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Executives

John D. Wright – President, Chief Executive Officer and Chairman

Peter Cheung – Vice President Finance and Chief Financial Officer

Chris J. Bloomer – Senior Vice President and Chief Operating Officer, Heavy Oil

Peter D. Scott – Senior Vice President and Chief Financial Officer, PetroBakken

Tim Sweeney – General Counsel of Petrobank

Petrobank Energy and Resources Ltd. (OTCPK:PBEGF) Q3 2012 Earnings Call November 13, 2012 10:30 AM ET

Operator

Good morning, ladies and gentlemen, and thank you for standing by. My name is Jason and I’ll be your conferencing operator today. At this time, I would like to welcome everyone to Petrobank Energy Resources Third Quarter Results Conference Call. All lines are currently on mute to prevent any background noise. I would like to remind you that this conference call is being recorded today, and is also being webcast on Petrobank’s website. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions)

I would now like to turn the call over to Mr. John Wright, President, and Chief Executive Officer of Petrobank. Please go ahead Mr. Wright.

John D. Wright

Thank you, Jason, and good morning everyone. Today, I'm joined by Chris Bloomer, Petrobank's Senior Vice President and Chief Operating Officer; Peter Cheung, Petrobank's Vice President Finance and Chief Financial Officer; Tim Sweeney, the General Counsel of Petrobank; and Peter Scott, who is PetroBakken Senior Vice President and Chief Financial Officer.

The purpose of this morning's call is to discuss Petrobank’s consolidated third quarter 2012 financial and operating results and also to provide an update on our operations. Also we will discuss the reorganization surrounding the distribution of Petrobank’s ownership of PetroBakken shares to the Petrobank shareholders. At the end of the presentation, we’ll open the call up for Q&A session and we will take any questions from those participating in the call by webcast and we will endeavor to answer all of your questions.

We do caution all participants that information provided during this conference call constitutes forward-looking information. Specifically forward-looking statements will be made relating to financial results, results from operations and the timing of certain projects. Actual results achieved during the forecast period may various results of numerous risks, uncertainties and other factors.

I’d now like to turn the call over to Peter Cheung for a discussion of Petrobank’s third quarter 2012 financial results.

Peter Cheung

Thank you, John. I'll begin by reviewing the financial results for Petrobank. As Petrobank’s Heavy Oil business unit projects are still considered in exploration and evaluation phase of development, all production and operating results reflect, out of our 57% owned subsidiary PetroBakken who released their Q3 2012 results on November 7. Peter Scott will provide a summary of PetroBakken's financial and operating results later in this call.

Adjusted net income attributable to Petrobank shareholders increased to $13.5 million in 2012 from 7.5 million in Q3 2011. Funds flow from continuing operations decreased 19% to $119.6 million compared to the third quarter of 2011, primarily as a result of lower realized commodity prices and increased differentials of WTI leading to lower gross operating netbacks at PetroBakken.

Funds flow from continuing operations per diluted share decreased only 13% to $1.19 as our lower gross funds flow was offset by share repurchases under Petrobank’s Normal Course Issuer Bid. Petrobank’s total capital expenditures for the quarter were approximately $293 million, a small decrease from Q3 2011. PetroBakken’s capital expenditures increased approximately $10 million from Q3 2011 primarily as a result of increased drilling. Petrobank’s capital expenditures decreased $20 million from Q3 2011 primarily because of our spending on the Kerrobert expansion project in 2011.

Now turning to our liquidity and capital resources, it is important to know that Petrobank and PetroBakken manage their liquidity and capital resources independently. As of September 30, 2012, independent of PetroBakken, Petrobank had cash of $96.1 million and a working capital surplus including cash of $84.9 million. In mid-September, we renewed our Normal Course Issuer Bid and can repurchase and cancel up to 7.8 million Petrobank shares until September 13, 2013.

