Responding to the continued weakness in oil prices, coupled with our focus on maintaining and strengthening our balance sheet, we expect that our exploration and development capital program will be in the range of approximately $350 million in 2016. This would represent a year-over-year reduction of more than 25% from our forecasted 2015 E&D capital expenditures of $485 million and nearly 50% from our E&D capital program in 2014. At current prices, our 2016 capital expenditures and net dividends from fund flows from operations would be in the range of 80% to 85% total payout ratio, with the surplus funds going towards debt reduction. We are maintaining the 2016 production guidance of 63,000 to 65,000 BOEs per day that we set in March 2014. Production in this range would represent year-over-year growth of 14% to 18% as compared to 2015. We plan to provide detailed 2016 capital expenditure guidance prior to the end of the year. Subsequent to the quarter, Vermilion was named to the CDP, Climate Disclosure Leadership Index, recognizing the depth and quality of our climate-related disclosure as compared to the 200 largest companies listed on the TSX. CDP, formerly Carbon Disclosure Project, is a global, not-for-profit organization that manages the world's only global environmental disclosure system. To be named to the Climate Disclosure Leadership Index, a company must have a disclosure score within the top 10% of surveyed companies. Vermilion has voluntarily reported the CDP since 2012. We believe that by measuring and understanding our current environmental profile, we can adapt our business strategy to operate in an even more environmentally and socially sustainable manner in the future. Vermilion believes that its focus on sustainability will ultimately need superior returns for all of its stakeholders. As commodity prices remain volatile and consensus grows that we are in a lower for longer oil price environment, we believe that Vermilion is comparatively well-positioned versus our industry participants. Other international diversification has contributed a tangible value to our results year-over-year and we expect that to continue. We have acted decisively to preserve financial flexibility by proposing a significantly lower 2016 capital budget in the range of $350 million, which follows our already reduced 2015 capital program. Our comparatively low level of financial leverage allowed Vermilion to avoid large equity issuances during this commodity cycle, while providing us with the capability to transact for the benefit of our stakeholders, if a suitable opportunity arises. Our active hedging program serves to reduce our commodity and currency exposure risk. For the remainder of 2015, we have approximately 33% of our production hedged, including approximately 60% of projected European gas volumes at prices near $10 per million BTUs. For 2016, we currently have more than 20% of our expected production hedged, including 40% of our anticipated European gas volumes with an average floor of approximately $8.75 per million BTU. Given our focus on growth in European gas, we continue to hedge into 2016 through 2018 periods at every opportunity and currently have 16% of our 2016 forecasted volumes hedged at floor prices of approximately $8.10 per million BTU. We continue to focus on maintaining and enhancing a low cost structure. And in this regard, our profitability enhancement plan that was initiated in 2014, in response to decrease in commodity prices is expected to stay between $70 million and $80 million in 2015. These advantages in our measured approach, the way we run our business has meant that we've never reduced our dividend and we do not foresee and need to do so in the future. With that, I will conclude my formal remarks. Operator, please open the phone for questions.
  • Operator:
    [Operator Instructions] Your first question comes from the line Pavan Hoskote with Goldman Sachs.
  • Pavan Hoskote:
    I'll start with a two-part question on European gas pricing. First, what's your expectation for gas pricing in Netherlands, Germany and Ireland relative to the NBP spot price going forward? And secondly, your presentation has some helpful slides on rate of return for your European gas assets. Can you talk a little bit about the sensitivity of this rate of return to lower European gas prices, more broadly is there a price at which you would want to reprioritize your Canadian assets over your European assets?
