Parex Resources Inc

TSX:PXT

Earnings Call Analysis

Parex Q3 Boasts Record Production, Eyes Growth

Parex set a new production record in Q3 2023, averaging 54,573 BOE per day, a 7% increase from the same quarter the previous year. This growth is attributed to successful operations in Arauca and across the portfolio, with strong production supporting a trajectory towards an estimated 60,000 BOE per day. The quarter brought a funds flow of $158 million, despite a rise to a 15% surtax linked to Brent price, which also drove a $14 million increase in taxes. Capital expenditure reached $157 million, largely due to obligations from a farm-in agreement with Ecopetrol. The company ended with a working capital deficit but expects a turnaround and a strong finish to the year, setting the stage for a promising 2024.

Record Production and Optimistic Output Projections

Parex achieved a production average of 54,573 barrels of oil equivalent (BOE) per day in Q3 2023, marking a quarterly record and a 7% increase compared to the same quarter last year. This momentum is anticipated to continue, with expectations set on commencing new production projects and reaching a significant production milestone from the Cabrestero Block.

Financial Flow Supported by Strong Pricing Offset by Increased Costs

The company reported a funds flow from operations totaling $158 million for the quarter, bolstered by strong commodity pricing and growing production despite facing higher production costs due to extensive workovers.

Tax Reforms Lead to Cost Increases

Recent government tax reforms raised the tax burden on oil and gas producers, resulting in Parex's surtax projections to increase from an estimated 10% to a projected 15%, directly linked to Brent crude oil prices, which have been hovering around $82 per barrel.

Capital Expenditures and Working Capital Outlook

Capital expenditures for Q3 2023 amounted to $157 million, driven by ongoing initiatives such as the farm-in agreement with Ecopetrol. Q4 is expected to see a reduction in capital expenditures. The quarter ended with a working capital deficit of $58 million, though Parex plans to return to a positive balance by Q4 and continue to build on this into 2024.

Strategic Priorities and High-Impact Projects Underway

Parex remains confident in its capacity to generate strong results for the rest of the year and into 2024, with strategic priorities such as reaching a definitive agreement on the Ecopetrol memoranda of understanding and the spudding of new high-impact wells.

Consistent Delivery and Shareholder Value Commitment

With projections to deliver around 60,000 BOE per day, the company stands firm in its core plan to return roughly one-third of total cash flow to shareholders through regular dividends, maintaining a strong return on investment for shareholders.

Higher Operating Costs and New Area Investments

Operating costs were higher this quarter due to several factors such as El Niño's impact on power costs and fluctuations in peso valuation; however, investments in low-operating-cost areas like Capachos and Arauca are expected to reduce costs moving forward.

Future Growth and Efficiency Focus

Parex's focus remains on investing in growth areas like Northern Llanos and Arauca, which, with investments like the Cabrestero waterflood, is expected to result in higher, more efficient production and lower capital expenditures in 2024, thus increasing free cash flow.

Shareholder Returns and Business Strategy

The company maintains a robust approach to rewarding shareholders, including a consistent dividend of $1.50 per share, an active share buyback program, and a strategy that leverages Parex's ability to grow business and generate substantial free cash flow.

Cabrestero Block's Sustainable Development

Cabrestero has been a prolific asset for Parex, with new peak production records arising from different opportunities within the block. The optimization of the waterflood is projected to stabilize production decline and maximize reserve recovery. The ongoing polymer pilot project promises to enhance oil recovery even further, with potential wider application expected in the timeline of late 2024 to 2025.

Earnings Call Transcript 2023-Q3

[Operator]

Thank you for standing by. My name is Tamika, and I will be your conference operator today. At this time, I would like to welcome everyone to the Parex Q3 Earnings Call. [Operator Instructions] As a reminder, today's call is being recorded.

I will now hand the call over to Mike Kruchten. Please go ahead.

[Michael Kruchten, executive]

Good morning, and welcome to Parex's Third Quarter 2023 Conference Call and Webcast. My name is Mike Kruchten, Senior Vice President of Capital Markets and Corporate Planning at Parex. And on the call with me today are Parex's President and Chief Executive Officer, Imad Mohsen; our new Chief Financial Officer, Sanjay Bishnoi; and Eric Furlan, Chief Operating Officer. [Operator Instructions]

As a reminder, this conference call includes forward-looking information 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 sedarplus.ca. Note that all amounts discussed today are in U.S. dollars unless otherwise stated.

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

[Imad Mohsen, executive]

Thank you, Mike, and good morning, everyone.

I would like to start the call by introducing Sanjay Bishnoi, our new CFO. With a rich and diverse international background in energy strategy and corporate finance, he is poised to play a pivotal role on the team going forward. Before I turn it over to Eric to discuss our operational results and to Sanjay to provide an overview of our quarterly financials, I'd like to share some opening remarks regarding the progress we've made in our Northern Llanos operations in Arauca, which is a core area for our long-term strategy. I will conclude the call with our outlook for the remainder of the year, which I'm optimistic about given the recent production gains that are positioning us to deliver strong results in Q4 and 2024.

