Penn West Petroleum's CEO Discusses Q3 2012 Results - Earnings Call Transcript

| About: Penn West (PWE)

Penn West Petroleum Ltd. (NYSE:PWE)

Q3 2012 Earnings Call

November 2, 2012 12:00 p.m. ET

Executives

Clayton Paradis – Manager, Investor Relations

Murray Nunns – President & Chief Executive Officer

Hilary Foulkes – EVP & Chief Operating Officer

Bob Shepherd – Senior Vice President – Enhanced Oil Recovery and Cordova

Rob Wollmann – Senior Vice President of Exploration

Mark Fitzgerald – Senior Vice President of Development

Analysts

Gordon Tait – BMO Capital Markets

Robert Bellinski – Morningstar

Jonathan Fleming – Cormark Securities

Roger Serin – TD Securities

Andrei Sardo – Hart Energy

Operator

Good morning. My name is Adam and I will be your conference operator today. At this time, I would like to welcome everyone to the Penn West Exploration Third Quarter Financial and Operating Results Conference Call for 2012. All lines have been placed on-mute to prevent any background noise. After the speakers remarks there will be a question-and-answer. (Operator Instructions) Thank you.

I would now like to turn the call over to Clayton Paradis, you may begin.

Clayton Paradis

Thank you Adam and good morning everyone. Welcome to Penn West 2012 third quarter financial and operating results conference call. My name is Clayton Paradis, Manager of Investor Relations. With me this morning in Calgary is our President and Chief Executive Officer, Murray Nunns; Chief Operating Office, Hilary Foulkes; and our Chief Financial Officer, Todd Takeyasu as well as other members of our senior management team.

Before we begin, there is just a couple of items I’d like to remind with results. Penn West exploration shares are traded both on the New York Stock Exchange under the symbol PWE and on the Toronto Stock Exchange under the symbol PWT. All references during this conference call are in Canadian dollars unless otherwise indicated and all conversions of natural gas to barrels of oil equivalent are done on a six to one conversion ratio. All financials are reported under International Financial Reporting Standards or IFRS.

Certain information discussed during the conference call may constitute forward-looking statements under applicable securities laws and necessarily involve risks. Participants are directed to Penn West third quarter news release and asked to review the advisory notice therein. This news release maybe found on our website at pennwest.com.

Official information detailing other risk factors that could affect Penn West operations or financial results are included in reports on file with Canadian and U.S. Securities Regulatory Authorities and maybe accessed through the SEDAR website at sedar.com and the SEC website at sec.gov or on Penn West website, again at pennwest.com.

During this conference call certain references to non-GAAP terms may be made. Participants are directed to Penn West MD&A and financial statements available on our website as well as filings available on securities website noted earlier to review disclosures concerning non-GAAP items.

I would now like to turn the call over to Murray Nunns, President and Chief Executive Officer.

Murray Nunns

Thanks, Clayton and good morning, everybody. As previously lead out of our recent Investor Day, our strategy is to unlock Penn West intrinsic value for our shareholders by optimizing our overall business performance and execution by continued research growth across our dominant positions in four Western Canada’s five largest light oil plays coordinated with balanced financial management.

We are committed to optimizing capital and operational efficiencies while providing dividend income for our shareholders. If and if we gain certainty in the outlook for commodity price realizations and cost structures, we will be in a position to choose add production growth in our resource assets through development of large light oil plays.

On October 17th, Penn West announced two important developments in the execution of its strategies, improving its financial flexibility and confirming that vast oil resource. First, we are in the process of closing on multiple divestment transactions that are expected to raise proceeds of approximately $1.3 billion by year end.

In addition, there are a number of other contemplated transactions and therefore we feel just prudent to announce our 2013 capital budget and volume guidance at a time more consistent with the industry peers in late December or early January.

I know in Investor Day we indicated a desire to announce this today, but it just makes sense to wait until these current transactions and other possible transactions have been consummated.

