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Executives

John Wright – President and CEO

Peter Scott – SVP and CFO

Rene LaPrade – SVP, Operations

Analysts

Brian Kristjansen – Canaccord

Cristina Lopez – Macquarie

Travis Wood – TD Securities

Bob Carlson – Janney Montgomery Scott

Petrobakken Energy Ltd. (PBKEF.PK) Q2 2012 Earnings Call August 9, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen, and thank you for standing by. My name is Jennifer and I will be your conference operator today. At this time, I would like to welcome everyone to the PetroBakken’s Second Quarter Results Conference Call. All lines are currently on mute to prevent any background noise.

I would like to remind you that this conference call is being recorded today and is also being webcast on PetroBakken’s website. After the speakers’ remarks, there will be a question-and-answer session. If you have dialed into the call and would like to ask a question, you will have an opportunity at that time. We will also be taking questions for those listening to the webcast. To submit your question, simply click on the link entitled “ask a question” at any time during this conference call.

I would now like to turn the call over to Mr. John Wright, President and Chief Executive Officer. Please go ahead, Mr. Wright.

John Wright

Thank you very much, Jennifer, and good morning everyone, and welcome again to our conference call. I’m joined today Peter Scott, our Senior Vice President and Chief Financial Officer; Rene LaPrade, our Senior Vice President-Operations; and Tim Sweeney, our General Counsel.

This morning call’s agenda will consist of a discussion of PetroBakken’s second quarter financial and operating highlights and at the conclusion we’ll open the call up for a Q&A session.

We would like to caution everyone that information provided during this call constitutes forward-looking information. Specifically, forward-looking statements will be made relating to financial results, results from operations, and the timing of certain projects. Actual results achieved during the forecast period may vary as a result of numerous risks, uncertainties and other factors.

I’d like to begin the call by turning it over to Peter Scott for a discussion of our second quarter financial results.

Peter Scott

Thanks, John, and good morning, everybody. Second quarter production of 38,750 barrels of oil equivalent per day grew 10% over the same quarter last year, even after including the full impact of dispositions we completed late into the first quarter of this year.

Compared to the first quarter of 2012, production has declined 8,000 BOEs per day, but remember, that includes the effect of 4,100 BOEs a day of dispositions, moderated activity levels and 2,300 BOEs a day of higher than normal downtime associated with break-up, and of course, natural production declines.

During the second quarter, we achieved an operating netback of $45.08 per BOE, which is lower than our average for the past six quarters, primarily due to lower price realizations, as our differential to WTI continued to be volatile and wider than historical norms. To give you an idea of the impact, our realized oil and liquids prices decreased 18% in the second quarter compared to a year ago, while WTI in Canadian dollar terms decreased only 5% during the same period.

Production expenses for the quarter improved on both an absolute and per BOE basis compared to a year ago, driven by our higher – overall higher production levels in the quarter. Compared to the first quarter of 2012, our absolute production expenses did decrease 12%, but were up 6% on a per BOE basis due to typical seasonality.

Similar to last year, production costs per BOE are expected to decrease through the balance of 2012, as we restore and grow production and complete infrastructure, which will reduce our oil trucking activities.

Funds from operations for the quarter were $121 million, or $0.65 per weighted average share outstanding. The year-over-year decrease is largely due to wider oil differentials lowering our operating netback.

Capital expenditures were in line with the second quarter of 2011 and is typical for our activity profile. Approximately, two-thirds of our capital program including 75% of our drilling remains to be executed in the second half of the year.

We have maintained our dividend rate throughout 2012 of $0.08 per share per month. Since the start of 2012, we’ve had a DRIP available to investors with a current participation rate of 63%, including Petrobank participating a 100% of the shares that they own. On a cash basis, our dividend represents of 14% of funds flow from operations for the first half of 2012.

At the end of the quarter, we had approximately $300 million of debt drawn on our credit facility that has a lending capacity of $1.4 billion. So we currently have $1.1 billion of available credit, and our diversified debt capital structure with a layered maturity profile complements the long-term nature of our light oil focused assets.

I’ll now turn the call over to Rene LaPrade, who will provide an update on our operations.

