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Pengrowth Energy (NYSE:PGH)

Q3 2012 Earnings Call

November 01, 2012 8:45 am ET

Executives

Derek W. Evans - Chief Executive Officer, President and Director

Christopher G. Webster - Chief Financial officer

Marlon John McDougall - Chief Operating Officer

Analysts

Greg M. Pardy - RBC Capital Markets, LLC, Research Division

Kyle Preston - National Bank Financial, Inc., Research Division

Roger Serin - TD Securities Equity Research

Cristina Lopez - Macquarie Research

Gordon Tait - BMO Capital Markets Canada

Operator

Good morning, ladies and gentlemen. Welcome to the Pengrowth Energy Corporation's Third Quarter Results Conference Call and Webcast.

I would now like to turn the meeting over to Mr. Derek Evans, President and Chief Executive Officer. Please go ahead, Mr. Evans.

Derek W. Evans

Thank you, operator, and good morning, everyone. Thank you for taking the time this morning to participate in this call. Before we get started, I must refer you to the advisory on forward-looking statements contained in our news release from this morning. As you know, Pengrowth reports its financial results in Canadian dollars. Accordingly, any reference to dollars in this call will be in Canadian dollars unless otherwise noted.

Joining me today for the call are Chris Webster, our Chief Financial Officer; Marlon McDougall, our Chief Operating Officer; and Fred Kerr, our Vice President of Investor Relations.

I will assume you've all had an opportunity to look at and peruse our third quarter results, which were released earlier this morning, so I don't propose to review that document line by line. What I'd like to do today is offer some strategic context for the quarter, highlight a few milestones and then open the lines to your questions about the quarter and our plans for the future.

As Pengrowth shareholders and as managers of this company, we're very aware of the recent performance of Pengrowth share price. We've fielded a number of calls from our shareholders concerned with their investment. We know this has been a difficult time for investors with the energy sector out of favor and the headlines dominated by negative macroeconomic and geopolitical news. We continue to work diligently to manage the elements under our control, such as operating cost, capital investment and strategy. We believe that we have the right strategy to generate optimal returns for our Pengrowth shareholders.

Our current share price, however, is significantly below the approximate $10 net asset value of our shares. This morning, we'll be recommending to our board that our premium DRIP program be suspended.

Let me take a moment to remind you of some of the elements of our strategy. We're working to develop a portfolio of thermal heavy oil production to complement Pengrowth's existing portfolio of light oil assets. Thermal heavy oil assets benefit from a number of things, including long reserve life, low production declines, strong capital efficiency, all of which will provide cash flow to support Pengrowth's dividend. Our goal is to exploit our existing inventory of oil and liquids-rich opportunities in the Swan Hills area and the Lochend and Garrington, Cardium plays, which generates strong cash flow while we bring our Lindbergh project on stream.

We envision a future Pengrowth operating a portfolio of thermal heavy oil projects from a variety of assets. In addition to Lindbergh, we'll continue to seek opportunities to expand Pengrowth's thermal project inventory. 3 years ago, we set out to transform Pengrowth into a dividend-paying exploration and production company and position ourselves in the unconventional space. The third quarter solidified that transformation with the successful integration of NAL.

The NAL acquisition increased our capacity and capability, adding additional production and reserves, providing additional light oil inventory, specifically in the Lochend and Garrington areas in Southern Alberta, and added key technical individuals to our team. The result is a larger, stronger Pengrowth, with a more diversified portfolio focused on oil and liquids development and a larger balance sheet.

I'd now like to highlight a couple of items from the third quarter. First and foremost, Pengrowth received or achieved record production in the third quarter, with an average of 94,284 BOE a day, a 20% -- 26% increase from the same time a year ago. The third quarter represented the first full quarter of production from the NAL assets, which I'm pleased to report have been successfully integrated into the existing Pengrowth portfolio.

Production in the quarter was reduced by approximately 1,300 BOE a day due to an extended schedule maintenance outages at both Swan Hills and Sable. In addition, 1,000 BOEs a day of dry gas production remained shut-in during the quarter for economic reasons. The Sable and Swan Hills outages have continued throughout October and are expected to affect fourth quarter production. As such, we provided an update to our guidance, as noted in our news release. While we anticipate meeting our full year 2012 production guidance of 86,000 to 89,000 BOE per day, we did adjust our expected fourth quarter or exit production to be approximately 93,000 to 96,000 BOEs a day. This guidance reflects actual production for the first 9 months and incorporates the production interruptions we are currently seeing at Sable and Swan Hills in the fourth quarter.

