Tourmaline Oil Corp

TSX:TOU

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Tourmaline Oil Corp. Q3 2020 Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to Mr. Scott Kirker. Please go ahead.

[William Scott Kirker, Secretary & General Counsel]

Thank you, operator, and welcome, everyone, to our discussion of Tourmaline's results for the 3 and 9 months ended 30, 2020. My name is Scott Kirker, and I'm the General Counsel for Tourmaline. Before we get started, I refer you to the advisories on forward-looking statements contained in the news release as well as the advisories contained in the Tourmaline annual information form and our MD&A available on SEDAR and on our website. I also draw your attention to the material tickers and assumptions in these advisories. I'm here with Mike Rose, Tourmaline's President and Chief Executive Officer; Brian Robinson, Vice President of Finance and Chief Financial Officer; and Jamie Heard, Tourmaline's Senior Capital Markets Analyst. We will start by speaking to some of the highlights of the last quarter and our year so far. And after Mr. Rose's remarks, we will be open for questions. Mike, go ahead.

[Michael L. Rose, Non Independent Chairman, President & CEO]

Thanks, Scott. Good morning, everybody, and thanks for dialing in. We had a very busy quarter with material acquisitions in the Alberta Deep Basin and very strong Q3 operating and financial results. So firstly, the highlights. We announced 2 strategic corporate acquisitions: Modern Resources Inc. and Jupiter Resources, Inc, yesterday, and they provide an additional 76,000 BOEs a day of current production, significant accretive cash flow and free cash flow. The Modern transaction is closed and Jupiter is scheduled to close on December 16. We do plan a follow-on sale of a board or grills overriding royalty on the Modern and Jupiter lands for Topaz energy for cash proceeds of $130 million. 2021 looks very strong with forecasted average production of approximately 400,000 BOEs per day, cash flow of $2 billion and free cash flow on strip of $856 million. Importantly, the ongoing EP program was a pre -- sorry, proceeding ahead of schedule, and we actually achieved our 2020 production exit guidance early. Our dividend will be increased by 17% or $0.02 per share to $0.14 per share quarterly, effective December 2020, and we had strong Q3 results with cash flow of $1.03 per diluted share. Total capital spending, excluding acquisitions of $241 million, and average production of 298,000 BOEs per day. A little bit more detail on the Deep Basin transactions in aggregate. The 2 corporate acquisitions will boost our full year 2021 average annual production estimate to 400,000 BOEs per day at the midpoint. So that's an increase of 25% and from our previous 2021 guidance of 320,000 BOEs per day. The acquisitions in aggregate include over 900 sections of prospective land in the North Sea Basin, 445 million BOEs of 2P reserves, and both assets or companies are in the most -- one of the most prolific and economic sub areas of the Alberta Deep Basin and both come with meaningful facilities and related infrastructure. We plan modest growth in the 3% to 5% range from the Modern and Jupiter assets in the '21, '22 timeframe basically to optimize efficiency and cost and then we'll migrate to a maintenance capital production model, similar to what we're running in the balance of the Alberta Deep Basin Complex after that. So production from the combined modern Jupiter assets is expected to increase from the current 76,000 BOEs per day to approximately 85,000 BOEs per day over those next 2 years. And then we'll keep it essentially flat after that in the current model. There are considerable operational capital land and facility synergies that we've identified between the Jupiter and Modern asset bases and the existing Tourmaline lands in the area. We expect the Jupiter and modern assets to cash flow, approximately $300 million annually and provide free cash flow of between $130 million and $150 million per annum in 2022 and beyond. And anecdotally, that's actually sufficient to fund the vast majority of the current increased dividend. As mentioned, we've agreed to sell Topaz a GORR on the Modern and Jupiter lands that will be effective Jan 1, 2021 for $130 million. It will consist of a 2% GORR on natural gas in 2021 that steps up to 3% in 2022. And thereafter, and it will be 2.5% on crude oil and condensate. Net of the GORR proceeds, combined the acquisition metrics are 2.6x '21 cash flow. And the free cash flow yield is 13% in '21 and 20% in '22. A little bit more detail on Modern specifically. We acquired it effective November 2, 2020. Total consideration, including debt, $144 million, so $73.75 million of cash and 1.5 million Tourmaline common shares, and the net debt was approximately $44 million. Those assets are located in the North part of the Deep Basin, current average production of 9,000 BOEs per day, 2 key reserves of 88 million BOEs. That's a Tourmaline estimate. Over 400 sections of land and 100% owned