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Earnings Call Transcript 2022-Q2

[Jostein Løvås, executive]

Good morning. Welcome to DNO's Second Quarter 2022 Earnings Call. My name is Jostein Løvås. I am the Communication Manager of DNO, and I will share some practical information. [Operator Instructions] We will start with a brief results presentation by CFO, Haakon Sandborg. After which, we will open for questions from shareholders and analysts. Executive Chairman, Bijan Mossavar-Rahmani, is also present on the call. [Operator Instructions] With that, I leave the stage to the CFO.

[Haakon Sandborg, executive]

Good. Thank you [indiscernible]. Hello, everyone. I hope you are enjoying a great summer, and thanks for taking the time to attend this discussion of DNO's Q2 operations and financials. This time, we kept the presentation fairly short and to the point, so I will focus on the main Q2 highlights and on the key financials for the group. As Jostein said, there will also be a Q&A session at the end to cover any questions that you might have.

It's a nice photo that you see on the front page of our presentation is from truck loading with crude from our Baeshiqa license. And you may know that DNO has been known as fast trackers for our field developments, but now we're also known as fast truckers, so that's good to see.

Let's move on to the next page -- slide. [indiscernible] Okay, to get started, let's begin with the Q2 highlights. We clearly had a strong second quarter with a further cash flow growth and significant strengthening of our balance sheet. We are thereby now in a net cash position for the first time since 2018.

Obviously, the high oil and gas prices are powering this positive development, but this also saw the contributions from our high-performance operations and the regular contractual payments from the KRG. As such, in our operator Tawke license in Kurdistan, we continue to deliver high production from the Tawke and Peshkabir fields with some growth in production now to over 80,000 barrels of oil per day. We are pleased to see that the natural field decline is being arrested and even reversed through our billing and development programs, including at the Tawke field.

As you can see on the slide here for our North Sea operations, the Q2 net production dropped a bit to 11,600 BOE per day from 12,700 barrels per day in Q1, and that was primarily due to planned maintenance at the Ula field. As for the new assets, as I mentioned, we also certainly at least started off production and trucking from the Baeshiqa license in mid-June, and that's initially producing from the Zartik-1 discovery well. We will now be drilling additional wells and engage in further field development and [ basal ] work to build up production from this exciting license.

We further maintain high development activity in several North Sea licenses, including on the Brasse project. We are now past the [ Phase 2 ] on this project, where it is ongoing on the feed studies, and we are on track for the planned PDO sanction for the year-end this year.

If we move on the next slide, and now moving over to our financial reporting, these are some of the key figures for Q2. We are again pleased to deliver high quarterly revenues at $361 million, up 6% from the first quarter. Kurdistan accounted for $239 million of the Q2 revenues. That was up from $209 million in Q1, mainly on the solid production and the higher oil prices. North Sea revenues came in at $121 million in the second quarter, down from $131 million in Q1. And the main drivers here include lower achieved gas prices this time, partly offset by higher oil prices and higher crude liftings.

Now on the other hand, unfortunately, we had a big drop in operating profit in Q2, down to $81 million from $236 million in Q1. This is primarily due to impairments of $127 million mainly on the Ula field but also from exploration expenses at $48 million, mostly from expensed exploration wells. So with these impairments and exploration expenses, our net profit also dropped significantly in the second quarter to a level of $72 million, but this is after some offset from tax income in the quarter.

Just to mention that also important that on a year-to-date basis through the first half of this year, it should be noted that we have basically doubled our revenues, operating profit and net profit from the same period last year. And we had strong operations and higher commodity prices.

Fine, let's go on to cash flow. And as you may know, and as we have mentioned in the past, this has long been one of the key strengths of our company here in DNO on the cash flow side. And for Q2, we are pleased to show further increase in operational cash flow to a strong level of $341 million. This is up by $65 million from Q1 admittedly with new support coming from a $54 million positive working capital change that in turn was partly coming from reduced KRG receivables due to the payments we received in the quarter.

We have paid 2 Norwegian or NCS tax installments of total $25 million in Q2. So with this, we completed the repayment of tax refund adjustments for 2021. During the second half of this year, we currently expect to pay $5 million in Norway with the first 3 tax installments of the tax year 2022. In addition in the second half of this year, we will receive a $19 million tax refund from the U.K.

As discussed and in line with our guidance for this year, we increased investments further in Q2 to $134 million. This was mainly for CapEx at $78 million and for capitalized exploration at $36 milli. In addition to the decomm work on the Schooner and Ketch fields in the U.K. accounted for $20 million in Q2. The net finance outflows of $230 million were primarily for buying back $203 million of the DNO03 bond in Q2.