  • Lorenzo Donadeo:
    I'll respond to the first question, and then I'll let Tony deal with the second part of your questions. So I think from Vermilion's perspective, and I think it's Vermilion's and I think in addition of that we've spoken to a number of investors over our marketing efforts over the past year, and I think the consensus is, from our investors and from a number of other publications that we constantly follow is that European gas prices will be trading in the range of about between US$6 and US$8 per million BTU or around $8 to $10.75. And you may see short-term periods of volatility. I could see prices dip down in the range of about US$5, which is about $7.50. I think there is a number of factors that, in our mind, point us in that direction. I won't get into all the details of that, because we can have a long discussion on that. But I think some of the key ones, I guess, if I could speak to them is that Norway and Russia who control over 50% of the European natural gas market really have indicated that -- through their actions, they've indicated that they're working towards the floor in the range of that US$6 per million BTU. And then when you look at the forward strip, it's currently trading between around US$5.70 to US$6 that sort of is reflected of that. And it's being pressured a little bit by weaker demand and mild weather and higher storage levels, but even at that level, with those constraints we're still seeing pricing in that range. And I think as we've mentioned, I think coupled with all that, I think Vermilion's hedged volumes, I think we spoke to them in our conference call this morning, and so we feel we're in a really good position from a hedge position. So I think overall those are the types of pricing that we see in Europe over the mid-term. And we remain quite bullish on European gas. We think that it will provide us the ability to drive some pretty strong returns. And so with that I'll maybe pass it on to Tony to maybe talk to the second part of your question.
  • Pavan Hoskote:
    If I may interrupt you here for a second, I appreciate all your comments on the European gas price outlook, but on Netherlands, Germany and Ireland specifically, do you expect pricing to be very similar to, let's say, to the NBP price or do you expect the premium or discount going forward?
  • Lorenzo Donadeo:
    Well, in the Netherlands, typically TTF trades very closely to NBP with the minor adjustments for transportation. So generally, we don't see that disconnect being much different. I think, Ireland, we're basically getting NBP less between $0.20 and $0.40 per mcf. And so I think those are in the range of what we're seeing. And I think on the Germany side, I think, Tony, can you maybe speak to the Germany side, because I'm not really clear on that one there?
  • Anthony Marino:
    Yes. the German gas trades off of TTF index and the price doesn't tend to deviate much from what we get as spot prices, gas prices per TTF and then it's eminently hedgeable using the TTF forwards. So it is very, very similar in Germany as well.
  • Pavan Hoskote:
    And Tony, if you could talk a little bit about rates of return for your European gas assets and the sensitivity around that, and if there is a price that you would want to reprioritize your Canadian assets over your European assets?
  • Anthony Marino:
    In our materials we have on the website, our corporate update presentation that we do each month, we include the economics for the historic program that we've drilled in Netherlands and that ExxonMobil has drilled in Germany in the assets that we own a 25% interest in there. Both of these projects have extremely strong economics, and I don't think that the viability of the project is going to be at all threatened if prices end up being lower than their current levels. For example, in the Netherlands, the historic program that we've had there using the historic, approximately 60% to 65% success rate that we've had prior to the drilling of our three most recent wells are not included in this analysis, but they've probably been more successful than anything that we've drilled to date. So using the program prior to that, the actual results at an $8.50 per MMBtu price, we achieved a tax IRR as well in excess of 100% on that Netherlands program. So with the current price for NBP at $7.85 per MMBtu, for TTF at $7.50 per MMBtu on a fairly flat forward, further at along the curve, those projects are still going to have really, really high rates of return and very rapid payouts that current prices that make it withstand substantially lower prices than those that we have today. Remember, that these are extremely productive wells. They're all conventional producers. They don't require fracturing. And you've heard about some of the production results we've gotten on the recent program, the best results we've received, we've achieved to-date, and that's not even reflected in these economics that we're representing here, so not very much sensitivity. In Germany, based on the actual results of the well that our operator there ExxonMobil achieved in 2014 at the same price tag, that is a 26% after-tax ROR, this year not included in there. They've also drilled a very successful extension and development well. So that one too has a lot of margin before it would be impacted by lower prices. That program is just in terms of viability of the program, it's not going to be very sensitive to pricing. We intend a ratable program in line with the regulatory environment in Europe and we don't intend to ramp up or ramp down very much in response to prices within any foreseeable range for the European gas. So does that take care of your question, Pavan?
  • Pavan Hoskote:
    It does. It's a very helpful and detailed response. And one last question from me, if I may, and is more of a broad question. But can you talk a little about natural gas demand trends that you're seeing in Europe, in response to the lower gas prices recently. Are you seeing a step up in demand from coal to gas substation?