Here we will provide you with an update on this bit of business in just a minute, but I can tell you we expect the currently announced transactions to close prior to December 31st, 2012 and proceeds will be used to strengthen the Company’s balance sheet. Further, on financial flexibility, we have indicated to our shareholders – shareholder base before that in the softer portions of the commodity price cycle, we in to ensure consistency in the dividend. Over the last three years, we have taken appropriate measures to ensure that balance integrity to support our endeavors.

So with that, I’d like to remind shareholders that Penn West Board of Directors has declared a fourth quarter dividend of $0.27 per share to be paid on January 15, 2013 to shareholders of record on December 31, 2012.

Now on the resource growth side of the equation, the combination of several years of land capture and appraisal work by Penn West teams has resulted in over 1 billion barrels of light oil enrichment, contingent resources in our Cardium and PROP assets being refined by independent qualified reserved evaluators. For details on the contingent resource studies, I would ask you to reference Penn West press release of October 17th that is available on our website.

So let’s take a step back. Why are those studies important, why are those contingent resources are important? The horizontal technology shift in 2006 created a different world for us in the oil patch in the world we operate in. The business models are evolving. It used to be a cash flow both quarter-over-quarter type model that you were trying to reinforce. We are now much more a canon in this basin to a mining style model where you’re building a large inventory of resource and been at the constant capital gains to go into manufacturing style development.

If you look at the type of transactions that have taken place in the basin now, that is what their premise done. What we’ve been doing over the past several years was refining the application of horizontal technology to our broad base – broad asset base and that’s important because ultimately the intrinsic value, the value of this company is what’s in those contingent resources in our asset base.

Bringing it back to today, we know commodity pricing is cyclical, impacted by broad economic factors and speculated volatility. We are mindful of the impact this has in our business, so we exercise prudence during all parts of the pricing cycle.

Additionally, pricing differentials between US benchmark WTI and Canadian crude oil streams have been weighing on Western Canadian producers in the first half of 2012. At times, the differential has been as much as $25 a barrel. While this has narrowed since Q2, the volatility of this differential is persistent and has a significant impact on our and industry netbacks.

Our current 2013 hedge position includes 55,000 barrels per day of our oil production hedged between $91.55 to $104.42 per barrel and additionally, 125 million cubic feet a day of natural gas production at $3.34 an mcf.

Turning now to our outlook, production volumes in the quarter were a little softer than anticipated primarily due to the impact of facility construction delays at Swan, a facility which is expected to come on stream late in Q1, 2013, therefore we are updating our 2012 forecast average production to between 61,000 to 63,000 BOE per day versus 165,000 to 168,500 per day previously.

I will now pass the call to Hilary Foulkes, our Chief Operating Officer to give you greater insight into our A&D program and ongoing operations. Hillary?

Hilary Foulkes

Thanks Murray. We will be talking a lot of those disposition programs lately, but ongoing portfolio management has really affected life here and it serves multiple purposes. It allows us to high-grade our asset base, focus our human and capital resources on the place latest impact and it’s one of the lever we can pull to provide the financial flexibility that we need to manage our business through all commodity price cycle.

As we discussed at Investor Day, when we designed this process, there was a very clear strategy to have a number of our non-core assets in the markets in a variety of ways through investment banking, through processes we’re running ourselves and directly through some of the relationships we have with industry partners.

We created competition between buyer and we gave ourselves choices that translates into value. We can issue our use at the final paper work on all of the transactions is progressing on schedule. We have executed purchase and sale agreements on all the one transaction and the last one is expected to be signed next week.

I am going to go off the script for a moment and acknowledge the divestment and legal pain here at Penn West for their incredible effort in getting these fields papers in such a short period of time. And I also acknowledge our field personnel who’ve been affected personally by these sales.

The volume impacts will be approximately 12,000 barrels a day and we have – we do expect to have the full $1.3 billion in the bank by the end of the year. On the operations here, a quick update for the quarter. As you know, we have eased our phases activity at the end of Q2 and we systematically reduced our rig counts and focused our attention on completing and tying in the inventory we built in Q1 and building facilities that will provide us with a long-term strategic operating advantage and growth potential in several of our key plays, notably Cardium, (inaudible) and Sawn Lake.

