Seven Generations Energy Ltd. (
OTC:SVRGF) Q1 2020 Earnings Conference Call May 7, 2020 11:00 AM ET
Company Participants
Brian Newmarch - Vice President, Capital Markets & Stakeholder Engagement
Marty Proctor - President & Chief Executive Officer
Derek Aylesworth - Chief Financial Officer
Conference Call Participants
Manav Gupta - Credit Suisse
Patrick O'Rourke - AltaCorp Capital
Amir Arif - Cormark Securities
Operator
Good morning, ladies and gentlemen, and welcome to the Seven Generations Energy Limited Q1, 2020 Conference Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct the question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, May 7, 2020.
I would now like to turn the conference over to Brian Newmarch. Please go ahead.
Brian Newmarch
Thank you operator and thank you for joining us for the Seven Generations Energy first quarter 2020 conference call. On the call today, our President and Chief Executive Officer, Marty Proctor; Chief Financial Officer, Derek Aylesworth as well as other members of our management team are connected remotely during this period of physical distancing.
Following the review of our results we'll open up the line to questions. As a reminder, all statements made by the company during this call are subject to the reader advisories included in the news release issued this morning and on our corporate presentation. All dollar amounts discussed today are in Canadian dollars, unless otherwise stated. The complete financial statements and MD&A are available on our website at
www.7genergy.com, as well as seen on the SEDAR website.
I will now pass the call over to our President and CEO, Marty Proctor.
Marty Proctor
Thank you Brian. These are challenging times for our industry and our stakeholders. The effects of COVID-19 have impacted us all. As it relates to our industry while we have seen a cyclical events in the past what is unfolded this year, the combination of demand destruction and global oversupply is unprecedented and will take time to resolve. 7G is positioned to weather this current environment and will emerge from this stronger and more resilient than ever.
Coming into 2020, our debt metrics were relatively low. We had significant liquidity on hand. Our decline rates were moderating and we were focused on three things; first generating as much free cash flow as possible from a stable production base. Dollars we plan to allocate to increase shareholder value through debt repayment and our share buyback program. Second, reducing our maintenance capital, requirements by continuing to drive better capital efficiencies and reducing decline rates and third, surfacing the value in our emerging lower Montney play.
While the commodity price environment has changed dramatically our focus has not. Our strategic cornerstones, a high quality asset base, operational excellence, market access, financial strength and stakeholder service have served us well and will continue to do so through this extended period of price weakness.
Our strategy is anchored by our high quality resource. Over the past two years we undertook a comprehensive scientific analysis of our asset including integrated studies of the geo-science, reservoir engineering and production engineering. Having a thorough understanding of our asset both regionally and stratigraphically has helped create optionality in our business, providing the ability to efficiently allocate capital to liquids or natural gas, to grow or pare back our production base and to accurately predict production quarter by quarter.
As we announced today we have reduced our overall capital program by more than 40% and our production base by 11% from the original budget and in the near-term have diverted capital from our highest condensate yielding areas in Nest 1 to the natural gas weighted areas in Nest 3. Our reduced production outlook relative to original guidance is also impacted by the deliberate decision to defer the startup of eleven new wells from Q2 into Q3.
The capital shift to our gas weighted assets has several secondary benefits; more prolific gas wells tend to improve corporate capital efficiencies and natural gas has a shallower decline rate. These drivers in addition to a slightly lower guidance range all converged to drive materially, lower sustaining capital requirements moving into 2021. Beyond 2020 we expect to have the ability if we choose to maintain 2020 production levels with similar levels of capital investments.
We remain Canada's largest condensate producer. We observed a severe widening of condensate differentials in May. Our analysis indicates that the condensate import pipelines were at or near capacity from December 2019 through March 2020. This indicates that while oil prices were weakening in early April when May condensate differentials were traded, we were experiencing record condensate imports into a market where the condensate buyers were reducing demand. While condensate demand is expected to be lower at least through Q3, we expect reduced import volumes and a drop in local supply to balance the market. We are currently seeing condensate differentials around $3 for June but expect continued volatility for several months. Over the long term we see phenomenal value in condensate particularly as major pipeline projects like the Trans Mountain expansion, Keystone XL and Enbridge line 3 proceed.
