Peyto Exploration & Development Corp

TSX:PEY

Earnings Call Transcript 2021-Q2

[Operator]

Hello, thank you for standing by. Welcome to the Peyto's Second Quarter 2021 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference may be recorded. [Operator Instructions]I would now like to hand the conference over to your speaker today, Darren Gee, President and CEO. Please go ahead.

[Darren Gee, President, CEO & Director]

All right. Well, thanks, Josh, and good morning, everyone. Thanks for tuning in to Peyto's Second Quarter 2021 Results Conference Call. Before we get started today, I would like to remind everybody that all statements made by the company during this call are subject to the forward-looking disclaimer and advisory set forth in the company's news release issued yesterday. In the room with me today, we've got pretty much all the Peyto management team. We've got JP Lachance, our VP of Engineering and Chief Operating Officer; Kathy Turgeon, our Chief Financial Officer; Scott Robinson is here, our VP of Business Development; Dave Thomas, our VP of Exploration; we've got Todd Burdick, our VP of Production here; and Derick Czember, our VP of Land. The only one missing is Lee Curran, our VP of Drilling and Completion. He is tied up this morning covering some operations on the drilling side. Before I get started with comments about the quarter today, I do want to recognize the efforts of both our office and field personnel this past quarter. They continue to conduct operations with safety foremost in mind. And although we're coming out of the COVID pandemic, that's still very much in everybody's mind in terms of health and safety of our people. And of course, as always, we've got operational risks where we've got a lot of rigs running as we do now that we have to keep track of on an ongoing basis. We haven't had any major incidents or outbreaks of COVID that shut us down, which has been really good, especially considering we do have active drilling crews and frac crews and pipeline crews, all working within our areas of operations. And our own people, obviously working in and around plants, doing turnarounds this quarter particularly and even into Q3 here. And so we've done a great job, I think, keeping the pandemic at bay, and it was another strong safety quarter. So well done, everyone. Onto second quarter results. Operationally, drilling and completions were very successful in the quarter with breakup, obviously shutting us down in the middle of the quarter. I think breakup this year was more or less normal in terms of how long we had to stay shutdown to see the frost come out of the ground and to dry everything out so we could move around again. We did shut 2 rigs down during breakup for some maintenance and upgrades, and that kept them on the sidelines, unfortunately longer than we had hoped. We were getting some upgrades that were making them more efficient. So we're happy to see that, but we were hoping to get them back to work a little sooner than that. And we came back after our breakup, obviously, a little bit behind our capital program and our drilling schedule. And that combined with some unexpected participation by one of our partners meant that our net drilling activity was a little more behind than what we were scheduling in Q2, and we want to catch up to that. So we've added a fifth rig as of the start of August, and that fifth rig should help us catch up even more than what we missed there by the end of the year. So we'll be in a good position going into the winter for some strong gas prices. Production held up pretty well in the quarter despite the fact that we didn't add as many new wells, obviously, in Q2, typical with breakup than we do in Q1 or other quarters. And our run time was really good other than that really hot week in June that impacted both ours and even more so the northern gas plants' throughput. What happens in the hot weather is that the big engines on those gas compressors begin to labor due to high temperature and end up getting either slowed down or even shut in. And we definitely saw that in that last week of June where at times, we saw Nova receipts drop from 12 Bcf a day to 8 Bcf a day in the heat of the day. And so our compressors are designed for some relatively hot summer days. We've got some fairly big cooler fans on them, that does experience some pretty good heat in the summer. So we didn't see that kind of an impact necessarily on our production, but we did see some. And of course, everybody, including all the houses in Alberta, saw the effect on power prices in the province for that week. We took a bit of a hit, obviously, in our op cost in the quarter due to that spike in pool prices for that week, I think we saw prices jump from about $50 a megawatt hour to at times $1,000 a megawatt hour. So unfortunately, pool prices took a hit. And since we do consume some power for our refrigeration plants, our operating costs were a little bit higher in the