  • Lorenzo Donadeo:
    Tony, do you want to touch that one.
  • Anthony Marino:
    Sure, I'll tell you what I do know about it. Over the longer term, I think that there is a substantial opportunity for gas to take market share away from coal. And the first reason is even unrelated to this recently modestly lower European gas pricing that we're seeing. Gas is such a clean fuel in comparison to coal, way less particulate emissions, no mercury generated, and of course, as far as the waste product of carbon dioxide it's much, much lower natural gas. Furthermore there is a desire on the part of certain European countries, I would say, particularly Germany to reduce its use of nuclear power. In fact, I think the objective there, if I remember correctly, is to completely eliminate the use of nuclear power generation by 2021. And so again, there is an opportunity for gas to take market share. Now, the drop in European gas prices that has occurred, this moderate drop has occurred, while there's still a quite strong levels compared to what we see in North America is, I think recent enough, and I simply do not have any data regarding the substitution of coal generation for natural gas. I would think that it's occurring, I simply can't quantify it. I do think that even independent of this of what will undoubtedly occur is response to prices. You'll have a greater effect, just due to the desirability from an environmental perspective of gas compared to coal.
  • Operator:
    Your next question comes from the line of Travis Wood with TD Securities.
  • Travis Wood:
    Quick question, and if you could just provide more color actually just around some of the infrastructure, issues that you're facing in Canada, how much of that impacted gas versus oil volumes, and then the timing of -- and kind of the plant projects that are in the queue to get that 2,400 into the market?
  • Anthony Marino:
    Yes, it's kind of the struggle over the past year that began with the integrity work done on the TransCanada system. It is getting better. The capacity of that system has been restored significantly, I would say, although not completely over the past quarters and we think that, that will continue. As far as our volumes that we have down, we have been running at a rate of around a 1,000 BOE/D for the last quarter. I think it was a little bit higher than that earlier in the year. We're going to get part of that on we think during Q4, that there's a larger volume of around 2,400 BOE/D. We estimate that is restricted not so much solely due to TCPL, but more just really localized plant capacity primarily in the Ferrier area. A lot of this gas is non-operated by us and it has to go through facilities owned by other oil and gas operators in a couple of cases. That probably isn't going to get remedied in Q4 and that represents a behind pipe volume that would be coming on production largely during 2016, although given the productivity of some of these wells in that Ferrier area wouldn't surprise me, if the limitation is not-completely corrected even until 2017. All that said we've got a lot of gas and NGL and condensate productivity. And we can still have, I think some pretty good growth, despite these limitations that we see either from TCPL or the plant restrictions from some of the other oil and gas operators out there, in the cases where we're a third-party processors at those plants.
  • Travis Wood:
    And looking ahead, do you think you could do something similar to how you guys built infrastructure out in the Cardium to help deal with some of the third-party issues that you're facing today in 2016?
  • Lorenzo Donadeo:
    Yes, generally we can't do that. We have two areas really there in west-central Alberta, where we've got significant productivity and the very bright investment program ahead of us. The largest of those is at Drayton Valley, where we have the Mannville and particularly the very condensate-rich Ellerslie, member of the Mannville. This formation and set of formations underlies the Cardium, so we already have substantial infrastructure in the area roads, well pads, pipelines, oil batteries and gas plants. We have actually this year completed a major expansion of our gathering and compression in the Drayton Valley area and that is allowing us to move the natural gas production and the associated condensate that we have for most big Ellerslie wells that we've drilled to market. Sometimes it go through our two company gas processing plants. In some cases, it goes through third-party such as Keyera in Drayton Valley, but generally, we're not facing too much in the way of restrictions there as far as plant processing, because we have built out this infrastructure project that should handle our needs for the next few years. The second area where we have a lot of productivity is in the Ferrier area to the south of Drayton Valley and there it's a little more challenging to get to market and I'm not sure that we would affect the major processing expansion in there. What we have done is upgraded one of our key compression facilities and that is allowing us to access more of the third-party plans that they do have room. But the instance that you asked about earlier, about having the 2,400 BOE/d behind pipe is a case, where we're not the operator of those wells and so we have to work on schedule of the operator allowing that gas to flow in their own plans. There might be some little things, we could do to move some of that gas around at the margins through our own compression and to our third-party plants that aren't full, but for the most part that's going to have to gradually come on mostly going 2016.