The third quarter saw higher-than-expected operating costs, primarily due to higher power cost, increased subsurface and surface maintenance and extended turnaround costs. Full year operating expenses are expected to average approximately $14.60 per BOE, which reflects the higher cost incurred year-to-date.

The 15% decrease in cash G&A costs from the third quarter of last year was a reflection of the synergies that were expected as a result of the NAL acquisition. Full year G&A costs are expected to be $2.68 per BOE, which includes $0.49 per BOE of noncash G&A.

We continue to see very positive results from our Lindbergh pilot, with current production averaging 750 barrels of bitumen per day per well pair and an average instantaneous steam oil ratio of approximately 1.6x. In light of the success achieved thus far at Lindbergh, we continue to evaluate ways to advance the timing and increase the scope of the project, and we will be able to release more details on these plans once we have reached and come to a commercial decision. We expect to be in a position to announce that commercial decision and our capital expenditure program for 2013 sometime in the first quarter of 2013. However, today, we'll be asking the Pengrowth board to approve a $55 million capital expenditure on the Lindbergh project, which represents long lead-time items required to get us moving forward with the execution of this project.

What you should expect to see from us in the first quarter of 2013, as we get ready to bring this project to a commercial decision, is not only the commercial decision, but the capital dollars -- updated capital dollars that this project is anticipated to cost, along with how we're going to finance this. At that juncture, we would also be bringing forward our conventional budget and a financing model, cash flow model that would provide clarity on what our cash flow over the next 5 years would be, as well as our debt to cash flow profile throughout that period.

Crucial to executing our plan is fiscal prudence and ensuring Pengrowth's financial strength and flexibility during this transition. To this end, we've taken several initiatives to maximize our financial flexibility. We view debt as a tool we'll use to add assets that support the long-term strategy, not for propping up day-to-day operations. Subsequent to the end of the quarter, we enhanced our financial position by taking advantage of attractive long-term rates to complete a debt offering of USD $385 million in notes with 7- to 12-year maturities.

We've received many positive comments from outside of service on the terms we were able to achieve with this debt. We know that many in the investment community will focus on total debt to cash flow measures. We also want to point out that much of our debt is term debt, so we have some room to maneuver. As you read in the Q3 release, subsequent to the completion of the notes offering, we have available over $800 million in undrawn borrowing capacity on our $1 billion credit facilities. We will be prudent stewards of our balance sheet and the offering provides Pengrowth with the financial flexibility as we progress with our strategy of becoming a niche thermal heavy oil producer.

Pengrowth also maintains an active hedging program with the goal of safeguarding cash flows during the quarter. We have enhanced and stepped up our hedging activities, taking advantage of spikes in oil and natural gas prices to lock in future value. We have also extended the terms of our hedging program significantly, hedging positions into 2013, 2014 and 2015 to help us ensure cash flow certainty. For 2013, we have approximately 12,500 barrels of crude oil hedged at approximately $93.87 per barrel, and 134 million cubic feet of gas hedged at an average price of $3.31 per million cubic feet. I would direct listeners to our third quarter MD&A and the notes to our financial statements for additional information on our hedging program.

These initiatives are intended to safeguard our financial position and provide a measure of stability and certainty to our cash flows as we advance our Lindbergh thermal oil development.

We continue to be excited about the transformation of this company and, in particular, the Lindbergh project.

I'd be happy to, at this juncture, answer any questions you may have. Operator, do we have any questions from the group?

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Greg Pardy from RBC Capital Markets.

Greg M. Pardy - RBC Capital Markets, LLC, Research Division

A couple of question for you, first, just on the power costs, curious what percentage of your operating costs that are power and what are you seeing in terms of trends just going into the fourth quarter? And then I joined a couple of minutes late, but just wondering if you can give us an update on just disposition plans, and so forth specifically around Weyburn.

Derek W. Evans

Sure. Let me take a quick cut at the power prices. What we saw was a significant increase in power prices in the month of September. Sort of all-in costs were about $145 a megawatt in comparison to a budget of sort of $97 a megawatt. So we had a lot of coal-fired generation offline in the province and prices spiked. So I wouldn't want to leave you with the impression that the trend is for higher power costs, but clearly, there's some volatility in the prices due to the reliability of some of these old coal-fired generating stations. As a percentage of our operating costs, we're approximately 25%, and I guess as high as 40% of your operating cost when you start looking more specifically at some of our high water handling operations. The update on the Weyburn disposition, we are in the market with that. I think we've had a significant number of people express interest, sign CAs and go through the data room. We're seeing good representation from a number of not just only E&P producers, but institutions that have interest in good, long life, long-term value assets. We have got a bid date that will likely occur towards the latter half of November. So we'll have some good clarity on whether we've got a number that we're comfortable with on that asset at that point in time.

