Vermilion Energy Inc. (NYSE:VET)
Q2 2014 Earnings Conference Call
July 31, 2014, 11:00 AM ET
Dean Morrison - Director of IR
Lorenzo Donadeo - CEO
Tony Marino - President & COO
Curtis Hicks - EVP & CFO
Pavan Hoskote - Goldman Sachs
Travis Wood - TD Securities
Good morning. My name is Chrissy, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Incorporated Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions)
I would now like to turn the call over to Lorenzo Donadeo, CEO of Vermilion Energy. You may begin.
Thank you, operator, and good morning, ladies and gentlemen, and thank you for joining us today to discuss our second quarter 2014 financial and operating results. I'm Lorenzo Donadeo, CEO of Vermilion. Joining me today are Tony Marino, President and Chief Operating Officer; Curtis Hicks, Executive Vice President and CFO; and Dean Morrison, our Director of Investor Relations.
Earlier this morning, we announced record operating results driven by our recent acquisitions, successful organic activity, and our consistent operational execution. We generated record quarterly fund flows from operation of $216.1 million, or $2.05 per share, in the second quarter of 2014. Combined with our strong funds flows from operations during the first quarter of 2014, this resulted in record six months fund flows from operations of $421 million, an increase of 25% year-over-year.
Average production also reached record levels at 52,089 BOEs a day in the second quarter, an increase of 12% quarter-over-quarter and 22% year-over-year. Our current growth is primarily attributable to strong results from our Cardium and Mannville developments in Canada and production additions from our recent acquisitions.
Second quarter Canadian volumes of 25,070 BOEs per day include approximately two months of production contribution from our southeast Saskatchewan acquisition completed at the end of April, while European volumes of 20,536 BOEs a day include our first full quarter of production contribution from our German acquisition completed in February.
Today, in view of our consistent operational performance, we’re further increasing our production guidance for 2014 to a range of 48,500 to 49,500 BOEs a day, up from our previous guidance of 48,000 to 49,000 BOEs a day, and original guidance for 2014, including Elkhorn, of 47,500 to 48,500 BOEs a day.
In Canada, we increased average Cardium production by 17% during the second quarter to over 12,000 BOEs a day. Since entering the play in 2009, we’ve drilled or participated in 258 gross, or 184 net, Cardium wells, and have consistently delivered industry-leading performance, reflecting the quality of our land position in the West Pembina region. Our results also reflect ongoing efforts to optimize completion technology and well design.
More recently, we’ve been able to achieve incremental improvements in production efficiency and a significant reduction in per section costs through our utilization of long-reach horizontal wells, some as long as 2.25 miles.
Further, we have consistently maintained our per unit cost at less than $6 per BOE for our operated production, allowing us to realize operating netbacks of more than $70 per BOE during the second quarter.
With our improving efficiencies and productivity, we now anticipate that we will require less capital and approximately five fewer wells than originally anticipated to meet the 2014 objectives of our Cardium program. As a result, we’ve elected to divert a portion of our previously planned Cardium capital to our Mannville development program.
Our Mannville condensate-rich gas program has achieved robust economics year-to-date, generating operating netbacks of more than $40 per BOE and after-tax rates of return in excess of 100%. With the incremental capital, we now plan to drill approximately 15 gross or nine net Mannville wells in 2014, up from our original budget of eight gross, 5.7 net wells.
We’ve really just begun drilling the condensate-rich Mannville gas program, and are getting better than expected results that are driving very robust economics. In all, we’ve drilled about 2% of our Mannville prospect inventory, and produced 4,600 BOEs a day in the second quarter. Needless to say, we’re quite excited about this play, and we think it will provide significant growth for Vermilion over the next several years.
We continue to appraise our Duvernay condensate-rich natural gas play across our 317 net sections in the Edson and Drayton Valley areas. Our position spans a breadth of the condensate-rich natural gas fairway, and costs approximately $76 million or $375 per acre.
To-date, we’ve drilled three vertical stratigraphic test wells, and have completed drilling operations on our first two horizontal appraisal wells. The first horizontal well is located in the down-dip portion of our Edson block. This well is closer to the gas window where condensate yields are expected to be lower than our overall position. The location was selected due to its proximity to one of our vertical stratigraphic test wells, which will be used for microseismic monitoring.
