Harvest Natural Resources Inc. (NYSE:HNR)
Q2 2008 Earnings Call
August 7, 2008 11:00 am ET
James Edmiston - President and Chief Executive Officer
Stephen Haynes - Chief Financial Officer, Vice President, Treasurer
Keith Head - Vice President and General Counsel
Bryan Frank - Cumberland Associates
Subash Chandra - Jefferies & Co.
Welcome to the Harvest Natural Resources second quarter earnings release call. (Operator Instructions) I would like to turn the call over to Mr. Keith Head, Harvest Vice President and General Counsel.
Good morning and welcome to Harvest Natural Resources 2008 second quarter results conference call. This morning our press release was broadcast in the company’s fax and email list. If you would like to be on one of those lists or you did not receive yours due to a technical difficulty please call our office at 281-899-5700. In a few hours a reply of today’s call will be available in the Investor Relations portion of our website www.harvestnr.com. Additionally a telephonic reply will be available this afternoon by dialing 402-220-2661.
This conference call will contain various forward-looking statements and information including management’s expectations regarding financial, operating and results. These statements are based on management’s beliefs as well as assumptions made by and information currently available to management.
Although the company believes that the expectations reflected in such forward-looking statements are reasonable we can give no assurance to such expectations will proved to have been correct. Actual results may differ materially from the company’s expectations due to changes in operating performance, project or drilling schedules, oil and gas prices as well as other technical, political and economic factors.
Additionally detailed information concerning a number of factors that could cause actual results to differ materially from today’s information is readily available in the company’s SEC filings under the heading Risk Factors. The SEC permits oil and gas companies to disclose their filings with the SEC only proved reserves that a company is demonstrated by actual production or conclusive formation tests to be economically and legally producible under existing economic and operating conditions.
We may use certain terms in this call such as resource potential, probable reserves, possible reserves, prospective resources and similar terms which the SECs guidelines generally prohibit us from including in our filings. Investors are urged to consider closely the discloser in our form 10K which is available from the SEC on our website. At this time I would like to turn the call over to James Edmiston, Harvest Natural Resource’s President and Chief Executive Officer.
Thank you Keith and thanks for joining us today on the call. Hopefully you’ve all had a chance to review our earnings release. I’ll make a few comments regarding our Venezuela business and our exploration portfolio and then Steve Hynes will discuss our second quarter financial results. Finally I’ll wrap up and then we’ll open up for questions.
Let’s start with Petrodelta in Venezuela. Operationally Petrodelta delivered 1.2 million barrels of oil or 13,600 barrels a day during the second quarter compared with 1.3 million barrels or 14,700 barrels per day in the same period one year ago. Oil production was up slightly over the first quarter production of 13,300 barrels per day and on target with guidance for the quarter. Sequentially production by month for the quarter was 12,200 barrels per day for April which was affected by a maintenance turnaround at the plant, 13,500 barrels per day for May and 15,100 barrels per day average for June.
During the second quarter 3.1 billion cubic feet of gas or 34 million cubic feet of gas per day was delivered compared with 3.4 billion cubic feet last year. As we said before one of the key objectives of Petrodelta’s business plan is to grow production rapidly with an early focus on development and proved reserve base.
Petrodelta currently has one work over rig which began normal well maintenance and the conversion of wells from gas lift to an electric submersible pump in November of last year. The work over maintenance program essentially arrested decline for the fields with both the first and second quarter 2008 production exceeding the fourth quarter of 2007. These conversations will continue both in the Uracoa fields and the Temblador fields over the coming months.
Petrodelta has the second work over rig under contract which is expected to begin work in the Petrodelta fields later this year. The first drilling rig was finally mobilized in the Uracoa field in April and spuded its first well UM 164 on April 21. Well UM 164 began production on May 29 with the initial rates exceeding 1,600 barrels of oil per day.
Similarly our UM 165 was placed on production at an initial rate of 1,500 barrels per day on July 3. Basically during the second quarter production reflects new production volumes for only one well, UM 164 and for only one month of the quarter. June production volumes with one new well producing for the month averaged both in excess of 15,000 barrels per day as I said before.
