Pipestone Energy Corp

TSX:PIPE

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, and welcome to the Pipestone Energy Corp. Q3 2022 results, revised corporate guidance and enhanced shareholder return strategy conference call. [Operator Instructions] As a reminder, this call may be recorded. I would now like to introduce your host for today's conference, Dan Van Kessel, Vice President, Corporate Development. You may begin.

[Dan van Kessel, executive]

Thank you. Good morning, everyone, and thank you very much for joining the call. With me, I have Paul Wanklyn, President and Chief Executive Officer; Dustin Hoffman, Chief Operating Officer; and Craig Nieboer, Chief Financial Officer.

On today's call, Paul will start by providing an overview of Pipestone's shift in focus towards moderated growth and enhanced shareholder returns, Craig will follow with an overview of our Q3 2022 financial results and Dustin will provide an update on our operations. I will provide an update on our go-forward guidance and hedging strategy.

I will now hand the call over to Craig Nieboer, Chief Financial Officer for Pipestone Energy, to provide the disclaimer and some comments relating to upcoming financial disclosure.

[Craig Nieboer, executive]

Thanks, Dan.

Listeners should be advised that some of our remarks today will contain forward-looking statements within the meaning of applicable security laws. I refer you to our advisories regarding forward-looking statements, non-GAAP financial measures and capital management measures in today's press release and in our Q3 2022 MD&A. All dollar amounts referenced in our remarks today are in Canadian dollars unless otherwise specified.

With that, I'd like to pass it over to Paul Wanklyn, President and Chief Executive Officer.

[Paul Wanklyn, executive]

Good morning, everyone, and thank you for joining the call.

I'm pleased to provide an update on Pipestone strategic plan and a shift towards an enhanced shareholder return strategy. When Pipestone as a public entity was formed in January 2019, we articulated a clear business plan to investors. The plan was to organically grow the business quickly and efficiently to a meaningful production plateau such that the company could generate significant free cash flow.

Over the past approximately 4 years, Pipestone has grown its production by 20-fold from 1,500 BOEs a day to 32,000 this past quarter. As a result of inflation pressures and technical constraints, Pipestone is reducing its forecast annual growth rate over the next 3 years and is shifting its focus towards maximizing free cash flow and shareholder returns.

Average annual production growth for '22 to '25 is now expected to be between 7% and 10% versus about 16% previously. And our '23 production guidance is now 34,000 to 36,000 BOEs a day, down from a previous forecast of 40,000 to 42,000 BOEs a day.

Pipestone was also utilizing a revised long-term target production plateau of 45,000 BOEs a day, down from 55,000 previously. This is going to enable the company's shift in focus towards delivering more meaningful returns to shareholders.

Given the inflation pressures we are experiencing, we feel it's prudent to manage spending levels and focus on continuing to maximize the efficiency of our drilling programs through a continuous 1-rig drilling program for our development activities. We've elected to spend an addition of 15% of our 2023 budget on delineating new potential development areas in the eastern portion of our land base, with production from this area expected to start on stream in 2024.

As we have mentioned in our press release, we've had exceptional well results in our western most wells in our program and recent central block drilling has resulted in wells approximately 20% lower in productivity compared to the Western wells. Our corporate presentation highlights a new forecast curve for these wells, which are highly economic and generate approximate 6 months payouts at our budget price deck.

Lastly, there is some pressure on timing and access to new midstream capacity as well as some -- on some of our existing interruptible service. As a result of all these factors, the company has decided to prioritize capital efficiencies, utilizing a 1-rig continuous program, which will -- which generates moderate growth profile to 10%.

We have listened to our shareholders and their desire for enhanced returns. And as such, we are implementing a base dividend, which will provide a consistent cash return to shareholders. The Board of Directors has declared an inaugural quarterly dividend of $0.03 per share, which will be payable on March 31, 2023 to all shareholders of record at the close of business on March 15, 2023. At yesterday's closing prices, dividend provides an annualized return of approximately 2.7%.

Secondly, to further enhance shareholder returns, we've announced our plan to initiate a substantial issuer bid in Q1 2023, under which Pipestone intends to offer to purchase up to $15 million of its common shares for cancellation. Additionally, the Board of Pipestone has provided its approval to renew its normal course issuer bid, under which the company is expected to be authorized to purchase up to 13 million shares over the next 12 months.