Our second horizontal well, which we operate at a 34.8% working interest, is located on a shared lease-line in the West Pembina block. During drilling operations, both wells encountered stability issues in the build section of the wellbore near the heel of the horizontal well. The wells were ultimately sidetracked to reach total measured depths of more than - to 4,700 meters.
The required additional drilling moved us into spring breakup, where bad weather created poor lease conditions, further contributed to extended drilling operation, which averaged approximately 100 days per well. This was approximately double our original estimate, and as a result, we are now anticipating total net well costs for the two wells of approximately $40 million, including drilling, completion, equipment tie-in, microseismic, and related monitoring well workovers. Both wells are expected to be completed in the third quarter.
Our experience with these first two appraisal wells should assist us in achieving targeted well costs of $12 million to $15 million on future drills. We anticipate the production and microseismic data from these appraisal wells will provide valuable in optimizing future horizontal wells as we move northeast to higher condensate targets in our land position.
Vermilion entered a new core area in the Williston Basin during the second quarter with the acquisition of Elkhorn Resources, a private southeast Saskatchewan producer. We’ve been evaluating this area for an extended period of time, and believe that the high netback light-oil producing assets in the Williston Basin fit well within Vermilion’s business model and areas of operational expertise.
The majority of production and development drilling opportunities are from the Midale formation, with additional opportunities identified in the Frobisher, Bakken, and Three Forks/Torquay formation. We’ve currently indentified approximately 175 gross or 152 net potential drilling locations in these formations and commenced a two-rig 13-well Midale program in June.
Moving to Europe, we had an active quarter with drilling programs in both France and The Netherlands. Following upon our highly successful 2013 Champotran drilling program, we drilled two of the five Champotran wells planned for 2014 during the second quarter. These wells achieved first oil on late July with initial rates averaging approximately 275 barrels per day per well. The remaining three wells in the Champotran program will be drilled and completed in the third quarter.
We also continued preparations for the phased transfer of our Vic Bihl gas production from the Lacq gas processing facility to an alternative third party. Delays in receiving required permit transfers have delayed our expectations of bringing approximately 850 Mcf a day of solution gas back on-stream in the third quarter of 2014 to early 2015. The remaining 3,400 Mcf per day of gas cap gas is still expected to be back on production in late-2015.
During the second quarter, we drilled the third and fourth wells of our seven well program in The Netherlands. The Havelte-01 well, it’s a 50% working interest, had no gas shows from the Zechstein and Vlieland targets, and was plugged and abandoned. However, as part of the Havelte-01 project, we will tie-in a previously stranded gas discovery at Eesveen-01. First gas from Eesveen-01 is anticipated in February 2015 at an expected rate of 3 million cubic feet per day net to Vermilion.
The second well, Lambertschaag-02, in the Slootdorp concession was determined to be non-commercial in the primary target zones, but did encounter other zones of interest with significant gas shows that will be evaluated in the second half of 2014.
Late in the quarter, we initiated production from the Zechstein carbonate formation of the previously idled DeHoeve-01 well that has a 42% working interest at a rate of 3 million cubic feet per day net to Vermilion. Of the three remaining wells planned for 2014, one is planned for the third quarter and the remaining two wells are planned for the fourth quarter.
Our Germany business unit is also taking shape. We’ve now established an office outside of Berlin, recruited a Managing Director, and are progressing well with our efforts to recruit a technical team to oversee operations and evaluate new opportunities in the country.
In Ireland, we announced the completion of tunnel boring operations related to our Corrib project on May 22. The tunnel boring machine has been demobilized and the project is progressing well with the remaining activities needed for start-up, including running a flow and umbilical lines through the tunnel, grouting of the tunnel, and certain offshore well workover activities. Subsequent to the end of the quarter, the most significant offshore workover activity was completed on the P6 well, one of the five wells required for start-up at Corrib.
The P6 well was flow tested for 24 hours at a final flow rate of 112 million cubic feet per day, so we tested that for 24 hours at a final flow rate of 112 million cubic feet per day at a flowing bottom hole pressure of 3,260 psi, representing a 44% drawdown from reservoir pressure. The well was still cleaning up at the end of the test, exhibiting an increasing flow rate and increasing flowing bottom-hole pressure when the test period ended.
The test rates were within expectations, reconfirming previous test rates. First gas from the project is anticipated in mid-2015 with peak production levels of approximately 58 million cubic feet per day or 9,700 BOEs a day net to Vermilion.