Each of our three most recent wells at Sawn produced an average of over 500 barrels a day in the first month’s production and they’re currently curtailed due to the facility of restrictions Murray referenced earlier. However, these delays are short-term in the grand scheme and the facilities built are for the long run.

With the Sawn Lake battery, Otter battery and Red Earth gas plant our incremental capacity in the Northern Carbonates plays expected to be over 24,000 barrels a day by mid-2013, if you accept to the confidence we have in that play. We control the oil infrastructure and the very strategic gas handling in the area. We see risks at our drilling inventory and increase the predictability in all of our key light oil plays and we perceive external confirmation of the contingent resources in our Cardium and Peace River areas.

We will continue to reposition the asset base to the profitable light oil resources assets. Our light wells production weighting growth is 66% this quarter through focus drilling of light oil resource plays, Cardium, Viking, Spearfish, Swan Hills Lake Point. This asset base continues to demonstrate the intrinsic value for each focus.

Wells are performing as per the type currently provided at Investor Day and in certain areas wells are exceeding those expectations. In Swan Hills for example, the 6 - 15 well came on stream late in April, but producing 760 barrels a day and it’s currently at 500. The 4 - 9 well (inaudible) in July was over 1,000 barrels a day and it’s still producing almost 400 despite infrastructure restrictions at GDP.

As another example in the Spearfish, our four well pad 13 of 25 it is in early days that came on just over 900 barrels a day, outstanding by any measure. We started the application of horizontal multi-stage frac technology in Ernest in 2010. We talk a lot about cost and efficiency benefits realized by moving from appraisals development and are experience in executing on these resource places now being realized through improved capital efficiencies.

The recent examples of empirical cost reductions include in the Spearfish early in completion costs coming down by 20% re-drilling peace at our wells pretty much in every play Cardium to dot plants from (inaudible) boundary rates.

At PROP, eight leg wells in 30 days to nine leg wells in 14 days, this translates into over 40% cost savings of course great Middleton, great iron, great crews. Our collective experience in cost reduction learnings are being applied across all of the asset team.

For the latter part of this year with certainty on our disposition program, we are now ready to accelerate activity levels. Yesterday, as Murray mentioned, our Board approved incremental capital of approximately $100 million for 2012. We will get the rigs rolling again and build momentum going into 2013. Full-year 2012 net capital before, therefore moves up slightly from 1.3 billion to 1.4 billion and this net capital does not include the planned proceeds from our recently announced dispositions.

We want to establish consistent operations through good planning, portfolio selection, the right rigs and the right crews. Our capital efficiencies will continue to improve. Our plays are predictable and performing. We have made the appropriate appraisal and infrastructure investments for the long-term growth potential of our oil resources.

This provides the ability to add production in key plays at attractive capital efficiencies as we move into 2013 and beyond. We will continue to unlock the intrinsic value in Penn West large scale light oil plays.

Just before we take some questions, I’d like to introduce the other members of our senior management team in attendance today. In addition to Murray Nunns, Todd Takeyasu and Clayton Paradis, with us are Mark Fitzgerald, Senior VP of Development; Greg Gegunde, Senior VP Production, Thane Jensen, Senior VP Operations, Keith Luft, General Counsel and Senior VP Stakeholder Relations, Bob Shepherd, Senior VP, Enhanced Oil Recovery and Cordova, Rob Wollmann, Senior VP Exploration, Dave Middleton, Executive Vice President, Managing Director of PROP, Jeff Curran, Vice President, Accounting and Reporting, David Sterna, Vice President, Commodities and Transportation.

I think we’ve got all these have covered. I’d like to now turn the call over to the operator and open up the phone line for questions.

