Pipestone Energy Corp

TSX:PIPE

Earnings Call Transcript 2021-Q4

[Operator]

Good morning, and welcome to the Pipestone Energy Corp. Q4 2021 Financials and Operations Update 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]

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 updated 2022 guidance and 3-year business plan. Craig will follow with an overview of our Q4 2021 financial results and Dustin will provide an update on our long-term production expectations for the assets. I will provide an update on our risk management activities.

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 measurements and capital management measurements in today's press release and in our Q4 2021 MD&A. All dollar amounts referenced in our remarks today are Canadian dollars unless otherwise specified.

With that, I would like to pass it over to Paul Wanklyn, President and Chief Executive Officer, who will provide an update on Pipestone's strategic progress.

[Paul Wanklyn, executive]

Thanks, Craig. I'm very pleased to announce our record Q4 2021 production results of 28,623 BOEs per day and full year production result of 24,584 BOEs per day, in line with our previously announced 2021 production guidance of 24,000 to 26,000 BOEs per day.

As a result of successful and ongoing central block delineation, strong capital program execution and a supportive commodity price environment, Pipestone has arised its 3-year business plan to modestly increase capital spending within forecast cash flow, which is expected to result in additional production growth in '23 and 2024. To facilitate this growth, we've secured incremental raw gas processing capacity, which we expect to be available in Q3 2023, increasing our total available processing capacity to approximately 46,000 BOEs per day.

As a result of an unplanned midstream outage during Q1, increased use of artificial lift gas as well as expected processing capacity constraints during the second and third quarters of this year, we reduced our 2022 production guidance range by approximately 8% to between 31,000 and 33,000 BOEs per day. This remains a 30% increase in production from our 2021 average. By Q4 2022, we expect to be fully utilizing our current available processing capacity and our forecast for the fourth quarter of 2022 is to average 37,000 BOEs per day.

Production is forecast to grow an additional 27% to a midpoint of 40,500 BOEs per day in 2023, as planned incremental processing capacity becomes available in Q3 of that year. When this capacity is fully utilized by the exit of 2023, we expect to reach volumes of approximately 45,000 BOEs per day and be maintained through 2024.

We also increased our 2022 capital guidance to between $210 million and $220 million, up from approximately $180 million to $200 million previously. The revised capital program is funded well within our forecast cash flow. Drilling activities are planned to further delineate Pipestone's asset, including step-out drilling eastward from our core activity areas while accelerating our growth into 2023.

The expanded capital program will include increased infrastructure expenditures, increased drilling and completion activities in the second half of '22, as well as the completion and testing of the Montney delineation well in the eastern portion of our land base at 12-36.

As we look at the terrible event unfolding in the Ukraine, we see even more reason to prepare for extreme volatility in energy prices, and highlight the reasons to create a fortress-like balance sheet for Pipestone. Our organic growth strategy has proven to be effective in creating long-term shareholder value, and we will continue to plan our capital programs within a free cash flow forecast at conservative oil and gas prices.

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

[Craig Nieboer, executive]

Thanks, Paul. During the fourth quarter, the company generated record revenue of $137.3 million, tripling the revenue from Q4 2020, as well as record adjusted funds flow from operations of $58.9 million. Full year revenue for 2021 was a record $391.3 million, which resulted in $166.4 million of adjusted funds flow from operations for the year. These impressive financial results were driven by the record average quarterly production previously mentioned by Paul of 28,623 BOE per day, which was comprised of 30% oil and condensate, 14% other NGLs and 56% natural gas. This represents a 16% increase in production over Q3 2021 and a 61% increase over Q4 2020.

Alongside the increase in production, the company achieved a record quarterly operating netback of $25.06 per BOE inclusive of $8.45 per BOE in realized hedge losses in the quarter, which represents an increase of 14% over Q3 2021 and 148% increase over Q4 2020. The company continued its 2021 capital program with 8 wells drilled and rig released during the fourth quarter of '21. Total capital expenditures, including capitalized G&A, were $39.2 million during the 3 months ended December 31, 2021, and $186.8 million for the year ended December 31, 2021.