Greg M. Pardy - RBC Capital Markets, LLC, Research Division

Okay, and, Derek, maybe just one final for me then. Beyond that, is there -- will there be any push then just to streamline the commodity portfolios that you've got with the stuff coming in from NAL? Or do you think Weyburn is pretty much it for the time being?

Derek W. Evans

Weyburn. So Weyburn is one of 2 assets that we pointed to as being available for sale. It's the first 1 we've got in the market. But if somebody's only going to offer me $1 for Weyburn, I'm not that desperate and I'm certainly not going to sell it for something that I don't think represents good value. We've also talked to the Southeast Saskatchewan asset, the 6,600 BOEs a day of non-operated light-oil production in Southeast Saskatchewan. Should, for whatever reasons, we not see the price or the dynamic around the Weyburn disposition that we're pleased with, we have that 1 teed up, and we could put that one into the market in very short order. Our timing, Greg, and I probably should have explained this better in the call portion, our timing about announcing our go-forward plan on Lindbergh is based on a number of factors. First and foremost, continuing to see the strong performance that we're seeing, but also being able to put in front of the investment community a strong financing plan that says this is how we're going to finance and pay for this. And one of the planks in that plan is the disposition of Weyburn and being able to provide clarity that we've either -- that we've moved it across and that we've sold it. So -- and if we haven't sold it or didn't get the price we want, that Southeast Saskatchewan was moved into position and that was executed on. So we see ourselves being in a position to provide that clarity, either on Weyburn or Southeast Saskatchewan, in conjunction with the other parts of the financial plan in the first quarter.

Operator

[Operator Instructions] Our next question is from Kyle Preston from National Bank.

Kyle Preston - National Bank Financial, Inc., Research Division

Just one follow-up question there on your shut-in gas 1,000 BOE a day, at what gas price would you look to bring that back on?

Derek W. Evans

So we're in the process, in the fourth quarter, of bringing on the gas that we actually control. Some of that shut-in gas was non-operated gas. And we would hope that the operator of those volumes would be seeing a gas price in the $3 area and we'd be comfortable bringing that back on. But as you know, non-operated assets are ones that I really don't have a lot of control over. But our -- we've been in the process early in the fourth quarter of starting to bring back on our portion of that shut-in gas.

Operator

Our next question is from Roger Serin from TD Securities.

Roger Serin - TD Securities Equity Research

3 or 4 questions, first of all, in the quarter, did you sell any production?

Derek W. Evans

No.

Roger Serin - TD Securities Equity Research

Okay. I'm wondering on the hedging. You've hedged a lot more. By my guess, you're just under 60% hedged on gas. If gas prices continue to improve, will you continue to increase your hedging position or are you close to -- I think you've got a 65% number but is that a net or gross?

Derek W. Evans

The 65% is a gross number. We will continue to add in hedges not only in 2013, but in 2014 and 2015 as well.

Roger Serin - TD Securities Equity Research

Okay. DRIP, can you maybe give me some color as to what your current run rate is for the DRIP? And also given where your share price is, is that something that you would look at modifying?

Derek W. Evans

I'm going to turn that over to Chris in terms of the run rate. I'm just going to preface those -- or any comments he might make by saying, as you probably heard, we're going to take the premium DRIP off, suspend the premium DRIP with the concurrence of the board today at a meeting.

Christopher G. Webster

So the run rate of the 2 programs combined is just over 50%. It's approaching 60%. So the regular program, the company managed DRIP portion is about 1/3 of that; the other 2/3 being the premium dividend program that Derek's described.

Roger Serin - TD Securities Equity Research

Chris, is if you were to take away the premium, do you have an expectation based on history that some of that would still stick around?

Christopher G. Webster

No, we haven't seen a whole bunch of volatility in the regular DRIP as a result of the premium. They were complementary and not direct competitors with each other.

Roger Serin - TD Securities Equity Research

Okay, and I think it's a good move to suspend the premium, so, good move. I've got, I think, 1 other question. So in the past, you've obviously looked at capturing value where you're not getting it. I think that, Derek, you've looked at selling bits and pieces that aren't producing. Can you confirm if you've sold some lands in the Duvernay and what sort of dollars or dollar per acre you might have got for that?

Derek W. Evans

So we've sold some lands in the Duvernay, but that was almost a year ago. And I would -- I don't have those numbers on the -- on my fingertips, but I'd be happy to get them for you. It was raw land, there was no production. And I'm thinking that it was less than $10 million. But I will get it -- it wasn't a huge land position and it wasn't -- it didn't generate a lot of anything more than, I think, somewhere in the neighborhood of $10 million, but I'd be happy to get that number for you.