Under our current Normal Course Issuer Bid and through our Automatic Share Repurchase and PetroBakken Share Sale Plan, we have repurchased 3.5 million Petrobank shares and sold an equivalent number of PetroBakken shares through to October 31, 2012. The sale of one PetroBakken share for each Petrobank share repurchased under this plan resulted in net cash proceeds to Petrobank of $1.1 million. Petrobank has elected to participate up to 100% level in PetroBakken’s Dividend Reinvestment Plan. We expect to receive approximately $8.5 million per month for the next several months. We expect that the November dividend and the December dividend will be received in PetroBakken DRIP shares and that the PetroBakken December dividend to be received in January of 2013 will be in cash.

Petrobank remains well capitalized with significant financial flexibility for future operations. Petrobank currently expects to fund our future capital expenditure program and operating ongoing operations with available cash and cash flow from operations.

I would like to now turn the call to Peter Scott to provide an operational update with respect to PetroBakken.

Peter D. Scott

Thank you, Peter, and good morning everybody. I’ll provide a quick overview of PetroBakken’s operations and third quarter results. Our results were released last week and our conference call and Investor Day were held on Thursday, November 8, and I encourage you to go to our website for further information.

Consistent with our history, we are in the busiest part of our annual capital cycle and the time when our production rate growth was active. Production in early November is approximately 45,000 BOE’s per day based on field estimates, 15% increase or nearly 6,000 BOE’s a day over our September average.

Early in the field, we have 17 drilling rigs, 6 fracking spreads and 13 completion service rigs working. For the fourth quarter, we expect to drill 83 net wells employing 105 net wells on to production. To date in the quarter, we have drilled about half of these wells and only brought on to production about one-third of our planned well count for the quarter.

With the well activity planned for the rest of the year and the completion of the Basel battery at the end of November, which will add over 2,500 BOE’s a day of production. We are well our way to achieving our 2012 exit production rates to 52,000 BOE’s to 56,000 BOE’s per day.

We've also announced an increase to our 2012 capital program, which will now total $975 million before dispositions or $340 million after disposition activity this year. About two-thirds of the $100 million increase is to keep our operational momentum going into 2013 and really represents an acceleration of first quarter 2013 activities.

Similar to last year, the effective execution of our drilling program, which means shutting rigs down early in December, and given the availability of services in a good operating environment, we are accelerating our Cardium drilling program partly offsetting this increase by reducing Bakken Mississippian activity.

We are also moving forward facility and optimization capital mainly in southeast Saskatchewan, which should help downtime during spring break-up in 2013. The remaining part of the capital increase relates to spending of about $25 million above our original plan to capture more resource to land sales on and farmers. We are now come of which is the land position of 218 net sections on a new potential resource play.

The quick review of the third quarter, production of 38,500 BOE’s per day and operating netback of $45.9 per BOE and funds flow from operations of $122 million or $0.65 per basic weighted average share outstanding were all essentially flat for the second quarter of this year.

When compared to the third quarter of last year, our operating netback and fund flow from operation this quarter were down about 10% and 20% respectively. Large part of the decrease was caused by lower commodity price realization, primarily driven by wider oil differential. In fact WTI prices at Canadian dollars turns increased 4% over last year and our realized oil and liquids price decreased 12%as a result of a deterioration in differentials. We expect differentials to continue to be volatile due to significant refinery turnarounds occurring late in the fourth quarter of 2012 and the first quarter of 2013. For planning purposes, we are still using an average of 10% of WTI to account for the volatility in the market.

As Peter mentioned, capital expenditures before dispositions in the third quarter totaled $283 million resulting in 82 net wells drilled and 52 net wells brought on to production. Our dividend of $0.08 per share per month continued in the quarter and represented 14% of fund flow from operations after our DRIP participation of 62%.

At the end of the quarter, we had approximately $400 million of debt drawn on our credit facility that has a lending capacity of $1.4 billion plus an accordion feature which would allow us to potentially increase it by another $100 million. We currently have $1 billion of available credit under the facility.

Operationally, the third quarter was pretty typical for us and the fourth quarter is meeting our expectation and we are well on our way to achieving our actual production guidance. Results in our resource plays continue to deliver and we have successfully gained access to a new potential resource play that will provide our shareholders growth for the company well beyond the Bakken and Cardium.

We expect the Petrobank’s spin out of its PetroBakken share position to be positive for all PetroBakken shareholders as the ownership structure get simplified. We look forward to welcoming Petrobank shareholders as our direct shareholders.