quarter than what we would have liked. But those have since obviously come back down again. In general, I'd say well results continue to come in better than expected, particularly our extended reach horizontal wells that we're doing, and our drilling down in the Chambers area has been very successful. We're finally seeing, obviously, the results down there. And we're also seeing the first of our results on the acquired lands in Cecilia, and those look really good. We do have a couple of turnarounds to finish here in August, and then all those great wells that we've been drilling will start to come on stream and boost our production from around the 90,000 barrels a day mark up to the year-end, where we expect to exit around 100,000 barrels a day just in time for winter. Speaking to gas price, the futures strip has strengthened a lot over the last quarter or so, such that our type well economics look even stronger, exceptionally strong, in fact. Those new economics are shown in our updated presentation on the website. We didn't get to see obviously the full effect of that increase in our realized prices and on our cash flows this quarter due to existing hedges, but as those hedges roll off, our realized price will rise substantially. That's also shown in the presentation. That said, our realized Q2 prices were still way up from a year ago, and that helped lift our cash flow close to 150% from $33 million in Q2 2020 to $82 million this past quarter, and we should see substantially greater lift even as we get into this winter and some of our basis differentials roll off even more. Cash costs per Mcf were a little higher than what we want, mostly due to royalties and transportation, which are a couple of things we don't have a lot of control over. We should see our OpEx and interest costs continue to fall as we go forward, especially as our volumes go up, but also as our net debt comes down, and we'll see lower interest payments. We are still, according to my check of the industry, the lowest cost producer in the industry as far as I'm aware. So we're still well ahead of the rest of the industry. Obviously, the royalty costs have gone up substantially with higher commodity prices. And that's affecting everybody's cash costs. But those controllables that we have, we're keeping those costs down. So good job to the team in keeping those costs in check. As far as maybe a more recent update goes, we're excited that we're building a new gas plant again this time down in our Chambers area. It uses a lot of equipment that we already have in inventory, and it will make production in the Brazeau area more efficient as right now, our gas has to travel quite a distance to get to our plant. And we'll be putting this plant basically right on top of the reserves that we're developing down there. We're excited that this is going to be our most environmentally friendly and efficient plant that we've ever built. We're going to put as much new technology into this plant as we possibly can to lower its emissions intensity. And of course, this plant increases our infrastructure footprint in the Brazeau area significantly, which tends to give us strategic control and provides additional processing flexibility really for the area, because we'll have 2 plants now, flexibility both to us and arguably processing capacity even for others in the area. Speaking about environmental performance. We released our first ESG report in the quarter. That's also up on our website. And it talks at length about all the environmental initiatives that we have on the go, to lower our emissions intensity going forward, things we're working on today, and what we expect into the future, all of which contribute to making our production even greener. Natural gas, obviously, is one of the greenest hydrocarbon fuels that we have at our disposal today, and we're trying to make ours as clean and green as possible for consumers. Longer term, we stated that we're investigating several options for carbon sequestration and underground storage. We have our big sunny empty storage cavern right underneath our main operations in the Greater Sundance area that could come into play for that. We've also been investigating several deep Devonian reef complexes that sit underneath the Greater Sundance area that we could potentially use for CO2 disposal and sequestration. So lots of good technology coming down the pipe. And I think Canada will likely be a leader in the world when it comes to capturing and sequestering CO2, making our hydrocarbon industry, one of the cleanest in the world. So we're excited to be part of that. Anyway, that's pretty much it for the quarter. It was, I think, both a solid quarter operationally, and our financials are starting to improve. We're looking excitedly into 2022 when things get significantly better for us even. And so that's pretty exciting. But Josh, why don't I stop there and we'll throw the call open to any questions from those listening in.