So all in, we thereby continue to finance higher investments and debt reduction through our strong cash flow. But at this time with the high bond buybacks in this quarter, we had some use of cash, $47 million in Q2. But I'd say, with -- we are still in good place with cash balances of $801 million at the end of the quarter.

Our free cash flow increased again to $167 million in Q2. And looking forward, we see a positive outlook for continued strong free cash flow generation also in the second half of this year.

Next one. Here, we have our capital structure. We continue to strengthen our balance sheet through the increasing cash balances, reducing our debt. And as I mentioned, we turned net cash positive in Q2. We have thereby had a remarkable route from net interest-bearing debt of $396 million a year ago to a net cash position of $129 million at the end of the second quarter.

As you see on the right here, we also have increased our equity ratio significantly to 42%. With the bond buybacks, we canceled $224 million of the DNO03 bond in Q2, and that left a remaining outstanding balance of $176 million in this bond at the end of the quarter. We have since bought back an additional $25 million in DNO03, and that reduced the current outstanding amount to just over $150 million.

I think I brought that before, but in addition to the strong balance sheet, this material reduction of debt that obviously also reduced interest expense and freed up cash flow for other purposes.

So next slide, looking ahead and on the back of current high activity and drilling of new production wells in the Tawke license, we now expect gross production from Tawke and the Peshkabir fields for this year to come in between 107,000 to 109,000 barrels of oil per day, and that's well above the previously guided level of 105,000 barrels per day.

I can note here that we have added another drilling rig with the Tawke license in June, so we currently have 4 rigs in operation here.

For the North Sea, we built 4 exploration wells in the first half of this year that added 1 good discovery, and we will follow with 3 additional exploration wells in the second half of the year. We have, right now, so give the value [indiscernible] to 4 NCS discoveries over the last 2 years, so our exploration program is really starting to pay off. With the Kveikje discovery this year, we have now added to our strong position in the attractive [indiscernible] area, and we look forward to drilling another exploration well in this area in Q4 this year. Otherwise, we have this less projected operational spend for the full year of $800 million, and that's in line with the guidance that we gave earlier in the year.

We have, based on the shareholder approval of an increased dividend authorization at the DNO AGM in May, we have now further announced a NOK 0.25 per share quarterly dividend to be paid later this month. In dollar terms, this equals about $25 million in total for this quarterly dividend.

Okay. So to sum up, we are growing organically through exploration and development. We are gaining dividends. We are buying back bonds, and we are building cash balances. In addition, we are certainly also looking to grow further by use of our financial strength to invest in new business opportunities. This will be within our core oil and gas competence.

For this purpose, we are now active in the business development discussions in the North Sea. And we are also looking at investment opportunities in new areas outside of our existing operations. So we will, of course, alert to you when we have progress to report on these new investments.

So again, thanks for your attention. I think we can now move on to the Q&A session.

[Jostein Løvås, executive]

Okay. I think at this stage, we have a question coming up from Teodor Sveen-Nilsen. He's an analyst with Sparebank 1 Markets.

[Teodor Nilsen, analyst]

I have 3 questions. First one on just your balance sheet. Of course, you have a very strong balance sheet now as you alluded to a net cash position. Should we expect DNO to run with a net cash position going forward? Or should we expect increased buybacks or dividends? So that's the first question.

Second question is on these rulings to assume [indiscernible]. We saw the Supreme Court ruling in February, and the car commercial court ruling now recently. Just wonder what's your thoughts are around these rulings? And does that impact your strategy or appetite for investments in [indiscernible] at all?

Third question is on Baeshiqa. Thanks for the update there. As far as I remember, you mentioned that exit rate of 8,000 barrels per day in your first quarter. Is that still valid, that you expect to be able to produce 8,000 by end this year?

[Haakon Sandborg, executive]

Thanks, Teodor. I'll start on the first one on the balance sheet. Yes, well, as I said, we are very pleased and happy with the strong strength of the balance sheet that we have achieved over the last couple years. They are now sort of back to where we were several years back when we had a strong position. So whether we will run with a net cash position or not, that's not really the target. We'll always see discussions on capital allocation and new investments and share buyback, bond buyback.