Rene LaPrade

Thanks Peter. As Peter mentioned, the second quarter always presents operational challenges due to spring weather conditions. This caused us to have limited access to well leases that result in little or no drilling and production interruptions. However, by the end of the quarter, we began ramping up activity and have since accumulated a large inventory of wells waiting to be brought on to production.

In the Bakken, second quarter production averaged 14,800 BOEs a day, impacted by both spring break-up conditions and non-core dispositions we completed at the end of the first quarter. During the quarter, we drilled six net wells in the Bakken business unit and brought four wells on production. Currently, we have seven drilling rigs operating in this business unit and have drilled 12 net wells since quarter-end, with 11 net wells waiting be completed or brought on production. This is consistent with what we expect this time of the year.

In the Cardium business unit, we continue to execute and grow production. Production in the second quarter was 15,900 BOEs per day. We brought 11 wells on production during the second quarter and since the end of the quarter, we have drilled another 10 net wells and brought 2 net wells on production, leaving a current inventory of 13 net wells waiting to be completed or brought on production. We currently have nine drilling rigs operating in the Cardium.

Our southeast Saskatchewan Conventional business unit provides a light oil-rich production base. Production averaged 5,100 BOEs per day in the second quarter of 2012. One drilling rig is currently operating in this area, and new wells drilled combined with further additions to infrastructure are expected to grow production through the balance of the year.

In our Alberta/BC business unit, we have over 190 net sections of potential new resource plays. Activity was minimal during the second quarter, but we plan to drill four wells in the second half of the year to further evaluate these opportunities.

Production for the company in July 2012 was 38,250 BOEs a day based on field estimates. This did not materially increase from June as activity was ramped up through the month. However, we currently have 27 net wells waiting to be completed or brought on production and 15 drilling rigs operating in our core Bakken and Cardium areas. With approximately 75% of our wells yet to be drilled in 2012, we expect this momentum to continue through to the end of the year.

I’ll now pass the call over to John Wright for a few words on the outlook of the activities at PetroBakken.

John Wright

Thanks, Rene. I’d like to thank everyone that joined on the call today. I hope your primary takeaway is that we’re well poised for the second half of the year. As a company, the third and fourth quarter is when the most activity always takes place and the greatest amount of growth is realized. Look for us to repeat our growth trajectory from last year as we get busy with our multi-rig programs in Alberta and Saskatchewan.

For the rest of 2012, we’ll continue executing on this expanded capital program and delivering growth in our exit production rates, which we expect to be between 52,000 and 56,000 BOE per day, resulting from our capital plan spending of $875 million.

The 2012 capital plan will build on our track record and is focused primarily on continued exploitation of our southeast Saskatchewan, Bakken, Conventional Mississippian assets, the development of our Cardium light oil properties in Central Alberta and a little bit focused on the continued exploration and development of our new Alberta properties, leveraging our significant undeveloped land base into new resource opportunities.

Finally, at the company, we’re very excited to announce that Mr. George Gervais has joined our executive leadership team as our Vice President of Exploitation. George brings a tremendous depth of industry experience and knowledge to our team, and we look forward to the value he will contribute to our business plan.

Thanks for joining us, again. And we welcome any questions you might have at this time. Jennifer, I’ll turn the call back to you.

Question-and-Answer Session

Operator

Thank you very much. (Operator Instructions) Our first question is from the line of Brian Kristjansen from Canaccord. Please go ahead with your question.

Brian Kristjansen – Canaccord

Thanks. Good morning, guys. Just with respect to repeating production growth in the second half of 2011 this year, can you quantify how much is behind pipe of 38,250 in July and if we can expect sort of that 4,000 – close to 4,000 barrel increase quarter-over-quarter?

John Wright

Yeah, I’m not sure I can exactly quantify what’s behind pipe right now, but I think you would expect us to show similar growth, when we get going here as we did last year, we were bumping our production on a monthly basis by 3,000 barrels a day through some of the more active periods. If you look at some of our historical numbers and I know you have a pretty good record there, Brian, you’ll see that the growth wedge really takes off here as those wells start coming on. I don’t think we – other than about 1,000 barrels a day that’s coming on just from normal shut-in productions through the end of June here, we haven’t seen that burst of growth hitting us yet.

