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Pengrowth Energy Corporation (NYSE:PGH)

Q1 2013 Earnings Call

May 2, 2013 8:30 a.m. ET

Executives

Derek Evans - President and CEO

Chris Webster - Chief Financial Officer

Jim Causgrove - Senior Vice President of Operations & Engineering

Fred Kerr- Vice President of Investor Relations

Analysts

Robert Bellinski - Morningstar

Grant Hofer - Barclays Capital

Dirk Lever - AltaCorp Capital

Roger Serin - TD Securities

Greg Pardy - RBC Capital Markets

Jason Frew - Credit Suisse

Operator

Good morning, ladies and gentlemen. Welcome to the Pengrowth Energy Corporation's First 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 Evans

Thank you, operator. Good morning, ladies and gentlemen. I'm Derek Evans, President and CEO of Pengrowth. Joining me today on the call are Chris Webster, our Chief Financial Officer; Jim Causgrove, our Senior Vice President of Operations & Engineering; and Fred Kerr, our Vice President of Investor Relations.

Before we begin, I remind you that certain information presented today may constitute forward-looking statements. Such statements reflect current expectations, estimates, projections and assumptions of the company. These forward-looking statements are not guarantees of future performance and are subject to certain risks, which could cause actual performance and financial results in the future to vary materially from those contemplated in the forward-looking statements. For additional information on these risks, see Pengrowth's annual information form under the headings Risk Factors and Forward-looking Statements.

Now that we have gotten that piece of work out of the way, let me just quickly remind you of some of the things that we have talked about in previous conference calls. In our conference call at the end of February, on February 28, we stressed three critical items. The first being that we had a differentiated strategy. A strategy that was niche focused inside of the thermal area and zero to 50,000 barrel a day type of bitumen project with low SORs, low declines and high production rates.

Second thing we stressed was that this strategy was differentiated but it would lead us to a more sort of stable, sustainable financial model, i.e. one where cash in equals cash out. And finally, we remain committed to the dividend of $0.04 per share per month. Today I am here to update you on the first quarter. Let you know how we are doing on our asset disposition program. Tell you that our differentiated strategy and our Lindbergh project are resonating with investors and remind you that we remain committed to a dividend of $0.04 per share per month.

Moving forward and talking a little bit about the first quarter, we had a solid first quarter with production, cash flow and operating costs all on track with quarterly and annual guidance. We spent $166 million on development activities in the first quarter of 2013 and participated in the drilling of 101 gross wells, 65.5 net within our key focus areas of Greater Olds and Garrington, Swan Hills and Lindbergh where at Lindbergh we drilled 26 net delineation wells.

We generated impressive results in the Cardium at both Lochend and Garrington and as we noted in our news release last night. As many of you know, Lochend Cardium is our best non-thermal asset with recycle ratios of over 4 times in the $90 (inaudible) price environment, which means that for every dollar we invest we get $4 back. While we love these economics, we don’t propose to grow our company on the backs of wells that can decline at 60% to 80% in the first year. This is where the appeal of our low decline thermal strategy really comes into play.

On that note, updating you on our two Lindbergh thermal pilot wells. They continue to exhibit exceptional performance, exceeding expectations with combined production currently in excess of 1,700 barrels a day and accumulative production of over 0.5 million barrels of bitumen. The pilot reached target production milestones in less than half the time expected, allowing Pengrowth to accelerate the project by a year versus original plans and to expand total plant production capacity to 50,000 barrels a day by 2018 pending regulatory approval.

Lindbergh steam oil ratios have remained exceptionally low in the range of 1.7 times and as I noted a few minutes ago, we drilled 26 delineation wells at Lindbergh, reinforcing our already strong confidence in the breadth and extent of this reservoir. The 12,500 barrel a day first commercial phase of Lindbergh is on schedule and on budget with regulatory approval expected this summer and significant production by late 2014.

On the disposition front, the asset sale market as many of you know is crowded and quite choppy, with lots of assets for sale and a shortage of buyers who have access to capital. I want to make four important points about our disposition programs. First and foremost, number one, we do not need the disposition proceeds this year as Pengrowth cash inflows and outflows are already balanced for 2013. The proceeds of any additional dispositions will be used to help fund 2014 investments.