and operated route natural gas plant, which has a fully loaded capacity of approximately 120 million per day. And a future minimum drilling inventory of over 200 locations. Moving to the Jupiter acquisition. We have entered into a definitive agreement to acquire Jupiter for 24.2 million Tourmaline common shares, and that represents a total consideration for the transaction of $626 million, and that's inclusive of net debt estimated at approximately $200 million. And as mentioned, that transaction is expected to close on December 16, 2020, and we provide some detail on the 92% of the share lockups that we have in place. The Jupiter assets are immediately adjacent to the modern assets. It includes average working production currently of 67,000 BOEs per day, 2P reserves of 357 million BOEs, 500 net sections of land with an average working interest of 84% and working interest in several gas plants in the rest -- even in capital areas. The greater Musreau rest payment capital portion of the deep basin where Jupiter and Modern assets are located, yield amongst the highest EUR wells and liquid yields in the entire Deep Basin complex. And on both asset bases, we believe we'll be able to deliver completed horizontals for 30% to 40% less capital cost, and we've done that on immediately offsetting acreage already in the Musreau capital area. The Jupiter production base has an estimated decline rate of 25% in the '21, '22 timeframe. We estimate annual maintenance capital of approximately $130 million or 20 to 22 wells per year to yield annual cash flow of $250 million to $260 million on production of 70,000 to 75,000 BOEs per day in 22, and that's at strict pricing. We believe the Tier 1 drilling inventory alone will support this level of drilling activity for an estimated 13 to 15 years. Jupiter did generate free cash flow in 2020. We believe Tourmaline's lower operating capital costs will increase that estimated free cash flow to approximately $120 million per year at strip beginning in '22. The Jupiter infrastructure includes working interest in 3 gas plants, two of which are operated by Jupiter and their current OpEx is estimated at $4.25 a BOE. So a little higher than ours, but we'll realize some of the field synergies that we see and drop that OpEx. And a substantial portion of the current Jupiter gas production assets of deep cut facilities and restating capital, yielding strong overall liquid production. The assets are currently producing approximately 20,000 barrels per day of condensate and NGLs. Looking at our third quarter results, they were, in fact, strong. Our Q3 production was 298,202 BOEs per day. So right in the middle of the Q3 guidance range of 295,000 to 300,000 BOEs per day. And that's net production we were actually injecting in July in California. So actual operated production was higher than $298,000. Our 9-month 2020 average production now sits at approximately 302,000 BOEs per day. As mentioned, we did achieve our exit guidance of between 322,500 and 327,500 BOEs per day during October and that includes the impact of the acquisitions that were completed at that time. So the aggregated small deface in acquisitions, not Jupiter and Modern and the Polar Star and Chinook acquisitions from February and March of this year. And it's really stronger than forecast new well performance from our post breakup EP activities primarily in the Alberta Deep Basin that allows the company to achieve that exit production guidance currently. So our revised exit production, assuming Jupiter closes is on schedule, December 16 is now 400,000 BOEs per day. And as mentioned, we're averaging 21 average -- or expecting '21 average production of between 390,000 and 410,000 BOEs a day, so midpoint is 400,000 and that will be constituted by 1.9 Bcf per day of gas and 87,000 barrels per day of crude oil, condensate and NGLs. Looking at our financial results for Q3 in a little bit more detail as mentioned, cash flow was essentially $280 million or $1.03 per fully diluted share on total CapEx, excluding acquisitions of $241.2 million and free cash flow for the quarter was $38.7 million. So 9-month cash flow is now at $788.8 million. 9-month free cash flow is $129.1 million. Our revised 2020 cash flow is now estimated to be $1.225 billion. That's based on full year average production of between 310,000 and 312,000 BOEs per day and that's controlled by production levels at the time that we closed Jupiter in -- the Jupiter acquisition in mid-December. Q3 OpEx was $3.26 per BOE, and year-to-date operating costs are $3.10 per BOE. So those remain amongst the lowest end of the sector. We also announced our investment-grade credit status during Q3, which combined with low prevailing interest rates contributed to an effective interest rate of 1.57% for Q3 of 2020. So we're certainly proud of that. Turning to our 2020 and 2021 capital programs. We have increased the 2020 EP capital program to $835 million from $800 million. The incremental spending relates to fourth quarter drilling on the Modern and