Brian Kristjansen – Canaccord

Okay. With respect to the Horn River sections that expired, what – of your remaining lands, what’s your remaining tenure on that or as well as on your Monias sections, any expiry there?

John Wright

I don’t think there is any expiries this year and I don’t actually think there is any next year. I think we’ve always said that we’re holding most of those lands for pure option value. And I guess hopeful, fingers crossed, moment the gas prices would spike up to a point where someone would find them attractive. They have never made our A list of investment opportunities. I think I would guide everyone to realize that if we have continued low gas prices, we will certainly not be actively pursuing any opportunities to retain that land position as we go forward.

Brian Kristjansen – Canaccord

Okay, great. And then just lastly, any update on your EOR efforts?

Rene LaPrade

Yes, it’s Rene LaPrade here. Yes. We have two pilots that are running presently, and these aren’t experiments. They’re actual full pilots that we’ve had injection into, gas injection. One is a parallel gas injection, an infill well that we have on gas injection. That started actually in June of this year. We’re starting to see some encouraging results with that pilot and have the existing toe injection gas pilot where we’re actually putting about 1 million a day of gas into it and we’re also seeing some very encouraging results. We hope to have, I guess, a better understanding of sort of the benefits to EOR on those particular projects hopefully by year-end.

Brian Kristjansen – Canaccord

Thanks, Rene. Thanks guys.

Operator

Thank you. (Operator Instructions) Our next question is from the line of Cristina Lopez from Macquarie. Please go ahead with your question.

Cristina Lopez – Macquarie

Hi, gentlemen. Just a really quick question on how you see the production profile developing over the next couple of years, is the – sort of the big build up at the back half of the year going to be similar in 2013 as well? Is that how you’re modeling the CapEx program sort of on a multi-year basis?

John Wright

Yeah. The nature of our assets, Cristina – by the way, good morning, Cristina, sorry.

Cristina Lopez – Macquarie

Good morning.

John Wright

The nature of our assets are such that we legitimately have to lay down the rigs for a pretty significant period of time over break-up. And what’s happening as we build our base of material production is the base decline of course is going down on our production. We’re also getting more and more facilities built and as we roll out with sort of full drilling programs in the Cardium where we’re both extending the reach of the program and infill drilling, we also get the advantage of having considerably higher levels of our production tied in through owned facilities, which means we don’t have break up issues.

So what you would expect is growth through the third and fourth quarters of 2012 I’ll go over and name a little bit here and suggest we probably won’t see as much shut-in production or as much as a production decline in the second quarter of 2013, simply because the facility investments we’ll be making through the end of the first quarter in 2013 and then the same growth profile out of the end of 2013 into 2014. Again, the amount of sustaining capital we need to put into some of our older assets goes down every year, so the base decline actually starts to attenuate. And we’ve got a bit of machine here where we just keep adding pretty chunky bits of production every year through reinvesting a portion of our cash flow.

Cristina Lopez – Macquarie

Perfect. Thanks guys.

John Wright

Thanks, Cristina.

Operator

Thank you. I’m showing that there are no further audio questions at this time.

Rene LaPrade

Okay, we’ll turn things over to some questions from the webcast right now. Our first question comes from Elizabeth Drake which I’ll direct to Peter Scott. Are the earnings estimates shown on Yahoo! Finance correct? Will you be showing losses?

Peter Scott

Thanks for the question. Sorry, I haven’t seen those estimates on Yahoo! Finance, but just to recap, we did show a loss in the second quarter of $21 million and that is primarily driven by the $61 million impairment that we took up on Northeast B.C. on our gas assets that we just discussed. But for the six months, for the first half including that impairment we actually did show net income of $17 million and I would expect us to show profits through the balance of the year.

Rene LaPrade

Thanks Peter. Our next question comes from Jody Chudley. Being experts in unconventional oil production, I’d be interested in your opinion on how much North American oil production will increase over the next several years?