[Operator]

[Operator Instructions] Our first question comes from Dan Nelson, private investor.

[Unknown Attendee]

Just wondering if you could give us a quick update on your CapEx spending for the full year, now that you've added another drilling rig and you're going to start on the new gas plant this fall. I think the old range was, what, $300 million to $350 million?

[Darren Gee, President, CEO & Director]

Yes, that's right, Dan. And I think we're still sort of targeting that upper end of the capital guidance at about $350 million. We'll see towards the end of the year, how much partner participation we see in some of the joint wells that we've got. That's a bit of a tricky thing for us to try and forecast. In the past, we were sort of forecasting that partners weren't going to be participating in wells and then lately partners have been participating in wells. So that changes our net capital outlay. And so that's one of the things that can sort of provide a bit of variability to what our capital forecast is going to be. The new Chambers plant -- we've got design underway going right now, obviously, and permitting and all the rest of it well underway. We own all of the existing equipment, virtually all of it anyway that we're going to be putting into that plant. So the early payments for new facilities, we don't have in this particular plant. Really, a lot of the capital outlay is going to happen during the construction part of it, where the labor, obviously, and the install is done. And I believe the majority of that is in Q1. Just looking over Todd Burdick here, VP of Production, and he's nodding his head that yes, we would typically say that a brand-new plant might be at the upper end of cost about $1 per million cubic feet of -- $1 million per million cubic feet. So a 50 million cubic foot a day gas plant might cost upwards of $50 million to build. I think the budget for this one was lower than that, probably closer to about $40 million. But again, half of it is kind of the install cost and half of it is sort of the equipment cost. And so if all the equipment is already paid for, then really it's less than $20 million that we would be looking to lay out for the installation at this plant site. I think we were thinking more like $17 million, $18 million, I think, is what you guys were kind of expecting. So really, that $18 million of capital is likely to occur in Q1, not Q4. So it doesn't -- this gas line doesn't really affect our capital program for this year at all. The fifth rig as you mentioned, under normal circumstances, obviously, would increase our capital spending. But again, we're sort of catching up to capital that we didn't spend in Q2. We'll get that deployed here in Q3 and Q4 to catch us up to our schedule to get to that $350 million number. And then a little bit of uncertainty still just with respect to where our partners are. So that upper end of the guidance is where we're targeting, but it could be a little bit higher than that, it could be a little bit lower than that, depending on participation levels by partners in the last half of the year.

[Unknown Attendee]

Okay. And incidentally, thanks for that comment on the possible free cash flow at the current strip prices and your CapEx plans over the next 4 years. That was a nice little nugget.

[Operator]

Our next question comes from Brent McLean with private investments.

[Unknown Attendee]

Darren, I'm wondering, as you get new production brought on in the coming months, if you're going to hedge that production? Or will you allow that new production to capture spot pricing?

[Darren Gee, President, CEO & Director]

Brent, we have a pretty mechanical hedging program that sort of looks forward into the future. We've got sort of levels that we're trying to get to. There's sort of a stair-step profile that we're trying to continue to hold that we build out into the future. So we are still hedging small amounts into the future. It's obviously a tough time to hedge because the current price is so much higher than the future price. The forward curve is backwardated quite steeply. As I indicated in the press release, 2022 prices, I think, are -- what are they -- I forgot what I put in here, even 330-ish, while 2023, $276. So it does fall off pretty hard into the future. But we're still taking those future prices off the table slowly. This is the challenge, obviously, in a rising price environment, you're going to see that backwardated forward curve and the spot price is always going to be higher than the future price. But that long-term future price is still very attractive for us. The economic return we generate on our drilling inventory is really good at $250 plus. And so anything over that is a real bonus. The spot price, obviously, is higher. In a rising price environment, that's going to be the case. In a falling price environment, what we had for the last almost decade, we were gaining on our hedges. And we would fully expect that probably in a rising price environment. We're going to be losing a little bit on our hedges on the way up because we're always going to be taking a lot of that future off the table. But I always have to remind everybody, including ourselves that our hedging program is not designed to win or lose, it's really designed just to smooth out the future volatility. And if at the end of the day, we come out with 0 gains, 0 loss, then it's achieved everything it's supposed to achieve at no cost, which -- a future -- confidence in the price by having a fixed price out there in the future is like insurance. Typically, you have to pay a premium for insurance, some sort of monthly premium. But in this case, if we can get away with getting that insurance of commodity price and not having to pay any premium, then I think we're doing really well over the long term. But we fully expect to have hedging losses as the price is rising, and we'll have hedging gains as the price falls. And that's just sort of the nature of how we're forward selling. But as I mentioned before, the forward price -- every forward price we look at looks very constructive to our economics. So we're happy to be a price taker and just take those future prices off the table.

[Operator]

[Operator Instructions] Our next question comes from Jerry McAfee, private investor.

