John Manzoni - President & CEO
Scott Thomson - EVP, Finance & CFO
Paul Blakeley - EVP, International Operations (East)
Greg Pardy – RBC Capital Markets
Brian Dutton - Credit Suisse
Chris Theal – Macquarie Securities
Talisman Energy Inc. (TLM) Q1 2010 Earnings Call May 5, 2010 10:30 AM ET
Good morning, my name is Melissa and I will your conference operator today. At this time, I would like to welcome everyone to Talisman Energy Incorporated first quarter results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks there will be a question and answer session. (Operator Instructions). This call contains forward-looking information. Certain material factors and assumptions were applied in making the forecasts and projections to be discussed in this call and actual results could differ materially from those anticipated by Talisman and described in the forward-looking information.
Please refer to the cautionary advisory in the May 5, 2010 news release and Talisman's most recent annual information form which contains additional information about the applicable risk factors and assumption. I would like to remind everyone that this conference call is being recorded on Wednesday, May 5, at 8:30 am Mountain Time.
I will now turn the conference over to Mr. John Manzoni. You may begin your conference.
Thank you, Melissa. Ladies and gentlemen good morning and thank you for joining our first quarter conference call. Today I am joined as usual by the management team and I’d like to welcome Helen Wesley who has joined us from Suncor where she was Treasurer and who some of you may know from her previous life as imparted in Investor Relations.
Helen is looking after our corporate services and this is her first quarterly call with Talisman. So, getting straight down to business, it’s clear that the markets now recognized that there is plenty of gas around and that's obviously impacting current gas prices here in North America.
Over the course of the last year we positioned ourselves both in terms of balance sheet capacity and in terms of portfolio to navigate through a period of low or volatile gas prices. And it doesn't change our strategic intent or direction. We can and we will be flexible in how we allocate capital in this period so that we can maintain our direction and at the same time maximize value. I’ll talk more about this a little later. We continue to make great progress on our strategic transition during the last quarter.
We have reached preliminary agreement to sell some non-core conventional gas assets in North America. And we expect those transactions to close in the next few months, which of course strengthens the balance sheet further. We have recently used some of that strength to make an entry into another top tier shale play acquiring a moderate entry position of just under 40,000 acres, much of which is in the heart of the liquids rich transition window in the Eagle Ford.
We have been evaluating the Eagle Ford for sometime and we are confident that it’s emerging as a top tier play. This addition to our portfolio fits the characteristics, which we have in all of our sales, which are that they are all we believe top tier plays in other words the best rocks. And they all have manageable land (inaudible) profiles which allows us to manage the pace of our capital expenditure profile against the backdrop of a challenging gas price.
We also found into some shale acreage in Northern Poland during the quarter, where we will shoot seismic this year and drill next year. We look at this as an option in our exploration portfolio. And since we are one of the few international companies with shale experience we think that fits well.
And finally, we close the Jambi Merang acquisition in Indonesia during this quarter. So over the quarter, we have taken a number of steps which continue our portfolio transition. As we stand today, we have a very strong balance sheet, we have flexibility in our capital programs and we are poised to deliver underlying growth from the second half of this year.
Looking at the results for the quarter, they show underlying improvement in both cash flow and earnings from continuing operations and contain the early indications that we are reaching an inflection point in production.
The increase in production from shale gas offsets the decline from conventional portfolio in our North American business for the first time this quarter. The main items to point out regarding the financials of the impact to hedges which are changing as they roll forward and depreciation charges in dry hole costs which impact our reported income.
The net income for the quarter was $228 million, up from the fourth quarter last year, where we reported a loss of $111 million, but down from the first quarter a year ago. The year ago number was dominated by gains on disposals.
Prices in net banks have increased both from the last quarter and the first quarter last year, driven mainly by oil prices although gas netbacks also increased a little. The strengthening Canadian dollar offset some of that gain on our revenues, particularly against this time last year.
Two factors to highlight in our income number, the first being the exploration dry hole costs. These are very low this quarter $6 million. Our international exploration write-offs are always lumpy, since they depend on the timing and of course the success of our exploration program.
But in North America, where in the past we have seen a similar lumpy pattern. This is likely to change going forward, as we move increasingly into the shales which are not subject to the same risks. So, in terms of dry hole cost in North America, we should be moving into a new and lower pattern. Depreciation charges were also low, reflecting the foreign exchange gain, as Sterling in particular weekend and also the reserve right backs in the UK which come within increasing oil price.