Point number two, we won’t be selling these assets at prior sale prices. We are disciplined sellers and have the flexibility to decline offers that don’t reflect our view on value. For example the $100 to $125 million of disposition agreements we’re currently negotiating do not include all of Bodo, just the parts for which we have received satisfactory offers.

Point number three, the assets we have available for disposition go beyond Bodo and southeastern Saskatchewan. We have an extensive inventory of additional actionable items. As a company, we have been collecting assets for over 25 years. We have a number of assets that are not material or necessary for our future vision of where we’re taking this company. Those assets are for sale and have been for sale for some time inside of the organization. Our organization has been asked to participate in finding ways to for lack of a better term, clean out our drawers and put these assets in the hands of people that value them more highly than we do. We are having great success in that regard.

In addition to that and this is point number four, we have a variety of tools at our disposal be on asset dispositions to generate cash, including project financing, monetizing midstream assets, embedding growth [overriding] royalties on existing assets and evaluating prepaid commodity swaps. The pipeline of cash generating opportunities for this company is extensive and is designed to tap multiple pools of capital.

In the first quarter, we closed the previous announced sale of the non-operated Weyburn unit interest in southeast Saskatchewan for gross proceeds of $316 million. These funds were used to pay down Pengrowth's credit facilities, leaving the facilities undrawn at March 31, 2013, with $1 billion of available capacity. More importantly, the sale of the Weyburn asset leaves Pengrowth's cash inflows and outflows balanced in 2013. Pengrowth can fund its 2013 capital program and maintain the current dividend without having to take on any additional debt this year.

As previously announced, on January 11, 2013, Pengrowth intended to sell up to an additional $700 million of assets in 2013. We are making good progress in that effort with $100 million to $125 million of disposition agreements that we are currently negotiating on the sale of non-core assets. We look forward to keeping you posted on our efforts here as we move towards our annual general meeting, and remind you that we are currently marketing our southeast Saskatchewan assets which comprise approximately 6000 BOEs a day of operated and non-operated, medium and light oil production. These are high quality assets that we expect to generate significant interest.

On the strategy front, our niche thermal strategy to become a long-term sustainable, dividend-paying energy producer is gaining traction with investors. We believe that focusing on zero to 50,000 barrel a day bitumen projects with declines, low SOR and high production rates, make sense inside of the paradigm shift that has occurred inside of the western Canadian sedimentary basin. But it also allows us to run a sustainable financial model where cash in is going to equal cash out, as well as supporting a dividend.

We have observed that highly focused niche producers such as Baytex, (inaudible) and Vermilion, tend to be rewarded with higher valuations than companies who lack focus. As we look forward in terms of outlook, Pengrowth remains on track to achieve its objectives of becoming a long-terms sustainable dividend paying energy producer. The development of the first phase of the Lindbergh thermal project is proceeding on time and on budget, with the EPEA approval expected this summer. The pilot performance continues to exceed expectations with current production surpassing 1700 barrels a day at a stable ISOR, Instantaneous Steam Oil Ratio of 1.7 times.

Estimated full year 2013 average production is expected to meet guidance, that is between 85,000 and 87,000 BOEs a day. While full year guidance remains intact, the company expects its second quarter production will be 3000 to 4000 BOE a day lower than in the first quarter due to the full impact of the Weyburn disposition begin accounted for in the second quarter, as well as plant downtime and plant turnarounds across operated and non-operated properties including Lindbergh, Quirk Creek, Sable Island, Dunvegan and Lochend. Our outlook for cash flow remains on track despite volatility that we are experiencing in commodity price, and that is largely as a result of our hedging program

We continue to make strong progress on our non-core asset sales. Pipeline of assets sale opportunities we have is extensive and is designed to tap multiple pools of capital. We look forward to updating you on the progress we have made on our non-core asset sales as well as our Lindbergh project at our annual general meeting on June 25.

Operator, I would be happy to take any questions at this point in time.

Question-and-Answer Session

Operator

(Operator Instructions) The first question is from Robert Bellinski of Morningstar. Please go ahead.

Robert Bellinski - Morningstar

Operating expense was up about 10% sequentially on a per unit basis, so I just wonder if you could give some details on the cause there.

