Vermilion Energy Inc

TSX:VET

Earnings Call Transcript 2017-Q4

[Operator]

Good morning. My name is Sharon, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Inc, Fourth Quarter Results Conference Call. [Operator Instructions] Thank you. Anthony Marino, President and CEO, you may begin your conference.

[Anthony William Marino, President, CEO & Non]

Thank you, Sharon. Good morning, ladies and gentlemen, thank you for joining us. I'm Tony Marino, President and CEO of Vermilion Energy.With me today are Curtis Hicks, Executive Vice President and CFO; Mike Kaluza, Executive Vice President and COO; and Kyle Preston, our Director of Investor Relations. I'd first like to refer to the advisory on forward-looking statements contained in today's news release. These advisories describe the forward-looking information, non-GAAP measures and oil and gas terms referred to today and outline the risk factors and assumptions relevant to this discussion.During this call, I'll provide you with an overview of our fourth quarter and full year 2017 financial and operating results and our 2017 year-end reserves and resource information, which was announced with our Q4 results this morning.Vermilion's Q4 production increased 8% from the prior quarter to an average of 72,821 boe/d. This increase was primarily driven by growth in Canada and the Netherlands and the resumption of operations at Corrib, following unplanned downtime last September and early October as previously announced.Q4 production was partially restrained by cold weather in Canada late in the year. The Forest Mazur event on a third-party gas gathering system and our Turner Sand's play in Wyoming and minor maintenance activities in Germany and Australia.Our annual 2017 production volumes increased by 7% or 3% on a per share basis to 68,021 boe/d at the lower end of our revised guidance range of 68,000 to 69,000 boe/d.As you recall, we reduced our full year production guidance by 1,000 boe/d at the time of our Q3 release, due to the unplanned downtime at Corrib.FFO in Q4 2017 was $181 million or $1.49 per share, representing an increase of 38% from the previous quarter as a result of higher sales volumes and commodity prices.FFO for the full year was $603 million or $5 per share, up 18% from the prior year due to higher production volumes and higher commodity prices.We achieved this annual production and FFO growth on a total E&D capital investment of $320 million.We generated FCF of $282 million, which represents a 5% increase over the prior year and was more than sufficient to fund our dividend while enabling further debt reduction.As a result of this strong FFO and FCF profile, we achieved a total payout ratio of 88% in 2017 and reduced our trailing net debt to FFO ratio to 2.3x in 2017 or 1.9x based on Q4 2017 annualized FFO as compared to a trailing ratio of 2.8x in 2016.Our Board of Directors approved a 7% increase in our monthly dividend to $0.23 per share from $0.215 per share, effective with the April 2018 dividend to be paid on May 15, 2018.This is our fourth increase since we started paying a dividend in 2003 and we have never reduced our dividend. The increased dividend is readily funded within our projected FCF at the strip for 2018.After adjusting for the increased dividend, we project a total payout ratio for 2018 of 87%, up modestly from 85% prior to the dividend increase.At the same time, we project 8% growth in production per share this year.Q4 operations review. I'll now provide you with an update on operations starting in Europe.In the Netherlands, production increased 59% from the previous quarter to 9,400 boe/d, following the amendment of permit restrictions on 2 of our pools and an inline test on a well that was drilled in Q3, 2017.During the 2-month test period, this well, the [Eesveen-02] in which we have a 60% working interest produced at a restricted rate of approximately 10 million cubic feet a day net to Vermilion.The well is expected to be on production in mid-2018.We also completed a 315 square kilometer 3D survey, our first new data acquisition since entering the Netherlands in 2004.In France, Q4 production increased 3% to an average of 11,200 boe/d, with the increase primarily attributed to better well uptime and ongoing well optimization.Activity during the quarter was focused on well workovers, advancing the drilling of 2 of our 4 Neocomian wells and preparing for the rest of our 2018 drilling campaign.On the regulatory front, the French Parliament approved the previously announced climate plan in December 2017.The new law prohibits the issuance of new exploration concessions and limits the renewal of certain existing production concessions beyond 2040.As we have previously