Earnings from continuing operations which strips out all the noise were a $122 million or $0.12 a share this quarter, up from the last quarter, but down from a year ago. A year ago we had strong hedges in place which allowed us to realize very strong prices. Costs are broadly flat from a year ago and slightly up from the fourth quarter. The increases from last quarter relate mainly to some well intervention work we did on the Tweedmill well in the UK to remove scale from the wellbore and some additional maintenance work in Norway.
As a general comment on cost pressures across the business, they are actually generally flat or have downward momentum from the contracts we have renewed last year, with the exception of North America where we see pressure in the rig and stimulation markets.
We have contracted for some dedicated crews in our Marcellus operations which has mitigated a lot of the pressure, but it’s clear that the general cost trend in North America is up.
Cash flow for the quarter was $837 million which was les than last quarter and a year ago, but taking out the impact of the hedging gains on prior quarters, the underlying cash flow was higher than both comparative quarters. We ended the quarter with more cash on the balance sheet than we started. This puts us in a very strong position looking forward, especially as we expect to receive cash from our North American dispositions around that year. Turning to capital expenditure, we said at the start of the year, we would spend $4.9 billion cash capital.
The strengthening Canadian dollar against both Sterling and the US dollar means that the activity levels we originally projected will now cost closer to $4.6 billion. Over the course of the rest of this year we will be examining our gas focused investment in the light how of how the gas price looks to be moving.
Today our Marcellus wells have a breakeven significantly lower than the realizations and that’s before the impact of any hedging. We are also drilling development wells in the Montney Farrell Creek where we are seeing the benefits of continuous drilling in terms of cost improvements and we believe we are on track to get to our target breakeven of around $4.
We’ll give you more detail on this and how we are thinking about capital programs into next year when we will talk with you at our Investor Open house in a week’s time. But if as we go through this year prices looked like they could remain at current levels, we will use our flexibility to ensure we maximize the value of the resources in the ground.
Turning now to production, production for the quarter was 435,000 barrels a day. And for production from continuing operations was 405,000 barrels a day, higher than last quarter and a year ago. And I want to draw your attention to a couple of points on production.
First in North America, on a continuing operations basis, stripping the impact of disposals, this quarter represents the first quarter since we began our transition into shale gas, that the shale increases have offset the conventional decline. This pattern is now set to be maintained going forward unless our North American production is now set to grow sustainably from here. The pace of that growth will depend on how much capital we choose to put in. But the important point is that the pattern is set.
At the end of April, we were producing a 150 million cubic feet from the Marcellus and I am confident that we will exit the year as we said between 250 and 300 million cubic feet a day. Second, I want to reiterate our overall guidance for the year in particular as the quarterly pattern is likely to be volatile. In January, I noted that excluding our North American disposals we would hold on 2009 production broadly flat this year. The assets for which we have announced sale in North America are producing about 42,000 barrels a day. And the exact annual impact will depend of course from the actual closing dates of the various transactions. But let’s say it’s around mid year that means since last year we were at 425,000 barrels a day. This year we’ll deliver something just over 400,000 barrels a day.
Although we are not changing the guidance we gave in January, I do want to flag that the production in the second and third quarters will be significantly lower than the first quarter, as we go into shutdown and as we actually strip out the North American production with selling. Towards the backend of the year, as we come out of those turnarounds Marcellus production continues to ramp up and as we bring on EMA the production rates increased significantly.
Let me now turn to Scott, to talk a little bit more about our balance sheet and the cash in hedging positions.
Thanks, John. I’ll review our financial results, balance sheet progress on focusing the portfolio and hedging position. Cash flow in the quarter was $837 million compared to $921 million in the immediately preceding quarter, due principally to lower cash proceeds from hedges partially offset by increased production. Cash flow of $1.3 billion in the first quarter of 2009 included approximately $600 million of hedging proceeds.
Earnings from continuing operations, which excludes certain non operational items, were a $122 million in the quarter, compared to $65 million in the immediately preceding quarter, due principally to lower dry hole expense, partially offset by lower proceeds from hedges.
Earnings from continuing operations of $320 million in the first quarter of 2009 included $600 million of hedging proceeds partially offset by lower commodity prices. Current income taxes were $235 million in the quarter, which was higher than the first quarter of 2009, because of higher oil prices and increased production in higher tax rate jurisdictions like Norway. Current income taxes slightly lower, than the immediately proceeding quarter, primarily because of lower taxes in Canada.