Jupiter assets to maintain existing production levels, early mobilization of 1 drilling rig in BC to maintain production on the Chinook and Polar Star assets and the small initial facility progress payment on Gundy Phase II, that expansion is scheduled for first half of '22. The 2021 EP capital program is now $1.1 billion versus anticipated '21 cash flow of $2 billion. And this program includes $160 million to maintain and optimize production on the Modern and Jupiter assets. It includes $100 million facility progress payment for Gundy Phase II deep cut that total estimated Phase II plant cost remains at $150 million once fully installed and operational in the first half of 2022. That compares to the Phase I Gundy deep cut cost of $180 million. And do remember, the Gundy Phase II is the only significant facility and growth project in our entire current 5-year plan. We remain on track for a record 2020 EP capital efficiencies of under 7,000 of flowing BOE, and they'll pick up modestly in 2021 to just around 7,000 per flowing BOE primarily because of that initial progress payment on the Gundy Phase II deep cut facility. Our new go-forward maintenance capital is estimated at $900 million for '21, including all acquisitions and is expected to systematically decline in subsequent years. We plan to drill, including the acquired assets, 225 wells approximately in 2021. Looking very briefly at our second half EP activity. New well performance consistently exceeded expectations during Q3, highlights included the first lower mining well on the 16 section block acquired in Q4 of '19 at South Gundy in BC, tested at a final rate in the lower mining of $9.4 million cubic feet per day and 560 barrels per day of condensate on 188.5 hour flow cast. And that's an important delineation well that may lead to a significant new liquid-rich Tier 1 inventory increase in our greater Gundy complex. The next 3 wells, I won't go through in detail. They're spectacular wells so you can read them yourself. Interestingly, they're all in the Deep Basin, which bodes well for the acquisitions that we announced yesterday. Briefly on the marketing front, we have an average of 475 million per day hedge for Q4 2020 at a weighted average fixed price of CAD 280 per Mcf, an average $146 million per day hedged at a basis to NYMEX of minus USD 15 per Mcf and an average 379 million cubic feet per day of incremental volume exposed to export markets, which include Dawn, Empress Chicago Ventura, Sumas, Malin, and PG&E. Nat gas fundamentals for '21 are steadily improving. Remember that approximately 72% of Tourmaline's natural gas volumes are exposed to markets on the western half of the continent. So that includes PG&E, Malin, Sumas, Station 2 and AECO, that's where the 2021 gas supply diminishment is anticipated to be the greatest, and hence, the price is the strongest. Tourmaline has diversification to the U.S. and other hubs aggregating to 620 million cubic feet per day by exit 2022 and 665 million cubic feet per day by exit 2023. We also have 4 Bcf with natural gas in storage facilities at Dawn, Ontario and PG&E, San Francisco, which we plan to draw through the winter months at very strong and attractive prices. During Q3, we actually injected 0.97 or just about 1 Bcf of natural gas into storage when the prices were lower than they are today. We did provide a new 5-year plan in our updated CoV and investor materials. Our anticipated 2021 cash flow, including the impact of the new acquisitions, as mentioned, is $2 billion at current strip pricing, and that will yield free cash flow of just over $850 million on CapEx of $1.1 billion. And that '21 free cash flow will be utilized to fund modest sustainable dividend increases, further reduce debt and potential tactical share buybacks we do intend to continue to reduce our debt to cash flow to well less than 1x during 2021 and maintain debt at that level, which will be somewhere in the $1 billion range. We are maintaining the same modest EP growth profile within the previous 5-year plan that equates to 3% to 5% per annum production growth and our plan, as we've consistently stated for an extended period of time is to not grow overall based on gas supply, but do attempt to capture more of it of note in the 5-year plan now at strip, the free cash flow over the 5 years is CAD 3.5 billion. We did increase the dividend due to the company's continued growth and sustainable free cash flow. So we've gone from $0.12 to $0.14 per share quarterly or $0.56 per share on a full year basis. And it's the fourth time we've increased the dividend since we instituted it in Q3 of 2018. On the Topaz front, the Topaz IPO was successfully completed. On October 26 this year, and Topazs' common shares now trade on the Toronto Stock Exchange under the symbol TPZ. Tourmaline owns 58.1 million Topaz shares, which had a market value of just under $850 million as of today. And I think that's probably enough commentary, and we're happy to move into the Q&A phase of this conference call. So thank you for listening.