indicated, we do not expect the new law to have a material impact on our future activity levels or production profile.In Ireland, production from Corrib averaged 56 million cubic feet a day or 9,400 boe/d in Q4, a 15% increase from the previous quarter.As reported in our Q3 release, Corrib had an unplanned 31-day downtime period in September and early October.This downtime reduced Vermilion's Q4 production by approximately 1,200 boe/d and annual production by approximately 900 boe/d.We continue to work closely with Canada Pension Plan Investment Board and Shell on the transition of ownership and operations from Shell to CPPIB and Vermilion and anticipate closing this transaction in the first half of 2018.In Germany, production in Q4 2017 averaged 4,200 boe/d, a decrease of 5% from the previous quarter. The decrease was primarily due to a temporary shut-in at 1 well in December for a SCADA installation.The well was brought back on production in mid-Q1, 2018.In Hungary, we were recently awarded the license for the Békéssámson concession for a 4-year term. The license is located adjacent to our existing Battonya South concession in Southeast Hungary and covers approximately 330,000 net acres, more than doubling the size of our total land position in the country.Subsequent to year-end, we drilled and tested our first exploratory well, at 100% working interest in the Battonya South concession.This well tested at a rate of 5.8 million cubic feet per day over the final 2 hours of a 22-hour test period at a stabilized wellhead pressure of 1,065 PSI on a 0.55-inch diameter choke, and a shut-in wellhead pressure of 1,305 PSI.Note the water production was observed during the test.The well logged 21 feet of net gas pay with an average porosity of 31% from an Upper Miocene Pannonia sandstone, occurring at a depth of approximately 3,450 feet.The well is expected to be brought on production in mid-2018.This marks the drilling of our first well in the Central and Eastern Europe business unit.In Canada, production averaged 32,900 boe/d in Q4, representing a 5% increase from the previous quarter and a quarterly record for the business unit.We drilled or participated in 6 gross, 4.0 net Mannville wells and brought on production 9 gross, 5.5 net Mannville wells in Q4, which contributed to this growth.Subsequent to the end of the year, we announced an acquisition of a private Southeast Saskatchewan producer for total consideration of $90.8 million.The acquisition added over 1,000 barrels per day, high-netback, 40-degree API oil, and 42,600 net acres of land straddling the Saskatchewan and Manitoba border near Vermilion's existing operations in southeast Saskatchewan. The acquisition closed on February 15 and our team is now integrating these assets into our southeast Saskatchewan operation.In the United States, Q4 production averaged 760 boe/d, a decrease of 27% from the prior quarter.The drop in production was due in part to a Forest Mazur event on a third-party gas gathering system, which has recently been brought back into service.Capital activity in Q4 was focused on the construction of 3 well pads in preparation for a 5 gross, 5.0 net well 2018 drilling program.In Australia, Q4 production decreased 9% from the previous quarter to 5,000 barrels per day, primarily due to planned maintenance during the quarter, which resulted in 8 days of downtime.We continue to focus on maintenance and debottlenecking activities and planning for our 2019 drilling campaign, which we expect will restore production volumes to our long-term target of approximately 6,000 barrels per day.2017 reserves and resources. We continue to grow our reserves and resources in 2017. Based on an independent report by GLJ as at December 31, 2017, our 1P reserves increased modestly to 176.6 million barrels equivalent while 2P reserves increased 3% to 298.5 million barrels equivalent.We replaced 103% and 134% of production at the 1P and 2P levels, respectively in 2017.PDP reserves increased 1.3% to 123.8 million barrels equivalent at an average PDP, F&D cost, including future development capital of $12.41 per BOE resulting in a PDP operating recycle ratio including FDC of 2.4x.Our PDP reserves represent 70% of 1P reserves.Our organic 2P F&D cost, including FDC increased to $10.57 per BOE in 2017 compared to $5.57 per BOE in 2016.The largest driver of the increase in F&D cost was the strengthening of the euro relative to the Canadian dollar in GLJ's foreign exchange rate forecast as compared to the previous year, which increased FDC for our European properties.As a result of this higher F&D cost, our F&D operating recycle ratio including FDC decreased to 2.8x in 2017 compared to 4.9x in 2016 and 3.6x in 