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Executives

Jim Grant – Investor Awareness Representative

Darren Gee – President, Chief Executive Officer

Jean-Paul (JP) Lachance – VP Exploitation

Scott Robinson – Chief Operating Officer

David Thomas – VP Exploration

Kathy Turgeon – VP Finance, Chief Financial Officer

Tim Louie – VP Land

Analysts

Robert Bellinski – Morningstar

Kevin Kaiser – Hedgeye Risk Management

Fai Lee – Odlum Brown

Peyto Exploration & Development Corp (PEYUK.PK) Q3 2012 Earnings Call November 8, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Peyto Exploration & Development Third Quarter Results Conference Call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. (Operator Instructions) As a reminder this conference is being recorded Thursday, November 08, 2012.

I would now like to turn the conference over to Mr. Darren Gee, President and CEO. Please go ahead Mr. Gee.

Darren Gee

Okay, thank you, and welcome to everyone to our third quarter 2012 results conference call. With me in the room this morning we’ve got our entire Peyto management team, which is a good thing, considering its snowy out there in Calgary today.

So we’ve got Scott Robinson, our COO, Kathy Turgeon, our CFO, Dave Thomas, our VP of Exploration, JP Lachance our VP Exploitation and Tim Louie, our VP of Land and of course we’ve got Jim Grant, our Investor Awareness Representative with a whole list of questions there from shareholders. So Jim, why don’t we kick it off with you?

Jim Grant

Okay. For those of you who are new with conference calls, we hope the first half is a question-and-answer session where I ask some of the senior management questions about Peyto and its latest financials before we turn the call over to questions from investors and representatives investment businesses.

So, we’re sitting here at the end of the eventful year, one of the biggest events and possibly the most surprising given our track record has been to take over of open ring. Well we’ve spoken about this three months ago of the last conference call, we now have experience to share, having drilled on the open range land and also share our whole quarter’s experience of operating the assets they had when we acquired them. Can you tell us about how the open range assets including with our legacy of efficient drilling? And what we’ve done so far with our new assets?

Darren Gee

Sure, Jim. I start by saying that our corporate takeovers is probably a big surprise for a lot of shareholders but it’s not something that we’re typically doing up until this point anyway last 14 years of Peyto have all being organic growth. So I’m sure when we announce that we were taking over company to summer that came as a bit of shock but I think when you look at the map of the assets and you consider all the operational synergies within that greater Sundance Cardium area you can see how it makes so much sense for us and really for the price that we paid, we think we can generate a very competitive return for our shareholders.

But it’s definitely a new thing for us, we never had to integrate an entire company into our own before, I want to send out a big thank you to the entire Peyto team for all their extra effort in folding all of these asset into our own and doing it so quickly and efficiently. Considering how well this went and how good we ended up added maybe we should consider doing it more than once every 14 years. I see our VP of Land rolling his eyes but I’ll tell you, it’s amazing how quickly we’ve gone after the upside in this acquisition, we’ve already drilled five wells on the former ONR lands and I think we’ve got another seven or something to get drilled before the end of the year.

So we’re really not wasting any time at all getting after those opportunities. And the asset that we bought the production base is solid, we of course have seeing some flesh decoying from wells that were added in early 2012 and late 2011 but we’d forecasted that that was going to happen. So I think we’d say that the assets are performing exactly as we predicted, we seen to more rapid recurring gas prices I think then we were forecasting in the summer time. So that really helps on the return side.

And of course, one of the things we did anticipate was there was a lot of processing capacity in these facilities and gathering systems that we ended up acquiring, that’s a big benefit because that means we can fill and the drill the fill which adds immediate incremental production without having to wait for new facilities to be installed. So I think all in over we’re very happy with the purchase.

Jim Grant

Right. Turning to JP Lachance, our VP of Exploitation, earlier this year JP, we turned our attention to the liquids variance species of wells but it’s my understanding that with recent improvements in gas price we’ve shifted back to a fair proportion of the leaner gas well species, perhaps you can fill us in on the economics of our current mix of targets with this in mind.

Jean-Paul (JP) Lachance

Thanks, Jim. I guess when a winner never materialized and gas prices start this up in earlier year we changed up our drilling mix to focus more on the species that had a higher liquid content and those targets gave us better returns in that pricing market, which instance, I should point out gas prices have strengthened and restored economics of those leaner gas place, so we’ve returned to them and you were fortunate here Peyto to have a debts of inventory and adaptable staff, field operations to meet those changes relatively quickly.

All of our place in attractive returns with the share price going forward for example on typical Sundance Cardium well has rate of return in both 27%, well at typical river of Bluesky will have returns in range between 30% and 40%.

Jim Grant

Okay. So JP, I’ve had a number of questions recently about one of the aspects of drilling horizontal wells that had increases our capital efficiency and that is the drilling multiple wells from a single pad. There were a lot of impacts from that act doing multiple wells with single pad, could you go over these impacts for us?