[Unknown Attendee]

A couple of questions. But the first is about bank costs, interest costs and the increased bank charges that had come on last year. I noticed the -- in the report that the bank costs seem to have come down a bit. In a prior conference call, the expectation had been that somewhere around the fourth quarter, the effect of the improvement in the financials and its impact on extra bank charges that, that would be seen in the fourth quarter and that, that was somewhere in the vicinity of -- on an annual -- excuse me, on a quarterly basis, about $5 million a quarter. So question one is, is that still the expectation? Or did some of that already come in? Question two also relates to that is, if you're able to cast further light on the plan in the new year around debt and for instance, there's a note coming up next September, one of your higher cost ones, it's not bad, and $25 million came in extra this quarter, I'm just wondering what our debt repayment thoughts are. So bank charges and debt repayment.

[Darren Gee, President, CEO & Director]

Yes. Great question, Jerry. I'm going to loop in Kathy sitting beside me here to talk a little bit about the interest charges that we're forecasting. So Kathy, our grid is such that as our debt comes down, our interest charges go down?

[Kathy Turgeon, VP of Finance, CFO & Director]

That is correct. But it comes down in steps. So as our leverage comes down, then we have a lower stamping fee, which is the major component of our interest cost. So we have an underlying bank interest costs which as we all know is extremely low and then a stamping fee is based on leverage. So it has been quite high. So as that comes down, every reduction in leverage will generate -- kind of a movement to a lower grid. So we're going to see that in steps over the next while. So when we came back in compliance under 3.5, that generated a lower stamping fee, not the lowest by any means but lower. Now in Q2, we came under 3x, which will now on a future basis, generate a lower stamping fee again. So then we see that interest rate come down. And as we move down the leverage tier, we move down the stamping fee cost. And so we see over time a reduction in the interest rate to kind of a normalized rate of just over 4% -- 4.25%, whatever, including all the notes, et cetera, would be our more average rate. We're going to see that in 2022 more so. But by Q4 2021, I mean we should be moving down to a pretty normal rate.

[Darren Gee, President, CEO & Director]

Yes. And so to go even further, that's the interest rate. But as you mentioned, we are obviously reducing the debt that we're paying that interest rate on as well.

[Kathy Turgeon, VP of Finance, CFO & Director]

Right.

[Darren Gee, President, CEO & Director]

So this year, maybe not as much debt reduction as we're forecasting for next year. Next year, we're forecasting quite a dramatic debt reduction because our free cash flow jumped so much. Get rid of a lot of these hedging losses. And a lot of the basis deals that we had in place that were high cost and our cash flows improve substantially, and that gives us a lot of free cash flow then to apply to the debt. That brings the debt down. And at the same time, the interest rate charged on that lower amount of debt is lower. So those 2 compounding factors obviously bring our total interest charges down every quarter that we're going out into the future by quite a bit.

[Kathy Turgeon, VP of Finance, CFO & Director]

So of course, the notes are -- the rates are fixed downhill. So...

[Darren Gee, President, CEO & Director]

Yes.

[Kathy Turgeon, VP of Finance, CFO & Director]

So that leads us to the next note or the first note term date, which is September or -- no.

[Darren Gee, President, CEO & Director]

Yes, September of '22.

[Kathy Turgeon, VP of Finance, CFO & Director]

September '22. So we're looking at options for those notes and in discussions with blenders. Obviously, the rates that we are charged is going to be a big factor. Free cash flow would be a factor, but it's still a bit soon to have a definitive plan.

[Darren Gee, President, CEO & Director]

The balance sheet is obviously getting quite a bit stronger. And so the concerns of that going forward are mitigated quite a bit. There's still, I guess, overall or underlying concern with respect to inflation and rising interest rates and how much debt we want to carry into a rising interest rate environment, if that's what we end up getting. And we're looking closely at that. I think with obviously all the debt that all the countries in the world have racked up, there's the expectation that we will get inflation and higher interest rates out there. We need to make sure that we've prepared ourselves for that and ensure that either we can lock in lower rates or we're paying down debt to reduce our total indebtedness that we have to pay interest on. Did that answer your question, Jerry? Thanks.

[Unknown Attendee]

Yes, it did. Very good.

[Operator]

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back over to Darren Gee for any further remarks.