[Operator]

[Operator Instructions] First question comes from Michael Harvey with RBC Capital Markets.

[Michael Steve Harvey, Analyst]

Just a couple of questions. First one, and you did touch on this, but I guess any more color on how you could envision the allocation of free cash in 2021 if the strip holds? Obviously, I heard your comments, but the free cash flow numbers are quite large, obviously or maybe asked another way, are there any rough ranges or brackets for how you're thinking about allocation to M&A? Or are there any triggers at all that would lead you to executing any more drilling? And the second part, just wondering on capital allocation. Obviously, the kind of game plan has been -- grow a little bit in the Montney and stay flat in the Deep Basin. It sounds like that will continue for some time here, but a sizable investment in the Deep Basin. So just seeing if there's any change to that thinking? Or what would cause you to allocate a bit more to the Deep basin?

[Michael L. Rose, Non Independent Chairman, President & CEO]

You bet. Thanks, Mike. No change to the capital allocation at the current time. So the Montney in North BC, our Montney gas condensate complex will remain the growth complex, and I get referenced that really the only significant growth project in the 5-year plan is that Gundy Phase II deep cut. There will be more net capital allocated to the Deep Basin simply because it's now a 250,000 BOE a day complex. And so there's a little bit of growth to optimize the Modern and Jupiter assets, and then they'll revert back to a maintenance capital level, which of course, will be higher than it was before we did those 2 transactions. On free cash flow allocation, I mean, yes, it is a large number. We're not going to increase the dividend that much, and we're not going to take debt down to 0. So I think the best way to look at the significant amount of free cash flow in that plan is that we have another pool of capital available for M&A to go along with the capital pool that we've created with the Topaz vehicle. We do not plan to grow Basin supply other than the 3% to 5% per annum growth that we've outlined in the plan. So we're not going to do that certainly through '21. If the strip improves from where it is now, '22 and '23 are [indiscernible], maybe we revisit that at some point. But right now, we're going to maintain that capital discipline for the current future.

[Operator]

Next question comes from Patrick O'Rourke with ATB Capital.

[Patrick Joseph O'Rourke]

You touched on there being synergies of these assets that you've acquired here. Obviously, you're quite forthright with the 30% to 40% on the capital side. Just wondering, on the operational side. And in terms of the cash flow numbers that you've put out there for the next couple of years, how much of those synergies are already baked in? And is there potential to go a little further than that?