In Australia, we continued preparations from our upcoming 2015 drilling program. Our current plan is to maintain our long-term Wandoo field production rate within our prior guidance of between 6,000 barrels per day and 8,000 barrels per day. We anticipate maintaining these production levels in Australia for the foreseeable future with drilling programs approximately every two years.
Concurrent with our increase in production guidance, we’re also updating capital expenditure guidance for 2014 to $650 million. The modest increase largely reflects increased Mannville development and higher-than-anticipated costs for the Duvernay program.
In April, our syndicate of lenders agreed to increase our three-year revolving borrowing base from $1.2 billion to $1.5 billion with a further addition of a $250 million accordion feature. At the end of the second quarter, we had available debt capacity of approximately $775 million. We believe this leaves us uniquely positioned to potentially grow and diversify our asset base through acquisitions in North America or international, should suitable opportunities arise.
With our conservative balance sheet, relatively low cost of capital, and significant anticipated free cash flow, including from Corrib, we have a distinctive advantage when transacting in today’s well supplied, buyer-friendly acquisition market.
Our objective remains to produce ratable annual production growth at the consolidated company level of approximately 5% to 7% per year before consideration of acquisitions or Corrib’s future impact. Combined with Corrib’s anticipated contribution to our production and cash flow streams, we currently expect to grow at a rate of approximately 16% per year between 2013 and 2016, and have average production exceeding 63,000 barrels a day in 2016.
Similarly, fund flows from operations are expected to grow at a rate of more than 18% per year during that time. We currently have a deep inventory of well-defined, high-quality, high-netback drilling prospects that will allow us to continue to provide steady growth to the year 2020.
In 2014, Vermilion is celebrating 20 years as a publicly traded company. It’s been a demanding but also tremendously rewarding 20 years. During that time, we remained committed to stewarding our company in the best interest of our shareholders. We are pleased with the results having delivered a compound annual total return to shareholders of 36.8% since our inception.
So with that, I’ll conclude my formal remarks. Operator, please open the floor to questions.
(Operator Instructions) And our first question comes from the line of Pavan Hoskote from Goldman Sachs. Your line is open.
Pavan Hoskote - Goldman Sachs
I'll start with a question on Australia. Your execution in Australia has been solid, and over the years, if anything, your inventory has surprised to the upside. Can you discuss how much more running room you have in the region? And also, do you see opportunities for acquisitions in this area as some of the larger companies potentially exit the region?
In terms of the future development inventory in Australia, I think it’s quite strong. As you know, we had a really successful 2013 sidetrack program. It’s a typical type of development that we use drilling quite long horizontal laterals off the existing wells in the field. The couple of sidetracks that we did in the 2013 program continue to give us quite significant deliverability on the order of - we can deliver probably 2,500 barrels of oil a day per well still at this point. They will decline over time.
We produced them part of the time, as we optimize the production from the field and maintain the market for the crude oil that we have there. In terms of the inventory going forward, we identify about a dozen future sidetrack locations. The typical drilling period that we’ve had is about, to mobilize a rig, about every year and a half. So, drilling two to three sidetracks at a time at a two sidetrack-pace, that would give us six drilling programs and close to 10 years of sidetrack inventory.
In addition, there are two exploratory prospects to the west of the field that we may drill at some point and if either of those were successful that would add to the future drilling inventory. So, I guess in summary we see around a decade of remaining development inventory in Australia.
In terms of the A&D market in Australia, we do have our eye on that. As you stated, there are potentially some opportunities that are coming along. What we’re starting to see in the acquisition market is that it seems to be a well supplied and buyer-friendly acquisition market. It’s providing us with a number of opportunities at, we believe, pretty attractive prices that will help supplement our organic growth.
With the planned ramp up of Corrib next year, where we’ve got lower capital requirements and material free cash flow, coupled with the company’s strong cost of capital and clean balance sheet, we believe we are very well positioned for future accretive acquisitions.
Pavan Hoskote - Goldman Sachs
And then, looking ahead into 2015 in Canada, how should we expect you to allocate capital? You obviously have two assets, the Cardium and Mannville, where we are already seeing very strong execution, but then you also have two new assets that could compete for capital between the assets that you recently acquired and the Duvernay shale. Should we expect a step-up in CapEx in Canada going forward?
We haven’t set the 2015 capital budget yet. We’re working on that now and we’ll present it to our Board in the fall, but I think I could safely say that as the company grows, you will see probably an in line increase in capital spending in all of the non-Corrib units in aggregate. The allocation between the business units may vary a little bit.