Preliminarily July production which includes both the 164 and 165 wells averaged about 15,800 barrels of oil per day. Current production in the field is running about 16,500 barrels per day with the latest well the UM 166 having just been completed but not yet accounted for in those numbers.
From a production stand point the performance of the wells drilled to date is very encouraging and the continued strong performance of the new wells is key to the production builds in Petrodelta. Also important is the drilling performance in terms of drilling and completion days per well; as that determines the number of wells a rig can be expected to drill in a given period of time.
As expected the drilling program began with the drilling of complete times well in excess of what we considered normal over the long term, much as was the case when the drilling program began in 2004. The first two wells took 36 and 32 days respectively to drill and complete; however, the third well, our first multilateral well took only 25 days to drill and complete.
So clearly the Petrodelta drillers are moving up the line curve and it shows market improvement in drilling efficiency in very short time. That type of performance improvement is to be commended and is a very encouraging parameter for the operations outlook of the new company has a whole.
Over the long term we expect the well to take 22 to 24 days to drill and complete. Petrodelta is committed to contract a second drilling rate which is expected to begin drilling in the third quarter. The rig is now in Mongering and is being assembled and tested and we expect the rig to be in the field drilling around the end of the third quarter. Petrodelta is also perusing a third drilling rig to begin drilling later this year.
In summary, from an operations view point, Petrodelta’s had a strong start. One rig has been in the field now for a bit over three months and field production has increased over 20% during that time. Drilling times are improving and both partners are eager to accelerate and expand on the success to date.
As you may noted in the end of our May press release, we received a cash dividend from Petrodelta corresponding to the period April 1, 2006, which would be the effective date of our new contract through the year end 2007, a $58 million net to Harvest. As I stated before we expect Petrodelta development program to be largely self funding and with a high initial reinvestment rate; however, we then later expect to start drilling in strong prices contributing to cash from operations.
Additional dividends during the interim period may be indicated until the capital program ramps up to full speed. Turning to the windfall profits tax, on April 15 the Venezuela government published a text of the Windfall Profit Tax and the official gazette as we told you earlier. If you read the press release you can see that we’ve gone to great lengths to provide as much detail as possible. As expected the taxes is applied as a reduction to the price per barrel we pay, when the threshold price is exceeded.
The effect of the tax on Petrodelta’s second quarter earnings was about $11 million or 30%. The net effect on Harvest was about $3.5 million. It’s important to note that second quarter results that’s been reported based on a point threshold as was originally published in the law. Subsequently that threshold was changed to the Venezuelan export basket which more closely relates to the quality of Petrodelta’s crew and will have the effect of increasing the price threshold as it applies to Petrodelta. That is a policy to change and Steve is going to take you through more detail on this point during his comments.
Let me turn now to the progress in our exploration programs. You will note that second quarter results included exploration charges of $2.3 million. We’re going at $1.4 million acre Budong PSC located onshore as West Sulawesi Indonesia is progressing. As you may recall we are going to fund 100% of the first $17 million of that program to earn our 47% interest. We’ve identified leads with prospective resources of $50 million to $100 million barrels in each of the two basements on the block.
Acquisition of the 550 kilometer seismic shoot is on going and should be complete in the fourth quarter. After completing the interpretation we expect to drill at least two wells; one in the Lariang sub-base and one in the Corana sub-base during the second half of 2009. Remaining net expenditures for 2008 are expected to be around $6.4 million.
In Gabon the Harvest operated 680,000 acre Dussafu PSC is also progressing. We are currently contracting for the reprocessing of 1,076 square kilometers of existing 3D covering the preexisting, undeveloped Gamba discoveries on the block. We also hooked two 550 kilometers in new 2D during the second half depending on permitting and vessel availability. Remaining 2008 net expenditures are expected to be around $2.8 million.