With these shareholder return initiatives in place, the company will target a run rate average debt level of $100 million with free cash flow in excess of this target to be primarily allocated towards further shareholder returns, including share repurchases under the company's NCIB and future SIBs and/or future dividends.

With that, I'll pass it on to Craig to discuss the detailed financial highlights for the quarter.

[Craig Nieboer, executive]

Thanks, Paul.

During the third quarter, the company achieved record average quarterly production totaling 32,109 BOEs per day comprised of 28% condensate and 40% total liquids, which represents a 7,405 BOE per day or a 30% increase over Q3 2021 production and 1,339 BOE per day sequential increase over Q2 2022.

In Q3, Pipestone generated revenue of $174.4 million, which represents a $74.2 million or 74% increase over Q3 2021 revenue of $100.2 million. The company realized an operating netback of $31.88 per BOE, an increase of 45% over Q3 2021. Excluding the realized loss on commodity risk management contracts of $2.52 per BOE, the company's field operating netback for Q3 '22 was $34.40 per BOE.

Total capital expenditures, including capitalized G&A during the quarter were $60 million -- $60.4 million during -- and the company continued its 2022 capital program with 5.5 net wells drilled and rig released and 7.5 net wells completed in the quarter. The company continues to achieve robust returns on invested capital with Q3 2022 annualized ROCE of 33% and CROIC of 31% as compared to Q2 2021 -- or Q3 2021 annualized ROCE of 18% and CROIC of 21%.

Pipestone produced adjusted funds flow from operations of $86.5 million in Q3 '22, nearly doubling its adjusted funds flow from operations of $43.7 million in Q3 '21. As a result, the company generated free cash flow of $26.1 million in the quarter, representing 30% of its adjusted funds flow from operations. And executing on its return of capital to shareholders plan, Pipestone utilized $13.2 million or 51% of its free cash flow to repurchase common shares pursuant to its NCIB program with the remainder allocated to deleveraging the balance sheet.

At current commodity prices, we expect to continue to produce free cash flow throughout the remainder of '22, which we plan to direct mostly to further deleveraging, would exit '22 net debt of approximately $105 million at the midpoint. As Pipestone has shifted its focus towards maximizing free cash flow and shareholder returns, the company intends to allocate its excess free cash flow going forward towards further shareholder returns.

The new base dividend that Paul described is sustainable down to $55 WTI and $4 AECO, and at a run rate of about $32 million annually, it's highly defensible with room to grow in the future. In '23, after accounting for the base dividend and the planned $50 million SIB at our budget price deck of $85 WTI, we are projecting an additional $68 million of free cash flow. In 2024, after accounting for the base dividend, we are projecting approximately $148 million of additional free cash flow generation. This free cash flow will be available to further augment shareholder -- our shareholder return-focused initiatives going forward.

With that, I'll turn it over to Dustin.

[Dustin Hoffman, executive]

Thanks, Craig.

Q3 was another busy quarter as Pipestone rig released 5.5 net wells, which included the final 2 wells from its 6-well pad at 14-19, 1.5 net wells on the 13-9 pad and the first 2 of 6 on its 11-05 pad. The company anticipates drilling an additional 5 net wells in 2022, including the remaining wells on the 11-05 pad as well as 1 well on the second phase of development at the 2-25 pad.

On the 11-05 pad, Pipestone recently rig released its longest well drilled to date with a lateral length of approximately 4,500 meters, beating our previous record of approximately 3,800 meters. The company also completed 7.5 net wells during the quarter, including 6 wells on the 14-19 pad and 1.5 net wells on the 13-9 pad.

Our capital program has been subject to inflationary pressure. For example, casing costs have doubled and now account for approximately 1/3 of the drilling cost of a well versus 20% 18 months ago. At the same time, however, we have continued to increase our meters drilled and fracs pumped per day, partly offsetting these service cost pressures. Utilizing a level-loaded 1-rig program in 2023 will help us continue to maximize our drilling and completion efficiencies going forward.

Over the past year, Pipestone has made significant progress in delineating the central and northern portions of its asset base and has improved its understanding of well productivity, fluid windows and gas composition. As Paul mentioned earlier, these locations are highly economic with the majority of the inventory in the central portion of the land base now being mapped in our VRGC 1 type curve region.

