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Earnings Call Transcript 2022-Q1

[Jostein Løvås, executive]

Good morning. Welcome to DNO's First Quarter Earnings Call. My name is Jostein Løvås. I am the Communication Manager of DNO, and I will share some practical information. Earlier this morning, we have published the quarterly report and presentation. In this call, we will not do a detailed walk-through of the slides. Instead, our CFO, Haakon Sandborg, will share some initial reflections before opening up for questions. Please note that all participants in this meeting are muted by the organizer and will not be able to unmute themselves, chat or share their screens. If you want to pose a question, please raise the tiny virtual hand on top of your screen. And with that, Haakon, the floor is yours.

[Haakon Sandborg, executive]

Thank you, Jostein, and hello, everyone. Welcome now to this earnings call. As you heard, a bit of a different format this time. We think reasons are partly because we have a good quarter with fairly uncomplicated financials this time. So we wanted to keep it now on a different level with not a formal walk-through or a full presentation, but just to mention some of the highlights and the main points. And then we'll quickly move on to a Q&A session, as we've heard.

For the quarter, we have a release out this morning, a stock exchange release. And in that, we are making the statement that oil and gas are back, but never left. And you might ask, why are you saying this? And it's basically because we, as a company, have stayed the course and remained true to our commitment to the E&P industry. And this is despite the challenges we've seen to the industry over the last couple of years and despite the challenges from COVID and supply chain constraints, et cetera. So we are just affirming that commitment to the industry in the release and in the heading on our presentation.

And when we look at the quarter as such, it's a very strong quarter, I think. We have a good cash flow. We have an increase in operating profit and with, again, very high activity in Kurdistan, where we have been spending 5 wells in the Tawke license in the first quarter. And this is both at Tawke field and the Peshkabir field. So we're working on the Baeshiqa new development. And here, we are doing drilling on the Zartik-2 development well, and we are basically more or less ready to start production once we have all the approvals we need from the government in place.

For the North Sea, we have a very good start of the year with a new promising discovery at the Kveikje area. And this is the first well we drilled this year, and it comes in with a good discovery. So again, a positive start to our exploration program.

With the improved profit that we have, we are now basically, as you've seen maybe from our announcements and presentation, reducing our gross outstanding debt, and we have increased the proposal or the request to the upcoming AGM to increase our dividends significantly for the coming year. So that's a very positive development as well. In the -- in our release material this morning, we discuss the production numbers, as we normally do. I won't go through all that, but basically say that for the Tawke license, it's a fairly stable production. And for North Sea is a bit down. Most of that is due to one field called Tambar field, where there was a shutdown in the quarter. So that has reduced the production for Q1 to 12,700 in the first quarter.

So those are some of the main operational things that I can highlight. I won't go into all the details on finance, but just say that we are up on Kurdistan revenues because we have kept up production in a good manner and had benefit from the increasing oil prices through the last quarter.

For the North Sea, we had a bit of a different situation. The revenues are down from $216 million in Q4 to $131 million in Q1. And that's basically because we had very high liftings in Q4, and we have now seen lower lifted volumes in Q1. That's the reason why we have booked lower North Sea revenues.

Yes, also some of the themes on that. Just to mention the important product that we keep expanding in Kurdistan on the gas capture and injection. This program, as you know, has been going on for a couple of years now, and we have succeeded in reducing flaring and gas emissions significantly. And in fact, the total reduced emission level is aggregating 760,000 tonnes of CO2 since we got started in mid-2020 up until through the first quarter of 2022. So we'll keep on expanding this project with the second phase now that we're working on. So very important.

I think what we should say about that, people ask us, what are you doing to contribute to the reduced emissions on the oil and gas industry. And this is our main product. This is something very tangible, something measurable that we can present and these are the efforts we are doing. So I think this is our main and a very important contribution.

Yes. Again, just to comment a bit on the Kveikje discovery. This is now becoming a very important exploration area in the Norwegian Continental Shelf. It's west of the Troll field. And there's already a nickname on these discoveries. They seem to form a sort of a highway of new discoveries or a ring road, if you want. So we are quite excited about our position in this area and look forward to the next wells that we will drill now in this Kveikje and the rest of Troll area. We were also happy to be awarded 10 new licenses in the APA round in Norway in January. So we keep on expanding and high grading our portfolio in the area.

Yes. [indiscernible] just we were down on revenues because of the lower liftings in the North Sea, but still had a very solid revenue of $339 million for Q1. And that gives us a very strong cash flow, both netback that we like to focus on, after-tax netback. It's up at $275 million now, a strong level and a much improved -- a much stronger operating profit, basically because of strong revenues and much lower costs. So those are those things.