John Wright

Well, I will take that one Jody. This is John Wright here. I think it’s far beyond our crystal ball’s ability to gauge how much growth we’re going to see. I will say there will be significant growth in light oil beyond the proposed growth from all the oil sands operations that are ramping up right now.

I would say generally in our industry, just as an overall comment, North America is kind of the sweet spot for unconventional oil development on a global basis. And that’s a positive coalition of existing infrastructure, a significant base of technology in the service industries and a large source of capital to go at and develop some of these new pools. So there will be a lot of growth here. And North America, on a global basis, will lead the unconventional oil growth curve significantly ahead of just about any other part of the global oil industry probably until the end of the decade.

Rene LaPrade

Thanks John. Those were all the questions from the webcast, I believe we have some more on the phone line. So I’ll turn it back to Jennifer.

Operator

Thank you. Our next question is from the line of Travis Wood from TD Securities. Please go ahead.

Travis Wood – TD Securities

Yeah. Good morning, guys. Just a quick question on rail opportunities out of southeast Saskatchewan and how you’re viewing that given the volatile differentials and if you’re looking at any short-term investment into those types of opportunities?

Peter Scott

Thanks Travis. It’s Peter Scott, here. We have looked a little bit at the rail opportunities. Quite frankly, what we see is that the arbitrage between the rail and what we can get by putting it down the pipe is – gets minimized pretty quickly. We have done some railing. And currently, what we’re seeing on differentials actually, they’re very tight to WTI, I think, in the low almost $2 range. So there is still the opportunity between WTI and Brent. But we don’t see that the arbitrage will be long enough to really make the investment into rail infrastructure payoff from our perspective.

Travis Wood – TD Securities

Thank you.

Operator

Thank you. Our next question is from the line of Robert Carlson from Janney Montgomery Scott. Please go ahead.

Bob Carlson – Janney Montgomery Scott

Hi, good morning guys. Just a real quick question. Within the company, what are you guys seeing as far as natural gas goes, I mean, down here in Al, we’ve got it over $3, we’ve got more and more talk about Westport building their gas conversion engines, my feeling is somewhere here, this is a sleeping giant waiting to emerge, and I’m just wondering what’s internally your feelings are?

John Wright

Okay. Well, thanks, Robert. I – this is John Wright here. And I’ll take a stab at the question. First of all, I’ll practice it by saying that I spent the first 30 years of my career in this industry being a gas bull and always looking for the next quarter to have higher gas prices. And I think our thinking has perhaps changed a little bit. Our perspective on the Western Canadian sedimentary basin, in particular, but North American general, is this is a very gassy part of the world. If you drill wells here, predominantly you’re going to encounter gas. With the advent of new technology, the things that we’re doing with horizontal wells, in multi stage fracs and we just as an industry keep getting better and better at it, there’s going to be more and more gas available and more and more gas that becomes marginally economic even at current prices.

From a gas user’s perspective, I think this is a terrific fact; from a gas producer’s perspective maybe not so terrific because we end up being our own worst enemies recognizing that we’ll continually be able to be more efficient at getting gas out of the ground. There is not going to be in the short-term a significant and by significant I mean a doubling gas prices that we get it up to the point where a lot of the – more distil opportunities become competitively economic with some of the great light oil opportunities that are out there. So I think we’re going to be a washing gas for a long time. I think it will be a great commodity to be a buyer of, I’m not sure it’s as great commodity to be a seller of.

Bob Carlson – Janney Montgomery Scott

Thank you.

John Wright

Than you.

Operator

Thank you. I’m showing that there are no further audio questions.

John Wright

Perfect. Well, ladies and gentlemen – Jennifer, I’m going to wind it up because I think we’ve always looked at our second quarter as being a moment of anticipation for the third and fourth quarter results that are to come.

I’d like to thank everyone for joining us today and we certainly look forward to updating all of our shareholders on our progress as we roll out that multi-rig drilling program in the Cardium and the Bakken with 15 to 18 rigs active through most of the rest of this year. Thanks again.

Operator

Thank you. Ladies and gentlemen, that does conclude the conference call for today. We thank you all for your participation and we ask that you please disconnect your lines. Thank you everyone and have a good day.

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