On the facility side, in early October of 2022, Pipestone funded and completed the expansion of the existing Keyera 8-15 compressor station. Following the installation of a fourth compressor, the capacity of the 8-15 station has now increased by 30 million cubic feet per day to a total of 120 million cubic feet per day. And based on field capital spending estimates to date, the company anticipates earning an approximate 14% working interest in the entire 8-15 facility.

Also in late October 2022, Pipestone completed the commissioning of a water handling disposal facility at its 15-25 pad, expanding the company's infield water handling capacity by approximately 15,000 barrels per day.

I'll now hand it over to Dan to provide an update on our 2022 and 2023 corporate guidance and an update on our hedging plans.

[Dan van Kessel, executive]

Thanks, Dustin.

Pipestone is increasing its capital expenditure guidance for 2022 from a previous range of $225 million to $235 million to an estimate of $240 million. This $10 million increase from the previous midpoint of $230 million reflects the anticipated rig release of 1 additional well, additional infrastructure spending as well as inflationary pressures. Pipestone's full year 2022 production guidance is unchanged. However, we anticipate being in the lower half of the 31,000 to 33,000 BOE a day range for 2022.

As mentioned earlier, Pipestone is modifying its 3-year production forecast and target production plateaus from approximately 55,000 to approximately 45,000 BOEs a day. The reduced production growth rate will enable the company to maximize its free cash flow and returns to investors.

Pipestone is guiding to 2023 production of 34,000 to 36,000 BOEs a day, representing an annual growth rate of approximately 10% over 2022 and approximately 15% below our previous forecast. The company anticipates spending $245 million to $265 million in capital in 2023, which includes approximately $30 million to $35 million in delineation capital for the eastern portion of its land base.

At a budget price forecast of $85 WTI and $4 AECO, this plan is expected to generate cash flow of $430 million and free cash flow of $135 million to $165 million. In order to support its shareholder return objectives, Pipestone expects to implement to maintain a rolling hedge position of between 25% and 50% of [forward] 12 months net after royalties condensate and natural gas production to mitigate the impact of commodity price volatility.

Currently, in 2023, Pipestone needs 4% hedged on natural gas at a price of $7.62 per Mcf and 1% on condensate at a price of $127 per barrel. Subject to market conditions, we anticipate increasing our hedge position towards the bottom end of our target range prior to the inaugural dividend payment scheduled in March 23.

I'll now hand it over to Paul to conclude the call.

[Paul Wanklyn, executive]

Thank you, everyone, for joining the call this morning. And with that, I'll turn it over to the operator for Q&A.

[Operator]

[Operator Instructions] Our first question comes from Jeremy McCrea with Raymond James.

[Jeremy McCrea, analyst]

I'm just going to ask the elephant in the room here. You didn't comment on your stock here this morning. And then just with this change in strategy here as well, too, I'm wondering if you can take me inside the boardroom and kind of was this unanimous? Was -- what were the kind of discussions to change the strategy? And then lastly here, if you were to look at your land base and hypothetically, if the -- I'm trying to understand where the well economics still are. As the NPV of a well is $10 million on your west side, what would be the NPV in the middle of your fairway and what do you think it could be on the eastern side of the fairway? So lots of questions. I'll leave it there.

[Paul Wanklyn, executive]

Yes. No, maybe I'll start it, and we can all -- we get our free for all of it, Jeremy. The stock price, unfortunately, we caught a bit of a down day on the market to announce the change in strategy. I think there's clearly a reaction to lowering our forecast production and obviously, cash flow for -- for next year, for '23. So that will -- I think it will take a while for people to understand the impact of enhanced investor shareholder returns as that balances off that overall decrease in cash flow.

So I think that's pretty much all I can say about that for today until we've got a chance maybe to socialize some of these changes with all our shareholders. But it's clear our major shareholders are all very supportive as are we of this new change in strategy. And so we're comfortable with the decision we made.

You asked about the NPV question, and I'll take a first crack at it. The -- there's a new page in our corporate deck which highlights the -- what we -- our VRGC -- our new VRGC 2 -- or 1, sorry, type curve in the central block. The east of the western-most wells that we drilled today, that have been a mixture of VRGC 2, 3 and a couple of 1s. But what we've seen is a bit of a leaning up in the type curves -- or in the well performance if you go Eastern from our initial foray into this block. And also probably 20% lower in productivity.

