Whitecap Resources Inc

TSX:WCP

Earnings Call Transcript 2020-Q2

[Operator]

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to Whitecap Resources 2020 Second Quarter Financial and Operating Results Conference Call. [Operator Instructions]And I would like to turn the conference over to Whitecap's President and CEO, Mr. Grant Fagerheim. Please go ahead, sir.

[Grant Bradley Fagerheim, President, CEO & Director]

Good morning, everyone, and thank you for joining us this morning. I'm joined by 3 members of our senior management team: our CFO, Thanh Kang; as well as Darin Dunlop, VP of Engineering; and Joel Armstrong, our Vice President of Production and Operations.Before we get started today, I would like to remind everybody that all statements made by the company during this call are subject to the same forward-looking disclaimer and advisory that we set forth in our second quarter news release issued earlier this morning.The second quarter of 2020 was extremely busy for Whitecap as we put in place realtime measures to deal with the effects of the COVID-19 pandemic. Our priority was the health and safety of our office staff and field personnel while we continue to deliver solid operational performance. We will continue to update corporate policies to maintain the safety of our personnel and to minimize any business disruption.Our production in the second quarter, as provided in our press release earlier today, was at the high end of our expectations at 70,807 BOE per day with a development capital expenditures of $21.3 million. We also acquired an asset in our core Northwest Alberta Peace River Arch area for $5.2 million, which included 220 BOE per day of production, along with numerous drilling locations for future development. As well, during the quarter, in response to the near-term collapse in oil prices, we voluntarily suspended approximately 2,000 BOE per day, which impacted average production in the quarter by 1,300 BOE per day. Approximately 1,000 BOE per day of the suspended production has now been brought back on production while the remaining productive capability requires further price recovery in order to restore.Crude oil prices experienced unprecedented volatility in the second quarter as a result of the demand disruption from COVID-19, with U.S. WTI trading in the range of negative $37.63 to positive $40.46. The OPEC Plus production cuts and North American producer shut-ins helped alleviate the decreased demand with WTI recovering to [ $38.31 ] in the month of June. Our risk management program minimized the financial impact of the volatility, and we realized $51.4 million of crude oil hedging gains in the second quarter.Despite the collapse in crude oil prices and volatility where we were able to generate $78 million of funds flow in the quarter, of which we spent $21.3 million on capital, $17.5 million on the dividend, bought back 1 million shares at $2.30 per share to keep our share flat count -- our share count flat and $5.2 million consolidating production and inventory in our Charlie Lake play. Net of all activities, we managed to reduce net debt by $32 million.We started the quarter with a strong balance sheet, and our Phase 1 and Phase 2 actions helped us maintain this competitive strength as we move forward through 2020. I will now pass on -- this on to Joel to provide more color on our very strong operational performance and provide an update on our HSE health, safety and environment initiatives. Joel?

[Joel M. Armstrong, Vice President of Production & Operations]

Thanks, Grant. The #1 priority for our operations group and field ops is always the health and safety of our people. COVID-19 has resulted in extensive review of our company policies at the field level and head office. Our success in avoiding instances of COVID-19 to date is a result of the hard work by all Whitecap staff to develop and follow the new guidelines. Our second quarter safety and environmental performance was exceptional with no injuries, which ranks as the best quarter in the past 5 years and spill volumes were 45% lower than the same period in 2019. I'd like to take the opportunity to thank our HSE, asset integrity and operations teams for their continued diligence and professionalism to achieve these results.The operations team was focused on various cost-reduction initiatives and realtime analysis and well-level operating income as crude oil prices fluctuated. This detailed analysis allowed us to maximize area netbacks by maintaining production volumes on wells that generated positive operating income. The second quarter was strong from a production perspective considering the challenges with a temporary decrease in crude demand and building inventories.Operating expenses per BOE were reduced by 8% quarter-over-quarter as a result of the cost structure review, which was implemented in late Q1. It's anticipated a component of the reduction will continue forward, although the majority is associated with activity-based operations.Lastly, from an ESG perspective, we continue to demonstrate our strong efforts by reducing our emission intensity by 37% since 2017 and have implemented a target to further reduce 20% over the next 3-year period. Of note, our report now conforms to Sustainability Accounting Standards Board, SASB, and Task Force on Climate-related Financial Disclosures, TCFD framework. Further details are available in our recently issued ESG report, which is located on our website.With that, I pass it on to Thanh to provide some color on the financial results.