From a returns perspective, the company generated strong returns on invested capital with Q4 2021 annualized ROCE and CROIC up 22.8% to 26.1%, respectively, as compared to Q4 2020 annualized ROCE and CROIC of 1.7% and 8.1%, respectively. In Q4, Pipestone generated $19.8 million of free cash flow after deducting capital expenditures and decommissioning costs. We also began deleveraging our balance sheet in Q4 with a reduction from our September 30, 2021 net debt balance of $219.5 million to exit at $204.4 million at December 31.

With this free cash flow, Pipestone has pivoted from being a net consumer of capital to a net distributor of free cash flow. In conjunction with the deleveraging, Pipestone commenced an NCIB in November 2021 to repurchase up to 5% of its basic shares or approximately 10 million shares over a 12-month period. In Q4 2021, Pipestone purchased 949,000 common shares for cancellation at a weighted average price of $3.60 per share, for a total consideration of $3.4 million. Subsequent to the year-end, as we've continued the program, we've purchased an additional 792,600 shares for cancellation at a weighted average price of $4.64 per share.

Going forward, as previously announced, Pipestone's first priority for its free cash flow in '22 is to deleverage the business, with a corporate debt target of less than $100 million, which would equate to less than 1x debt-to-cash flow at a $45 WTI price. $100 million debt balance also equates to a run rate 2022 debt-to-cash flow of 0.3x at an $80 WTI price. Pipestone expects to achieve this target by midyear.

As already demonstrated in Q1 2022, Pipestone intends to continue to utilize its NCIB throughout '22 as part of its commitment to providing shareholder returns. In '22, after deleveraging and executing on its NCIB, Pipestone still expects to have generated additional free cash flow that will be available for additional debt repayment to build the fortress balance sheet, as Paul mentioned, and our other shareholder returns or additional capital to expand the business.

I'll now hand it over to Dustin to provide an update on our long-term production expectations for the assets.

[Dustin Hoffman, executive]

Thanks, Craig. The previously released year-end 2021 McDaniel 2P reserve report includes 149 undeveloped locations, which supports growth to 45,000 BOE per day plateau and can be held flat until 2032. Pipestone has internally identified an additional 160 net Tier 1 unbooked locations on its central and eastern acreage blocks. Tier 1 locations are defined as having a payout of less than 12 months and an $80 per barrel price forecast. These locations support further production growth to a risk production plateau of approximately 55,000 BOEs per day by exit 2025, which could be held flat for approximately 10 years.

To achieve this production level, Pipestone will have to continue to contract incremental processing capacity. The company estimates there to be approximately 250 million cubic feet per day of currently available or planned sour gas processing expansions in the Pipestone area that could be easily in service by 2025.

With that, I will turn it over to Dan to provide an update on our risk management program.

[Dan van Kessel, executive]

Thanks, Dustin. First, I'd like to highlight where commodity prices are currently trading relative to our budget. WTI prices are currently in the order of $115 to $120 per barrel. And this compares to our conservative long-term forecast of $80 per barrel, which we're utilizing to forecast all the cash flow and free cash flow under our plan.

As well as WTI has done over the last number of months, condensate pricing has done even better. As a reminder, condensate is the only raw hydrocarbon that Canada imports every single day in order to facilitate -- to satisfy its demand. Over the course of Q1 2022, condensate differentials have ranged between a USD 2 and USD 5 per barrel premium to WTI, which is expected to continue through at least the first half of '22 as a result of increasing domestic demand and relatively flat supply growth in Western Canada. As a reminder, all of our cash flow forecasts incorporate a par condensate differential to WTI.

