Parex Resources Inc

TSX:PXT

Earnings Call Analysis

Parex Resources faces production challenges but remains optimistic

In Q2 2024, Parex Resources reported stable production at 53,568 BOE per day but faced operational setbacks, particularly at the Arauca block. Despite these challenges, Parex remains financially strong, achieving an 80% increase in free funds flow year-over-year and repaid $10 million in bank debt. The company shifted capital to the Capachos and Block 32 areas to offset Arauca's underperformance. Parex is optimistic about production growth in Q4 and sustaining shareholder returns, aiming for a funds flow netback of $31 to $33 per barrel for the year. Capital expenditures are expected to be cautious, aligning with lower production profiles.

Performance Overview

In the second quarter of 2024, Parex Resources reported an average production of 53,568 barrels of oil equivalent per day (BOE/d), which remained stable compared to the previous quarter. This steadiness, however, masked underlying challenges in the Arauca area, where early optimistic projections have faced hurdles such as poor wellbore conditions and water intrusion. In response, the company has strategically paused its drilling activities in Arauca to allow for a thorough reassessment and recovery plan, with plans to return to development there by 2025.

Financial Performance

Despite production shortfalls, Parex showcased strong financial resilience with a funds flow from operations of $181 million this quarter. This robust performance was bolstered by favorable pricing realizations and a one-time foreign exchange gain of $21 million related to Colombian tax settlements. The company’s net income experienced some pressure due to higher deferred tax expenses and exchange rate fluctuations. Additionally, production expense is projected to remain elevated at $12 to $13 per barrel for the year.

Strategic Capital Allocation

With the challenges faced in Arauca, Parex has pivoted its capital investment toward the Capachos and Block 32 areas, where drilling activities are expected to yield lower-risk production increases. Capital expenditures for the quarter totaled $98 million, which was below forecasts due to the halt in Arauca operations. The company has guided for a conservative capital expenditure profile for 2024, ultimately positioning itself for a sustainable growth trajectory.

Free Funds Flow and Shareholder Returns

The company reported an impressive 80% year-on-year increase in free funds flow, resulting from effective capital discipline and operational efficiencies. Leveraging this free cash flow, Parex intends to return around 33% of total funds flow through dividends and share buybacks while maintaining capital expenditures within 66% of its guidance. This strategy reflects a balanced approach to shareholder return amid production challenges.

Production Guidance and Long-term Outlook

Looking ahead, management has tempered production growth expectations for the remainder of 2024, focusing instead on stability and planning for incremental growth into future years. It anticipates remaining aligned with its production targets for Q3, followed by potential growth in Q4, although the exit rate for 2024 will likely be lower than initial expectations. This cautious approach underscores the company's commitment to sustainable management of its diverse portfolio and maximizing shareholder value in the long run.

Key Takeaways

Overall, Parex Resources exhibits resilience despite operational setbacks in production. The company is poised for a calculated recovery plan, maintaining a solid financial foundation supported by strategic capital allocation to drive future growth. Investors can look forward to a structured approach aimed at returning value through dividends and share buybacks, while the management prioritizes a sustainable production outlook over aggressive expansion.

Earnings Call Transcript 2024-Q2

[Operator]

Hello, and welcome to the Parex Resources Q2 2024 Operating and Financial Results Conference. [Operator Instructions] I will now turn the call over to Mike Kruchten, Senior Vice President of Capital Planning. You may begin.

[Michael Kruchten, executive]

Good morning, everyone, and welcome to Parex's Second Quarter 2024 Conference Call and Webcast. My name is Mike Kruchten, Senior Vice President at Parex. And on the call with me today are our President and Chief Executive Officer; Imad Mohsen; our Chief Financial Officer; Sanjay Bishnoi; and our Chief Operating Officer, Eric Furlan.

[Operator Instructions]

As a reminder, this conference call includes forward-looking statements as well as non-GAAP and other financial measures with the associated risks outlined in our news release and MD&A, which can be found on our website or at www.sedarplus.ca.

Note that all amounts discussed today are in U.S. dollars, unless otherwise stated.

I'll turn the call over to Imad. Please go ahead.

[Imad Mohsen, executive]

Thank you, Mike, and good morning, everyone. The second quarter highlighted our portfolio's ability to deliver strong financial results and return of capital for shareholders. I'm pleased to say that in '24, we have delivered an 80% increase year-on-year in free funds flow on strong pricing realizations as well as reduced capital.

Part of what's driving our strong financial results is the excellent performance from our base assets at Cabrestero and Block 34.

To date, results from water flooding have been encouraging with generally flat production profiles and reduced capital requirements going forward. We are generating significant free funds flow from these core areas. This can be attributed not only to [ ask ] quality but to the benefits derived from our pre-investment activity on drilling patterns and facility investments.