[Darren Gee, President, CEO & Director]

Okay. Thanks, Josh. We did have a couple of questions coming in overnight from analysts and investors that we would like to address. One of them I want to point to Dave Thomas, our VP Exploration. There was a question just about our Chambers plant and the inventory -- future inventory we have down there to support that brand new plant. Dave, can you maybe address that question?

[David Alan Thomas, Vice President of Exploration]

Sure, Darren. We have close to 150 drilling locations on our Chambers lands. It's a really good mix of Cardium, Notikewin and Wilrich targets. And that includes over 50 extended reach lateral wells. Assuming the outcomes remain similar to our current results, we could keep the new Chambers plant full for over 10.5 years with just that inventory. And that leaves plenty of scope to continue flowing extra gas up to our Brazeau plant or to expand the Chambers plant at some point in the future. We'll also continue to grow our Chambers land position and to add to our existing inventory, just as we've done for years at all our other plants. So this is just a snapshot in time, but it's definitely looking quite good down there right now.

[Darren Gee, President, CEO & Director]

That's great. Thanks, Dave. One of the other questions that came in was with respect to our ability to generate so much free cash flow over the next 4 years that we can completely eliminate our debt and the fact that at current prices anyway, our economics look very attractive. So JP, maybe I can loop you into this question. The question is really, if our economics are so good and we've got so much free cash flow, why aren't we putting more capital to work, drilling more wells, growing production faster?

[Jean-Paul H. Lachance]

Yes, good question. I guess, first of all, our type well economics as we look at them today with the latest strip, they have -- actually, this is put on our website now. This information is up there, latest template for returns on our type well. This -- a lot of these wells have shown payouts of less than a year or just over a year. So I mean, obviously, that's something we haven't seen for quite a while. I mean, that's a lot to do with price, obviously, but also with the efforts of folks here trying to get costs down and improve results too. The quick payout certainly helped with the capital allocation decisions since we can take price uncertainty off the table, obviously. But your question is why don't we do more? Firstly, I think we should look -- we looked at our 5-year plan here, a model where we continue to spend at the levels we're at this year, say roughly $350 million of capital investment over the next 5 years, this year and the next 4 years. And it shows we can grow our production roughly about 7% per year, depending on capital efficiency and decline assumptions. But that we can do well within our projected cash flows, and we'll have significant free cash flow available after that. But we have to temper our enthusiasm. As one of Canada's larger natural gas producers, we certainly don't want to flood the market until egress is built out and drive prices down. So clearly, the backwardated strip is expecting producers to do just that. And so we'll need to have some restraint or these great returns will quickly also go away.

[Darren Gee, President, CEO & Director]

Yes. No question. And I think that's a common theme amongst the larger gas producers in Western Canada right now, which has probably led to the consolidation of more of the gas production in the basin. We did a small acquisition at the start of the year. And Scott, one of the questions we got in was are we looking at more acquisitions? Are we looking to consolidate the basin more? Or are we content with our land base today? Or what kind of opportunities are out there on the M&A side for us?

[Scott Robinson, Vice President of Business Development]

Yes, Darren, that Cecilia acquisition that you're referring to was a very nice one. Just in retrospect, it was timed nicely with the gas price increase. So we like it. We fit in very well seamlessly to our existing operations and the upside, I think as we've identified, we started to tap into that, and it's coming to fruition. So we're looking at more of that, the stuff that plugs in. That's -- if you look at look at our past, we haven't done a lot of acquisitions. We haven't needed to do a lot of acquisitions, and that's one of the nice things about right now is certainly we're not in a position to have to do anything. We've got an extremely rich inventory, as Dave has pointed out at Chambers and other areas. So it's nice to be in that position to be very selective on what we look at. And we're looking at stuff in the 5- to 10-year range here to complement what we already have, the bolt-in stuff that fits in and conforms to the attributes that we look for, low-cost infrastructure strength and the expertise that we have in drilling these cretaceous formations. But having said that, we're also looking longer term at some other potential new core area plays. We're not going to force that. We'll look at the opportunities that make sense within the capital efficiencies and the use of our capital across the broad investment sector we have. But there -- it's become a little tougher, obviously, with gas prices going up to get the deals, and we're seeing that in property transactions. Back when gas price was lower, we were looking at deals done in that 10,000 per flowing barrel range. And that's more or less doubled here with the gas price increases. But we'll continue to chip away at the areas that make sense where we have a real competitive advantage over others.