As we look at our Q1 results, we observed that our continued focus on operational excellence is paying off. We achieved efficiency gains on our drilling and completions execution and we are working closely with our vendors to further optimize costs. Drilling and completion costs of our latest wells in Q1 most of which were pre-crisis were just $7.3 million per well, a $2 million reduction compared to just a year ago. These are significant repeatable improvements driven by enhanced well designs and the ingenuity of our people not from cutting corners or compromising the long term performance of our inventory. While we have been reducing costs we have continued to improve long term well productivity.
We have also been very active at further reducing cash costs relative to our original guidance despite 2020 production expectations being reduced by nearly 11%. Many of our unit costs are unchanged. In the case of operating costs we have now reduced our expected guidance midpoint. This exemplifies some of our recent accomplishments and we believe we can replicate on a go-forward basis.
Derek will speak more to our financial performance but I do want to mention despite the challenging environment our financial strength remains intact. Right now our debt loads are manageable without redeterminations or maturities until 2023 and we have more than $1 billion of available capacity on our credit facility that has turned out to December 2024. Through our active hedging program we have also de-risked more than 80% of the balance of our 2020 condensate production further ensuring our durability and financial resilience.
We’ve recognize that all of our stakeholders are feeling the stress of the current economic environment. We will continue to communicate and work collaboratively with our partners to find ways to support one another and get through this difficult period. To align ourselves our board of directors as well as our management team have taken a reduction in wages as we navigate through the current economic climate. These themes speak to our corporate resilience.
I'll now hand the call over to Derek to talk a bit more about the additional financial considerations.
Derek Aylesworth
Thank You, Marty. We've taken a lot of [spend] away from the latest budget and we've done so without significantly impacting overall volumes this year. This is the culmination of several factors including better trending well costs that Marty referred to which are coming in significantly below our 8.5 million per well cost assumption in the original 2020 budget. Those costs were based on our best available information in the fall of last year and the revised budget now reflects well cost and design assumptions that we've actually been able to achieve during Q1 of 2020. In addition, our planners have had more time to optimize the timing of wells and surface construction. With production potentially remaining in the 175 to 185 range for the next 18 months or so and with a reduced decline rate the number of wells required to be brought on as well as the accompanying pads and minor infrastructure have been reduced significantly.
As we think about the commodity outlook, a theme we hear often from investors and analysts is our positioning around shut-ins or volume curtailments. Because a portion of our transportation costs, OpEx and G&A as well as all of our interest costs are fixed. The spend that we avoid by shutting in production is relatively minimal. We also generate significant revenue from our natural gas sales and we're seeing better NGL realizations that all contribute to our corporate profitability. Putting these components together there is not a material cash flow benefit to shutting in production and thus far we haven't been impacted by apportionments, curtailments or forced measure from our midstream partners or customers.
And so while we have no involuntary drivers to shut in, we do have voluntary options available to us. Storing condensate, weather in tanks, railcars or simply in our reservoirs by reducing or deferring production can add value when considering the contango in the oil curve and we closely monitor market structure to maximize our assets value. To take advantage of this opportunity we have contracted for access to approximately 160,000 barrels of condensate storage.
With this in mind, we've both deferred the on-streaming of previously planned pads in May and made arrangements to store some condensate volumes to enhance our value creation by simply deferring a portion of cash flows by a few months.
The Strength of our balance sheet is in its liquidity and its maturity profile. We have access to over $1 billion of undrawn [indiscernible] $1.4 billion credit facility. That facility was renegotiated late last year and matures in December of 2024. It's a covenant-based facility with no redetermination requirements until maturity. The main covenants on that facility are the requirement to maintain a senior debt to EBITDA ratio below 3 times and an interest coverage ratio above 2.5 half times. Our unsecured debt matures about half in the spring of 2023 and half in the summer of 2025. Those obligations have limited financial covenants which primarily oblige us to pay our interest in principal on time. We anticipate being well within all of our debt covenants should current pricing persist for some time.
While we are comfortable with our total debt and its tenure, we have been optimizing the composition. As you saw on our released this morning, we have swapped some of our long-term notes into our credit facility which gives us flexibility at repayment and reduces our overall interest costs.
We have also been aggressively adding hedges over the past few months as well to ensure that the potential for larger structural changes whether from demand, politically driven supply shocks or the pressure from abundant global crude inventories don't upset our near-term planning and profitability. Our consistent hedging program has drastically muted the impact on our cash flow from the massive sell-off in oil pricing we've seen and we have been quick to act on bolstering our near-term hedged position while we see this distortion in prompt month futures pricing. Our hedging approach has been consistent yet nimble and is doing its job of enhancing our revenue profile when we needed most.