[Michael L. Rose, Non Independent Chairman, President & CEO]

What we put in over the next 2 years as far as dropping OpEx was approximately $0.50 per BOE. Yes, there is an opportunity to do better than that. But we left it there for now until we take over the assets, and I'm sure we'll find more synergies than what we've already identified. And Jupiter has a significant processing spread on the ground. Modern has a very new and efficient plant at route that's not full and our Musreau 8-13, 9-13 complex sits right in the middle of both asset basis as well. So there will be lots of opportunity to optimize and improve OpEx metrics.

[Patrick Joseph O'Rourke]

Great. And then you guys have had a very defined strategy on the gas marketing side, having those molecules facing the western side of the continent here. As you're becoming very meaningful on the NGL side. I'm just wondering if there's any strategies or things that you're thinking about to extract a little bit more value from those NGLs?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Well, yes. And that process has been in place for for some time. I mean, our goal is to maximize the return from all of our hydrocarbon production streams. And so we were a relatively large NGL producer prior to this deal. So we have -- really, what we're putting in place is a comparable marketing and transportation, long-term strategy that we've already put in on the gas side, which we started kind of over 7 years ago. So some of those diversification efforts have included in Northeast BC, participating in the RIPET system and moving the propane and getting the Far East index pricing and we have another series of initiatives in place to optimize that whole NGL stream. Brian, anything you want to add to that?

[Brian G. Robinson, VP of Finance, CFO & Non Independent Director]

The only other thing is when we reset our contracts with the buyers of our NGLs at Fort Saskatchewan, we did so in a manner that took some of the short-term price risk out, which we hadn't done in the past. So I think that's helped our netback. And you start to see that in Q3 as well where you could see our NGL price popped up there a bit.

[Patrick Joseph O'Rourke]

So with a little bit more critical mass on the next reset here, does that put you in a bit of a better negotiating position? Or are those things you think going to stay in kind of the same shape?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Well, I think we probably potentially have a little bit more leverage.

[Operator]

Next question comes from Jordan McNiven with Tudor, Pickering, Holt.

[Jordan McNiven]

Just kind of piggyback on some of your earlier questions and earlier comments here. I mean you guys talked about not wanting to take debt to 0. And so just wanted to think through that. You all talked about the dividend and not wanting to grow it necessarily too much, which I think makes sense in a cyclical commodity business. So just wanted to further dig in on that and get your thoughts on how you would feel potentially doing special dividends still temporarily to supplement the common one when things are going well and not pushing up the common dividend too much along the way. So just thoughts around potentially giving specials and where that might layer into the priority Q versus, say, buybacks or other uses?

[Brian G. Robinson, VP of Finance, CFO & Non Independent Director]

Thanks, Jordan. It's Brian speaking. We favor the idea of a structured dividend where we methodically increase it as we get more and more confidence about the tenure and position of our free cash flow, including more hedge activity into '22 and '23. We're monitoring those companies that are using these various variable dividend algorithms. So far, we don't feel that it's something that's attractive to Tourmaline. We prefer to do it the way we're handling it right now.

[Jordan McNiven]

Okay. So it sounds like then a buyback would certainly rank ahead of that, is that fair?

[Brian G. Robinson, VP of Finance, CFO & Non Independent Director]

Yes.

[Jordan McNiven]

Okay. And then just another one. Is there anything you guys can share just in terms of third-party fees associated with the acquired assets and potential tenure there or ability to renegotiate and capture further synergies there?

[Michael L. Rose, Non Independent Chairman, President & CEO]

I think there's the potential to always reduce them. Jupiter had gone through a fee renegotiation process over the past couple of years and then had made significant headway from where they were prior to that. And so kind of see that as an ongoing continuum. We did not build any of that potential upside into the acquisition that we're doing. And so time will tell if we do even better. So we just built field OpEx reductions in and nothing to do with the base processing fee, but we'll optimized, we'll increase the volume, as mentioned, kind of 5% per annum over the next 2 years, and there'll be some opportunities to do other things. Anything you want to add to that?