At Cabrestero, we are seeing encouraging results from our polymer injection pilot and are now in the process of designing a full field expansion and formalizing our plan. Building off Cabrestero enhanced oil recovery success, we are replicating this approach at Block 34. The initial water flood patterns are demonstrating strong performance, and post-water flooding implementation, we expect polymer injection to be a viable option.

Turning now to North Llanos, I'd like to provide some high-level comments on our performance and then hand it over to Eric to provide more specifics on our operational results and plans for the second half of the year. At Arauca to date, results have underperformed compared to our initial expectations. While we are optimistic -- we were optimistic at the onset, we have since encountered operational and reservoir challenges as activity has progressed at the block. As a result, we have paused our in-year drilling campaign to provide the team and our partner with time to reassess our results and develop a plan to optimize the field's potential over the longer term.

With activity in Arauca paused, we have shifted capital to our Capachos block where we are now drilling a follow-up well to Andina Norte-1 and at Block 32 where we have successfully drilled an extension to the field. These 2 areas combined are positioning us to partly offset our Arauca volumes and drill lower risk appraisal and development wells to add production and potential reserves in the second half of 2024.

While the third half of the year has certainly presented its challenges, we are targeting to grow production into year-end, look forward to initial results from our 24 high-impact Big 'E' wells, and we'll continue to use our free funds flow to deliver share buybacks and regular dividends.

I'll now ask Eric to provide additional details on our operational performance.

[Eric Furlan, executive]

Thanks, Imad. In Q2 2024, production averaged 53,568 BOE per day, which was relatively flat when compared to Q1 2024. At Arauca, we saw a strong initial performance from Arauca-8 with extremely high natural flow rates that made us excited about the field's potential. Since this strong initial performance, the block has performed below our expectations due to a multitude of factors, including wellbore conditions, water intrusion, asphaltenes and tighter rock than anticipated.

It is our view that these complexities can be worked through over time. We are going to complete workovers on the wells where we see potential and are assessing the next steps to best restore and optimize production from the field in the short and long term.

As Imad mentioned, in the interim, we have reallocated one of the rigs to Capachos. And once we finish necessary completions and workovers in Arauca, we plan to release the second rig.

It is important to note that while we have resized Arauca, we still see long-term potential from the field. With development opportunities identified, we currently plan to return in 2025 following analysis and recalibration of the initial program's results.

With Arauca capital pause, we have reallocated capital to Block 32, where, as Imad mentioned, we successfully drilled the extension to the field. This is supporting a multi-well appraisal development campaign and is expected to add barrels to our second half production profile for 2024.

This decision to go back to Block 32 was largely driven by the anticipated mapping size being larger than what was originally thought, which has since proven out by the first successful step-out well as well as our logging on the follow-up well.

Turning to our 2024 Big 'E' exploration plan, we continue to progress, including our near-term prospect, Arantes at Block 122. To provide an update, the timing for this well has been extended due to previous mechanical issues as well as revised target depth based on recalibrated seismic analysis. We're currently at roughly 16,500 feet and plan to reach total depth in late Q3 2024.

Aligning our Big 'E' strategy, we are planning to supply 2 further exploration wells in the second half of the year, at VIM-1 as well as Capachos.

With that, I'd invite Sanjay to please go ahead.

[Sanjay Bishnoi, executive]

Thanks, Eric. Overall, despite production shortfalls, we had a strong quarter financially. Funds flow provided by operations was $181 million, supported by strong realizations as well as a positive $21 million onetime foreign exchange gain related to the settlement of the company's 2023 Colombian tax payable. This onetime gain flowed through FFO and positively benefited netbacks during the quarter by over $4 per barrel.

The company's net income was reduced due to the increase in deferred tax expense, which was also caused by movement in the exchange rate.

Currently, we continue to see elevated production expenses related to a strong Colombian peso, increased well service costs and onetime maintenance and facility costs. Despite electricity costs trending downward, our view today is that our production expense will remain elevated and be between $12 to $13 per barrel for 2024.

Offsetting this is strong pricing realizations and lower estimated tax even at the top surtax spend, leading us to a $31 to $33 per barrel FFO netback at $85 per barrel Brent as per our previously guided numbers.

Quarterly capital expenditures were $98 million. This was lower than our forecast due to the pause of drilling and facility work in Arauca as well as smaller adjustments such as seismic and contract amendments.

Given the lower production profile that we see for 2024, management is hyper focused on capital discipline to drive the company's free funds flow profile. With the reallocation of capital that we are doing in-year, the timing of production growth has been extended into the back half of 2024. As such, we are forecasting that our third quarter production volumes will remain generally in line with what we saw this quarter with growth in the fourth quarter and into year-end.

At our current forecasting and today's commodity prices, we anticipate meeting our long-term capital allocation framework to return 33% of total FFO through the regular dividend and share buybacks while spending at or below the 66% threshold that we had set.

During the quarter, we repaid another $10 million of bank debt. So at point end, we had a working capital surplus of $34 million and cash of $119 million.

With that, I will pass it over to Imad for some final remarks.