[Thanh C. Kang, Chief Financial Officer]

Thanks, Joel. WTI averaged USD 27.85 per barrel in the second quarter compared to $46.17 in the first quarter, a 40% decrease. Canadian crude oil prices differentials improved from the first quarter with the Edmonton Par differential averaging USD 6.14. Realized oil prices prior to hedges and tariffs were $26.55 per barrel compared to $47.48 in Q1 of '20, a decrease of 44%. Realized NGL prices averaged $13.17 per barrel compared to $12.30 in Q1 of '20, an increase of 7%. The increase was mainly due to higher propane and butane prices, which represents 62% of our NGL mix. Realized natural gas prices were consistent with the first quarter and averaged $2.16 per Mcf compared to $2.18 in Q1 of '20. The royalty rate in the second quarter was 9%, which was lower than the first quarter rate of 15%. This was driven primarily due to lower crude oil prices. Operating expenses in the second quarter were $11.18 per BOE, 8% lower than the first quarter. As Joel mentioned, the decrease is attributed to cost-reduction initiatives in response to the low commodity price environment. In addition, our transportation expense of $2.39 were consistent with the first quarter.G&A of $0.79 per BOE were 12% lower than the first quarter. The decrease is attributed to a full corporate review of all expenses, including a voluntary 10% reduction of our management team's salaries.Stock-based compensation recovery of $2.4 million was recorded in Q2 compared to an expense of $27.3 million in Q1. The decrease is primarily due to the change in the fair value of the total return swaps resulting in an unrealized hedging gain of $12.3 million. This was partially offset by a realized loss of $4.6 million on total return swaps that we settled in the quarter.The DD&A rate was $12.54 per BOE in the second quarter compared to $18.72 in the first quarter of 2020. The decrease is attributed to the noncash impairment expense booked in the first quarter. Funds flow for the quarter was $78.1 million or $0.19 per share, which generated a total payout ratio of 50% after capital invested and dividends paid to our shareholders. Whitecap's balance sheet remains in a strong position with quarter-end net debt at $1.24 billion on total capacity of $1.77 billion. Our debt-to-EBITDA ratio was 2x, and our EBITDA-to-interest ratio was 12.7x, both well within our covenants. So a very strong quarter for Whitecap despite the low commodity price environment. We're on track to achieving our 2020 average production guidance of 65,000 to 67,000 BOE per day on our capital expenditure budget of $190 million.I'll now pass it on to Grant for his closing remarks.

[Grant Bradley Fagerheim, President, CEO & Director]

Thanks, John.

[Operator]

Mr. Fagerheim, we cannot hear you at this time, sir.

[Grant Bradley Fagerheim, President, CEO & Director]

Sorry. I was just saying, as we enter into the second half of the year, we expect to see continued volatility in commodity prices as the COVID-19 pandemic continues. However, overall, we see crude oil prices improving as we head into 2021. Whitecap is in a solid position with a robust hedge book, strong balance sheet, low decline rate and high netback assets and, most importantly, a dedicated team of people at Whitecap. We do anticipate there to be an increased amount of industry consolidation that will take place in the back half of 2020 as well as in 2021. At Whitecap, we have the opinion that size and scale are important factors in driving profitability and longer-term sustainability. With that said, we believe that we are well positioned to play a role in the consolidation phase the energy sector is entering into. Our interest is in assets and corporations that are principally focused in our core geographic operating regions with preference to light oil as it still drives the strongest operating netbacks in the sector.With respect to our dividend, we have not made any changes to our current dividend of [ $0.171 ] per share as we feel the strength of our assets can support the dividend in the current pricing environment as evidenced by our second quarter free funds flow generation.We will remain diligent to safely operate and optimize our assets with a continued focus on capturing additional opportunities to further strengthen Whitecap and deliver reliable and consistent returns to our shareholders. On behalf of our Whitecap management team, our Board of Directors, we would like to thank each of our shareholders for your interest and support of Whitecap. Wishing everyone good health and safety through these very disruptive times. With that, I'll turn the call over to the operator for any questions. Thank you.