Turning to the US we’ll start with our Gulf Coast Area of Mutual Interest. As indicated in the press release we’re nearing a spud date on the Harvest Hunter #1 at 12,000 foot over pressure big spurt tests in Calcasieu Parish Louisiana. This is the first of what we hope to be main prospects generated from our Gulf Coast Ami that was announced in May. To be quite honest we’ve been ready to spud the well since June and have been waiting on a contracted rig to complete the wells that it’s currently drilling for another operator. Our current expectation is to move in a rig up the well in mid month. The well is going to take about 30 days to drill.
We also progressed our base prospects having acquired an additional 5,500 acres of leases in affect of this general “land off its lease sale” on July 1. This is another of our projects with our Gulf Cost GMI partners. We now have about 12,000 acres under lease with over 13 lease identified to date in the Myacine, Frio and Vicksburg intervals.
Our affiliate fusion is now reprocessing in the 3D survey and we expect interpretation to be complete around year end. Preliminary engineering work and permitting has began and frankly permitting will be a critically path item on this project due to it’s location and the involvement of several agencies. We hope we get export rate drilling on the project late next year.
In general I could not be more please with the way the Gulf Coast AMI team is working together; in addition to the internal spud of the Hunter well and the maturation of the base prospect the team continue to generate and evaluate other ideas and prospects. Given the progress of the team to date, I’m hopeful that their efforts will be the source of several more drilling opportunities in the near and immediate term.
As we’ve discussed previously, we’ve also entered into an agreement to complete leasing of acreage and drill an exploratory well in another US basin; that leasing program is ongoing. Harvest will be the operator and we’ll have a working interest of 50%. We’ll hope to be in a position to share more on this program with you depending on the completion of the leasing program.
Currently we project the exploratory well to spud sometime in the first or second quarter of next year. Overall we expect to invest about $12 million in the second half of this year on our currently identified US exploration programs, which includes the cost associated with the drilling of the Hunter #1. With that it’s just a shot of 10,000 on the operation side and I’m going to turn it over to Steve to discuss second quarter financial results in detail.
Good morning. Our Form 10Q that was filed this morning is available on our website at www.harvestnr.com. Net earnings for 2008 second quarter were $800,000 or $0.2 per diluted share compared with the law of $6.9 million or $0.18 per share for the 2007 quarter. Our second quarter results include $2.9 million of exploration expense, primarily for the acquisition of seismic.
Petrodelta’s second quarter earnings prepared under national financial accounting standards were $36.1 billion or $11.6 million net to our 33% interest. After adjustments we conformed with the US joint specific accounting principals, our 32% share, Petrodelta’s earnings was $9.1 million. Petrodelta results of operation are summarized in that mix of our Form 10Q and are also attached to our press release. The GAAP adjustment that was made to adjust the Petrodelta net income to Harvest share is $3.2 million.
I would like to go through Petrodelta’s income statement and some details provide more clarity around the operating and international results reported by Petrodelta under IFRF. Production and sales for the second quarter were 1.2 million barrels of oil and 3.1 billion cubic feet of natural gas. On a 1.7 million a barrel of oil equivalent, Petrodelta pays a 30% royalty in kind to the Venezuela government and 3.33% special royalty tax in cash which is primarily for the benefit of the municipalities.
After the 3.33% royalties, sales net to Petrodelta was 1.4 barrels of oil equivalent. The average price relieved for oil leverage was $83.12; the average price is determined by the market prices for the quality of oil produced Petrodelta and the impact of the laws of the special contribution, to the extraordinary prices at the Hydrocarbon International market by the government.
As you know on April 15, 2008, the Venezuelan government published in their official gazette the Windfall Profits Tax. The Windfall Profits Tax was effected April 15, 2008 the date it was published. The Windfall Profits Tax is established with a special 50% tax to the Venezuelan Government when the average price of Brent exceeds $30 a barrel and the percentage has increased from 50% to 60% when the average price of Brent exceeded $100 per barrel.