Second and third quarter current income taxes are expected to be lower than the first quarter due to seasonal turnarounds in the North Sea and we expect full year 2010 current income taxes will be in the range of $700 million to $850 million, assuming $80 WTI and US Canadian dollar parity.
Exploration and development expenditure during the quarter was $735 million of which $247 million was directed towards North American shale activity with the majority spent on progressing development of the Pennsylvania, Marcellus and Montney shale programs.
$273 million was spent on development activity in the North Sea, a significant portion of which related (inaudible) North and EMA developments. $62 million was spent on development activity in South East Asia and the rest of the world with a $123 million spent on international exploration. As John mentioned, our cash capital spend for 2010 is projected to be $4.6 billion down from $4.9 billion as a result of the strengthening of the Canadian dollar relative to our initial plan. On the disposition front, we continue to make good progress in focusing our portfolio.
Our recent sales were announced with good metrics of approximately seven times cash flow and $43,000 for flowing barrel. Since May 2008 we have filled $5.2 billion of assets at attractive metrics of approximately $60,000 for flowing barrel.
During the first quarter in South East Asia, we acquired a 25% working interest in the Jambi Merang PSC in Indonesia and entered into a formal agreement in Papua New Guinea. We also added an option to our exploration portfolio by entering the Baltic basin in Poland. We farmed into two shale gas concessions in subsequent to quarter end were awarded a third concession that was pending government approval.
This provides us an opportunity to leverage our international and shale gas experience in a perspective European shale play. Since quarter end, we spend $360 million to acquire 37,000 net acres in the Eagle Ford shale play. As John mentioned, the properties are attractive as they are located in the liquids rich transition window derisk for commercial development, come with modest production and we control the pace of the spending.
At March 31, 2010, we had $1.9 billion of cash on the balance sheet. Our net debt decreased from $2.1 billion a year end to $1.8 billion at the end of the quarter, reflecting $200 million of free cash flow and favorable exchange rate movements.
As I mentioned in February, we expect capital expenditures to exceed cash flow for 2010. We will fund the capital program with cash on hand and proceeds from dispositions. We will likely end the year with approximately $1.5 billion of cash on hand after accounting for 2010 acquisitions to date in the Indonesia, P&G and the Eagle Ford.
This financial flexibility will allow us to continue to pursue organic investment opportunities in 2011. As the macro economic environment improves or opportunistically take advantage of additional small bolt-on acquisitions.
Importantly last weeks Moody’s changed thousands of railing with the stable from negative and affirmed our senior unsecured rating. We are now rated BAA with Moody’s, BBB at SMP and BBB high at DBRF. This action by Moody’s is a positive development and reflects increased confidence from the rating agencies in our ability to successfully execute the strategic transition.
Turning to our 2010 hedging program, we have hedged approximately 40% of estimated 2010 oil production in three different programs. 28,000 barrels per day are hedged in 50 x 80 collars, 25,000 barrels per day are hedged in 70 x 90 collars and 22,000 barrels per day are hedged in 50 x 60 collars. Approximately 60% of our 2010 production is oil or oil linked and therefore we have significant upside exposure to higher oil prices.
For North American gas, we have protected approximately 335 MMCF per day 2010 productions through physical and financial hedges with approximately 50 MMCF per day in NYMEX collars with the US $6 floor and a US $7 ceiling and the majority of the remainder in AECO collars with a $6.20 floor and a $7.50 ceiling.
In the second half of 2010, approximately 50% of our North American gas is hedged and after taking into consideration royalty payment significantly more than 50% of our economic disposure throughout the rest of 2010 is hedged.
For 2011, we have hedged a 140 MMCF per day of gas at approximately NYMEX $6 and we currently have no 2011 oil hedges in place currently
Those are my highlights. I’ll turn the call back over to you, John
Thank you Scott. Ladies and gentlemen just before your questions a couple of things I want to reiterate. The gas prices in North America are now reflecting a concern about over supply and that condition could last for some time. But we have positioned ourselves to handle it however long it lasts. First, we have a very strong balance sheet by design to allow us to maintain our direction and continue our transition. Second, we have flexibility to adjust our capital programs to maximize the value of our resources depending on the gas price. We are not bound to drill the hole (inaudible) and we can move capital around to optimize our spend patterns.