2015.Despite the increase in reported F&D costs and the reduced recycle ratio as compared to 2016, these metrics remain strong relative to the oil and gas sector and reflect the significant improvement in capital efficiencies we've achieved over the last several years.In addition to growing our reserve base, we pursued various initiatives to expand our resource base to support our longer-term growth profile.According to the independent report by GLJ as at December 31, 2017, our 2017 resource assessment indicates a risked best estimate for contingent resources of 176.7 million barrels equivalent in the development pending category and 32.8 million barrels equivalent in the development unclarified category.Over 80% of our risked contingent resources reside in the development pending category.Respective resources were assessed at a best estimate of 153.4 million barrels equivalent.In 2017, we converted 20.5 barrels equivalent of contingent resources and 1.7 million barrels equivalent of prospective resources to 2P reserves, illustrating that our contingent and prospective resource bases remain a source of reserve additions.More detailed information on our reserves and resources can be found in our AIF and reserve press release issued this morning.Organizational update. We had several leadership changes that we announced with our Q4 release. All of them are internal promotions, following the retirement of 2 of our existing leaders and the creation of a new operating business unit in Ireland.I'll provide a brief summary of these changes and lead you to review the individual biographies that are included in our press release.Curtis Hicks, currently Executive Vice President and Chief Financial Officer is retiring effective in 2018 after 15 very successful years with our company. Curtis has been a key member of the executive team, helping to guide Vermilion as we have expanded from 2 countries in 2003 to 10 countries today.We thank Curtis for his numerous contributions to Vermilion and wish him the best in his retirement and let me say more personally that Curtis has been an extraordinary friend and colleague for me at Vermilion. I'll miss his intelligence, kind demeanor and professionalism and I'll also miss his participation in these quarterly calls.Internal promotion, leadership development and succession are very important at our company. The CFO role is a critical one and we've been fortunate to have a long time to prepare for Curtis' retirement.Lars Glemser, currently our Director of Finance will succeed Curtis as Vice President and Chief Financial Officer.Lars joined Vermilion in 2015 as Operations Controller and progressed through a developmental assignment in Investor Relations before becoming Vermilion's Director of Finance.A number of you may know Lars through his work in investor outreach, both in his previous IR role and as Finance Director.While we'll miss Curtis, we're delighted to be able to effect this seamless transition and we're excited about working with Lars as Vermilion's CFO.In our operating units, we rarely rotate and refresh our leadership and maintain a mix of expatriate and national management in our non-Canadian businesses.In line with this philosophy, we're proud to announce a series of interlocking Managing Director appointments.Scott Seatter, currently Managing Director of the Netherlands business unit will take over as Managing Director of the United States business unit.Scott replaces Dan Anderson, our current Managing Director in the U.S., who will be retiring in April, 2018. I've had the honor of working with Dan several times in my career and I would like to thank him for his contributions to Vermilion and wish him the best in his retirement.Replacing Scott in the Netherlands is Sven Tummers. Sven was previously Commercial Manager for us in the Netherlands and now has been promoted to Managing Director of the Netherlands business unit.In anticipation of the transfer of Corrib operatorship to Vermilion, after the CPPIB Shell acquisition closes, we have created a new operating business unit in Ireland.Darcy Kerwin, previously Managing Director for our French business unit has been appointed to the newly created role of Managing Director Ireland business unit.Replacing Darcy in France is Sylvain Nothhelfer. Sylvain was previously Technical Services Manager for the French business unit and now has been promoted to Managing Director of that unit.I'm confident these appointees will continue to contribute to our safe and successful global operation in their new leadership roles.That concludes my planned remarks.We would be happy to address any questions that you might have.Operator, would you please open the phone lines to questions?