I’ll now pass the call over to Chris Bloomer to update on Petrobank’s operation.

Chris J. Bloomer

Thanks so much Peter. Good morning everyone and thanks again for participating in the call. I’ll go through some operational highlights and I have some comments on new Petrobank at the end of this section. At Kerrobert, full field production in the third quarter was average 305 barrels per day compared to 236 barrels per day in the second quarter 2012.

During the third quarter, we continue to operate Kerrobert using a consistent and patient operating plan to achieve balance across the combustion zones and achieve a sustained ratable increase in production of production of upgraded THAI oil.

We are satisfied we are having achieved to satisfactory operating balance between air injection and production and have been increasing air injection across the field. Rates are our 50% higher than our last quarterly update. We continue to increase air injection rates and believe that this will lead to higher production in the near-term as the increased air injection expands the combustion zone.

Just recently, we completed our water disposal well, which will have the material impact on operating costs and lowering them and increased our operating flexibility.

At Dawson, we commenced cold production the first of two horizontal THAI wells during the third quarter. We expect to initiate cold production at the second well before the end of 2012. These wells are expected to produce for a period of time preconditioning the reservoir for start-up of the THAI demonstration project.

The Saskatchewan heavy conventional heavy oil production area, we reactivated eight wells in the Kerrobert trend lands for cold production, all of these wells are in the early stages of cleanup and production. We expect to drill an additional four stratigraphic wells in Q4 2012 to better define our resources in the lose land area. These wells will be completed and placed on cold production at early in 2013 as part of our plan to opportunistically exploit a primary production potential of our assets.

At Arcon, we continue to enhance our existing patterns and progress new processes which have the applicability for THAI and beyond. We continue to receive international interest for the THAI process and several discussions are ongoing. Due to complexities however of dealing with international parties we cannot comment on and when or if these discussions will lead to agreements to license the THAI technology.

Let me comment on the new Petrobank. This is a new area going forward. With the recently announced reorganization of Petrobank and PetroBakken, I’m excited about the prospects of new Petrobank. We will be well capitalized with approximately $100 million in cash and approximately 100 barrels of exploitable oil in place, and we own a 100% of the THAI technology. We will be a THAI heavy oil focused company that will exploit cold heavy oil production opportunities on our lands when it makes sense.

To be clear, we will continue to be commercializing the THAI technology at Kerrobert. We are commencing coal production at Dawson that could lead to another THAI demonstration project. We are going to exploit cold production on our lands and we are planning for future THAI projects. Currently Alaska support as many as three new THAI projects along the Kerrobert trend.

We are going to add more perspective resources to our land inventory and we are going to continue to enhance our intellectual property portfolio and pursue future technology licensing opportunities through Archon.

Thanks again for your attention and we look forward to growing the new Petrobank. Turn back over to John.

John D. Wright

Thanks, Chris. Just a follow-on from Chris’ point about our reorganization as the Petrobank and PetroBakken corporate entities. Just to explain the process, Petrobank shareholders will effectively receive Petrobank's proportionate interest in our PetroBakken share holdings and maintaining their interest in the remaining Petrobank assets through their ownership in new Petrobank as Chris just described.

Petrobank shareholders will receive in aggregate a number of new PetroBakken shares equal to the number of PetroBakken shares held by Petrobank immediately prior to the reorganization. We think that ratio will be somewhere between 1.06 shares to 1.1 shares of PetroBakken for every share of Petrobank.

New PetroBakken shares for each Petrobank share held will be issued following the reorganization, and each Petrobank shareholder will also continue to hold one new Petrobank share for every share held at present. This reorganization will not result in any changes to the businesses, Board or Senior Management of either company.

PetroBakken's accelerated capital program in the fourth quarter of this year should lead to higher production throughout 2013. PetroBakken will continue to deliver returns through both yield and growth for shareholders and PetroBakken is a well financed corporation to able to execute on its strategy with over a $1 billion of available credit and debt capital structure with diversified sources of significant investment, layered maturity profile that compliment the long-term nature of our light-oil focused assets. And as Peter says, I think PetroBakken is looking forward to all the Petrobank shareholders joining in the growth of the PetroBakken assets.