Murray Nunns

And just before everybody hits their self, I’ll just reiterate that I said $61,000 to $63,000 on the guidance, of course its $161,000 to $163,000. So with that, let’s open up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line Robert Bellinski from Morningstar. Your line is open.

Robert Bellinski – Morningstar

I have two questions. First, what’s your willingness to part with one of your plays – one of your larger light oil plays in whole in order to focus additional efforts in developing a play like the Cardium? Just getting – or give me a little bit more focused fewer plays.

And then second, I was just wondering what percentage of your Duvernay lies directly underneath your Cardium position? And what are your thoughts on taking advantage of existing process and infrastructure in that region?

Murray Nunns

I’ll kind of answer this in a broad sense, Robert. First when we look at the two portions of the company we’re roughly split 50-50 between the vertical and horizontal production on our resource plays and our base assets that are really what we’ve been using at the funding source to develop those plays. We’re yielding really good sale metrics as we reduce on that series of base assets. So we really don’t have to lob off any one of our single larger resources plays to continue the model as we’ve been generating it. So we’re really not contemplating a sale of any of those at this time. We think there is a tremendous inherent and intrinsic value in those. So we want to retain those.

So that would be how we address that side of the equation. So we can continue to sell out of that side and I think Hilary maybe can add a little bit of color to that.

Hilary Foulkes

Nunns, I do think that part of the asset base that we’ve been able to move out so far on the non-operated side has really given us the leverage that we need. We still have more work to do on that front. We talked about continuing focus both on our time and attention and our dollars on a smaller number of plays and we can still do that with funding from what we refer to as our non-core assets.

Murray Nunns

Yeah, and I would acknowledge that Hilary is a wizard in the industry of this and as we’ve been doing this for a number of years, but there is still a lot of those scattered assets within the inventory of base assets we’ve used.

On the second side, on the Willie Green, there is about a one-third or less, we could definitely with our existing infrastructure get through the appraisal phase on the Duvernay with existing infrastructure. I suspect in a general sense on this play that the ultimate builders of the infrastructure maybe the mid-streamers on this when I don’t think anybody is going to be trying to put their flag in on this too early as an individual company, like if there is just too much capital on that side of the business. I suspect that point we get filled by the mid-streamers, but again we can do the basic appraisal work probably to our existing infrastructure.

Robert Bellinski – Morningstar

Okay, great thanks.

Operator

Your next question comes from the line of Gordon Tait from BMO. Your line is open.

Gordon Tait – BMO Capital Markets

Good morning. Just down far enough on something you said Murray, you noted that the basin is becoming a little bit more like the mining industry where you’re proving up resource plays and then to turn them into lease manufacturing stout operations now.

My question then is twofold like first of all, do you think you’re at that point or when do you think you’ll be at that point for Penn West to kind of print into this sort of manufacturing production to growth.

And then secondly, what sort of an organic growth rate do you think that you can generate from your asset base once all the dust settles on your asset is positioned?

Murray Nunns

That’s twofold on that I think. In terms of the evolution of the transfer, I think if you’d looked at this company two to three years ago on those resource assets, we’ve had about 30% of our production involved in the resource asset side of the company and about 70% on the legacy. Right now we’re approaching about 50-50 in terms of the relative position of the resource assets versus the legacy base.

We think we still have refinement to make on the execution side before because ultimately I think it you want to be in a growth mode, you’ve got to be in that 35,000 to 40,000 barrel with a cap efficiency and we’re not there yet. We’ve done a lot of appraisal, a lot of build out. So I think there is still a progression of time while we, I would say, tighten our skill sets and demonstrate that consistently. Once we have had then we would contemplate the growth.

I think I won’t speculate on the growth rate. I will say, good gas companies when they’re going, they use 25,000 barrels a day cap efficiency, they can grow it about 10%. That seems to be the max oil, a little slower, a little tougher. I suspect any contemplated growth rate would be below that if one was to evolve the model away from what it currently is.