[Operator]

[Operator Instructions] Your first question comes from Dennis Fong from Canaccord Genuity.

[Dennis Fong, Exploration and Production Analyst]

So just with this first well into Hungary, given somewhat of a relative -- a successful test, how should we think about the potential acceleration of CapEx in the country? Or this may be a little bit premature? And then secondly, how many wells do you have committed via this license agreement that you have as well?

[Anthony William Marino, President, CEO & Non]

Okay, Dennis. Thank you for the question. We're really happy with that successful test that we had in Hungary. It will, we believe generate production a couple of years earlier than we anticipated production beginning for the Central and Eastern Europe business unit. We have remaining on -- an answer to the second part of your question, we have remaining on Battonya South, 1 well commitment. Probably that well will get drilled in 2019. As far as the acceleration of activity in Hungary or in the rest of the CEE, we have a lot of good prospects, I feel in each of these countries. We have the -- this type of gas drilling that we just announced in Hungary available to us and again at least 1 more well on Battonya South. We just last summer shot a 3D in Slovakia. This is a place that had very little seismic cover, really just a few lines of 2D, some discoveries had been made on that very sparse 3D a few decades ago. Some were tied in, some tested at quite reasonable rates and were not tied in. And so we felt there was a great deal of potential there, as has been observed many times in the past across the world to shoot a 3D in a place that prior only had 2D and as I will point out, it was a very sparse 2D grid previously in Slovakia, typically when you do that in a place where there's been success on 2D before, you can find a lot of new prospects on 3D and I'm very, very optimistic about that program. It's primarily a relatively shallow gas program, most of the targets in the 500-meter to 1,200-meter range. We do think from the very preliminary 3D interpretation that we've done there, there is perhaps a deeper set of targets as well. We may look at the possibility of accelerating that program, given the data that we now have and probably, relatively short permitting times there. At present, there's no change to our long-range plan but that is one possibility for acceleration. In addition, in Croatia, we are the largest oil and gas rights holder on shore. We took some successful 2D data there, over the past year and we have those wells slated to -- the wells that we intend to drill there are slated for the next couple of years, potentially beginning in 2019 and I don't really have any comment about whether we'd have an acceleration there or not. I think we're going to acquire some additional seismic as part of that program and that might affect our decisions there. So that really covers that business unit in terms of the activity but we are very pleased with the result that we had on that first drilling and I am optimistic that over the medium- to long term, that can become a significant business unit for us in Europe as have the other countries that we've established a franchise in previously.

[Operator]

Your next question comes from Tom Callaghan from RBC Capital Markets.

[Tom Callaghan, Associate]

Just wanted to inquire on cash taxes there and specifically any color you may be able to provide around 2018 in terms of what you're expecting?

[Anthony William Marino, President, CEO & Non]

Sure, Tom. So for 2017, what happened in Q4, there was an administrative change in the Netherlands with respect to how we deal with ARO deductions and we are able in the Netherlands and in France to deduct future ARO on a unit of production basis. So we're able to -- there was a onetime acceleration that happened in Q4. It was about a $10 million positive impact to Vermilion. So that resulted in, quite frankly, in a claw back in taxes in Q4. So as we look out to '18, we see some modest increase in tax rates in France from about 7% in '17 to sort of 10% to 13% in '18. In Australia, a modest increase from about 26% in '17 to sort of 30% to 32% range in '18. And then we see a big impact in the Netherlands. We had a negative tax rate this year because of the ARO deduction and we're going to go 25% to 28% tax rate in '18. And that's a function of 2 things: the ARO impact that doesn't happen again in '18, but also we've had a significant shift in our production profile in the Netherlands. As we've previously discussed, we had some regulatory issues that we dealt with this year and as a result our production was held back. We see good production gains in 2018 and frankly, that's going to be all taxed at the marginal rate because of all of our shelter will have been used up with sort of the base production. So those are the 2 key considerations for why taxes are going up in the Netherlands in 2018. So overall on a corporate basis, we were just around 5% this year on a cash taxes basis and we're going to go from about 11% to 14% range in 2018.

[Operator]

[Operator Instructions] Your next question comes from Patrick O'Rourke from AltaCorp Capital.

[Patrick J. O'Rourke, Analyst of Institutional Equity Research]

Congratulations on the retirement there, Curtis. Going to miss you on the call here and seeing you out and about. Just a couple of quick questions. Dennis took a few of mine on Hungary but just curious in terms of specific well costs there? And then in terms of market access for that gas, would you be modeling that as -- I know it's pretty interconnected in Europe, is that TTF type or German-type pricing there?

