Petro Rio SA

BOVESPA:PRIO3

Earnings Call Transcript 2018-Q3

[Operator]

Good day, ladies and gentlemen. Welcome to the conference call to discuss third quarter 2018 results of PetroRio. Thank you for standing by. [Operator Instructions] This event is also being broadcast simultaneously over the Internet via webcast and may be accessed through PetroRio's Investor Relations website at www.ir.petroriosa.com.br by clicking on the banner 3Q '18 Earnings Release.

Before proceeding, let me mention that forward-looking statements that might be made during this conference call relative to the company's business perspectives, projections, and operating and financial goals are based on the beliefs and the assumptions of PetroRio's management and on information currently available to the company.

Forward-looking statements are not a guarantee of success. They involve risks, uncertainties and assumptions as they are related to future events and therefore depend on circumstances that may or may not occur in the future.

Investors should understand that general economic conditions, industry conditions and other operating factors could also affect the future results of PetroRio and could cause results to differ substantially from those expressed in such forward-looking statements.

I now would like to turn the conference over to Mr. Roberto Monteiro, the COO; and later to Mr. Milton Rangel, Head of Finance. Please, Mr. Monteiro, go ahead.

[Roberto Monteiro, executive]

Thank you very much. Welcome again. I would like to thank everyone for joining our quarterly call to discuss third quarter '18 results. I would like to clarify that we are the 2 officers of the company. Nelson and Blener are not in Brazil, and that's why Milton and I will be leading this conference call. Milton, who is our Head of Finance. I will begin the presentation with the highlights for the quarter and then will speak about the operational highlights and then Milton will go over our financials.

Starting on Slide 2. I'd like to mention the third quarter '18 highlights. The first one is obviously our net revenue of BRL 224 million in the third quarter. Operating results of BRL 130 million, the highest ever operating results of the company. Our EBITDA totaled BRL 107 million in the quarter, the highest ever adjusted EBITDA in the company's history. We had the highest contribution margin, what we call netback, of $33 per barrel, almost 50% netback, reaching now a very significant number. All of these numbers will be detailed later on by Milton.

Another point that I would like to highlight in the quarter is the end of the drilling campaign that we conducted in 2018, and we're going to give you more color on that in the coming slides.

And the last point, it is not really about the quarter, it's a subsequent fact, which is the signing of the acquisition of 18.26% of Frade Field, which happened a few days ago.

Well, first, let me speak about the acquisition in -- on the next slide. I'll speak about the acquisition of this 18.26% weighted interest of Frade Field from impact. As you can see in this timeline of the company, this is part of our DNA. This is part of our growth strategy to acquire field to have growth. In 2018, we were able to sign this deal, which is quite an interesting deal for PetroRio. We're starting to decentralize our operating risk, now encompassing other assets. We had total 100% managed change, and now we have one more asset joining our portfolio. Unfortunately, we cannot disclose more details on this. I know that we are going to have questions about this, but we cannot disclose the price for contract reasons. This amount will appear, of course, in the future income statement, but I cannot disclose anything at this point. We consider this acquisition very efficient and interesting, in terms of dollar per barrel -- both in terms of dollar per barrel produced and in terms of dollar per barrel in resource. This is a profitable deal. And this is a deal that perfectly fits our portfolio. We are talking about adding a little over 3,000 barrels a day of production and adding something around 12 million and 15 million barrels of reserves for the company with this deal.

Moving onto the next slide. Let's talk about our operational highlights for the third quarter of 2018.

The first highlight that I would like to draw your attention to is Manati. Manati produced above the take-or-pay contract, we produced 44.3 million cubic meters in this quarter. And talking about over our operating efficiency was above 98% in the quarter. In other words, maintaining the high levels of operating efficiency that we achieved in 2017. Our lifting cost at Polvo was $26.60 per barrel in the quarter. We had a month when it was $25, but the average for the quarter was $26.60.

And like I said, the completion of the 2018 drilling campaign, which extended quite a lot light spinoff this year at Polvo. And we'll speak more about that momentarily.

On the next slide, let's speak a little about Manati. Here, we can see Manati's production. This month-by-month and day-after-day. It is important to understand here that Manati has quite a stable production, very close to the field's capacity. The gas for Manati is in high demand.

There are 2 important factors to explain this high demand for the gas for Manati. Number one, the fact that the south and the southeast of Brazil needed -- been dispatched so much gas to the north and the northeast and so Manati is used to supply this demand for gas in the northeast.

The second point is our gas contract at Manati is in Brazilian reals and further depreciated. We also get -- had a competitive price in the market. Finally, one last point about Manati is that the company that PetroRio is working strongly as operator of the field and working with the other consortium players to review the provision for abandonment of the field. Just like what we did with Polvo in the past, we are preparing to review the provision for abandonment.