So as mentioned, we have increased our dividend proposal, and we have bought back bonds in Q1. And we are now doing a call or partial call on the DNO03 bond of $200 million. and that was released yesterday. So in addition, with the bonds we have bought back, $23 million something, we will significantly reduce the outstanding amounts under the DNO03 bond. So I think it shows the real strength of what we are doing now that we are further strengthening our capital structure and balance sheet and reducing interest expense and keep on expanding our investments. So a strong position for the company.

And you would see that reflect that also, of course, in some of the key metrics for our balance sheet, including the equity ratio that we focus on in DNO.

Right. That was just to kind of give you the background on the quarter. Happy now to go into a Q&A session, Jostein, and see what interest we have and what people want to know more about.

[Jostein Løvås, executive]

Yes. I think we will start with some questions we have received in advance from a private investor, [ Torsten Figon ], on behalf of himself and several other investors. The first one is, are you able to increase drilling activity and as such production at Tawke even at more at these high prices?

[Haakon Sandborg, executive]

Yes. Yes. Thanks, [ Torsten ] for that question. Yes, we are able to ramp up, and we got to be able to adjust our production levels in the Tawke field. And we have done so in the past, as you have seen. Now we are doing a lot at the moment. We are coming up to 4 rigs drilling at Peshkabir and Tawke fields. And we do want to be sure that we learn from the new wells that we drill and that we have a responsible and sustainable program for the long term. So we will see what we can do, but we have guided that we will keep the Tawke total production output at 105,000 barrels per day this year. So I think that's a good level. And we will see how long we can keep it stable.

The Tawke field is more matured and is on decline. Whereas the Peshkabir field is a newer field and we'll be able to keep that up in a good way, we think. And just to add that we have good long-term reserves here that we can give us a good reserve to production, RP, ratio for many years ahead. So the answer is basically, we can take it up and down. But we will keep it stable now with the drilling program.

[Jostein Løvås, executive]

Another question from [ Torsten ] is, what is the discount to your oil produced in Kurdistan? Does the discount include increased transportation costs as other E&P companies have communicated?

[Haakon Sandborg, executive]

Yes, it does. The discount so-called on Kurdistan is basically that there is a quality part and there's a tariff for pipelines part of the discount that we have on our deliveries. The discount part of quality has remained stable. But there's been some increase in the tariff on the pipelines, especially through the Turkish pipeline that we use to transport our oil through Turkey up to the port city of Ceyhan in Turkey. And if you take the volumes of oil produced that we report in our -- that we have in our quarterly report and divide that with revenues and you'll come up with an estimated price per barrel. And you will see that, that indicates a -- if you do that, to say an indication that you're being -- that we're paying around $14.5 per barrel in total quality discount and tariffs.

So the increase here is around $1.5 per barrel from $13 to $14.5. So this is partly then linked to -- the increase in tariffs is linked to the -- because of the link to the oil price. So when the oil price is much higher, we pay more in tariffs under that structure. The effect for DNO in the Q1 is around $2.5 million increase in tariff for Q1. So that's the level we are talking about, [ Torsten ], on the increase. Yes, I hope that answers the question.

[Jostein Løvås, executive]

And then there's a question that I think we partially answered yesterday. And that is whether we were intending to call back DNO03 in May. Is there anything you want to add, Haakon?

[Haakon Sandborg, executive]

I don't know. Good question, I think. But we have already announced that yesterday, that we are doing that. We're calling $200 million of the bond, as I said, and we have another $23 million -- close to $24 million that we hold in the company. So we are reducing that bond by close to $224 million.

If you want to think thing forward, yes, what are we going to do? Well, if you look back on the track record of the company, we've been a -- I don't know, been a conservative and proactive issuer, where we've been very often prepaying, refinancing our outstanding bonds well ahead of maturity. This bond we bought back now, DNO03, has maturity in 2024. So in that context, it's not unlikely that we will look at it again in the coming quarters to see what we will do. And we will sort of maintain always that we have a long-term profile on the maturities, which is important to us and also manage the debt level. So I think, yes, this is something we will keep on focusing on, is really an important part of our strategy to be sort of front of the curve on the bond refinancing and that we want to keep a strong and robust balance sheet at all times.

[Jostein Løvås, executive]

Then we have a question from Teodor Sveen-Nilsen, analyst with Sparebank 1 Markets. I believe you have to unmute yourself, Teodor.

[Teodor Nilsen, analyst]

Can you hear me?

[Haakon Sandborg, executive]

Yes, we can.

[Jostein Løvås, executive]

Yes.

[Teodor Nilsen, analyst]

Great. Congrats on good Q1 numbers. Three questions for me, if I may. First off, on your balance sheet position. Of course, you now propose to increase your dividend, but just looking forward over the next few quarters, it won't be very surprising if you have a net cash position soon. So I just wonder if you could say anything about net gearing ratio, target ratio going forward. Do you intend to run the company with a net cash position? That's my first question.