What it means for Canada given the really good results that we’ve had so far, is that I think you will see an overall increase in the level of spending. You‘ll see pretty strong growth rates in our production and cash flows from Canada.
With respect to the four programs that you mentioned, we’re actually quite optimistic about all of them. You’ll see significant spending in the Cardium, I don’t know if it will be as high as it has been in the previous years, but nonetheless sufficient to maintain quite strong productivity and depending on how we decide to allocate the capital potential for additional growth in that program, you will see more capital going into Mannville and significant growth in the production from that program.
We will have a meaningful level of capital spending in southeast Saskatchewan. Just like in the Drayton Valley area, we’ve got multiple elevations to drill dedicated horizontal wells there that use the same surface infrastructure, they are good targets, and we will grow the production and cash flow from that asset with a moderate level of capital spending going in there.
With respect to the Duvernay, I would not anticipate a large program in 2015. We’re not particularly driven by expiries. We have very few licenses that expire in 2015 that need to be validated. So we’ll have a measured program, I imagine we will have some Duvernay spending, but since we are not driven by expiries nor are we driven by a need to provide production growth out of that particular asset given the number of sources worldwide that we have to provide production growth, I would expect a moderate level of spending. I don’t know exactly what that would be.
It could be comparable to the well counts that we have this year or perhaps it could be a little bit greater just depending on how we do on our initial wells and how rapidly we want to pursue the delineation and development of that play.
I would also point out that, as Corrib comes on, mid-2015, we do expect that the need for capital spending there is going to essentially be eliminated and so we do have that advantage in our capital profile going from 2014 to 2015 with partial year Corrib spending, and then probably I would expect quite low spending, if any, in 2016 on Corrib.
(Operator Instructions) And our next question comes from the line of Travis Wood from TD Securities. Your line is open.
Travis Wood - TD Securities
Quick question on the Duvernay, you mentioned you ran into some drilling issues through the two wells. But can you share any details around the technical aspects that you’ve found over the last three or four months from the Duvernay progress so far?
Travis, I think we’ve learned a great deal about drilling in the Duvernay. We are in the middle area between K Bob and Williston Green where there hasn’t been a huge amount of activity historically although it does look like it’s picking up for the industry overall in this middle area in Edson, Drayton Valley area.
I guess from a technical standpoint specifically on the drilling, I think from the first two wells, the well in Drayton Valley and the well in Edson that in the future, we know how to handle some of these thin intervals that they turn out to be a bit clayer -- clayier and therefore presenting some addition problems with hole stability and I think we know the right mud weight and mud program to use to control those.
I wouldn’t expect to have to re-drill in the future, so I think our future Duvernay wells are going to have a significantly lower drilling cost than we saw in these wells. I think we’ve learned a great deal about the completions looking at this whole range of industry activity from K Bob through Williston Green and this is one reason that we waited so long to make our first Duvernay efforts after putting together that land base beginning in 2011.
As I mentioned on the previous question, we weren’t driven by expiries, we’re not particularly driven by a need to produce production growth out of this specific play, and it gave us a luxury of being able to move down that industry learning curve in completions. Completions are the critical part of the - really the critical part of the well.
They determine the entire productivity that we’re going to have, it’s the biggest part of the cost as well, and of course, it being a relative expensive play, we were very fortunate to be able to kind of test the play I guess, test the completion techniques using the rest of the industry’s experience and therefore capital and I do think we’ve learned a lot about the completions.
I think we’re quite ready to complete these wells and we’re certainly hoping that we have a pretty good effort on the initial couple of wells that we’ve drilled with respect to the completions and all that said, I would expect some further completion improvement even after these first couple of wells because every area in the Duvernay is going to have its specific completion needs.
Travis Wood - TD Securities
And do you guys happen to have the next several targets already identified, or are you just continuing to focus on the two that you're in the process of completing now?
In terms of identifying the next couple of drilling targets, we are thinking ahead -- looking at our land position and where we want to get additional data points about productivity, so we have a number of choices given that it’s such a big land base, but for the moment we’re, as you say, we are focused on making sure that we hit relatively high productivity completions out of these first 2 gross, 1.35 net wells that we’ve drilled.
(Operator Instructions) We have no further questions in queue; I'll turn the call back over to our presenters.
Thank you, operator, and thank you to all the participants for participating in our conference call today.
And ladies and gentlemen, this does conclude today’s conference call, you may now disconnect.
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