Derek Evans

Robert, thank you for the question. Really two big drivers on operating costs. This is the first quarter where you would have seen the full inclusion of the Lindbergh operating expenses and those operating expenses at the pilot stage are about $24 to $25 of BOE. So prior to this quarter they were all capitalized last year. This year they’re actually being rolled in. so they have a higher disproportionate impact on your operating costs than your average BOE. The other driver in the increasing operating costs, which went from about $114 million to about $118 million on quarter over quarter basis is related to non-operating expenses. So our partners operating expenses they actually have gone up. Our operating expenses actually went down in the quarter.

Operator

The next question is from Greg Pardy of RBC Capital Markets. Please go ahead.

Greg Pardy - RBC Capital Markets

Just a few for you. Could you remind me, with the $700 million of assets that you’re planning on selling, what would the production range be of cash to that or have you not disclosed that?

Derek Evans

Greg, thank you for the question and it’s a good one because the $700 million is a notional number. We will sell up to that and as I pointed out in the call, we don’t need to sell that -- it doesn’t need to come into the fold this year in 2013. We’re really working on 2014 here. When we modeled this we said that this would roughly be 10,000 BOEs a day at roughly $70,000 a BOE and we adjusted our model for that. What we’ve been driving towards and you heard me talk to a little bit in the scripted part of the conference call, we’ve been running a real effort inside the company to find assets that really are core to our mission on a go forward basis, but have great value to other people.

And we’ve been quite successful in starting to move those across the line. And really the whole drive there is to make sure that not only do we achieve a high dollar per flowing BOE number for the assets that we sell, but we also mitigate the cash flow impact to the organization. So yes, we’re trying to sell up to $700 million worth of assets this year, but the sub context is how can we minimize the cash flow impact when we sell those assets.

Greg Pardy - RBC Capital Markets

Maybe just switching gears to Lindbergh, the 26 well delineation program, did that confirm, make you very comfortable in terms of the geological characteristics elsewhere on the lease versus what you’re seeing at the pilot?

Derek Evans

It has. The reason you do the delineation work is to make sure that you understand -- you’ve got good boundary (inaudible) in terms of the resource. So I think we had some positive surprises. We had one or two negative surprises, but all in the whole it met our expectations. The other interesting thing though that has come out of the resource delineation work is really where we see that bitumen water contact. We had been defining that utilizing what we call the McMurray cutoff which was at about 10 ohms. We’re based a lot of (inaudible) analysis and bitumen saturation work that our team has been doing. We now believe that the appropriate cutoff for the Lloydminster is something closer to 6 0hms and that has the impact of actually increasing the net pay in portions of the reservoir. So that has been a very pleasant and positive surprise.

Greg Pardy - RBC Capital Markets

And then just I know it’s still early, but 2015 is getting closer. How are you thinking about marketing this? Is this going to be a combination of rail? How is it going to work?

Derek Evans

Well, Greg, if you could give us some color on when some of these new longer haul pipelines were coming through we could be more definitively in our answer. But I think I’m pre guessing, you’re not going to be able to -- you or anybody else are going to be able to give it that color. We have built and we’ll maintain maximum flexibility. So there are four pipelines that drive by Lindbergh and they all go to (inaudible) which is a very liquid hub and probably a good place if you put your oil on the pipeline to get it to. So we are talking to all four of the operators of those lines. We also -- when we moved the cost estimate up on the facility from $450 million to $586 million, couple of the reasons or things we did there were increase the tankage, so that we could run more of a truck operating facility. So that we could hold more production and eventually truck it. We also put in place a truck loading facility that would have at least 12,500 BOEs capacity.

So we are set up to truck from Lindbergh to rail or truck to pipeline, or we will hopefully have the flexibility to tie into one of those four pipelines and pipeline to either (inaudible) or perhaps even pipeline to something -- a place such as Wainwright where we could perhaps move crude or bitumen on to a train for a north-south type of journey into the Gulf Coast.

Greg Pardy - RBC Capital Markets

Okay. And just the last one for me is, what's your base decline now for 2013, and what are you targeting this capital efficiency-wise, obviously ex-Lindbergh?

Derek Evans

I got the first part of the question. Our decline is, we utilized it, when we are modeling we are utilizing an effective decline of about 20%. A static decline if we stopped investing in the organization or capital into the assets, would probably be something closer to 18%. And, sorry about it, the second part of your question?