On the risk management front, over the past quarter and into Q1 '22, Pipestone has increased its oil and natural gas hedge position for the upcoming year. The objective of our hedging program is to secure the rapid deleveraging that is forecast to occur at current strip prices over the coming quarters. Currently, Pipestone has approximately 2,800 barrels per day as Canadian dollar WTI hedged for Q1 '22 at approximately $89 per barrel. Approximately 3,700 barrels per day for Q2 2022 at $94 per barrel, 2,000 barrels per day for Q3 2022 at $90 per barrel and 1,750 barrels per day for Q4 2022 at $90 per barrel. The recent additions to our hedging program have increased our average 2022 oil hedge position to be approximately 25% of our forecast condensate production at an average price of CAD 91 per barrel.

With respect to natural gas, Pipestone has a full year 2022 average of approximately 34 million cubic feet per day swapped at an average AECO price of $3.35 per Mcf. The company is ultimately targeting to maintain and be in the order of 35% hedged on natural gas for full year 2022 with an emphasis on the summer months.

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

[Paul Wanklyn, executive]

Thanks, Dan. Pipestone has the asset and the team to deliver pure leading growth in production and cash flow, while at the same time generating significant annual free cash flow to deliver to shareholders. At an oil price of $80, as Dan mentioned, we forecast generating approximately $600 million in cumulative free cash flow in the next 3 years. At USD 100 WTI, this cumulative free cash flow approaches $900 million or 60% of the company's current market capitalization. As a result, Pipestone is very well positioned to deliver significant shareholder returns over the next 3 years.

With that, I'll turn it over to the operator for Q&A.

[Operator]

[Operator Instructions] And our first question comes from Josef Schachter from Schachter Energy.

[Josef Schachter, analyst]

Congratulations on a good quarter and a good year. I have 3 questions. Can you go through a little more color of the disruptions and also the planned activity in terms of the plant turnaround this summer? Just what's going on and just add a little more color on the time line and what impact and what recovery methodology they've done, so this doesn't knock -- hit you out of the blue from -- in the future?

[Dustin Hoffman, executive]

Yes, that's a great question, Josef. I'll take that on to start with here. It's Dustin. So unfortunately, we had some -- a couple of outages in January, February through the Keyera Wapiti plant. The facility itself has run great since the latest outage. I can tell you that there is a lot of work ongoing at that particular facility to improve its run time. So we have the utmost confidence that the Keyera staff will get that plant running at a high level that we would expect it to be at. As far as the rest of the year goes, all 3 of our midstreamers have significant outages planned. So Tidewater and Veresen have their kind of major turnarounds planned for midyear. Keyera has got another shorter outage planned. And then once we get back going kind of post turnaround season at the end of the summer, we fully anticipate that we'll have all of our midstream processing capacity full through to the end of the year.

[Josef Schachter, analyst]

Okay. Good. Second question for me, cost side. When I listened to the calls from the drillers and the frackers, they're all talking about needing 5 or 6 more frac crews by the second half of the year and maybe 20, 30 more rigs to meet the need. Are you guys starting to see much more inflation on those costs? And what are you thinking in terms of what you need to do in terms of your budgeting?

[Dustin Hoffman, executive]

Yes. Josef, Dustin here again. I'll take a stab at this one. I'll remind you, last year, astutely, I think we've locked in some of our highest percentage spend commodities like sand and casing at what looks to be very attractive pricing today through 2022. So that's going to help us dramatically this year. There's no doubt that there's some inflation in the market. I mean, obviously, the price of diesel alone for truck hauling and whatnot is increasing. We truly believe that we'll be able to combat some of those inflationary pressures with additional efficiencies, as we go to the larger pads and the longer laterals, and we've developed a very efficient logistical system for drilling and completing our wells. So we're hopeful we'll be able to combat some of that, but fully appreciate that there is some inflation in the market right now.

[Josef Schachter, analyst]

Are we looking at 10%, 20% for those costs? Or where do you see them? I know you said you're locked in, but heading to the end of the year in 2023, there's resets every number of months, every 6 months. When do you see that push heading?