But I think to me, one of the things I look for is the equity ratio. We are now well above 40%. I think that's something we would like to try to maintain a strong balance sheet by having a good equity ratio like that. That's what also we'll guide you on every [ reveal ] around the debt levels. But in general, we're quite interested in more of the bond buyback opportunities. That will depend on the pricing and the market developments that we see, of course, also our use of our funds. But in general, interested in bond buybacks. And I know some of the investors have contacted me directly for possible discussions on that, and I'm available. So I'd like to say, here's my phone, and give me a call. I'll be able to discuss with you on the bond buybacks. But I think we're happy with where we are now in general and the balance sheet. So I think it might go up and down, the net interest-bearing debt or net cash situation the other way. But in general, we are now in a good place with our capital structure.

On the supreme court ruling, I'm not sure...

[Teodor Nilsen, analyst]

Can I just add a follow-up on that? Also just to be clear, is the pecking order is the bond buyback is probably higher on the agenda than dividends or buybacks, if I understood you correctly.

[Haakon Sandborg, executive]

No, no, I wouldn't say that. We are -- we have announced the quarterly dividend today, and that's important. Also managing the debt level is important and, again, looking at new investments. So as I say, the capital allocation here to use the word financial strength, we have to weigh these opportunities against these other. So I wouldn't say one is more important than the other, like you are saying. But this is a total consideration that we go through.

Okay. On the Supreme Court to the discussion around the trade scam. [indiscernible] on that?

[Bijan Mossavar-Rahmani, executive]

I don't have very much to add to this issue that has already been very widely reported. And I know those of you who follow the company, the shareholders or analysts, are well familiar with the issues. I can only say that as long as I've been Chairman at DNO, which is going on about 10 years now, and while trying to determine these issues in one form or another, were -- have been raised, we continue to run through [indiscernible] to invest operate and increase production and be part of the Kurdistan economy and the oil sector, and that all continues.

Our operations continue as before. Our investments continue as before. We are firmly committed to Kurdistan. This time, the challenges aren't different than the prior challenges. There have been court hearings and -- in which we have not participated. We have not been represented as far as we are concerned. Our contracts were signed with the Kurdistan regional governments. They are governed by English law. And we are part of the political process that has led to some of these challenges and issues, and we have the full support of the Kurdistan government. We continue in terms of our operations and our commitment to our investments on a business-as-usual basis. I believe that is the position of all the other companies that are active -- [indiscernible] oil companies are active in Kurdistan, and we will watch developments as they occur. But for us, it's business as usual. And we believe the predominant current contract regime is a positive one. [indiscernible] it's been part of the reason Kurdistan has been so successful creating the very active and successful oil and gas industry without any sharing contracts. [indiscernible] invested in Kurdistan. They've been around 70, 80 years. There must be 70, 80 countries throughout the world that have provided sharing contracts. As the legal structure of their international -- when they asked the structure of expected industrial company participation, it works -- it's worked well for them. There's a reason production-sharing contracts are the contracts of choice. They are -- they create the right incentives for companies to invest and to be rewarded on the success. And so there is -- we believe that we are within that international legal and operational structure, and it's worked well for all parties and that we would hope and expect that, that would continue.

[Haakon Sandborg, executive]

Thank you, Bijan. The third question was on Baeshiqa and what to expect on production ramp-up. So we are currently producing fairly lower volumes from the first discovery well, as we mentioned. And we'll be running 3 more wells. We expect to have those mostly done by the end of this year. So there's been a bit of a delay here DNO still getting everything in place so ramping up. So I'll be a bit careful by giving you a precise estimate on the exit rate, on the production rate at the end of the year. It sort of depends on how fast and how successful we are in drilling these 3 wells and the results that we will see from these wells, of course. So there's a learning curve with any new assets like this to understand at the pace of what do we have here? And we think we have a good idea, but there's more work to be done to understand this better. So as we become more familiar with this, we'll be able to come back to the investors and discuss a bit more on how we see production coming out going forward.

But we're happy to be in development phase now and in production, and drilling has started. And it's working well so far. And as you know, we track it off to our [indiscernible] export terminal and ship it out with the pipelines from there. So all in all, things are moving forward, but I'll be a bit reluctant to give you an answer at this stage.

[Bijan Mossavar-Rahmani, executive]

I think [indiscernible] that Baeshiqa and DNO's operations is that because of our operational style and culture, and because these are onshore fields that we -- even as we've learned more about the fields through the development drilling, we produced and learned at the same time. So our line, of course, as you all well know, an offshore project where you can drill multiple wells that have a huge [indiscernible] confidence and a sense of what's the [indiscernible] of your production before you order the platforms and spend much larger sums and time putting a development project base.