  • Travis Wood:
    And last question, just in terms of the Notikewin Wells. Can you give any comparison or contrast between some of the liquids yields on those versus the Ellerslie program?
  • Lorenzo Donadeo:
    The Notikewin has lower yields than the Ellerslie. That Ellerslie in the Drayton Valley, although the yields very up there, it's not probably an average for us to 80 to 100 barrels per million of condensate plus additional C3 and C4 in the Notikewin and the also the floor, which exist in the Ferrier area the yields are lower, usually depending on the plan that's being processed at usually in the range of 20 to 50 barrels per million of total liquids.
  • Operator:
    Your next question comes from of Kyle Preston with National Bank.
  • Kyle Preston:
    I got two questions for you here. First one on your Australia horizontal sidetrack program, can you just remind me how many wells you're drilling there and what sort of production you expect out of that?
  • Lorenzo Donadeo:
    Kyle, the original plan that we had for this year's Australian program was to drill a dual lateral sidetrack off of an existing well. What we're doing right now is we're going to go ahead and put the first sidetrack on that we drilled, that is quite a long well, it's about a 3,500 meter measured depth at a total -- at a true vertical depth of only about 600 meters. So an extremely long well, one of the longest, in fact, extreme extended reach wells drilled at this kind of shallow vertical depth yet in the world at around a 6
  • Kyle Preston:
    So you're confident even with this just one well bore, you're able to manage between 6,000 and 8,000?
  • Anthony Marino:
    I think that we would be able to do that, yes. Of course, the wells won't last forever and that's one reason that we would go in and probably drill something else in Australia during number of targets that we have there during Q2 of '16 and then that would set us up probably for a couple of years without drilling maintaining the targeted field production, probably achieving a very slight incline in the field, and all the time throwing off free cash flow, even in 2015, a drilling year and with much low oil prices that we've seen in 2015.
  • Kyle Preston:
    And second question here just on the M&A market. Just wondering what you're seeing here for acquisition opportunities? And whether or not your prioritization has changed it all between Europe, U.S. and Canada, just given the slightly weaker gas prices we're seeing in Europe?
  • Lorenzo Donadeo:
    We continue to look at acquisitions globally. What we're seeing in the U.S., the U.S. acquisition market, if you just look at straight production type assets, producing assets, still quite expensive and not seen a big sort of reduction in sort of the bid-ask spread in terms of what sellers are willing to sell for and what buyers are willing to buy for. Canada haven't seen a lot of opportunity, but we're looking at, I would call them, smaller tuck-in deals that are in and around our existing assets, but we can acquire lands that are non-producing where we see drilling occasions and we have good defined drilling inventory that we can bring into the portfolio at a relatively low costs, you tend to get matrix on the non-producing lands, especially when they're in and around your existing areas and you understand them very well, that are more attractive that we think that over long term can have some pretty significant value and increase the depth of our inventory. In Europe, we continue to look for acquisitions and we think that there's going to be some good opportunities there over the next six to 12 months. Generally, internationally, these assets come out, but you have to be very patient and sometimes they take a little bit longer, but we think that there's going to some good opportunities for us to acquire new assets that fit in well with our European focus, and primarily focused on gas, but also potentially some oil as well. And I think that, it will really allow us to build on our substantial footprint that we're establishing in Europe and allow us to continue to grow our momentum that we're going there with Corrib coming on here shortly.
  • Operator:
    There are no further questions at this time. I will turn the call back over to Mr. Donadeo. End of Q&A
  • Lorenzo Donadeo:
    Well, thank you, Connor. And thanks everyone for participating in our conference call today and for your continued support to Vermilion. Thank you.
  • Operator:
    This concludes today's conference call. You may now disconnect.