Roger Serin - TD Securities Equity Research

Okay. And lastly, given the success you've seen at Lindbergh, or at least early days, is there any sense that you would look to increase the scale from the original proposed amount in terms of volumes?

Derek W. Evans

That is something that we're continuing to work on. Clearly, we've been talking about a 30,000-barrel a day project up to this point in time. And with what we're seeing with these very low SORs, that I think there's a very good chance that you're going to end up building something that is significantly bigger than that project up [ph] there, perhaps up to the 50,000 BOE a day range. I think the -- where we're at, Roger, is we're taking our 2010 cost estimate, and we're looking -- and as you are aware, that 2010 cost estimate was built with a GOR or SOR, steam oil ratio, of 3.5 in it. And we're updating it, and we're saying, we're clearly going to likely be producing more total fluid than we had originally anticipated. What is this going to cost? What do we do? how do we build in optionality, and how do we adjust for the reality of the transportation realities of today? Are we going to truck? Are we going to rail? Are we going to pipeline? What sort of redundancy and flexibility do we need to build into our infrastructure or our facility today in terms of incremental tankage, truck loading facilities, dealing with recovery units? So all of these things are being worked on and processed and this is some of the color that we hope to be able to provide in the first quarter when we come forward.

Roger Serin - TD Securities Equity Research

Okay. Not looking to steal any of that thunder, do you need different regulatory environments to expand the pilot from the current -- from the proposed levels?

Derek W. Evans

So we have an application in for the first 12,500 BOEs a day. And there's no -- there's nothing that -- there's no additional regulatory requirement that would be required to get that done. The next portion is the next phase that has been laid out at 17,500 BOEs. And we have -- we will be putting an EIA application in, which is the required application for that size of facility at some point in 2013.

Operator

Our next question is from Cristina Lopez from Macquarie.

Cristina Lopez - Macquarie Research

Just a quick question on Lindbergh as well. So talking about getting board approval early for some long lead-time items, what would be sort of a rough estimate of the long lead-time items that would be at the total CapEx expenditures for 2013?

Derek W. Evans

Percentage of...

Cristina Lopez - Macquarie Research

Sorry, no, so you've got the $55 million. So is that all you need for 2013 capital for long lead-time items or how much more into the 2013 budget do you think you'll be required for those long lead-time items?

Derek W. Evans

So the $55 million is really for, as we said, long lead-time items, sort of $15 million to $20 million of that would end up being actually expended in Q4 and -- but I don't want to lead you with the impression that that's the end of the long lead-time items. This is sort of the first of the long lead-time items. If we've got this project sanctioned from the board in the first quarter, there would be an additional $100 million of long lead time -- sort of second-generation long lead-time items that we would be proposing or that we would go to work on as we're not expecting to get the EPEA approval, which is the 12,500 BOE a day approval until the second quarter of 2013.

Operator

Your next question is from Gordon Tait from BMO Capital Markets.

Gordon Tait - BMO Capital Markets Canada

You've covered up most of the areas I had questions about, but just one more on Lindbergh. Could you just remind us, assuming, because it looks like the results are still coming in better than you expected, that this is green-lighted in Q1. What is the construction time and approximately how long do you think it would take you to -- between the time you actually commence construction of the first phase of the commercial to when you see production? What approximate time line are you looking at?

Marlon John McDougall

Gordon, it's Marlon here, I'll take that one on. Construction in the field is about a year from the time that we start civil construction. So if you looked at the EPEA application approval to be sometime early in Q2, and civil construction being -- starting sometime in the summer and starting to drill, we would be about a full year starting July, August area. And then we would start steaming in the third or fourth quarter of 2014. So that's roughly the time line, all things dependent on approvals and, obviously, sanctioning. So we're talking about something that we don't have approval for yet.

Operator

There are no further questions registered at this time. I'd like to turn the meeting back over to Mr. Evans.

Derek W. Evans

Thank you, operator. And just as we wrap up here, first and foremost, thank you for joining us on the call post-Halloween Eve. But also, thank you for sharing sort of some of the enthusiasm and excitement that we see around our Lindbergh product. We continue to be delighted with the results that we're seeing, and we're looking forward to being able to present a very full picture of not only what does Lindbergh look like from a 2013 capital perspective, but what our entire capital program on the conventional side would be, as well as updating you in the first quarter on the sale of where we are on Weyburn and/or Southeast Saskatchewan. So with that, I thank you again and please don't hesitate to give us a call if you've got any further questions.

Operator

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

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