I'll now pass the call back to Marty for a few closing remarks.
Marty Proctor
Thanks Derek. The last two months have brought new and unprecedented challenges to industries, governments and communities alike. When the COVID-19 pandemic began our first priority was to protect the health and safety of our people and our communities and our second priority was to ensure production operations were uninterrupted. We efficiently and systematically suspended all drilling and completions activities by the first week of April consistent with the plan that we had communicated to the market on March 10. As recommended by provincial health authorities our office workers in Grand Prairie and in Calgary have been working remotely over the past eight weeks. This transition to working from home went very smoothly because our excellent information services professionals had equipped our team with the tools and training that we needed long before the crisis began. I am very proud of the way our entire team has responded to these challenges. And I am confident in the ability of our team to work hard to strive for continuous improvement and deliver results for shareholders in the years to come.
Operator, I will now ask you to open up the line to questions.
Question-and-Answer Session
Operator
Thank you. Ladies and gentlemen we will now begin the question-and-answer session.
[Operator Instructions] So your four question comes from Manav Gupta. Please go ahead.
Manav Gupta
Hey Marty, quick question here the way the press release was structured I'm trying to understand that there is a lot of focus that was put in the fact that you are reasonably confident that even where we are given the strip and your hedges and the lowered CapEx, you actually don't expect to add any debt materially. Am I thinking about it in the right way?
Marty Proctor
Good morning, Manav. Yes, exactly so. I mean that was the intent of the revision, the second revision to our budget to ensure that we cannot add additional debt and so we are flexible. We can do that and so that is exactly what we've done. We've attempt to align our capital program with expected cash flows.
Manav Gupta
Okay. So that would primarily mean that somewhere between now and yearend, so in the three quarters you believe that funds flow operation would be somewhere in the range of 350 to 400 that would allow you to fully cover the remaining CapEx of $384 million, I am just looking through some numbers. Is that the right thought process?
Marty Proctor
Yes. I think those numbers are in the right ballpark. I mean to be clear, it was our intent to put out this revision with all the facts that were available and I mean it's possible that commodity prices improve, possible as well that commodity prices get worse from here. We are flexible and will adapt and we're nimble and so at this time, yes I think your math is pretty close.
Manav Gupta
Okay. And the last question which I want to understand is there is a short term thesis where obviously there are some buyers of yours probably who are shutting in their projects and I mean we see some of the bigger [indiscernible] integrated oil companies shutting in some projects. So there's a little bit of a lull in condensate demand but when we look out A, a number of your competitors may not have the liquidity to grow their volumes you've seen some fed competitors come in and cut their CapEx very hard so there is no growth coming from there. Then you have these pipelines which are moving forward and then what I thought always a little bit of a structural challenge to you was these DRUs which are not completely off the market because nobody has the CapEx to actually build them. So I'm trying to understand can you quantify or not quantify but talk to some of these near-term headwinds with long term macro trends on the condensate side of the business?
Marty Proctor
You bet and you make excellent points and that's exactly how we're feeling here as well. So in the short term, yes there's a bit of a challenge in balancing the supply and the demand of condensate. In some ways this isn't very different than what we had seen in the middle of 2018. There was a temporary surge in supply that coincided with a reduction in demand. This is a little more pronounced of course but yes we see it the same way as you and we benefit from the fact that we actually have pretty significant revenues coming from natural gas. We are a diversified producing company. We are a very low cost producer.
You've seen that in our cash costs as well as in our capital and so a thorough review of our projects pad by pad indicates that all of our pads will generate revenues in excess of our variable cost now. We've chosen to defer the startup of some wells. Some of our newest wells of course have the best condensate gas yields and they've got very high condensate rates. We think it's better for net present value and better for ready for cash flow even for 2020 to delay the startup of some of our condensate wells and to better pricing but yes exactly as you say for the long term we absolutely see that being a condensate producer will be a huge benefit for our shareholders. We do have diversity to shift to some leaner gas in the near term but for the long term we're confident in the outlook for condensate.
Manav Gupta
Thank you for taking my questions.
Marty Proctor
Thank You, Manav. We appreciate you calling in.
Operator
Your next question comes from Patrick O'Rourke of AltaCorp Capital. Please go ahead.
Patrick O'Rourke
Hey, good morning guys. My apologizes in advance if my five-year-old burst onto the call here like it did last week but just a quick question in terms of the reallocation of capital here maybe the pad strategy. I know that we've been looking at upper middle and lower Montney drilling. Is there any change to that? I believe that some of the Nest 3 lower Montney wells had higher condensate yields relative to the upper end and the middle in places and at time. So are we cutting back to just upper and middle or is it still a three layer strategy there?