The Windfall Profit Tax applies onto the oil revenue and as a reduction the price per barrel received by Petrodelta and PDVSA and consequently is deductible for Venezuela income tax purposes. Petrodelta has reduced also revenues for three months as of June 30, 2008 by $23.1 million for the period of April 15, 2008 through June 30, 2008 based on its integration of the law. The Windfall Profit Tax has been applied at the Petrodelta level for two and half months, from April 15 through June 30, 2008.
For the second quarter of 2008, the world market price for the quality of oil produced by Petrodelta averages approximately $100.20 per barrel or 81% of WTI. The Venezuela one time profit tax which is applied as a total reduction to the price per barrel was received above ceratin thresholds reduced the national price for Petrodelta’s delivery by 17,000 or $0.08 per barrel to $0.12 per barrel.
The application of the tax from the effective date, April 15, 2008 reduced Petrodelta’s fourth quarter earnings by $11.1 million or $3.5 million net to Harvest’s 32% interest. The natural gas price is contractually fixed at $1.54 per thousand cubic feet. On July 10, the Venezuela government published the official gazette and amendments to the Windfall Profit Tax. The amendment changed the basis of the profit adjustments from Brent to the Venezuela export basket at prices published by the Ministry of Petroleum.
The amendment does not provide guidance for the Venezuelan basket nor does it provide an effective date for the change, therefore the calculation of Windfall Profit Tax was for the three and six months ended June 30, 2008 has not been adjusted for the pending clarifications from the Venezuelan government and legal counsel.
Historically Venezuelan export basket prices has been lower than Brent price of oil per barrel. This will cause the threshold price to move up since the Venezuelan basket of prices will be lowered in the Brent price of oil per barrel, which will reduce the amount of Windfalle Profit Tax at the Petrodelta level. For the period January through June 2008, the Venezuelan basket has averaged $11.23 below WTI price per barrel and $2.08 below the Brent price per barrel.
Operating expenses were $18.9 million of which $4.3 million was work over expense. Operating expenses per barrel of oil after the 32% income royalty, we’re $16.10 or $12.48. To clear we are dividing 100% of the costs by 70% of the production volumes for each unit cost. Salary and related employee benefits were $1.7 million higher in the second quarter compared to the first quarter due to the increase in work over and drilling activities.
General and administrative expenses were $2.1 million or $37 per barrel of oil for Petrodelta. Factors of income were $3.6 million or $3.09 per barrel of oil for Petrodelta. Total Cash cost including Operating G&A and other factors other than joint ventures were $21.05 per barrel of oil per month or $17.34 including work over expenses. Regarding our 2007 share repurchase program we have completed the purchase of $50 million of approximately $4.6 million shares of common stock. Furthermore our Board authorized the purchase of an additional $20 million of common stock outstanding.
Now let’s review our cash position; at the end of June 30, we had $160.7 million of cash of which $3.5 million restricted as security for Boliver denominated debt in Venezuela. Our Venezuelan affiliate, Harvest Vinncler has outstanding debt of $20 million Boliver, which is equivalent to $4.7 million at June 30.
Since the end of the second quarter Harvest Vinncler prepaid the remaining downsized debt. Net cash asset debt on June 30, 2008 was $156.1 million or $4.49 per diluted share. The update as of June 30 is concluded. I will now hand this over back to Jim.
Thank you, Steve. That was quite a lot to go through from a financial standpoint. We are trying to and going through great pains to deal and reconcile these are Petrodelta’s numbers which would drive our current earnings with those in Harvest, so I would encourage you if you have any questions on the numbers, give Steven a call offline and whatever maybe we can deal with him in the Q-and-A. Let me make a few last comments before we open up for questions.
First I hope we communicated the Petrodelta’s turn in the quarter. Very simply we expect to see continuous sequential growth in production and unit cost reductions as production expands. The rate of production build depends primarily on the number of rigs running and the efficiency of the drilling program.
Many of you have seen the development drilling build we experienced in the second half of 2004 and from the earlier results Petrodelta has posed no big surprises. Besides from development drilling Petrodelta has a very big runway for growth. From an appraisal and development of Petroleo to reactivation and further development of Temblador; to exploration and development of well saco.