[Imad Mohsen, executive]

Thank you, Sanjay. While we have faced challenges and some disappointing subsurface results during the first half of the year, we have a portfolio that allows for flexibility when it comes to capital allocation. With stable reservoir performance from Cabrestero Block 34 and the ability to quickly pivot to development opportunities at Block 32 and Capachos, we are optimistic on our production forecast for the back half and believe we have made the correct shift to deliver to the lower end of our annual production guidance.

As we have adjusted our production outlook, we are also having capital match that -- capital [ massive trend ], as Sanjay mentioned. Even at a lower production profile at today's commodity prices, we can generate significant free funds flow to support future investment and shareholder returns.

I want to take a second to thank you -- thank all of our employees for their commitment for the past few months, their ability to be adaptable and resilient as we adjust plans in support of our strategy. It's a reflection of the strong and dedicated team we have at Parex.

To end, I also want to thank our shareholders and partners for their ongoing support.

This concludes our formal remarks. I would now like to turn the call back to the operator to start the Q&A session for the investment community. Thank you.

[Operator]

[Operator Instructions] Your first question comes from the line of Alejandro Demichelis of Jefferies.

[Alejandro Anibal Demichelis, analyst]

Yes. Just one question, please. Given the situation that you're mentioning in Arauca and production for this year, how should we think or how are you thinking about production growth for 2025 and 2026 because previously you told us you could be growing at about 5% per annum over there?

[Michael Kruchten, executive]

Thanks for your question. For -- as we think about the long-term plan, I'm going to pass this to Imad, how he sees the company evolving over the next couple of years.

[Imad Mohsen, executive]

So the way I look at this, Alejandro, is we will put the money where it makes sense or it makes money. I'm not pursuing growth at any cost. And that's part of why we reallocated capital to where -- places where it made sense this year. That would mean that our exit rate for this year will be lower than what it was planned initially -- I mean, when we issued the initial guidance.

If I look at '25, '26 and beyond, I have confidence in the portfolio capability to withstand a long-term growth. But we didn't do the work yet. We are now -- the budget for next year will start in early -- by the end of this year, we'll announce it early '25. And that will be driven by where we would allocate capital to bring more benefits for shareholders, and that's where you get your number.

I don't -- I think the fact that we could reallocate capital and stay within guidance and still reduce the capital overall is a tribute to the diversity of the portfolio and the optionality we have. But to put exact numbers on it is hard at this stage. It's not -- the idea is still to try to have a thriving, growing company going forward.

[Operator]

[Operator Instructions] Your next question comes from the line of [ Daria Lima ] with Bloomberg.

[Unknown Attendee]

I have a couple on the production. I wanted to know were there any protests noted in Llanos 34 in Q2?

[Michael Kruchten, executive]

Sure. I'll pass that to Eric.

[Eric Furlan, executive]

No. As far as -- I think the question is regarding protests or social disruptions. Most of our disruptions -- we did have disruptions in Block 34, but that was mainly associated with power disruptions and a flooding event, which can happen in that area. But the social disruptions have not been material thus far.

[Unknown Attendee]

Very clear. And also on the production cost, I've noticed they have grown in Q2 versus Q1. Could you shed some light on that?

[Michael Kruchten, executive]

Sure. Sanjay?

[Sanjay Bishnoi, executive]

Yes, sure. Yes, we did see some onetime facility and road maintenance costs that were passed through our operating expenses in Q2. And I'd say that was the primary driver of the increase.

I would say that in previous discussions, we've talked about power prices being elevated. We've now seen power prices in the country normalize. So that's a positive indication for the business. And as I mentioned in prepared comments, we would expect that for the year our production cost will be between $12 to $13 per barrel.

[Unknown Attendee]

And just one last one for me. On the CapEx side, due to the pause of Araucan focus on Llanos, do you see any increase in capital expenditures in the second half of the year?

[Michael Kruchten, executive]

I'm going to pass that to Imad.

[Imad Mohsen, executive]

I mean, if you look at our expectation to be on the lower side of the overall year guidance, you can do the math in terms of how much burn rate that will bring you. I don't know exactly the dollar amount, Mike. Is that high or lower than first half?

[Michael Kruchten, executive]

Yes. We -- I think we spent roughly $183 million in the first half of the year. And midpoint of our guidance was around $410 million. So we expect to be less than $410 million. So if you just do the math on that, it's -- we'll have slightly more CapEx in the second half of the year, but relatively it will be pretty close.

[Imad Mohsen, executive]

So I don't see a huge jump in CapEx in the second half if that's the question. We are trying to be careful with how we deploy capital. It's not a knee-jerk reaction.

[Operator]

[Operator Instructions] There are no further questions at this time. I would like to turn the call to Mike Kruchten for closing remarks.

[Michael Kruchten, executive]

Thank you very much for joining our second quarter conference call. Please feel free to reach out to Parex and we can take any additional questions that you may have about Parex. Have a great day.

[Operator]

We thank you for joining. You may now disconnect your lines.