Greg Pardy - RBC Capital Markets

I mean generally when you are doing your modeling, do you have capital efficiency targets that you are looking at or does everything just sort of roll up from the bottom?

Derek Evans

We have a number of targets that we want to see. The capital efficiencies all roll up in terms of -- into the overall model at the end of the day, which is when you throw all the capital -- when you put all the capital to work, it's somewhere in the $40,000 per flowing BOE type number. So we look at NPV, we look at debt payout. When we were looking at drilling Cardium well and Swan Hills well, we are looking for a payout under 2 years, typically. That is the beauty of these wells. They tend to have IRRs that are in the 50% or 60%, but we want to get our capital back out as quickly as we possibly can so that we can continue to either reinvest in these types of projects or move it towards Lindbergh.

Operator

Thank you. The next question is from Grant Hofer of Barclays Capital. Please go ahead.

Grant Hofer - Barclays Capital

A few questions from me. First off just a quick modeling question. With respect to the divestitures that are currently being negotiated, do you have any sense at this point for even just ball park numbers for associated production volumes and what the timing of that might be?

Derek Evans

We do but we are not prepared to disclose those at this point in time. We want to get more of these across the line. I think we will be providing some of that clarity at our annual general meeting, Grant.

Grant Hofer - Barclays Capital

Okay. No worries. With respect to the Lindbergh pilot, the data that’s been disclosed consists only an aggregate production number between the two well pairs. Is there much variability between the two?

Derek Evans

Actually, there is not a lot of variability between the two and I am pretty sure that the directory is disclosing both of the wells individually. And in our own material we are showing the wells, the individual wells as standalone pairs. The interesting thing is that there is not a lot of variability and they both appear to behaving in a pretty consistent fashion, which is interesting given that one of them has a PCP pump in it and the other has a submersible pump in it which was part of the pilot experiment to see which of those pumps would work better. And I would have thought that progressive cavity pump would have had more challenges just because it doesn’t have the same degree of ability to change the pumping speed is easily in something like an ESP.

Grant Hofer - Barclays Capital

Last question. Obviously a bit of a pullback in volumes anticipated in the second quarter here. Any commentary from you guys on the impact of breakup across the asset base.

Derek Evans

So just on the first part of that, those volume pullbacks are actually anticipated. We’re not changing our guidance. We knew that we would have a big turnaround season in the second quarter and the laundry list of facilities we went through is about half of the actual number of facilities that are going on turnaround. To the second part of your question which was really the impact of breakup, I think the concerning thing for us and it’s not really or has not really impacted our productions yet is what happens if we get a fast milk and a lot of rain at the same time. Can the ground actually soak up all of that moisture? So it could get muddy and it could get expensive in the life of the well. But just we’ve been broken up at the Lochend Cardium place since March 1. So [raw band] went on out there on March 1 and we actually positioned three drilling rigs and a lot of equipment in late February so that we could drill through break up to the extent that break up has prolonged our ability to get in there and complete those wells on time, maybe somewhat impact it.

Operator

The next question is from Jason Frew of Credit Suisse. Please go ahead.

Jason Frew - Credit Suisse

I wondered if you could give us some more color on how you’ve motivated the personnel within the company to focus on debt to cash while on the asset sale program and anything specific that’s changed internally.

Derek Evans

One of the things that we changed in our long term computation program was instead of having the performed multiplier in that long term computation program driven entirely off of total shareholder return, we took it and we split it in half and said half of it will be total shareholder return, but the other half will be driven on debt to trailing EBITDA. And what we’re trying to do there is focus our employees on two things. First and foremost that a low debt to EBITDA number which they can impact it by making sure that our cash flow is maximized and that on the debt side that they’re doing everything they can to help us sell non-core, non-cash flowing assets, that they can actually help drive that number and the lower we keep that number the better it positions the company in terms of moving forward with this capital program. The other thing we pointed out to them is that there’s a very high correlation between low debt to EBITDA and multiples applied by in price cash flow and multiples that are applied inside the soft market. So we point out that it’s in their best interest on not just one, but two fronts to make sure that that ratio is low as possible.

Operator

The next question is from Robert [Bree], private investor. Please go ahead.