So we've just elected to say, let's -- we're going to -- going forward, we're utilizing that new type curve in our forecast. And if you look at it, it generates a 6-month payout and a better than 200% IRR and as well in the middle of all the results we've seen to date. So we're pretty pleased with -- we're comfortable and pleased with the development plan we've put forward.

[Jeremy McCrea, analyst]

Okay. Okay.

[Paul Wanklyn, executive]

You asked, I think, a little bit about the Eastern block. I think that's the other shift, and we've made a commitment now to spend up to $35 million to delineate and hope to likely tie in later next year some wells in the eastern block to start to prove up the productivity. As we go east though, we fully expect those wells to again prove out to be more volatile oil wells. And probably more similar, we think, to some of the activity we're seeing south of us by other competitors. And we think they're going to be highly economic. We fully expect them to be -- to compete with the economics for what we're seeing in the central block, but we need to go and prove that. So we're -- we've really made a pretty reasonable and -- commitment to go and start to work on unlocking that value in the eastern block this year.

[Operator]

Our next question comes from Dan Grager with Peters & Co.

[Dan Grager, analyst]

Paul, you talked about the delineation of the eastern block. That $30 million to $35 million, how many wells are you going to drill and are these wells going to be essentially scattered? Or are they going to be off the 12-36 pad? And then as part of your 45,000 plateau, how much of that is part of the east?

[Paul Wanklyn, executive]

No, we're not specific yet about which pad we're drilling. The wells we drill in the eastern block will be off 1 pad. And we'll be clear with that within -- in the next little while on which pad that is. And then our intention is to tie that pad in to get true production history from it. So at this point, it's likely 2 wells. We're still working on that final plan.

The overall plateau at 45,000, really, we can reach that 45,000 with no contribution from the eastern block wells. But what the eastern block gives us is further runway and without getting specific in how many years, et cetera, it just gives you a far further runway to hold that plateau flat.

[Operator]

Our next question comes from Michael Zuk with Athena Capital Markets.

[Michael A. Zuk, analyst]

I just had a quick question with regards to perhaps the internal dialogue, how management and the Board sees the company's competitive posture, I guess, as it applies to management. The stock price at the merger with Blackbird was $3.40. Today, unfortunately, it's $3.66. Production has gone from 1,500 barrels a day to 32, over 30,000. AECO is up 2.5x from $2.27 to $5.96. How does Pipestone see itself competing in a market that's seeing less and less capital directed towards energy names?

[Craig Nieboer, executive]

I'll take a first shot at that, Michael. It's Craig, the CFO. I mean, ultimately, our job is to maximize returns from the asset, which we continue -- we have done and will continue to do. And the shift in focus to shareholder returns and moderated growth, I think, highlights that. So we're focused on providing shareholders with robust return on capital, but not just on the financial statements, but in their bank account and their pocket book as well.

So as you look at the go-forward business plan, it's extremely a high generation of free cash flow. We're committed to returning the majority of that once we hit our debt target to shareholders. And I think that just takes a time for shareholders to, A, understand that. And B, anytime return of capital, return of cash model, you need some longevity for people to fully value it. So when you say how are we going to compete, I think we've competed extremely well versus our peers on return metrics. And now we're going to be competing with our competitors on actual returns to shareholders metrics, and that will just take some time.

[Michael A. Zuk, analyst]

Okay. I look forward to seeing that.

[Operator]

[Operator Instructions] Our next question comes from Luke Davis with RBC.

[Luke Davis, analyst]

Just curious with your return of capital strategy. You kind of aligned buybacks and SIB alongside that base dividend. That might kind of support the stock price a bit. But are you concerned at all that, that will sort of eat up trading liquidity? Or how are you sort of thinking about that side going forward?

[Craig Nieboer, executive]

Luke, it's Craig again. I mean ultimately, we were very active in our NCIB over the last year. And the tightness of our float has always been a bit of a challenge to our trading and our -- probably our ultimate liquidity in the market. I mean at the end of the day, the shares are still undervalued in the whole sector. But if we're say, in the bottom-ish part of our peer group on a multiple, just the economics of all that just makes total sense to buy back shares.

So we're going to have a combination model of cash return and share buyback go-forward. But I think at these multiples, it just makes so much sense to buy back shares, too.

[Operator]

[Operator Instructions] At this time, I am showing no further questions. Ladies and gentlemen, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.