I’ll say more about our 2011 program when we have our investor day in a week’s time. The addition of the Eagle Ford in the portfolio gives us more options into 2011. Third, we have strong hedges in place for the remainder of this year and finally our diversity is helping us in the current environment. We are about 60% oil weighted and as I will describe to you next week a significant proportion of the production growth we project over the next 12 months is liquid.
The portfolio will demonstrate underlying growth from the second half of this year and when we meet in a week’s time I will outline in more detail for you, how that will manifest itself into next year.
And with that ladies and gentlemen we’d be very happy now to answer any questions you have.
(Operator Instructions). Your first question is from the line of Greg Pardy of RBC Capital Markets.
Greg Pardy – RBC Capital Markets
Couple of questions maybe just first on the Marcellus, John, given the drilling that you have done so far and the IPs rates of 5 million a day that you know this past quarter, is there anything that would then move you to expect higher EUR averages beyond the 3.5 bcfe or higher IP rates on average than the three million a day you are budgeting?
Greg thank you for your question, I am going to ask Paul, some risk at all. I’ve got to ask Paul to answer the question, just to reiterate what we have been seeing in the first quarter and then how we think about that?
Couple of things to say on the Marcellus as you quite rightly say we have planned this year on average IPs in the Marcellus of 3 and EURs of 3.5, the well results in the first quarter have been better than that. In the first quarter we have seen average IPs of 5 and average EURs of 6 on the wells that we have drilled in the first quarter, but we sort of need, we are mindful that this year’s program we are going towards the tail-end of this year be drilling into areas we haven’t drilled before Columbia, (inaudible) counties for example and so whilst the first quarter looks good, we are not going to change our guidance at this point on the basis of just a single a quarter of good result.
Greg Pardy – RBC Capital Markets
And then maybe just switching over to the Eagle Ford which counties does the 37,000 acres fall into, what would you consider to be critical mass from an acreage position in a play and then can you give us that any color around break evens or any other details just as what you are expecting on a program this year.
So Paul, over to you again on the Eagle Ford?
Three questions there Greg, the acreage we have required is in the (inaudible) counties which as we have map the Eagle Ford play in the last 18 months is in the very heart of the play and some of the thickest parts of Eagle Ford what we are seeing up to 350 feet of shell within the place. So it’s in the very, very hard of what we believe are the very best parts of the Eagle Ford within the transition window. In terms of critical mass I’d say that this marks clearly a fourth leg to shell portfolio within North America now. It’s an entry position, the 37,000 acres on their own would sort of support business that could go up and ramp up over time to sort of circle 300 to 350 million standard cubic feet a day. And you know we will continue to look full value adding opportunity should they come along within our North American portfolio.
In terms of breakevens, we and others are clearly starting to see the Eagle Ford rapidly emerge as one of the leading return shell place in North America. We are very confident from the world results that we have seen on this acreage, just as a reminder it have been a six horizontal wells on the acreage that we have drilled already. We are very confident as we see all of the characteristics for this to be a sub $4 breakeven play within our portfolio.
Your next question is from the line of Brian Dutton of Credit Suisse
Brian Dutton - Credit Suisse
Tell us little strategy as I understand, it is to focus upon growing returns of your business and not just production and its also within a process that really emphasizes allocating capital towards your best expected rate of return projects, so Paul just talking there a little bit about the new plans of Texas but also note that you have added other play in Poland so really have three questions all related together and as really how did these ventures fit within your internal competition for capital and within that competition contacts and what’s your current projects do you have lose capital within that capital to be. And thirdly Paul just talked I mentioned there about the scope of the potential production but did these two projects really have the resort depth to maturely contribute to Talisman’s profitability?
You are right, we are you know have a safe profitable growth [matter] internally and the emphasis is on profitable and on growth but just as much on profitable. Let me just make a general comment first, last year replacement cost for the company as a whole came down 40%, as we will explain next week they will continue to comedown, so I think that returns are demonstrably improving across the portfolio as we move into, as we are shifting the capital employed base of the portfolio into the new ventures.
Now naturally, once got the balance, existing activity which is production today, profitable production today with future activity, profitable production for tomorrow. And there is always a debate, there is always a discussion, there is always judgment about how much new capital one puts into new ventures, long run ventures. As you know we spend quite deliberately $700 million between $600 million and $700 million per year on exploration and we have maintained that relatively constant.