[Operator]

[Operator Instructions] And your first question will be from Amir Arif at Cormark.

[Amir Arif, Analyst of Institutional Equity Research]

Just a quick question, Grant, just on the acquisition. Can you just give us some color in terms of the acquisition characteristics that you would look for? Are you looking to stick with light oil? Or are you willing to look at shale and other opportunities and stick within your core areas? Or in larger scale, I guess, would you be willing to step out of existing core areas?

[Grant Bradley Fagerheim, President, CEO & Director]

Sure. So yes, thanks, Amir. What we're -- the acquisition that we did in the first quarter and future acquisitions, we anticipate staying in and around our existing core areas where we can drive operational synergies, looking to increase our inventory of opportunities into the future without sacrificing the decline characteristics of our assets. So the way we historically operate our assets are quite different from the way most companies operate. We prefer to drive things down to a lower decline rate and have each one of the assets, in essence, live within its own cash flow. So as we did with the small acquisition, it was a complementary acquisition in the second quarter. Future acquisitions, you'll look to see potentially larger in scale as we continue to look at larger asset acquisitions as well as other corporations. But the key characteristic for us will be focus on light oil, perhaps a little bit of natural gas. But we are focused on light oil at this particular time and making our company stronger for the longer term.

[Amir Arif, Analyst of Institutional Equity Research]

Sounds good. And just a second final question, just on the hedging front. You're well hedged this year. It definitely helped in the quarter given where commodity prices went. But as we look into 2021, the curve isn't -- doesn't show a lot of [ contact ] though for the next few years. And so just curious how you're thinking about hedging at current levels? Or do you just protect it through lower balance sheet levels?

[Thanh C. Kang, Chief Financial Officer]

Yes. Thanks for the question, Amir. It's Thanh here. So our hedging objective remains the same. We're looking to mitigate that price volatility and protect our economic returns. As you mentioned, we do have a good portfolio here in 2020. A bit light in 2021, with only 5% hedged. We did take a pause through the program with the pandemic and ultra-low crude oil prices here. But we're still actively looking at getting to that 20% to 40% in 2021 before the end of the year here. So what you'll see us use when commodity prices are in this $40 to $50 WTI level is cost as collars. So it gives us a good level of downside protection, but also upside participation as well. When we start seeing WTI approach that $50-plus level there, you'll see us use swaps to lock in those economic returns. So the objective between now and the end of the year is to get us to that 20% to 40% hedged for 2021.

[Operator]

Next question will be from Jeremy McCrea at Raymond James.

[Jeremy McCrea, Director & Equity Research Analyst]

I got a couple of questions here. The first one is, Grant, when you say we need size and scale, can you give a bit more -- some more numbers around there? Like do you think you need to be 100,000 BOE, 150,000 or just some kind of metrics? And then also if you can give a little bit more details on the Charlie Lake number of locations you have? How much capital do you see shift into this area? And maybe actually even broader, just where commodity prices are, how do you expect CapEx to shift throughout your plays here versus, say, prior years?