With roughly 6 billion barrels known to be in placed on the asset, Petrodelta is not likely to run out of opportunities anytime soon. From a valuation standpoint, as Petrodelta executes on its growth program and as fiscal and operational stability returns to the business, I expect the market to begin to close the gap relative to the transparent industry bench marks that exists for those Venezuelan assets.
Again Harvest’s growth programs elsewhere also are progressing rapidly and I look forward to the spud of our first exploratory well in the Hunter #1. The drilling of the Hunter well affords Harvest the opportunity for material reserve additions as well as near term cash flow. The cycle time from drilling these exploratory well of production and development drilling is very short. Yes it is exploration, but the risk reward profile of this prospect is highly attractive.
We consolidated the acreage around the bay prospect through an advancing exploratory test late next year. Further the MI partners have every intention of adding to that overall portfolio in the near future. Our exploratory programs in both Indonesia and Gabon have made progress and we expect to test both of those next year. The important thing about these programs is that individually, each of them have the potential to materially change the base of Harvest, owing both to the quality and the risk profiles of the programs as well as the muted valuation that afforded the company as measured by our price value today.
As the press release noted, Harvest completed its 2007 stock repurchase program and the Board authorized a further $20 million in stock repurchases. The rush now for repurchasing the stock remains unchanged. The board and management feel now more than ever that returns on the repurchase of stock at current prices remain very compelling and will not affect our ability to fund our growth programs in the near term.
I’m going to close on that point and we are going to now open up the call for questions. Are there any questions?
(Operator Instructions) Your first question comes from Subash Chandra; please go ahead.
Subash Chandra – Jefferies & Co.
A couple from me on the first joint venture; what do you see as Petrodelta level CapEx this year?
It’s all dependant on the timing of the second and third rig Subash. We think the second rig will come in somewhere around the end of the third quarter. We would like to put a third rig out there in the fourth quarter. The run rate per rig in CapEx I believe is running about $4 million per rig per month. It’s really down to the timing on the rig.
Subash Chandra – Jefferies & Co.
Then a one rig program just so I can sort of figure out the boundaries; the one rig program would be in the order of may be $20 million and then scaling up from there?
I don’t have a problem with that. Right now Subash its probably lower than that but if the rig becomes more efficient, drills wells in shorter periods of time, that number would go up, because you’re using more tube fitters, etc, so as you move forward the mid 20 days and stuff, $4 million per rig per month is the basic number for now.
Subash Chandra – Jefferies & Co.
The production profile, I’m understanding that it’s fairly new but also looking at some valid history what do you see it looking like and as far as that when does it get put on pump?
Say that again?
Subash Chandra – Jefferies & Co.
The production profile that these new wells sort of an IP decline rate, when do they get put on pump and what does it look like in the tale of production?
I mean it’s what we’ve stated before. The overall portfolio, the range of reserves per well on the overall portfolio changed to be at about 0.5 million barrels for 1.25 million barrels per well. So you’ve got wells that were throughout that range. If you look at the first few wells, they’ve all come on in the 1500 type barrel if they raised 1000 barrels and that’s on the oil side.
We put pumps in the hole right from the outset ESPs and they are going to be producing on the order of 2500 barrels of fuel a day; so it comes down to the water cut as well, but there’s a fairly wide variance I guess Subash if you were to take the first month average production as you drill fifty wells; so there is not a simple fiscal well that all fits in those ranges that I just outlined.
And so the water cut; what does it sort of start at and where do you see it going?
The water cuts different on every well Subash, so the first well had a higher water cut that the second well for instance. The second well is still producing with virtually no water cut, the first one is producing with water. You got to keep in mind that overall production out there is; these are all mature fields and they have a fairly high water cut at this point.
So again the water cut varies well to well and we’ll continue to do that throughout the portfolio, but overall, taking that into account the overall portfolio looks; our reserve for well wise looks in the 5,000 barrels a day to 1.25 million barrels total; first year average production in the 100,000 barrel a day range up to 300,000 barrel a day range per well. So those are kind of the ranges you are dealing with off a wells.