Poland for instance fills within that budget and the exploration portfolio will be high graded accordingly to accommodate whatever else we chose to put into that budget and over time as Richard works the exploration portfolio the quality of that exploration portfolio is also going up, some things are longer dated, some things are shorter dates but actually the constancy of 700 million so that the exploration team in particular can shift and sort the portfolio and adjusted vertical portfolio so that we can only drill the highest quality opportunities, is a very important thing you can’t jerk those things up and down because the team needs to know how much capital it has allocated, now that’s the decision that we have made. And that decision is aligned and consistent as you know with finding 600 million to 700 million barrels of resources over a 5 year period at finding cost of less than $5 a barrel that seems to us to be a reasonable allocation both of resources and a reasonable contribution from our exploration program into the renewal of the firm.
So that’s really how we think about it, Brian. Its always a judgment, I haven’t got any analytics, except to say that we do rank all of the investment opportunities across our portfolio, so we know what the projected returns of every new incremental investment are and we are constantly making decisions off the bottom of that list.
And that was one of the major contributing factors, which led us to say, the conventional gas business is simply the least returning business and I think you could already see that. And it’s not just about putting less incremental capital and it’s about removing the capital base from the portfolio in order that the total portfolio can return more.
Now it’s slightly off to your question, but it’s about judgment and I have just given you a few dimensions of how we think about returns and profitability in the portfolio. Eagle Ford, support point. This would be big enough to standalone by itself, so the 350, 300 million cubic feet 50,000 barrels a day. It would be big enough to stand by itself. This 400 wells that we can see today on that land that’s a material slice of business, but on the other hand one could also look at it, as a good entry position on which we could build, if we can find the next opportunity in which we can see value, so I would say standalone today, but it could be built upon.
Does that try to get at your question?
(Operator Instructions) Your next question is from the line of Chris Theal of Macquarie Securities
Chris Theal – Macquarie Securities
Can you just expand a little bit more with respect to the Eagle Ford, what is the land tenure profile in terms of expiry and what kind of royalty resume do you see there?
My general point is, as I said the Eagle Ford is like the others, it does not have extensive land expiry issues. Paul do you want to just expand a little bit on the profile and the royalty?
I mean we have much like the rest of the shale portfolio that we have built in the Marcellus, the Montney and Quebec. We have laid in the entry into the Eagle Ford in a way what we have very manageable land expiries to put it into prospective on the acreage that we have picked up in the Eagle Ford, we would need to spend roughly a minimum of $30 million to $50 million per year for the next 2 to 3 years to retain the acreage and that’s clearly a very, very management land expiry profile for us to deal with and is very similar as I say to the other acreages and positions that we have. In terms of royalty rates, the sort of average royalty that we are seeing is roughly 18%.
Chris Theal – Macquarie Securities
One more question when you look at cash taxes in the first quarter essentially all your taxable or tax expense was in the form of cash, can you give us some color on how you see the cash tax environment playing out over the next couple of years.
Let me ask Scott, to see if he could describe cash taxes because I know it’s been the subject to some questions.
So cash tax of current income tax from the first quarter as I mentioned was 235 million that was down slightly from Q4, 2009 so we had higher taxes in the UK with the increased production and slightly higher oil prices and that was offset by lower taxes in Canada.
Relative to Q1, 2009 cash taxes were up pretty significantly and that’s to be expected the primary driver was normally and frankly, where we had significantly increased production and higher tax rate jurisdiction. Going forward into the rest of 2010, second quarter and third quarter taxes we would expect to be a little bit lower because we pay a lot of cash tax or current income tax. In the UK and Norway we are going to turn out these in there and then it will accelerate a little bit in the fourth quarter. Its obviously very hard to give an exact guidance figure on current income tax because it depends on the production of the various areas in the capital expenditures, but we today in my script as I mentioned are given a target of $700 million to $850 million and I think that’s at around the analyst consensus price tag, so hopefully that gives you a sense of where we are heading for 2010 as we got to 2011, when we go to the open house next week, we can give you a little bit more guidance on production and capital and taxes at that point.
(Operator Instructions) There are no further questions; I’ll turn the call back over to you Mr. Manzoni.
Thank you very much ladies and gentlemen, thank you for listening to our call. We will look forward to seeing many of you I hope during next week in either New York or Toronto as we do our investor open house and until then have a safe day. Thanks very much.
This concludes today’s conference call you may now disconnect.
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