We've put a discovery well on the production as we drill additional wells. So we put them out on production. We have -- as Haakon mentioned, a trucking system in place to move it immediately to market as soon as we're given the go-ahead. It didn't take very long for us to start production as [indiscernible] exporting and start earning revenues on the sales of the oil, which is under the same regime as -- the pricing for an oil regime as we tuck in Peshkabir fields in the [indiscernible].

Expect that when we do, we're going to have production as we continue to drill, and we're still very much excited about the opportunities at Baeshiqa. Hopefully, at some point when we're further along, we will arrange as we've done in the past to organize analyst and shareholder trips to Baeshiqa. It's a wonderful and historic part of Kurdistan and Northern Iraq, and it's always to me, personally, is a pleasure to go there and so much history.

We saw the history and nature. And so I would hope in-not-too-distant future, we'll have an opportunity to invite those to go out there see for yourself and what we're doing at Baeshiqa and catch up on what we've done further at Tawke, and the private license is at Peshkabir. It's a pretty impressive operation and a large [indiscernible] and continue to expand.

[Jostein Løvås, executive]

I believe the next question comes from Tom Erik Kristiansen at Pareto.

[Tom Kristiansen, analyst]

With the growing cash pile you have now, you clearly have a lot of capacity to do M&A, and you can do big transactions compared also to the size of the existing business that is substantial, of course. Can you say something about what you're seeing out there, where you are looking? I think a lot of people have expected Norway to be a direction you are looking, of course. But can it also be offshore West Africa or other places where you can use your long history in emerging markets as well?

[Bijan Mossavar-Rahmani, executive]

Could be. It could be. I think because of the strength of our balance sheet, because of the cash flow stream, for us, looking at options it's not just a question of are we out into the market looking for things. The market's coming to us. Others pay other companies to look at our balance sheet, and they know that we're in a position to move and have -- want to move fast on other opportunities. So both a push and pull, and there are opportunities that we are looking at. And some [indiscernible] basis, others in more advanced stages and not to mention when we have something to report, obviously, to all the [indiscernible], of course, you will be the first to know. But we are actively looking, and we are -- it's both strength for us from me from and the market and other peer group companies.

[Haakon Sandborg, executive]

And of course, from a point of view that it's important to even find and engage the transactions that we had a new value, and looking to grow our production in Norway is high on the priorities. But as we mentioned also looking at, elsewhere now -- and also to see like on mentioning that we are getting an incoming interest coming our way. So like to look at it and work on. So hopefully, we'll come back to you quite soon on if you have success and are making good progress.

I think we have other questions, Jostein.

[Jostein Løvås, executive]

We don't. So unless Tom has a follow-up question, Sorry?

[Tom Kristiansen, analyst]

Yes, please, one follow-up question here before the team here is back to kind of the debt level. Is there an absolute debt level that you feel is appropriate for existing business kind of how much step would you like to repay? Or put it another way with just kind of how the cash flows are coming out of Kurdistan and the cash pile is growing, is there kind of a limited -- if you cross $1 billion, for instance, of a cash balance, will that trigger dramatically bond buybacks, buybacks of shares or higher-yield one-off dividends, something like that? Is there any kind of figures you should look at that going forward?

[Haakon Sandborg, executive]

That's a good question, but I don't think I'll give you a precise answer. But you've seen that we've been very active in the bond buybacks and with our debt reduction in Q2. We have made strong progress in strengthening the balance sheet. It would be kind of natural to look at the shorter dated DNO03 2024 maturity. But we would also look at the 2026 maturity DNO04 potentially.

So it's a [indiscernible] question on what the better return would be. But as I said already, is another question -- looking at the balance sheet, looking at our equity ratio, there's no absolute level. If we have a major transaction, we might move up again on the debt level for the temporary levels. We expect to come down again with a good cash flow.

I think we are in a good place where we are now. We can displace any further short term. But we do want to grow, and we want to use our investments -- our capital into new investments. It will sort of fluctuate over time as you see the balance sheet in the vest. But it's good to be where we are now and spending each other quarter-by-quarter. So we have a lot of financial flexibility now.

[Jostein Løvås, executive]

Okay. With that, I think we'll just wrap it up, and thanks to you all for participating, and we look forward to seeing you again on a later occasion.

[Bijan Mossavar-Rahmani, executive]

Bye.

[Haakon Sandborg, executive]

Bye-bye.