Moving onto the next slide. Here, we talk more about Polvo. To begin, operating efficiency. We can see that it's going back to normal level. 98.1% operating efficiency, an average of 10,081 barrels produced in the quarter. If we adjust by the scheduled stoppage that we had in January, we can consider a 50% increase in production since the beginning of the drilling campaign from now. When we started the campaign, we were producing about 7,000 barrels a day. And now our output is around 10,350 barrels a day, 10,300 barrels a day. So this is a significant increase in production. The operating efficiency is totally under control.

Let's go to the next slide. Let's begin with more about the costs at Polvo. Polvo is one of the great achievements of the company. One of the great achievements was to become a lean operator, a lean low-cost operator. We were able to substantially reduce our operating costs. Now we are at a cost $26.60 per barrel of lifting cost. Obviously, the big driver of this cost, one of the reasons explaining this reduction in lifting cost was increase in production. When we look at the absolute cost, there was a slight increase in the third quarter. The main reason explaining this increase is that some of our costs are pegged to oil price. And the daily cost to operate the FPSO well oil, there was an increase in the price to $100,000 a day.

We had an escalation with oil. Now we don't have oil escalation. We have a fixed price of $100,000 a day per the FPSO. So these 2 items were the main "offenders" here, but they were more than offset by our increase in production, which results from the exploratory campaign, which is the next line of the drilling campaign of 2018.

Here, we have a summary of the drilling campaign. We had a CapEx of $42 million. With this $42 million, we increased 3.7 million barrels of probably reserved, 1P, and in the life of the field if you take into account the certification of reserves. We are talking about a useful life of 1P reserves until 2024. So we expanded the lifespan of the field.

This increase in reserves of 3.7 million barrels with $42 million according to our estimate has a payback of approximately 6 months. And the useful life of the field can be extended a little more with new wells drilled. We're even considering a possible drilling campaign for 2019, most likely considering 3 to 4 new wells to be drilled, of course, everything has to be submitted for approval by the board. Everything has to be studied at length, but this is more or less the direction that we are following.

Thank you very much. I turn the floor now to Milton Rangel, our Head of Finance, to give you a summary of our financial highlights.

[Milton Rangel, executive]

Regarding the financial highlights of the third quarter, we had a net revenue of almost BRL 125 million, more than twice that of the third quarter '17. And this is financial highlights that this level of net revenue was very close to what we achieved in the second quarter '18, although we sold about 100,000 barrels less. We also achieved the highest operating results in the company's history, BRL 130 million, to us, which is quite significant and really important.

The cash generation capability of our generation -- of our operation, highest adjusted EBITDA, which is the EBITDA net of nonrecurring effect that sometimes do not a cash effect or it was the highest ever, BRL 107 million in the quarter. Very strong results, a margin close to 47%, 48% in the quarter -- in this quarter, the strong results that we achieved in this quarter. Contribution margin for Polvo, as Roberto mentioned, regarding the netback was close to 50%. And this was the highest netback margin in our history, so this is another great deed for the company.

So in a nutshell, this slide shows very strong results that we posted and a number of record marks being achieved by the company in this quarter.

Moving on, here, we have Brent price performance since September 2017. You can see it continues increase in oil price an average of almost $76 per barrel in the third quarter '18, which is obviously tailwind for our results. As for our offtakes, we still have an offtake of 461,000 barrels in August, 231,000 barrels in September. A lot less because we've had an upfront opportunity results in average opportunity to have a commercial discount below market average for an oil with the characteristics of the oil from Polvo.

So we talk about thousands of barrels sold, but we have to also take into account the quality of the offtake. We ended up with a high inventory 530,000 barrels (sic) [ 531,000 barrels ] in our inventory.

Next slide, we have the income statement in the quarter and year-to-date. Again we talked about a strong revenue, the highest revenues for our history, almost BRL 300 million year-to-date. Again, reinforcing the point that I mentioned before, it is not just about increasing sales and revenue, but above all, profitability, with netback margin of almost 50% is the best ever in the history of the company. It really reinforces our financial discipline, reinforces the quality that we try to add to our results.

Something which is not in this slide but if we compare with some return indicators, such as return on equity and return on assets, we have observed that PetroRio numbers start to stand out among the best in the industry for, let's say, oil and gas companies. And a lot comes from this -- from the high margins that we are delivering, from a high asset turnover, which happened given an increased revenue vis-à-vis the new investment made, so a level of revenue generation with low CapEx, particularly after the investment in Polvo, and that group is very satisfied with our results.