[Grant Bradley Fagerheim, President, CEO & Director]

Sure. Just regarding the -- when we talk about size and scale, the reason we think about it in this context is that capital programs to be most efficient from an operating perspective, bringing a capital program rather than introducing one well at a time into our capital program or 1 or 2 wells, we'd like to have a more consistent program over a -- we'll say, a 6-month to 1-year period of time. And you're able to do that when we get to be of more size that we can put a program together in each one of the areas with this lower pricing environment that we're dealing with in the approximate $40 to $45 WTI oil price environment. So there's that component from an operations perspective, which drives our efficiencies from a capital perspective. As well, we think that the downstream marketing arrangements that we're going to be entering into or need to enter into, you're going to have to be larger in scale when you're talking about 8- to 21-year commitments on transportation that actually has the effect of bringing down your debt capacity. So whether that's -- we don't have an absolute number, but what we can say is that we think at the 70,000 or 71,000 barrels a day where we are currently, we're probably going to have to be at least 2x that size moving forward. That doesn't select a certain 100,000 barrels a day or 120,000 or 150,000. But we do believe in order to attract investors, we have to demonstrate the long-term sustainability of our assets as well as the way we're running our program on a go-forward basis. So that's the first part of your question.On the Charlie Lake, the -- we've continued to add to the number of locations we have. We added, through that the acquisition, 20 locations. And we are very active with adding additional locations in and around our existing asset base in the Deep Basin. Much of our activity has been confidential in nature as to what we've been doing up there. So you asked about the question on whether we see a shift in capital. Well, we definitely see a shift in capital because we don't -- we're not spending any capital right now. But when we bring capital back, and we're anticipating that potentially in the fourth quarter or maybe into the first quarter of next year, and it is going to be commodity price dependent and what we'll call net realized price. So when we look at the return characteristics around the capital being deployed in each of the areas, yes, we anticipate putting more into the Peace River Arch than we have historically. But at these particular levels, we're not bringing that capital at this particular time. So we'll make that decision as we move forward if we see commodity prices come back to the levels of -- to where we can get acceptable returns on the capital we deploy.

[Operator]

Next question will be from Adam Gill at Eight Capital.

[Adam Gill, Principal]

You guys identified $50 million of cost savings pretty quick into the downturn. Do you believe there's any potential to expand on those cost savings through the back half of this year?

[Thanh C. Kang, Chief Financial Officer]

Yes. So it's Thanh here. The original savings that we identified, that $50 million, $42 million of that was operating costs, $8 million of that was from a G&A perspective, and that included the 10% reduction in management salaries here. So I think we're pretty tight, I would say, from both an operating cost and a G&A. I mean our G&A cost per BOE is $0.80 per BOE, which is one of the lowest amongst our peer group, if not the lowest. So I don't think there's much room to move from that perspective. On the operating cost side, there were some negotiations that we had to have with all of our service providers. And so I think in a improving price environment, that would be very difficult, I think, to reduce much further. If anything, our thoughts on that is about 25% to 30% of that, Adam, would be structural and permanent in nature. The rest, there'll be a cost inflation factor associated with that as well as increased activity levels will increase the operating cost as well.

[Operator]

[Operator Instructions] And your next question will be from Chris Jones at Haywood.

[Christopher Jones, Associate Analyst of Energy Research]

Just on the unrealized portion of the hedge book for Q2, a loss of $108 million was reported versus an unrealized gain of $149 million in Q1, so there's a bit of a differential there. And I'm assuming a good chunk of this is tied to improving oil prices. But can you sort of provide a high-level walk-through on some of your assumptions for crude that is embedded in that unrealized loss number?

[Thanh C. Kang, Chief Financial Officer]

Yes, the -- it's really -- that's exactly what it is. It's the change in commodity prices from March 31 to June 30 based on strip prices on those dates. So you're going to see, given the volatility here, big changes to our mark-to-market. We saw that on the crude oil hedges as well, but we also saw that on our total return swap working the other way, which provided an unrealized hedging gain of $12.3 million. So the change there is all commodity prices.

[Operator]

At this time, gentlemen, we have no other questions registered. Please proceed.

[Grant Bradley Fagerheim, President, CEO & Director]

Well, I just want to say thanks to each of you for your time and interest today in Whitecap Resources. And as we conclude this quarterly earnings call, we hope you remain healthy and strong and have some time to enjoy the summer sunshine. All the best. Thanks again.

[Operator]

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.