One final one; so the Temblador field, how many locations have you mapped out there?
We haven’t finished the mapping. We are looking at first off reactivating some wells that have been shut-in for quite a long time; obviously production is up in the field slightly, but the big issue we have right now is segregating that production and integrating it back into the Uracoa facility etc, but I think there’ll be fairly ample drilling opportunities in Temblador. In fact is second rig will probably go to Temblador first.
Your next question comes from Bryan Frank; please go ahead.
Bryan Frank – Cumberland Associates
The first question has to do with long term operating costs. I know you’ve only drilled two wells; obviously the current production cost is higher than it will be. Do you kind of at this point of forecast for what those will settle in at?
Bryan, the answer is no, but let me give you some color on it, so you can relate back to where it is. As you recall I think late 2004, early 2005, when you were producing around 30,000 barrels a day, I think the operating costs at the lease level were $2.50 and that was pretty much the low point. Costs had gone up since that time largely due to the following: First off, obviously it’s a production rate being lower and the denominator is basically one almost one-third of what it was.
Second thing is as you recall under the operating service agreement we were not paying royalties. So we were taking 100% of the cost divided by 100% of the volume. In the tax and royalty type contract that we have now you are taking 100% of the cost and dividing it by 70% of the volume. So on an equivalent cost basis your unit costs go up by the 30% associated with the royalty.
The last factor is, I think everybody knows commodities and services around the energy industry are up relative to what they were back in 2004. With that said there is a lot of leverage in increasing the denominator, our production rate daily and there is even more leverage associated with the scale of operations as we go up. There is a substantial amount of cost in Petrodelta that we categorize as fixed cost, especially around compressing electricity generation etc that as production increases, those costs don’t increase, they are just spread over a lot more barrel.
There is going to be jumps over time as you get past certain dry fields in production as you start bringing on more Temblador, as you start doing things that is lying here where, capital will have to be invested in the new facility you will see some jumps in those costs, but clearly I would say that the costs we are working out now are very, very much on the high side and we will see those costs come down sequentially as production goes up.
Bryan Frank – Cumberland Associates
At some point will you be in a position to give more color to that?
Yes, no doubt. I mean we tried to offer what guidance we are comfortable with now Bryan. I mean it really does come down to timing of when the rigs get there and us being able to predict ramp up rates with more certainty. Like once you have three rigs running out there, I think we’ll be able to give you much better numbers and by that time you’ll see some sequential changes in cost balance.
Bryan Frank – Cumberland Associates
In the Q you have the Petrodelta financials; there is a big number from investment earnings and other for this pre-quarter, almost $5 million to Petrodelta, what is that? Below income from operations, investments earnings and other there was very little in the first quarter there.
That’s accrued interest. We haven’t been paid for some of the oil and gas invoices as you are aware, we talked about before and that’s the accrued interest amount.
Bryan Frank – Cumberland Associates
So Petrodelta gets the benefit of some kind of implied interest on the balances?
Bryan Frank – Cumberland Associates
Okay and then the final question is you paid back the debt in July; were you able to pay it back at less than face value as you have previously?
I think what you are talking about is the debt was Boulevard denominated debts and we did pay it down with Boulevard’s Venezuelan currency and as we’ve done before, we received that Venezuelan currency as a result of some of the international swaps that we’ve done.
Bryan Frank – Cumberland Associates
So how much cash then did it take to pay down the $4.6?
I don’t have that in front of me Bryan.
Bryan Frank – Cumberland Associates
But some number less than $4.6?
Okay sir at this time I am showing that there are no further questions.
Okay, well as you were too easy on us today. Let me reiterate I look forward to the upcoming quarters directionally. We certainly feel confident about the direction of the production curve. We are all eager here to see our exploration programs kicked off; not only here in the US but elsewhere and we look forward to talking more about and producing more certainty around the production forecast for the future in the coming third quarter. So with that, thank you.
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