Pengrowth Energy's (PGH) CEO Derek Evans on Q2 2014 Results - Earnings Call Transcript

| About: Pengrowth Energy (PGH)

Pengrowth Energy Corporation (NYSE:PGH)

Q2 2014 Earnings Conference Call

August 8, 2014, 05:30 PM ET

Executives

Derek Evans - President and Chief Executive Officer

Analysts

Mark Friesen - RBC Capital Markets

Chris Cox - Raymond James

Dan Healing - The Calgary Herald

Gordon Tait - BMO Capital Markets

Operator

Good morning, ladies and gentlemen. Welcome to the Pengrowth Energy Corporation's 2014 Second 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, Anthony, and good afternoon, ladies and gentlemen. I'm Derek Evans, President and CEO of Pengrowth. Joining me today on the call are Marlon McDougall, our Chief Operating Officer; Chris Webster, our Chief Financial Officer; and Bob Rosine, our Executive Vice President of Business Development.

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.

I'll review Pengrowth's second quarter 2014 results, but first I want to remind shareholders about Pengrowth's strategy and our execution of that strategy. We continue to make significant progress on our journey of transforming Pengrowth into a sustainable low-decline, dividend-paying, higher cash flowing energy producer with excellent progress on our Lindbergh and Cardium projects.

Construction on the first commercial 12,500 barrel a day facility at our Lindbergh project is nearly complete, and we look forward to commissioning and first steam in the fourth quarter. The Lindbergh pilot performance continues to exceed expectations, and the successful completion of the Lindbergh commercial project is expected to generate a significant increase in production and cash flow starting in 2015.

In preparation for the anticipated Lindbergh production growth, Pengrowth has entered into a transportation agreement with Husky Energy for delivery of production from the initial commercial phase of Lindbergh to Hardisty, Alberta, with options to nominate future volumes as Lindbergh expands. Pengrowth will retain maximum flexibility with regards to transportation options at Lindbergh by utilizing both rail and pipeline to move production to market and maximize netbacks.

During the quarter, Pengrowth announced an update on the bitumen reserves and contingent resources for its Lindbergh project. The update resulted in an increase of 19.6 million barrels of proved reserves and an increase of 87.4 million barrels of proved plus probable bitumen reserves. Total proved and proved plus probable bitumen reserves at Lindbergh were 101 million barrels and 230 million barrels respectively as at May 31, 2014.

Before impact, net present value at a 10% discount rate, 2P reserve value at May 31, 2014, Lindbergh update more than doubled to $4.20 a share compared to the 2013 year-end estimate of $1.95 per share. Pengrowth is one of the most active drillers in the Cardium in Western Canada. Our Cardium development program continues to demonstrate industry leading cost and well results. Drilling and completion times continue to be reduced and frac stages increased, resulting in lower cost, better performance, all that is generating improved capital efficiencies of approximately $28,000 per flowing barrel. Pad drilling has decreased capital costs on a per well basis as well as allowing us to drill through break up, which will support strong volume performance through year-end.

We realize that Pengrowth shareholders value receiving a dividend and remain committed to maintaining the dividend at the current level of $0.04 per share per month, a level that has been maintained since July of 2012.

I won't rehash our quarterly report, which is very thorough, but I did want to make a couple of observations about our most recent financial results. Pengrowth's second quarter production remained robust even after chasing into accounts the impact of previously announced and planned maintenance turnaround activity in the quarter. Average daily production in the quarter was 73,823 BOE per day, which was a 2% decrease compared to the first quarter production of 75,105 BOE per day. The planned maintenance and turnaround activities during the quarter, which are now completed, reduced production by approximately 1,500 BOEs per day compared to the first quarter. Pengrowth is on track to meet its 2014 full year guidance of 71,000 BOEs a day to 73,000 BOE a day.

Second quarter 2014 funds flow from operations was approximately $121 million or $0.23 per share, which represents an $18 million or 13% decrease from the first quarter 2014 funds flow of $139 million or $0.27 per share. A sharp pullback in natural gas prices coupled with higher operating expenses associated with the planned turnaround activity in the quarter were the primary drivers for the lower funds flow.

Second quarter 2014 operating expenses of $114.5 million or $17.05 per BOE increased by $10.5 million or 10% compared to the first quarter of 2014 operating expense of $104 million or $15.39 a BOE. Higher maintenance costs associated with planned and forecast turnaround activity in the quarter were the primary reasons behind the higher expenses. Historically, turnaround and maintenance activities are carried over in the second quarter and we tend to see higher operating cost as a result. Despite the higher cost in the quarter, full year 2014 operating expenses are expected to remain on track with our previous guidance of between $15.20 and $15.80 per BOE.