[Brian G. Robinson, VP of Finance, CFO & Non Independent Director]

Nothing. That's good.

[Operator]

[Operator Instructions] Next question comes from Fai Lee with Odlum Brown.

[Fai Lee, Equity Analyst]

I'm just wondering if you can comment a bit on the background, and how the Modern and Chinook deals came about, just curious whether you're specifically targeting assets you want to add into your portfolio or if people are knocking on the door?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Well, there are assets that we've certainly paid attention to for an extended period of time, both companies were in sales processes, and we just participated through those existing processes.

[Fai Lee, Equity Analyst]

Okay. And in terms of the -- you've talked about a little bit of improvement in gas prices. How is that affecting our opportunity set for acquisitions?

[Michael L. Rose, Non Independent Chairman, President & CEO]

It hasn't -- if the question, Fai, is has the runout in price made it more difficult to do transactions, I would say no, but I mean, time will tell, and Brian referenced the tenure to the gas price improvement of '22 and '23 move out of backwardation, that may become an issue. I mean, there are companies that have a significant amount of kind of balance sheet repair for a lack of better terms to enact. And so there's still opportunity sets available out there. That's really the best thing I can come up with right now to that question.

[Fai Lee, Equity Analyst]

Okay. And just the last question. In terms of now that your largest natural gas producer the news in Alberta talking about potential negotiation to attract petrochemical producers to Alberta. Have you given a thought -- I know it's longer-term, but about potential offtake agreements with petrochemicals producing in the province? Is that something you would consider?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Well, we've been looking at all sorts of opportunities for gas supply, including petrochemical for an extended period of time. And as we continue to grow our overall gas production. We're going to continue to diversify what we do with those gas molecules. And I mean, I guess, currently, we're the largest -- our real goal, though, is to be the most efficient, the most profitable and the cleanest nat gas producer in Canada.

[Operator]

[Operator Instructions] Our next question comes from Mike Shannon with Hill Park Holdings. [Operator Instructions] We have a question from Fai Lee with Odlum Brown.

[Fai Lee, Equity Analyst]

Mike, just a follow-up. You mentioned that you want to be the cleanest gas producer. I know that you're looking at electric rigs. And I'm just wondering along those lines when -- what other initiatives you're looking at or where you see that going forward?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Well, we have a significant effort to ultimately eliminate diesel usage in oil drilling and completion operations, which provides a significant emissions reduction. We have heard 5-year targets on CO2 emission intensity reduction and methane reduction, and so we have some field trials on -- in various methane reduction projects and developing some of our own technology for both running drilling rigs off high line power and the continued elimination of diesel. Our water management businesses in both the Deep Basin and Northeast BC in the instances in our larger complexes where we can deliver that water and remove that water by pipeline systems rather than trucking. There's a big emissions reduction associated with that as well. So we track it all. And as I mentioned, had those hard 5-year targets to continue producing a net cleaner methane molecule. And don't forget Canada produces the cleanest methane molecule in the world.

[Operator]

[Operator Instructions] Again we have a question from Mike Shannon with Hill Park Holdings.

[Unknown Analyst]

Mike, can you tell us what the pro forma corporate decline is with all these acquisitions?

[Michael L. Rose, Non Independent Chairman, President & CEO]

Currently, it's in that 34% to 35% range, and we see it dropping to a 26% to 27% by year 5 of the 5-year plan.

[Operator]

[Operator Instructions] And we do not have any telephone questions at this time. Mr. Kirker, I will turn the call over to you.

[William Scott Kirker, Secretary & General Counsel]

Thank you, operator. Thanks, everyone, for calling in and listening. And as always, if you have questions in the interim, please feel free to contact us off-line.

[Michael L. Rose, Non Independent Chairman, President & CEO]

Thanks, everybody.

[Brian G. Robinson, VP of Finance, CFO & Non Independent Director]

Thank you.

[Operator]

This concludes today's conference call. You may now disconnect.