[Dustin Hoffman, executive]

For sure, I mean, the biggest impact, obviously, has been on, say, fuel costs right now, which obviously is a bit of -- we've got a natural hedge on that because the product that we actually produce. But yes, 5 to 10 points on some of the services is kind of what we're seeing, Josef. And like I said, thankfully, some of the larger spends we've got locked in. And like I said, we've got some additional efficiencies that we're working through. Specifically, as we drill longer laterals, we just become more efficient and we're expecting to be able to keep our costs flat.

[Paul Wanklyn, executive]

And maybe just one other comment I'll add, Josef, it's Paul here. As you know, we enjoy a geographical advantage in the general Pipestone area along with some other producers near us in that the service center at Grand Prairie in close proximity to us, we enjoy a cost benefit of being that close from a logistical perspective. So I mean, that will go away certainly in the next couple of years to Dustin's point as well. So I think that's maybe an overlooked advantage of this general vicinity in the Montney play.

[Josef Schachter, analyst]

Super. One last one for me. On Slide 7 of your new presentation, you show where you're working on the northwest side of your land, but there's a lot of drilling occurring more in the southeast by competitors. Have you been watching? And have you been noticing anything that gives you desire to maybe move and drill more on the south? Are they having any successes that are pleasantly surprising?

[Paul Wanklyn, executive]

Yes, that's a great question. There are some, I think, some pretty solid results being pulled out of the wells southeast of us on trend with our eastern acreage. And I think we're obviously paying close attention and there is a read-through to that -- some of that eastern acreage and the potential we see there. And I'll note the -- we are planning to now go and complete the 12-36 plant well that's on the eastern edge of our block sometime later this year. So that's been welled. It's been standing case for more than 3 years now. And so we're just planning completion operation there.

[Josef Schachter, analyst]

I see that on Slide #8. Is there facilities in the area to move those volumes?

[Paul Wanklyn, executive]

No, not currently.

[Josef Schachter, analyst]

Okay. Congratulations again.

[Operator]

And our next question comes from Garett Ursu from Cormark Securities.

[Garett Ursu, analyst]

A couple of questions. I guess, they're kind of related. I don't know if you'd call them kind of the downside of success, but you guys have been obviously very efficient, very successful, which means you probably don't have the tax pools that other guys have. So in the current environment, are you guys going to be cash taxable this year? Or when do you see that kind of tax horizon coming up?

[Craig Nieboer, executive]

Yes. Garett, I mean, at current outlook, we expect to be cash taxable starting next year. So nothing this year, but starting next year based on current commodity prices, we'll start paying some cash taxes. We're estimating sort of being 13% to 16% of EBITDA on a run rate basis going forward at current strip type prices.

[Garett Ursu, analyst]

Okay. Okay. And I guess, similarly, with these -- with your wells paying out so quickly, more of the wells are coming out of the Alberta royalty holiday. So are we thinking 7%, 8% royalties this year or obviously lower than other guys, but higher than that 5%? Or where do you see those going with the payout so quick?

[Dan van Kessel, executive]

Yes, you bet. And obviously, what commodity price you're using for '22 has a large impact. But at a, call it, $100 WTI for the remainder of '22, we would expect to be in that 7% to 7.5% range. We are still planning to bring on close to 30 net wells over the course of 2022. So there's a lot of incremental production that's still got fresh $18 million to $20 million [ C-star ] on it. As we move into '23, though, we would expect that to continue to creep up, though.

[Garett Ursu, analyst]

Okay. Okay. Understood. Good problems to have with pools and royalties, because it means you guys are profitable.

[Operator]

And I am showing no further questions. I would now like to turn the call back over to Paul Wanklyn for closing remarks.

[Paul Wanklyn, executive]

Thanks, everyone, for dialing in today. And again, we're pretty excited about the progress we've made and the outlook for our future growth. So thanks, everyone, and I appreciate it. Have a great morning.

[Operator]

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.