Gordon Tait – BMO Capital Markets

And give a sense of when you might sort of be emphasis through that. It sounds like you’re high grading the asset base. So I mean at some point next year, where you think you are in that process?

Murray Nunns

I think real reserve comment on that in terms of the timing of that. We are still in an evolution I think in repositioning the company. And I don’t want to put a timeframe on it. It is something that may occur as an option for us on the future, but I don’t want to, I don’t want to walk it in on the timeline.

Gordon Tait – BMO Capital Markets

Okay, thanks.

Operator

Your next question comes from the line of Brian Kristjansen from Canaccord Genuity. Your line is open.

Brian Kristjansen – Canaccord Genuity

Give a sense of where your bank line is going to be post dispositions?

Murray Nunns

I’ll turn that over to Todd Takeyasu our CFO.

Todd Takeyasu

Sure. I’ve got September 30 for the three prime lever above $2 billion strong. So we expect to exit somewhere about half of that after we play our feather in some of the 13 count moved into ‘12 which we talked about a bit in our press release.

Brian Kristjansen – Canaccord Genuity

With respect to the capacity in cut post-disposition. Do you have a sense on that side?

Todd Takeyasu

Well we’re a borrower base, sorry we’re a covenant base, Brian. So we won’t to be taken in sort of borrow base hit rather or debt capital limitations are more related to our senior debt to EBITDA and our debt-to-capitalization.

Brian Kristjansen – Canaccord Genuity

Okay, perfect.

Todd Takeyasu

Hopefully, which we expect to be reasonably in hand by the year-end certainly.

Brian Kristjansen – Canaccord Genuity

Okay, thanks. And maybe Mark, could you comment on your backlog of drilled wells that have yet to be put on thing?

Mark Fitzgerald

Brian, Murray talked about some of the delays we’re seeing through the quarter on facility side which is back some of the production capacity primarily in the North through end of the year and ultimately into Q1. A lot of the information’s in the release that we’re bringing on production obviously in Spearfish based on activity through earlier in the year have some baking production and little bit of Cardium production coming on late in the fourth quarter. And then the Carbonates, the point production will carryover based on when those facilities come on late in the quarter and to Q1.

Brian Kristjansen – Canaccord Genuity

Okay, and then lastly, your expected timing of the Slave Point contingent resource and where you’re at in the water flood progress right now?

Hilary Foulkes

We haven’t actually finished the contingent resource, we’ve begun the contingent resource study in the Slave Point but we’re looking at probably the end of the first quarter, maybe early second quarter before that’s finished. Now that’s some of the contingent resource side and on the EOR side I’m going to pass the call to Bob Shepherd who is running that group.

Bob Shepherd

Sure, on the Slave Point water flood our first project we expect to have online there and for the end of the first quarter we are ordering equipment right now, we have the pilot area and engineering is complete, construction will start early in the first quarter.

Brian Kristjansen – Canaccord Genuity

Okay, thanks Bob. Thanks guys.

Operator

(Operator Instructions) Your next question comes from the line of Jonathan Fleming from Cormark Securities. Your line is open.

Jonathan Fleming – Cormark Securities

Guys, I wonder if you can give any sense at all on to the size and scope of the second round of disposition, does it half as big as the current package and is it oily or gassy or how can we think about this?

Murray Nunns

Bigger than a bread basket, smaller than – I’ll give it to Hilary.

Hilary Foulkes

Yeah. One of the things that we’ve tried very hard to do is keep some I guess lack of transparency around what it is that we’re trying to market, it’s been extremely successful that strategy for us. The more definition we get around this the more we deputized values. So for the time being I’d like to just let you know that there are other discussions ongoing, some of them around joint ventures, some of them around great asset sales and again as we did in the fiscal round we’ll see what the answers are and then we’ll make a decision.

Jonathan Fleming – Cormark Securities

Okay, well thank you.

Operator

Your next question comes from the line of Roger Serin from TD Securities. Your line is open.

Roger Serin – TD Securities

Hey everyone. Couple of questions, when will you be providing 2013 guidance?