Marty Proctor
Good morning Patrick. Great question and your five-year-old is welcome on the call. We welcome all participants. So don't worry about that. Yes to the reallocation of capital that’s -- it's a very good question. We have explicitly said that we've moved capital from the higher liquids area of Nest 1 over to Nest 3. We haven't generally changed our strategy though around allocation to the three layers and even in the Nest 3, as you observed we're getting some excellent gas and condensate rates from our lower Montney. We've actually added a couple of lower Montney wells in that Nest 3 area because those lowers are so prolific there. So we have looked at that. We have shifted our capital allocation a little bit just towards more gas but the lower Montney will continue to be a significant component of our development plan now and even more so in the future.
Patrick O'Rourke
Okay, thank you.
Marty Proctor
Thank You Patrick.
Operator
[Operator Instructions] Your next question comes from Amir Arif from Cormark Securities. Please go ahead.
Amir Arif
Thanks. Good morning, guys. I have a question about your maintenance capital and then so I just want to clarify what I think I heard you mentioned on the call that you were able to hold production flat in the 175 to 185 range with spending levels of about 650 for the next 12-18 months?
Marty Proctor
Good morning, Amir, yes we did say that and there's a couple, there's quite a few factors that go into that. I mean, first off we are going to be sustaining a lower capital base. That's important to note. Secondly our capital efficiencies have been improving largely because of cost savings but also because we do intend over the next little bit at least, maybe the next year or two to tilt towards a little more gas both of those probably deliver better capital efficiencies.
So yes, we do anticipate that some of these improvements that we've been achieving are going to be sustainable and will help to reduce the maintenance capital. I think one of the most important components of that though is that our decline rates are coming down year-by-year. We've seen that already over the last several years and we anticipate that to continue to happen. We think decline rate moderation continues to be something like 2% to 3% per year and we're targeting around the mid 30% declined by 2022. So all those things and more contribute to that sustaining capital improving.
Amir Arif
Sounds good. Just a second question just on the Nest 3, when I look at the economics in Nest 3 it's actually better than Nest 1 or Nest 2. It's got lower capital efficiency, better IRS. So is there any physical limitations at how much capital we [cannot] shift over to Nest 3 if commodity prices stayed below 35 on the outside and gas prices continue to strengthen?
Marty Proctor
Yes. It's a good question. You'll recall that we invested more than $100 million last year in a large pipeline to connect Nest 3 to the core that has a lot of room still and so I think for our expectations we can direct more capital to Nest 3 for wells for drilling a completion that is without a need for additional facility capital. I don't see us being constrained by facility take away capacity with the outlooks that we've examined with all of our scenarios.
Amir Arif
Okay and just a couple of quick modeling questions. The increase in the gas [weighting] in your revised guidance, just it was small movement towards gas despite how much capital being allocated to Nest 3, does that show more in 2021 in terms of a higher gas [weighting]?
Marty Proctor
Yes, exactly so and so the, there is still a pretty long period between spotting a well and getting it on production. So it'll take a bit of time for the move towards more gas to actually take place but yes, we'll see certainly a little more gas [weighting] in early 2021, if we continue on this path. I mean it depends on what's happening with condensate prices and so on but our expectation is that, yes the benefits of tilting towards more Nest 3 will be even more apparent in 2021 than in the second half of this year.
Amir Arif
Make sense and then just finally on the condensate storage for the volume that you are storing in April. Is the intent to still sell those in the second quarter or based on the current strip which you hold those on to – into the third quarter or even the fourth quarter?
Marty Proctor
Well, the key thing is we've got flexibilities. So the whole intent is to do what we can to improve the prices we’ve received for all products but particularly that condensate that you mentioned that we're heading into storage. So we've got some flexibility as to when we take it out and again we will attempt to take it out when we're more confident that prices are conducive to doing so.
Amir Arif
Okay. Sounds good. Thanks.
Marty Proctor
Yes thanks very much Amir for calling.
Operator
[Operator Instructions] So there are no further questions at this time. Please proceed.
Brian Newmarch
Well, thanks everyone for joining us for our call this morning. Please feel free to reach out directly to myself Brian Newmarch or Ryan Galloway with any further questions you may have. Operator you may disconnect the call.
Operator
Ladies and gentlemen this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