Firstly, I'd like to recognize our team who recently delivered our inaugural well at Arauca, which is the deepest onshore well drilled in Colombia's history. This historical well also marks a significant milestone as it is the first to be drilled on the block since the 1980s when operators left due to social instability.

The successful delivery of our Arauca-15, which is expected to commence production before the end of the year, showcases our team's ability to operate in challenging areas and is a differentiator as an operator who is aggressively pursuing Colombia's world-class reservoirs. I'm also pleased to announce that we are making meaningful progress at Arauca-8, which is one of our high-impact Big 'E' exploration wells. I like this one. The well is currently a pacesetter for Parex achieved through the application of modern drilling technologies. And as we progress the learning curve in that area, we expect to -- and as we progress our learning curve in that area, we expect to see this well near the end of the year and look forward to sharing initial results in early 2024.

With that, I'll invite Eric to cover our operational results. Please go ahead, Eric.

[Eric Furlan, executive]

Thanks, Imad.

In Q3 2023, production averaged 54,573 BOE per day and represents a quarterly record for Parex, up 7% compared to Q3 2022 and up 1% from the prior quarter. As Imad mentioned, we are seeing fantastic progress at Arauca, both socially and operationally. We are also finding success across the rest of our portfolio through our exploitation and exploration efforts, which today supports strong production of roughly 59,000 BOE per day with record production from our Cabrestero Block, success from our Block 34 horizontal wells and impressive results from our horizontal well in Block 81, where we had a discovery last quarter.

Building on this production growth over the remainder of the year, we expect to grow through the commencement of production of near-field exploration discovery on the Cabrestero Block, where we have drilled into a new pool with promising results, delivering another horizontal well in Block 34 and bringing Arauca-15 online following the multi-zone testing that we are doing. Although the operational size has been slower in the first half of the year than projected, the capital we deployed and the team's diligent efforts are now paying off. We feel like we have lots of reasons to be excited on the operational front.

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

[Sanjay Bishnoi, executive]

Thanks, Eric.

Before I get into our results, I wanted to quickly say that I'm very enthusiastic about joining Parex. My initial impressions are that the team and outlook for the portfolio are excellent, and I look forward to contributing to the company's success.

Now let's move on to the results. Funds flow provided by operations for the quarter was $158 million, supported by strong commodity pricing and growing production, offset by higher production costs from workovers and energy prices as well as higher current taxes.

The higher current taxes relate to the government tax reform that was passed in late 2022, which increased costs on oil and gas producers, specifically through the establishment of an income surtax of up to 15% linked to the historical Brent price. With year-to-date Q3 2023 Brent pricing and the forward curve near $82 per barrel, we moved from an estimated 10% surtax to a projected 15% surtax. It is important to note that for the quarter, current taxes were increased by $14 million to reflect this.

Capital expenditures for the quarter were $157 million, which was driven by our farm-in agreement signed in 2021 with Ecopetrol for both the Arauca and Llanos 38 Block, where we have carry obligations. We expect Q4 2023 capital to be lower as our costs associated with drilling at Arauca revert to a 50% working interest for our farm-in agreement and as we have less Cabrestero activity planned.

We ended the quarter with a working capital deficit of $58 million. This was primarily a result of the timing of certain capital related to the farm-in agreement as discussed as well as the buildup of inventory, which has peaked. Looking forward, our plan has us as a positive -- had a positive working capital balance by Q4 of 2023 and building our working capital in 2024 through the production growth that we are seeing today, a forecast that has lower capital as well as the deployment of long lead items and equipment inventory off of our balance sheet over the next 6 to 9 months.

With that, I would now like to turn the call back to Imad for some final remarks.

Please go ahead, Imad.

[Imad Mohsen, executive]

Thank you, Sanjay.

The strategic deployment of capital throughout the year has begun to reap rewards. And we have realized meaningful production gain as well as succeeded in gaining access to our outcome, which represents new province for the company. With that momentum, we are confident in our ability to deliver strong results for the remainder of the year and into 2024. Importantly, I'd like to highlight a few strategic priorities that we have been progressing in support of our long-term strength.

We continue to make meaningful progress in reaching and signing a definitive agreement on our Ecopetrol MoU. I cannot stress that one enough. We are -- we expect to spud our next big high-impact Big 'E' exploration well on Block 122 called Arantes by year-end. This is expected to be the first well of several as we target the high-potential Foothills trend.