Moving on, we have our net cash flow and our final net cash balance. I'd like to show that if we add these first 3 columns, revenue from operations, costs and expenses with royalties, we've got to an operating cash generation up BRL 85 million, which was the highest ever reported in our history. Again, this is a very important feat for us, an important achievement.

It's also important to observe that we were able to maintain our final net cash of the company higher than BRL 500 million, which is a high level despite the drilling campaign in Polvo in this quarter. Alone, we spent a little over BRL 60 million. So again, our cash generation and investments made, up to my investments, I must say, still we had a very strong net cash balance. We have a very solid balance sheet. Our credit rating profile very good so if we need to increase leverage of the company through new acquisitions and new assets we are well positioned for that. And we are well positioned to grow the company.

I'd like to highlight that with this acquisition, some impact that we announced that we didn't need to get any debt -- we didn't need to increase the depth of the company, which enforces our position for future acquisition.

Finally, moving on next slide on the outlook. There are 3 main points to mention. First, is the closing and integration of FRADE JAPÃO's results, after we close the deal we'll be able to disclose more impact. Secondly, new M&A opportunities in mature fields. This clearly in our DNA to continue a very active research of new targets with a mindset to diversify portfolio, generate cash and value for our shareholders. And thirdly, planning for determining to drilling campaign at Polvo.

As Roberto mentioned, we see Polvo was up to more than -- for 2019. Pursuing possible new wells to be drilled, always trying to maximize the recovery factor of these assets, but always in a profitable manner. We are very happy with these results that we delivered.

Although we hit another record month, we know that when we do that, we raise the bar, and that increases our responsibility and motivation to go even farther.

So I'm going to turn the floor back to Roberto for his final remarks. Thank you.

[Roberto Monteiro, executive]

Thank you, Milton. As my last point, I would like to highlight that this year, we had the 2018 drilling campaign that might look trivial, it might look simple, but it is important to remember that Polvo Field was, for almost 2 years with no new drilling. The company this year, in 2018, decided to conduct a drilling campaign. We were able to have this drilling campaign with no negative events. It was a very safe campaign with full respect for the environment and in compliance with all of the rules. This was a significant achievement for the whole PetroRio team.

And here, I would like to publicly acknowledge our people because, you know, our company is made of people, not just of assets. The company is made of people, too. And people are, no doubt about it, our main asset. So I want to give a big thank you to all PetroRio employees. Regardless of their area, their role, their department, thank you very much, team, for your effort, for your focus, discipline and dedication.

And as you all know, a good part of our employees, more than 70% of our headcount, are partners of PetroRio. So thank you very much. Again, thank you for your dedication and your effort is for the benefit of all of us.

Thank you very much. We now open for questions.

[Operator]

[Operator Instructions] Our first question was sent over webcast by Mr. [ Hogdoresucuera ].

[Unknown Analyst]

At Polvo, the prospect identified in the 2018 drilling campaign, are they in the report to 2P and 3P? Or are they as prospective resources and/or contingent resources, which are not included in the report?

[Unknown Executive]

All we accessed in the 2018 campaign was primarily what we called the 2017 reserves, the undeveloped, proved, non-developed reserves, and this is what we access primarily in 2018, but we also access a little bit of 2P, but the bulk that we access was proved reserves, proved non-developed reserves. For a new drilling campaign, our goal would be to look for reserves that are classified today as being 2P.

[Operator]

The next question from Mr. Raul Grego, Eleven Financial.

[Raul Grego Lemos, analyst]

Actually I have two questions. One, it's related to possible new drilling campaigns in 2019 at Polvo. What can you prospect and how much would that require in terms of investment? Could we expect something close to the 2018 drilling campaign? Or will the investment be more relevant? Would it require more cash?

My second question has to do with the acquisition of Frade. Of course, whatever you can tell us about it will be appreciated. What do you expect from this deal? And are they any restrictions to explore Frade Field since there was an episode of an oil leak in 2011? So if you could give us some color on that acquisition, that will be appreciated as well.

[Unknown Executive]