Second question, Kveikje discovery. Any thoughts around development solutions and costs associated with that?

And my third question, just in general on the oil industry. Of course, cost inflation is a hot topic now and it looks like, at least on NCS, that is something that most operators are observing. Do you have any comments around that? And what do you see in Kurdistan versus NCS?

[Haakon Sandborg, executive]

Thanks, Teodor. Maybe I'll address your questions in sequence. Yes, on the balance sheet, our ratios and what we think about, as I mentioned already, we have a covenant in our bond facilities. That is based partly on an equity ratio of minimum 30%. So we think about it mostly in our company that we focus on maintaining a very strong equity ratio, which turned around and will give you the debt side as well. But that equity ratio is now at 37%. It's a good level. I personally like to see that go above 40% and stay above 40%. It gives us good headroom on the covenant if something should come up. So we're thinking about it that way.

We have in the past discussed what it would be, our minimum cash in the company. And you know, if you look back, that we have kept high cash balances over time. And that's also to have a conservative financial position and strategy that we are prepared to meet complications if we have that and to always be in a strong and liquid position. So we'll keep the cash at high levels. And I think we discussed internally at the moment, at least exceeding $400 million of cash in the balance sheet would be a prudent level. I mean, it can go up and down, but, say, that would be the floor that we think is very -- a strong level for us to keep.

On the Kveikje question, the development solutions, yes, I'm not sure I can answer that. But I just believe there are nearby infrastructure available, and this could be developed in a cost-efficient manner. But let's see if I have some input from others. Yes. I'm somehow not accessing that. Let's see.

Yes. I think my colleague help me saying it's several options tied to this highway or a ring road that I talked about. So I don't have a real answer on that just now. But there are several options that we have available, and that will be addressed as we develop, hopefully, this interesting and posing discovery.

Cost inflation, yes, that's becoming a problem more so now in the current situation. And yes, I'm going to say that, in Kurdistan, our main -- some of the main costs are around the drilling costs. We have good contracts with our main drilling contractors, long-standing relationships with the building contractors. So I think we can -- I think we're in cooperation with our business partners on the drilling side, can keep those expenses that they won't escalate that much. Some of the other services, we see cost inflation in Kurdistan, but not to any alarming effects so far.

Maybe more of an issue in the North Sea, that we see some of it there. And you'll see when it comes from steel prices that we use, but raw materials, et cetera. But I think it's more on the -- personally, I think it's more on the services side that you will see pressure. You see some of the oil service companies doing real well now and seeing a revival in their markets, which should then, in turn, will mean that they are getting better prices. So yes, I think the answer is there will be more pressure on the cost side, especially in the North Sea, Teodor.

[Teodor Nilsen, analyst]

Okay. Just on Kveikje, of course, I understand it's early days, so hard to comment on that. But is there any chance that you will be able to submit a PDO under the temporary tax regime, i.e., by end 2022?

[Haakon Sandborg, executive]

We'd love to do that, but that's going to be very hard to do, I think, Teodor. So we have to miss that window on that one.

On the other hand, the way it looks, that will be doing well even without the tax incentive support. So I think that's not going to drive it.

[Jostein Løvås, executive]

Then we have some questions from Nikolas Stefanou with Renaissance Capital in London.

[Nikolas Stefanou, analyst]

It's Nick from RenCap. I've got a couple to ask, please. So Haakon, I just want to go back to the balance sheet question. And I mean, calling back those bonds, presumably in a rising interest rate environment, the refinancing would be a bit more expensive from a cost of debt perspective. How does that tie in with your inorganic aspirations? Because I think you have stated in the past that you are quite keen on buying something out of Kurdistan. So if you could comment on that and perhaps the kind of like size such a transaction could be and how the capital structure could look like on the part of [indiscernible]. You are the CFO, how you kind of like think of that. That's the first question.

And then the second one is on the shareholder distributions. I just wanted to clarify if the NOK 1 per share, if that's kind of like a firm sort of like commitment to pay as dividend this year? Or is it -- would potentially you could do as kind of like an indication? And I also know that you have the -- you did ask for approval to buy up to 10% of the outstanding shares back from the market. I mean clearly you're not going to do that. But I just want to see how kind of like buybacks could fit in with these [ strict ] distributions this year.

[Haakon Sandborg, executive]

Good. Thank you, Nikolas. Good questions as always. Starting with the calling back of the bonds. As I already discussed, is also part of our debt management and how we do it. We have proactive, as I said, in the early prepayments and refinancing and always be with a long-term view on our long-term profile on our debt maturities. But does that tie into acquisitions and capacity to take on acquisition is the way I understood your question.