Murray Nunns

I think the timeframe we’re giving because we are contemplating the potential project transactions and we obviously want to get, when we put this stack in the ground we want to put it in ones, we want to put it in the right spot obviously. So I would say more than likely January, early January in that first half of January is the likely timeframe, Roger.

Roger Serin – TD Securities

Okay. You obviously eluted to further asset sales and you’d be very effective on these asset sales, is there a sort of size that’s more or less optimum to shrink down too to make the business model go around?

Murray Nunns

Yeah there is – you can look at it from a couple of different cuts, yes there probably is. We got an exact spot we’re driving towards, no, not at this stage. I think more of that we’re driving the balance sheet in a general sense, look for markers below two times debt of cash flow I think is sort of where we’d like to position but a tremendous amount of act depends on the character of the transaction. Are you transacting an early life asset that takes away very little cash flow but is in an combination JV structure or you’re moving off all harvest assets that are not our positions.

So like I said, that is a bit more of a – we have to see how the pieces come together and we, as Hilary indicated, we do like to keep that part of the process earlier to pick.

Roger Serin – TD Securities

Okay, with so you really loved this question. With that in mind, Hilary can jump in at any time too, so if you were to process that this assumption into the question, so you want to fund your dividend unchanged, you would have dropped you want to fund production declines being flat, you want to replace production, keep your mix approximately the same, and with the capital efficiencies that you guys eluted to is goals at your Analyst Day. Obviously the other drivers and its commodity prices, what commodity price range do you think you need for that to go around?

Murray Nunns

I think if you, I won’t – and I’ll reference in the Investor Day and the cash flow sensitivities, but about a $10 move and this can be either differential or price equates to about $450 million, but I would reference there is a cash flow sensitivities were there we presented in Investor Day. I think if you’re trying to square the circle look towards that and not that for range of numbers.

Hilary Foulkes

And I think part and parcel of this is also, it’s not just that kind of circular thing that I think you’ve got in your head, it’s also transitioning the asset base from kind of when these two are very different ones. And so with that come increasing net facts and simply better profitability, so as we do these disposition we’re actually shifting into a different type of asset base with a different scale of profitability.

Roger Serin – TD Securities

Okay I get that, I guess you’re also changing the asset mix a little bit in the decline rates probably move up modestly over the first few years as you moved to increase the pad drilling and horizontal drilling.

Hilary Foulkes

Yeah, I mean there is an element of that with us a steady state of activity, you kind of – you’ve mitigate that and with the application of enhanced oil recovery, so we’re starting to get watering around and the Slave Point as a good example, and you start to mitigate those declines with that.

Roger Serin – TD Securities

Okay, thanks very much.

Operator

Your next question comes from the line of Andrei Sardo from Hart Energy. Your line is open.

Andrei Sardo – Hart Energy

Good morning. Could you talk briefly about any plans you may have regarding Alberta Bakken shale play at this time?

Murray Nunns

Rob, I’ll turn that over to Rob Wollmann, our SVP of Exploration.

Rob Wollmann

Hi Andrei, currently on the Alberta Bakken we continue to monitor a bunch of offsetting competitor activities. Our plans currently are modest for the next, for the short term as we focused on our development programs that have better capital efficiency.

Murray Nunns

And I would say that’s a general pattern across when we look towards the 2013 budget. As we’ve been upraising fairly heavily for the last three years and greater focus on the pure development in the end of business.

Andrei Sardo – Hart Energy

Thank you.

Operator

There are no further questions at this time. I will turn the call back to the presenters.

Murray Nunns

First, thanks everybody for listening in on Penn West’s explorations of third quarter conference call. As you can tell, we’ve been barked on the repositioning of the balance sheet and indeed the repositioning of the company and we’re fine with our execution capabilities. So I’d like to thank everyone for attending and as we have further developments and we’re ready to go on the budget, we will provide details. Thank you everyone.

Operator

This concludes today’s conference call. You may now disconnect.

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