We continue to progress the learning curve in new areas such as Arauca, which is expected to improve our portfolio's capital efficiency going forward. And as Eric alluded to, our strong quarter-to-date production is being driven in part by exploitation and near-field exploration being core to our strategy. Contributing to the success are short-cycle opportunistic adds as -- such as on Block 81, where production is outperforming our original expectations, and horizontals in SoCa, where we are seeing the delivery of capital-efficient product. Our portfolio is full of these types of opportunities, which we plan to continue taking advantage of.

As we look to the end of 2023, I'm pleased with the operational momentum that we have achieved in the back half of the year, which puts us on track to deliver about 60,000 BOE per day and sets us and shareholders up for great 2024.

Core to our long-term planning is a return of roughly 1/3 of our total cash flow to shareholders through regular dividends and share buybacks. And our priority for the next year is to grow our production, improve capital efficiency and deliver exploration success. Combined, this should generate significant free cash flow and ultimately, shareholder value.

I want to end by thanking our employees for their impressive contributions, our shareholders for their continued support and say, again, welcome to the team, Sanjay.

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

[Operator]

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

[Alejandro Anibal Demichelis, analyst]

I have two questions if I may, please. The first one is you mentioned the change in working capital turning positive as of this quarter actually. So could you please give us some kind of sense of the size of that kind of change in the working capital? That's the first question. And then the second question is, how do you see the production costs evolving as you're bringing new wells, you're doing more in Arauca and so on?

[Michael Kruchten, executive]

Great. Thank you very much for the call. I'm going to pass it first to Sanjay, and I'll have Eric talk about the OpEx. Thanks.

[Sanjay Bishnoi, executive]

Sure. Yes, thanks, Mike. And nice to meet you, Alejandro. I think from a positive working capital standpoint, really the drivers of that are we're going to see better production. We're going to see lower CapEx in the quarter. In terms of specific numbers, I think we'll hold off on giving any guidance on that. Obviously, there's some unknowns such as commodity prices, et cetera, that will factor into that as well. So we're going to leave our comments today with just we do expect to revert to a positive balance by the end of the quarter.

[Eric Furlan, executive]

Okay. And thanks, Sanjay.

With regards to operating costs, yes, operating costs in this quarter were higher for a couple of main reasons. One, the El Niño effect is creating a much higher power cost in Colombia that was outside of what we had budgeted for the year. So that accounts for about half the increase in operating costs. We've also had some changes in peso valuation and in addition, some additional workover costs associated with some shutdowns and social disruptions that we've had in a couple of areas that we've covered in the past.

As far as going forward and the question regarding new areas, generally speaking, areas like Capachos and Arauca are our lowest operating cost deals. They're generally prolific fresh production. So our original initial operating cost is much lower, roughly around half of what we are corporately. So as we bring those volumes on, we do expect those volumes to be very efficient from an OpEx perspective.

[Operator]

[Operator Instructions] Your next question is from the line of Kevin Fisk with Scotiabank.

[Kevin Fisk, analyst]

I just have two questions. The first of which is if you can give us an update on the political and security situation? And then if you're able to give us any initial thoughts on what the CapEx and production look like next year, including what sort of areas you would like to focus the spending on and where production growth will come?

[Michael Kruchten, executive]

Great. Thanks, Kevin. I'll let Imad talk about the overall macro political situation first, and then I'll tell you about the plan for next year.

[Imad Mohsen, executive]

Thank you, Mike.

I mean, overall, we are currently fully operational. We have had minimal social challenges, I would say, so far this second half of 2023. There was regional elections at the end of October, we didn't see any adverse effects. Now we are, in general, very well aligned with the government in terms of its desire to bring gas to the country through the MoU or in terms of getting the most out of the fields we have through exploitation and technology in our strategy. So we've seen very good support, no issues in terms of getting permitting. And we have the running room we need.

That being said, I'd say, in Colombia, there could be volatility sometimes. So I can never guarantee that next week would be perfect. And -- but as a company, we demonstrated our ability over the long term to be successful. And because we create these win-wins with the communities and they are to operate, and we take steps to proactively work with our stakeholders to ensure that.

[Michael Kruchten, executive]

Kevin, with regards to next year, we'll be providing an update in -- early in the new year how our plans for 2024 are. And certainly, when we look at our 3-year plan, we'll be tweaking that and updating that data also. One thing I want to confirm is our strategy remains the same. We plan to continue to invest in growth areas such as Northern Llanos, Arauca. We'll continue with some of the programs that we've seen success for this year, such as the exploitation in small E in the Casanare Southern Llanos region. And we'll have a diversified program across the Lower Mag and even in the Middle Mag next year.

Now some of the things where we've invested considerably over the last 2 years, such as the Cabrestero waterflood, the Arauca farm-in really leads us to lower CapEx and hire more efficient production as we move into 2024. So I think those key elements remain the same, higher production and lower CapEx, generating higher free cash flow next year.