[Darren Gee, President, CEO & Director]

Super. The question always comes in about inflation. Obviously, that's very topical today, both in the broader economy and also as it pertains to our business, and are we seeing any inflationary pressures on our cost structure? And so we did -- obviously, as we noted in the press release, we've pre-bought some equipment, well site equipment. We've pre-bought some pipe. We've got good relationships with our service providers. But Todd, maybe you can -- and Lee is not here to comment, but maybe you can talk a little bit about how we're mitigating some of that inflationary pressure if we are seeing it, and how long before we start to see some of it trickle into our business. And maybe you can speak a little too about our environmental initiatives that we got going forward. Obviously, we're spending some money on lowering our environmental footprint, lowering our CO2 emissions intensity. We obviously are sort of killing 2 birds with 1 stone, buying lower emissions intensity, well site equipment and buying it today to offset the potential of inflation. So can you speak to those 2 topics a little bit?

[Todd Burdick, Vice President of Production]

Yes, for sure. Yes, with some pretty major supply chain disruptions with COVID and other, I guess, worldwide factors, we are starting to see some price pressure, especially anything steel related, whether it's tubing, casing, line pipe, valve, that sort of things. So we had an opportunity basically Q1, Q2 to get our hands on pipe that was on the ground already or get at least in the queue for pipe that's about to come out of the mills. And we were able to secure some pretty good pricing on that front. Similarly with the equipment that goes into building separator packages, heads and shelves and that sort of thing. Getting ahead of that will help us for the next year. With the Chambers plant, I guess it's fortunate that we bought a bulk of that equipment 5, 6 years ago. So I think were we to buy it today, we'd be looking at quite a bit different cost for this plant probably closer to that $1,000 per million that you had alluded to. As far as the environmental front, so we've been trialing and refining these low-emission electric skids for the past 2 years. They went through 2 winter seasons. We really wanted to make sure that there would be no major issues through the winter, and we saw some pretty cold temperatures through that winter. And we've really been moving towards more electrification since 2016 when we started putting -- or even earlier when we moved to SCADA and that sort of thing where we're running solar panels and batteries. So we're learning, and we've been learning for quite a while. And so we were ready to really jump into the water if you look at -- if we want to put it that way, order these 80 skids. So the first 2 are actually installed on a 2-well pad that comes on this week. And as far as how far they'll last, we expect probably the end of Q2 next year. So we'll be -- probably early in 2022, we'll be looking again to secure some good pricing by ordering bulk. From an emissions perspective, these installations should reduce our total emissions by about 4 kilograms per BOE, which translates to just over 2%. So that's our total emissions intensity. And in addition to that, we sell an incremental 40,000 gigajoules of gas per year that normally would have been vented into the atmosphere. So -- and of course, that's a further contribution to our goal of an incremental reduction of our total emissions intensity by 25% by 2023. So we've got other things that are going on, retrofitting pneumatic pumps in the field. The things we're going to be doing at the Chambers plant that you described in the announcement are all -- will all lead us towards that 25% reduction.

[Darren Gee, President, CEO & Director]

Yes, that's awesome. All right. Well, I think that's all the questions that we had. I don't see any more up there, Josh. So thanks, everyone, for tuning in to the call today. We're eagerly anticipating getting through this summer, particularly with respect to gas price realizations and some of our hedge losses and into next winter. The fall looks really good and our fourth quarter projections into 2022 look really strong. So we're excited to get there. We've been waiting for these low realizations to get past us for a bit. So it's good to finally put them in the rearview mirror and get moving forward. Our 2022 right now looks fantastic as far as what we're projecting. I think Peyto might actually generate record cash flow in '22 based on the current strip. So we're very excited about that and all -- that brings, getting back to the days of old when we were financially much stronger. So things have definitely looked up and picked up and are looking really good going forward. And we'll be excited to get back to you in November with Q3 and will be well underway into the winter by then and be even more excited about what's happening in 2022. So thanks for tuning in, and we'll talk to you then.

[Operator]

Thank you. This concludes today's conference call. Thank you for participating. You may now disconnect.