Lindbergh pilot continues to be very strong with production from two well pairs averaging 1,640 barrels per day of bitumen in the second quarter with the production in June averaging 1,730 barrels per day. As expected, the Instantaneous Steam Oil Ratio has risen as the well pairs commence their natural decline, but remains robust, averaging 2.4 times during the quarter. Cumulative production from the pilot has now exceeded 1.3 million barrels. After two years of higher than expected production rates and reserves recovered to date, the pilot continues to exceed our expectations.

Civil, mechanical, electrical and building construction continued for the first 12,500 barrel a day commercial phase and is progressing as planned. Central processing, surface pipeline and well-pad facility assembly is ongoing. All major equipment has been set in place. And central processing facility structures are nearing completion. Over 90% of budgeted capital for Lindbergh's first commercial phase has been spent or committed as of July 31, 2014. The project remains on track for commissioning and first steam in the fourth quarter. Pengrowth has completed the planned 2014 drilling program.

In preparation for the anticipated Lindbergh production growth, Pengrowth has entered into a 10-year take-or-pay transportation agreement with Husky for the delivery of production from the initial commercial phase of Lindbergh to Hardisty, Alberta, with options to nominate future volumes as Lindbergh production expands. Access to the pipeline is anticipated to allow Pengrowth to maximize pricing for its Lindbergh bitumen, which is expected to receive Western Canadian Select prices. Pengrowth will retain maximum flexibility in regards to transportation or option to add Lindbergh and will utilize both rail and pipelines to move production in order to offset seasonality price effects and maximize netbacks.

Cash G&A expense for the second quarter were $19.4 million, approximately 16% decrease from the first quarter expenses of $23.1 million. On a per BOE basis, second quarter of 2014 cash G&A expenses were $2.89 per BOE, a decrease of $0.53 per BOE compared to the first quarter of 2014. Pengrowth is revising its full year 2014 cash G&A expense guidance from $2.70 to $2.90 per BOE to a range of $3.15 to $3.25 per BOE. The revised guidance reflects higher professional and personnel costs than originally forecast.

In early 2013 at our Annual Investor Day, we outlined our corporate strategy for transforming Pengrowth into a more sustainable energy producer that generates strong cash flow and enjoys the lower decline rates. As we head into the second half of 2014, that transition is one step closer. We are nearing completion of construction at our Lindbergh thermal project with commissioning and first steam expected in the fourth quarter. We continue to optimize the performance of our non-thermal program with Pengrowth being one of the most active Cardium drillers with industry leading well results and cost. We remain on sound financial footing with $133 million of cash on hand and an undrawn $1 billion of credit facility.

This is an exciting time for Pengrowth. We look forward to updating you on the story in the coming months as we head towards the finishing line on the initial commercial phase of Lindbergh.

We'd now be happy to answer any questions you may have. Anthony, do we have any questions in the queue.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question is from Mark Friesen from RBC Capital Markets.

Mark Friesen - RBC Capital Markets

Derek, maybe you could just clarify the changing guidance on the G&A for a second? It was down in the quarter due to reduced personnel expenses, but in the guidance was increased due to increased personnel cost. So I wondered if you could clarify that.

Derek Evans

It's a bit of two things. That's what we were trying to explain there. The difference between the first quarter and the second quarter has a lot to do with bonuses, year-end bonuses being accrued in the first quarter, and that cost is not showing up in the second quarter. The second part of your question why are we increase our guidance, we are increasing our guidance as we're adding more technical folks back into our integrity groups, our measurements and our environmental and safety groups over the last two quarters. And those people are going to become a permanent picture inside the organization. So we had not moved to replacing people that had left last year and we're now catching up.

Mark Friesen - RBC Capital Markets

And that wasn't necessarily expected at the beginning of the year?

Derek Evans

No.

Mark Friesen - RBC Capital Markets

At Lindbergh, you mentioned that you had completed drilling, I guess, 18 horizontal wells this past quarter. Any surprises there or anything we should know with respect to how the well placement went or the reservoir penetration that you achieved for the well?

Derek Evans

No. I think it's fair to say that everything went as well as we expected. We chatted a bit today about whether we should expect to see some lower costs as a result of some of the efficiencies that we gained as we worked through that progress. We're just in the final accounting of that now. But a very successful drilling campaign.

Mark Friesen - RBC Capital Markets

And I guess finally just for me with respect to the marketing agreement that you mentioned with Husky, that gets the product to Hardisty. You mentioned plans of using pipe or rail leaving Hardisty. Do you have any color that you could provide in terms of maybe contracts you've entered from that point for either pipe or rail or how you see that going in the future?

Derek Evans

It's a transportation agreement. I'll get killed by my marketing department if I refer to it as a marketing agreement. So what we have in place is an agreement with Husky that provides us with a great deal of flexibility to take-or-pay contract. So we can still truck to rail from our existing facility and camp for some time. So we haven't dedicated all of the volumes at this juncture to this Husky agreement. So there's some flexibility in terms of how much product could move to Husky, say, for Q2 and Q3. And we may feel more comfortable or believe that we could achieve higher netbacks by moving it to rail in Q4 and Q1 of the year.