Okay. I'm going to begin talking about 2019 CapEx. Now this year, we achieved very substantial CapEx marks. I would think of CapEx for 2019, we're still trying to size the drilling campaign, and so on and so forth, but I would think of something close to $55 million, a range between $55 million and $60 million, which was the CapEx for the campaign this year. Like I said, it would be more or less in that range. I think that this year, we were exceptionally efficient. Of course, we will achieve this next year as well. But the targets are a little far away and so on and so forth. So I would say that something approximately $55 million to $60 million. Regarding Frade, Frade Field. Well, Frade Field has 2 things. We are entering Frade as nonoperators, we're not the operators. We are just the participants of the consortium. We do participate in most of the decisions, but we are not operators. So what we can bring to Frade today is just joint work with the other consortium players, Petrobras and Chevron, so that we can bring to the consortium our operational culture so that we can make suggestions and so on and so forth. What we think we can get from Frade? Yes, there was an oil leak. But, after this oil leak, the field reduced dramatically its output given the discontinuity of water injection. If you will remember in 2011 when there was this oil leak, it was because of water injection. And so the field, in our view, has a lot of reserve vis-à-vis the production. It produces about 17,000 barrels a day, but the reserve is absolutely huge vis-à-vis its production. So we believe that in the future, there will be opportunity to improve the recovery factor of the field, and the field will -- well, either production will increase or the lifespan the field can be very perennial. This is our opinion about Frade today. You know we cannot speak on behalf of the consortium. We cannot talk about a new drilling campaign at Frade. We are not the operators. We are not the only owners of the field. We have 18% -- 18.26% and we'll participate in the committee of operations, of investments and so on and so forth.

[Raul Grego Lemos, analyst]

If I can have a follow-on question, please. For 2019, do you want to have more M&A activities, do you want to have a more relevant participation or a higher working interest at Frade to perhaps become the operator of the field? Or would you be considering other M&A deals of other producing assets?

[Unknown Executive]

Well, as part of our strategy -- well, PetroRio's strategy is to grow through M&A, and if possible, capturing the operation of the field. So obviously, if the possibility exists, PetroRio will work into this possibility with a lot of attention. So, all we can say is that if this possibility exists, we'll look into it. If that possibility does not exist, PetroRio will try to expand to other fields to other possibilities. Because we operate other field, we've got profitable, very profitable field. We expanded lifespan of the field, and we did a number of things, we hit a number of record marks at Polvo. Manati, we are not operators, but Manati is also very profitable field for the company, a very interesting asset. We participate actively in the operational meetings. We are always making suggestions of improvement. We're always proposing actions to drive down costs and so on and so forth. So our culture will always be there. Our culture of being a lean operator will always prevail.

[Operator]

Next question from Gustavo Allevato with Santander.

[Gustavo Allevato, analyst]

I have a question regarding production for 2019. To what production do you expect you could produce of oil and gas with M&A considering Manati? And my second question is, when do you expect to finalize the deal with FRADE JAPÃO?

[Unknown Executive]

Could you repeat the final part of the question, please? I think you want to have a time line to close the deal of acquisition at Frade Field?

[Gustavo Allevato, analyst]

Yes. When do you expect to complete the acquisition of Frade, in the first quarter of next year, second quarter? And what are the procedures, what are the necessary steps that you need to go through to complete the deal?

[Unknown Executive]

Well, regarding production, we never gave any output guidance. What I can tell you, though, is with the acquisition of these 3 assets, in terms of barrels of oil equivalent, will reach something close to 16,000 barrels, that would be the idea. If you look separately, today, our production -- our share of Frade production in January should begin at 3,000 barrels a day. Polvo production, like I said, it's going to add 10,350 barrels, so we can have the decline calculation based on that. And Manati will be a little low this year, but not too much lower. So -- and that can give you a pretty good idea of our production. When you look at Polvo, because after the drilling campaign that we did this year, we extrapolate this 10,300 barrels for next year, even considering the natural decline of the field, the 2019 production, there will be an exploration, the company will be equal or perhaps a little higher than 2018. But just because the wells started operating in the middle of the year, that's for Frade Field, our expectation is that in the third quarter, the whole deal will be closed. We expect closing to happen in the first quarter '19, more towards the beginning of the quarter than towards the end of the quarter.

[Operator]

Our next question is via webcast by Mr. [ Hogdoresucuera ].

[Unknown Analyst]

In the first quarter '18, do you expect to sell the whole inventory that was left in the third quarter '18, plus the production of the fourth quarter? What inventory do you expect to hold in the fourth quarter?

[Unknown Executive]

Well, Rodrigo, our strategy year-after-year, the company tries to change the year with a minimum inventory possible or to end of the year with a minimum inventory possible. Now having said that, the inventory that remains, range from 200,000 to 250,000. This is what normally remains in the FPSO, so we'll see if the sales of the fourth quarter, considering that should be fourth quarter production, plus the offtake of the inventory that still remains currently at the FPSO. Now it is important to remember that we're only going to have an offtake if there are favorable conditions with favorable discounts and so on and so forth. So our expectation, I mean, we're thinking of ending the year with a low inventory, but it will really depend on the market, and it will really depend on the discounts that have been applied at that moment.

[Operator]

We will now close the question-and-answer session. PetroRio's conference call is finished. We would like to thank all of you for your participation, and have a good day.