Unknown Shareholder

Yes. My question relates to the Keystone pipeline specifically. You partially answered my question, but how much of a plus would the creation of that pipeline be to your company?

Derek Evans

The Keystone pipeline is a big plus to not only our company, it’s a big plus to Alberta. It’s a big plus to Canada and it’s a big plus to the oil and gas industry as a whole. It’s a very important direct line to the gulf coast for adding production. And such, it’s one of the key transportation alternatives that we’d like to see go forward. The other thing that I’d add Robert is that it’s also a big plus to the U.S. The U.S currently -- this pipeline will allow not only ourselves but other members of industry in western Canada to move product into the U.S. Gulf Coast. And that is the world's largest refinery complex. So about 9 million barrels a day of product, 4.5 of which is set up to run heavy oil. And it's currently being filled by product from Mexico and Venezuela. We would like to be able to put our Canadian crude in there, and we think that would be beneficial not only to Canadians but also to our U.S. partners as well.

Operator

Thank you. The next question is from Dirk Lever of AltaCorp Capital. Please go ahead. Please go ahead.

Dirk Lever - AltaCorp Capital

In your release, you had talked about the Lochend battery increasing to -- you are increasing capacity there to 10,000 a day and you would be 40% of that. Are you constrained right now at Lochend and you are looking to get that on for the end of April. Will it ramp up right away then? Do you have enough production behind pipe ready to go?

Derek Evans

Dirk, thanks for the question. Lochend is -- I referred to it a little earlier on as an area where we had actually moved equipment in at the end of February in anticipation of a March 1 breakup. We got that equipment in, we have got the battery expanded. It's 10,000 BOEs but it's fundamentally setup to run about 18 million cubic feet a day of gas and about 7000 BOEs a day of oil production. It's up and running. So we are operating at capacity. And we hope to ramp up our production above and beyond that in the next little while. So our production has not been constrained out there. And really the key point, and this wasn’t in your question, but I am going to take the opportunity to make a point. We have no flaring out there. All of our production is tied in and conserved.

Operator

Thank you. (Operator Instructions) The next question is from Roger Serin of TD Securities. Please go ahead.

Roger Serin - TD Securities

Really one question. You went into some discussion on other funding options and I just want to clarify that I heard them correctly. The three that I got were midstream creating a [Gore] and JV options. Are those correct or did I miss something?

Derek Evans

So you heard correctly on midstream and Gore. We also talked about the potential of doing the equivalent of a volumetric production payment type of vehicle. That’s something that we are currently investigating. When we didn’t mention but I will mention now is, as you are aware, part of that $586 million cost estimate on the (inaudible) project involves about $35 million worth of -- sorry, the Lindberg project involves $35 million worth of cogen type of expenses. We would be looking to talk to people that we will be interested into entering into some sort of leaseback arrangement on that and pulling $35 million out of that estimate. So we are looking at a number of, what I call, one off type of scenarios. Different things that we could be doing. They would fundamentally tap differences sources of capital, not looking to producers or other participants in the business to buy our assets. So clearly, you are looking on the midstream side, the Gore side and our generation side. The BPP and volumetric production payment type of proposals really are things that we believe we can do and we spend a fair amount of time investigating. And the real question is, do we want to do them and what is the discount rate associated with bringing that forward or that future cash flow forward. But there is an arbitrage that’s existing in some assets where if assets are going to trade at a significant discount, it's going to trade on a PDP basis at 15%, why wouldn’t you consider volumetric production payment where there was the opportunity to discount five years of forward cash flow at 3% to 4%. We think that makes better sense than selling an asset on a PDP basis at discount 15%. So when we talk about having optionality, I probably didn’t do a very good job of explaining all of the different things that we’re looking at or the depth of analysis and understanding that we already have those options.

Operator

There are no further questions registered at this time. I would like to return the meeting back over to Mr. Evans.

Derek Evans

Thank you, operator and just a quick thank you for everybody that was on the call this morning. We appreciate their interest in Pengrowth and we just want to reiterate that we’re very excited about the quality of the quarter, the continued strength of our Lindbergh projects, how our strategy is resonating with investors and just remind people that we remain committed to that dividend of $0.04 per share per month. Thank you very much.

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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