Well, when we take back this debt, we will still have a very solid position on our balance sheet. And we have high production, low costs and we generate cash flow. We think we'll be able to have an even stronger position going forward. So we will still have good capacity to do transactions and M&A that we have been looking for. Much of the recent focus has been on the North Sea for transaction opportunities. As you may have seen, I'm sure a lot of discussion that you also witnessed there is -- with the current oil prices, the high levels and the fluctuations, it's hard to agree on the valuations for M&A between the sellers and the buyers. So that's part of the reason why we haven't landed anything over the last year -- years.

But I think it's very safe to say that if we do it in the North Sea, we'll have very strong support from our RBL banks. That will be a part of the financing on an acquisition. And if there should be opportunities elsewhere, especially then Kurdistan, we will have to see what levels of size we can look at. But recently, most of the focus on M&A has been on the North Sea.

And then the NOK 1 per share dividend request to the AGM is to be seen as a request from the Board of the company to the shareholders so that we can dividend up to that level if that's seen as prudent and a good thing to do during the 1 year from the AGM that's taking place at the end of this month until -- a 12-month period until the next AGM next year. So we're not saying we're going to pay out all that NOK 1 in the first month, but it will be something the Board will decide how that's going to be done in parts or in full and when it will take place. So it's sort of up to that level is the authorization we're asking for.

I think your third question was on the 10% buyback on the shares. So that's sort of a standard authorization we have had in the AGM request to the shareholders for many years. It's been some time since we used it. We like to have full flexibility. And you will see that in the request to the AGM that we're asking for several repeating authorizations, and the request for buyback of shares is one of those repeating authorization that we like to have in place. So we have full access to opportunities if we see a good situation where we can use that or some of the other authorizations that we were asking for.

Yes. I hope I answered your questions, Nikolas.

[Nikolas Stefanou, analyst]

And just a follow-up. Now that -- sort of just a clarification on Baeshiqa. Are we still kind of like targeting the same kind of like exit rate that we spoke about last quarter? Or is it -- or do you [ casting might ] exit that?

[Haakon Sandborg, executive]

I'm not sure we discussed, Nikolas, the exit rate. We had...

[Nikolas Stefanou, analyst]

I think what [ the general ] is saying was around 8,000 barrels per day.

[Haakon Sandborg, executive]

Sorry?

[Nikolas Stefanou, analyst]

I think what [ the general ] is saying was around 8,000 barrels per day on a gross basis.

[Haakon Sandborg, executive]

Yes. So we could easily get to that level, I think, if we can get drilling on the 3 wells we are targeting this year together with the 2 wells we have already in the discovery wells. So that's fully possible to get to that level. So we are drilling now, as I said, Zartik-2 and then...

[Jostein Løvås, executive]

Sorry. I think we said 4,000 for the year in the previous set, not 3....

[Haakon Sandborg, executive]

That's what I'm saying. That's the average. But I think Nikolas is discussing the exit rate, 10,000 apparently was mentioned. So I can just confirm, Nikolas, we would be able to get there if we can get these 3 wells done and the development program done the way we plan. And awaiting the remaining government approvals to get all this work completed by year-end.

This was intended as a short call. Maybe Jostein, you will manage the remaining part of this and...

[Jostein Løvås, executive]

Yes. I think we will close now. There's -- I think Teodor asked a quick follow-up question. That would be the last, I think, from -- for now. Sorry. I think you have to unmute yourself.

[Teodor Nilsen, analyst]

Just a short follow-up, maybe it's not that short. But it's regarding cash dividend versus buybacks. Any comments on your preferences between those two choices?

[Haakon Sandborg, executive]

Yes. We have -- had started a dividend program some years back and wanted to have sort of a long-term reliable and something you could understand what will be coming dividend program, then we have the unfortunate drop in the market with COVID, especially in 2020. So we suspended the dividend payments. So we want to come back now to a long-term dividend program so that people can know what to expect from the company. So that's going to be one target, is to have a long-term dividend program. So that's one preference.

Then dividends versus buybacks, well, I don't know that [ we'll give clear priority the other way ], but this, we want to keep this dividend program in place for the benefit of our shareholders. And if there's an opportunity to do something on the buybacks on the shares as well, I'm sure the Board will discuss and consider that. But what has been established is the ambition and the target to carry out a long-term dividend program. So at least you can look for that and then that will then maybe be complemented by buybacks.

[Jostein Løvås, executive]

Okay. I think this earnings call is over, and we thank you all for taking part. And we look forward to see you on the next occasion.

[Haakon Sandborg, executive]

Very good. Thank you all.

[Jostein Løvås, executive]

Bye.

[Haakon Sandborg, executive]

Bye-bye.