The remaining company, new Petrobank, will also be a well capitalized junior heavy oil exploration and production company leveraging unique patented technology. New Petrobank expects to have over $100 million of cash. The increase from today's cash levels comes from the normal exercise of stock-based compensation inside Petrobank before the reorganization and the receipt of PetroBakken's December dividend in cash in early January 2013.

Our Kerrobert THAI project has seen a quarter-over-quarter production growth and we expect recent increases to air injection levels will result in higher production in the near-term. We've increased our land base and initial planning is under way for up to new THAI projects on these lands. Our long term strategy of purchasing assets early in their stage of development using technology to create value and ultimately distributing standalone businesses to our shareholders for future value creation will continue.

We expect to mail a joint information circular to Petrobank and PetroBakken shareholders next week. The reorganization is subject to the approval of shareholders of each of Petrobank and PetroBakken in mid-December, and I hope you would agree with us in believing that this is a positive transaction for both entities.

With that, we are pleased to open the phone lines for the Q&A session, and as Jason has explained how we will proceed, I’d also comment that we will be taking questions from the webcast and we will endeavor to answer all the questions posed. Thanks.

Question-and-Answer Session

Operator

Thank you, Mr. Wright. (Operator Instructions) There are no questions registered on the telephone lines. I would like to return the meeting over to Mr. Wright.

Tim Sweeney

Thanks, Jason. It’s Tim Sweeney here. I think we have a couple of questions from the webcast that I’ll start off with. The first question comes from Rafael Cascio turn it over to Chris. Petrobank investors since 2006 and I’m still waiting for time to become commercial. PBG considers starting Seg-B operations to support economically – to supports economically THAI becomes viable. Could you please explain how the company will support itself for 300 barrels a day? It did not seem that this value will increase anytime soon.

Chris J. Bloomer

Thanks Rafael and multiple questions. I think that the – as I send earlier, we are going to be THAI focused company. We don’t plan to move into SAGD, that's not really our area of expertise although we will look at cold production, which is pretty straightforward but our focus is going to be THAI.

We are making progress. As John mentioned, we're seeing quarter-over-quarter growth in production. We are certainly not satisfied with 300 barrels a day. We have moved out of our balancing phase. We are now getting into our – ramping up our air again and we expect that with the ramp up in the air that we will see and there will be a lag effect, but we will see an increase in production going forward.

With respect to the economics, I think we’ve said before that the break-even production rate at Kerrobert is 1,000 barrels a day, and certainly we think that's achievable in the near-term. And as operations continue to see more air injection and production growth, we do think this will achieve an economic project there and that can lead to other projects going forward. So we’re certainly not satisfied with 300 barrels a day and that's something that we hope to see change in the near-term.

Tim Sweeney

Thanks, Chris. Our second question comes from David Stephen, which also direct to you. What percentage of capacity is air currently being injected at Kerrobert?

Chris J. Bloomer

Thanks, David. Appreciate the question. We, just to be clear on this point, our design capacity – our target ultimate injection rate per well is about 3 million cubic feet per day. So 12 wells, that's 36 million cubic feet of total injection capacity for the whole project. Right now, we are injecting at about 4.5 million cubic feet per day, which is around 12% of the targeted 3 million cubic feet a day per well or 36 million cubic feet a day for the whole project.

We are ratably increasing the air injection, we started in September, early October modestly increasing the air rate after having balanced out of the field. And we are on a ratable increase of air injection. We see that things are stable still and that we're seeing the effects of the increased air with more temperature and but operations are steady. So we're very optimistic, and we'll continue on this path, and we expect that over time there will be lag time with the air injection and production, but we expect to see the effects in the near-term.

Tim Sweeney

Thanks Chris. Those are the questions from the webcast, so I will turn the call over to John.

John D. Wright

Thanks Jason. Seems that are no further questions, I'd just like to thank everyone for your participation. You will be receiving some time in the near future of the information circular regarding reorganization. We encourage you to look through that and we look forward to completing that reorganization by the end of 2012. Thanks again.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.

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