[Operator]

Your next question is from the line of Conrad Bereznicki with Peters & Company.

[Conrad Bereznicki, analyst]

I have two. The first one is just around shareholder returns. And how are you thinking about that changing going into 2024? And then the second question I had is just around Cabrestero. Maybe you can just highlight to us some of the wins that we've seen from the waterflood and then how you think polymer might change that going forward?

[Michael Kruchten, executive]

Great. I'll start off with the shareholder returns, and I'll pass that to Eric.

As we see shareholder returns going forward, I think that's really three pronged. We have a healthy dividend to $1.50 a share. We have a share buyback program that's been very consistent, and I think probably industry leading, if you look at the number of shares that have been repurchased over the last 3 years. And I think the third element is actually just growing the business. And I think that's our competitive advantage in our peer group of the ability to generate free cash flow to do all 3 things.

So as we look into shareholder returns as we go forward, we'd like to continue on all those 3 prongs as we go forward.

Eric?

[Eric Furlan, executive]

Thanks, Mike.

Yes, Conrad, Cabrestero has been a key area for us, and it's kind of a block that keeps on giving to us. Here we are, 10-plus years after we started operating there, setting new peak records from the block on the backs of multiple different opportunities. We mentioned the discovery -- the recent discovery. So we're finding additional opportunities with their seismic. The waterflood is starting to ramp up. We are seeing positive oil production responses and optimization of that waterflood over the long term will steady the decline and maximize reserves recovery.

And then finally, when we talk about polymer, what does polymer do for us? It takes us to that next level. It pushes the product into the ground that has a similar characteristic to the oil in the ground. So it's more efficient at pushing the oil out. And it has two real impacts. The first being, you can recover the oil much more quickly, more efficiently, using this technology and ultimately, a higher recovery factor. So we're on track with that pilot this year and are excited to see those results and the possible application on a wider scale.

[Imad Mohsen, executive]

Can I add something here, Eric? I mean -- it's not only Cabrestero, Cabrestero is our lab and as Eric said rightly so we can apply it in other places, most notably in Llanos 34.

[Michael Kruchten, executive]

Thanks, Imad.

[Conrad Bereznicki, analyst]

Got it. Just maybe to that point, when do you expect to see a response? Is it 6 to 8 months is a typical response you would see in these reservoirs? And then would you look at maybe moving to a larger scale development, would that be '24, '25 time frame, late '24, '25?

[Michael Kruchten, executive]

Those are reasonable estimates. I mean the first part will be monitoring injection performance, how well is it displacing in the reservoir. And then as you said, probably 6-plus months to see some response and end of year to have some decisions on an expansion either to a larger pilot or more full scale type development.

[Operator]

[Operator Instructions] Your next question is from the line of Tom James with Greenwich Associates Limited.

[Unknown Analyst]

You're drilling very deep wells in Arauca in #15 and #8. Obviously, you really expect very high impact. Can you give us any more color on what your expectations would be in terms of reserves and production?

[Michael Kruchten, executive]

Thanks, Tom, for the question. I'll pass that to Eric.

[Eric Furlan, executive]

Yes. Thanks, Tom.

I mean we base our expectations on historical performance from some of the wells in Arauca area that had a capability easily of 3,000 to 5,000 barrels a day. So it's not completely blind. We have an understanding of the reservoir distribution there. As far as commenting on reserves and potential, obviously, we see a lot of potential there. We have about 3 or 4 zones that we're mainly going after with all of these wells. So it is multi-zone potential. And depending on how those zones stack and which ones are successful, there is a very large prize there. But -- so that's what we're looking at.

As far as well costs, we had a lot of challenges in the first well. We learned a lot from the first well. We had social challenges there that disrupted us. We're setting -- we're drilling a pacesetter well as we speak, that is ahead of schedule. And maybe the most cost-efficient well ever drilled in the area as we go to our final casing stream.

So we're excited on two fronts: the opportunity, the multizone and the cost improvements and performance improvements we've seen drilling these wells.

[Unknown Analyst]

So #8, I guess, you're expecting the same depth as #15?

[Eric Furlan, executive]

It's slightly shallower, but essentially, yes. It's a 20,000-foot type well in line with Arauca-15.

[Unknown Analyst]

When do you expect to get the results from #15?

[Eric Furlan, executive]

We'll be doing a selective testing or multi-zone testing here in the next 30 to 45 days. There are numerous challenges to test. So after that time, we'll have a more wholesome understanding of the well. And with regard to Arauca-8, we expect to have logs and some preliminary characterization before the end of this year.

[Operator]

At this time, there are no further questions. I will now hand the call back over to Michael Kruchten for any closing remarks.

[Michael Kruchten, executive]

Thank you very much for joining us today. We appreciate your feedback and feel free to contact us if you have any further questions. With that, have a great day.