Mark Friesen - RBC Capital Markets

And so any details in terms of how much the take-or-pay contract covers volumetrically or what your plans are moving it out of Hardisty on the other hand of this contract?

Derek Evans

Our marketing group will sell it into the WCS type of arena. There's a number of things that I think are going to happen as we drive forward. One of the reasons we wanted to get this product to Hardisty was because you have the ability to, we believe, at some point in time transload on to rail. There is a lot of transload facility being generated there. So that ultimately in the long term gives flexibility to either choose compounded pipeline or to rail, again based on where we see differentials. But in the short term, the agreement that we have provides us with lots of flexibility from a take-or-pay perspective to either send it everything or part of that truck, the remainder to rail ourselves.

Operator

The next question is from Chris Cox from Raymond James.

Chris Cox - Raymond James

Was any of the recent cost provision at Lindbergh accounting for the costs associated with this pipeline to connect in with Husky system?

Derek Evans

No. That cost is not part of the phase one cost estimate. Remember, Chris, that we take extensive trucking facilities that we've put in place and extra tankage. So those were some of the increased costs that we had incurred on phase one to ensure that we had the flexibility to rail our product or to truck to transload and rail our product throughout. So the pipeline cost was not in our phase one cost, primarily because we didn't have an agreement in place.

Operator

Our next question is from Dan Healing from The Calgary Herald.

Dan Healing - The Calgary Herald

Was the plan to use the Alberta gathering system of Husky from the start and how much is that part of the capital cost amount in terms of the 15-kilometer pipeline?

Derek Evans

It was actually four pipelines that run by Lindbergh in relatively close proximity. So Pengrowth spent a considerable amount of time trying to understand what the best option for our higher-quality crude would be. So our crude has a higher-gravity than most of the oilsands crude. Crude is above 11-degree API. It has a very low nickel and vanadium content and a very low diluent content. So we went looking for a pipeline provider that would provide us with the best opportunities to move that crude in a most cost effective manner that we could.

So we did not know which of those four we were going to go to. And as a result, that cost was not included in our phase one. The actual cost of, I think it's about 15-kilometer pipeline, is somewhere in the neighborhood of $20 million. And that would include not only a drillbit line, but also a diluent line, delivering diluent to our facility at Lindbergh.

Dan Healing - The Calgary Herald

And how much diluent do you need on a percentage basis for the drillbit?

Derek Evans

It depends on how we decide to move it. So at the current time, our diluent content is somewhere between 10% and 12%. Again, that higher API gravity requires us to use less diluent. And that's the required amount of diluent we need to help us break the emulsion and separate the oil from the water, treating process. The temperature and the viscosity of the product is then sufficient to allow us to truck and transload to rail. So at the current time, we're using somewhere between 10% and 12% diluent.

Dan Healing - The Calgary Herald

And just to make sure I understand, with this transportation agreement, if you do decide to send shipments by rail, would they then ship out from Hardisty?

Derek Evans

No, ultimately they can ship out from Hardisty from the Husky pipeline, because the Husky pipeline will take it to Hardisty and then we could transload that from there. I think in the short-term way, you're more likely to see that's trucking it to a number of the transload stations that are in quite close proximity to us around our Lindbergh facility to transload and using those transload stations to load railcars.

Operator

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

Gordon Tait - BMO Capital Markets

I remember you saying that you thought it was quite important to heat the reservoir quite slowly before you start first production at Lindbergh, so that there were no steam break-through. So I guess with that in mind, are you still looking at sort of around 12,000 barrel a day, 13,000 barrel a day average production for next year?

Derek Evans

It's in vision that we will circulate steam through the injector and the producer on all of these well pairs. We're up to three months. And we will see a situation where as you're circulating, you actually make some oil production. So on our pilot wells, at the end of the three months, we were actually making about 250 barrels of bitumen per well pair just on circulation before we started into full (inaudible), which is when you actually start injecting steam as opposed to circulating steam.

Gordon Tait - BMO Capital Markets

So it'll be sort of a slow ramp-up next year?

Derek Evans

We'll be getting first steam into the well pairs in the fourth quarter. So as you roll through the 2014, you're going to see production go from about a minimum of 2,500 barrels a day to something in the neighborhood of 16,000 barrels a day, with an average for the year at 12,500 barrels a day.

Operator

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

Derek Evans

Thank you, Anthony. And ladies and gentlemen, thank you for joining us this afternoon for the second quarter conference call. As you can tell, strong quarter and we're very excited about the fact that we're getting close to the finish line and commissioning of our Lindbergh. We look forward to updating you on our progress in that regard, not only on the commissioning side, but when we've got first steam as well. So it's exciting here for the information to come. And again, thank you for your interest in Pengrowth.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!