[Anthony William Marino, President, CEO & Non]

Patrick, thanks for the question. For that well, probably typical of the type of drilling we're doing in Hungary now, the cost would be about EUR 2.6 million for the DCET to get it away from drilling to tie in, putting it around CAD 4 million. So they are pretty inexpensive wells for the potential production that is available. The price there is based on TTF. The European market, really with the exception maybe of the Iberian Peninsula is very well interconnected and so with very minor basis between these various delivery points, the pricing is close to that TTF price. And then the European market is one that continues to be very strong, in fact there have been some very high gas price spikes very recently over the past week to some extraordinarily high levels due to very cold weather on the continent and in some cases, due to lower production. So we expect it to continue to be a strong market. It's a good market to hedge into and it's a key part of our strategy.

[Patrick J. O'Rourke, Analyst of Institutional Equity Research]

Okay, great. And then just a second question. In terms of the Saskatchewan acquisition that you guys did, looking out there, are there other roll up opportunities in the similar -- sort of size and nature available out there that you'd be looking at? Is this an asset you want to continue to grow? Or just strategically, how are you looking at it at this point?

[Anthony William Marino, President, CEO & Non]

Well, I mean the Saskatchewan in general and Southeast Saska specifically are excellent places to produce. You've got a -- you've got good regulation, you have very low provincial royalties, a lot of incentives to produce, you got a great workforce there. So it's a desirable area from those perspectives. You know the light oil, which is by far the dominant product there, there's just a little bit of gas, no heavy oil. The light oil in Southeast Saska garners a very high price, it's downstream of any bottlenecks, so it's not subject to some of the other problems you get with, for example, WCS pricing in Canada. All these things make the region desirable. It is our -- next to West Central Alberta, it's our other core area in Canada. It's a place that we can very effectively execute our growth and free cash flow model. So we're very happy with the acquisition that we made of that little bit over 1,000 day barrels of very high netback oil that we closed in February. As with our other quarries in Canada and throughout the world, we are open to adding to those positions. We feel that we conduct our M&A activities, evaluations, bidding, potentially closing transactions in a very disciplined fashion. So every deal that we would make has to test, it has to pass the same set of tests. We don't use an optimistic price deck, we use the backwardated strip to evaluate, and then with that, it has to create real accretion for our owners, not out of leverage but out of real accretion, assuming in these evaluations that we would've used all equity to finance. It needs a rate of return well in excess of our cost of capital. Under that backwardated strip, and it has to be capable of generating sufficient cash flow to cover its own CapEx stream to grow in any -- in its share of any imputed dividends, under the strip again. So these were very difficult tests for any asset to meet and their intended to ensure that when we make a deal, it adds to the value of the company for the existing owners. So Southeast Saska additions -- any further additions to the portfolio would be the same as anywhere else in the world, they have to meet those tests and it's not a very easy set of criteria to meet. Therefore, we're open to it but I wouldn't call it likely that we would continue to acquire in any particular area. I think it'll happen over time. We can't predict exactly when it would occur but there's nothing impending and the main thing I want to leave you with is that, if we were to make another deal there or in any other region, we'd be very confident that it's adding to the sustainability of our model and to the value of the company for the existing shareholders.

[Patrick J. O'Rourke, Analyst of Institutional Equity Research]

Okay. And final question just very quickly before I hang up and [listen here]. In terms of Irish, the core of asset performance, I know natural onset declines were sort of expected here in the first part of 2018. Just any change in that view or how the asset's performing right now?

[Anthony William Marino, President, CEO & Non]

Yes. No change in that view. The Corrib is performing as we expected. At this point it outperformed right up to the end of the year having a significantly longer plateau at the midpoint -- than our midpoint expectation. And from here, we expect a decline rate that is in line with our previous forecast.

[Operator]

[Operator Instructions] We do not have any questions over the phone line at this time. I will turn the call over to the presenters.

[Anthony William Marino, President, CEO & Non]

Thank you, again for participating in our Q4 and year-end conference call. As a reminder, our 2018 AGM presentation will preempt our Q1, 2018 conference call. We, therefore, look forward to speaking with you again after our Q2 2018 release in July.

[Operator]

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