Jean-Paul (JP) Lachance

Sure. Yeah Jim, well the drilling from pad is nothing new to the industry, we’ve been a little slower to adopt it. We’ve always prior to ourselves in having industry leadings by timeline times for wells in our core areas. So drilling back to back wells off the same pad and delaying the first wells completion the subsequent production is not a big concern with that strategy. And however, the benefits we’ve seen in cost savings we then turning into production, so we’ve estimated cost reductions of about $350,000 on the overall cost of a two well pad, now these savings are realized by only having to mobile the equipment into the site once it’s across all the aspects of our operations like drilling through equipment, just twice.

There is also cost savings are running away in one pipeline to the location. So by year end little drill from about 10 of these pads with completions from six pads still to come over the next two months, but besides drilling from pads where we can’t, we also have become more efficient in our drilling. Now Peyto will have drilled – by the end of this year will have drilled about 200 horizontals. Now that experience is translating into fewer drilling days and reduction in costs.

A typical well in 2012 has been drilled in 20 days, down from an average of both 30 days in 2010 and 23.5 in 2011. We’ve also enjoyed significant reduction in cost in our Sundance Cardium wells in this past year by employing our design with 11 of them, and that’s reduced our drilling and complete costs for this species down by about 10%.

So the bottom line here is that our average drill complete equipment tie and costs for our current mix of species is down to about $4.8 million per well from about $5.1 million a year ago and that equates to the increase of 5% on the rate of return of a well using the currents pricing.

Jim Grant

Well, I’m going to direct the next question to Scott Robinson, our VP of Operations and COO. Scott, we’ve reported that we have a number of wells with behind pipe capability as well over 20 more wells to drill over the balance of the year, can you update us on the current and year end production rate as well as provide us with some details on our facility capacity situation and how the remaining production additions over the balance of the year will fit in?

Scott Robinson

51,000 where we’re at right now Jim, successfully put those in the press release and that’s the radar where we would hope to be with the wells that we brought on stream. JP eluted to the fact that there have been some delays and hence we got this inventory of 10.5 wells we need to come on stream that we have an estimated 6,000 barrels of expected production addition to come from over the next few weeks as we get those on.

And then as you stated another 20 wells that we have in the queues to drill and complete over the balance of the year. So with this total search of activity at the end of the year we’re really expecting a strong push for our production and it couldn’t come at a better time coming into this winter’s gas market.

We put out there that we’re estimating 57,000 barrels of production and allowing for some decline from where we’re at right now and the additions that the 10 wells high pipe plus the 20 that we’re going to drill. It means we’ve got to fit in another 35 or 40 million cubic feet a day of gas between now and the end of the year. This production addition is basically split between three areas, a third of its focused in and around the open range plans where we’ve got two facilities with above 20 to 25 million cubic feet a day of unutilized capacity. Another third of this activity is focused around our Wal Hey (ph) infrastructure where a Wal Hey plant is sitting with above 15 million of unutilized capacity.

And then the last third is associated with Falher wells right in the heart of our Sundance operation. We’ve recently completed a fairly large gathering line extension from Nosehill, our Nosehill plant that would come and get those incremental volumes and we’re sitting at Nosehill with another 25 million of unutilized capacity.

So if you put this all together, we’ve got 35 million to 40 million of additions to make between now in the end of the year to get that 57,000 number and we’ve got 60 million to 65 million of capacity amongst these three wells. So we’ve got a little extra room and perhaps we get better year end results and be able to fill some of that extra room as well.

Jim Grant

Great. So turning to Dave Thomas, our VP of Exploration, it’s been a busy year for your group with an active recount ranging between six and eight rigs, can you provide us with some details on how many wells we’ve drilled to species and how the production results are stacking is compared to the past few years of horizontal drilling that we’ve carried out, where are we going from here with our large inventory prospects?

David Thomas

Jim, we were running six drilling rigs up until recently. In September when we bumped that up to eight rigs in mid November we planned to increase that to nine rigs until the end of 2012. As of the end of October this year, Peyto had drilled really 65 horizontal wells which broken down by species where 20 Wilrich, 13 Falher, 11 Notikewin, 3 Bluesky and 18 Cardiums.

Throughout the year between November 1st and December 31st we planned to rig release a further 22 horizontal wells including 13 Wilrich, 5 Falher, 1 Notikewin, 1 Bluesky, 1 Cardium and 1 Cadomin that will give us a total of 87 drills or 74.8 net horizontal wells drilled in 2012.

Overall, we’re seeing that our production results by species are holding up quite nicely to our expectations. For 2013, we planned to drill 100 horizontal wells or 85 net and to get us there a 10th drilling rig will be added January 1st but about March 1st we’ll probably drop back to 8 rigs for the balance of 2013.

And our 2013 flat horizontal well species mix is made up of 29 Wilrich, 26 Falher, 15 Notikewin, 7 Bluesky, 20 Cardium and 3 Cadomin wells. The biggest change in this mix over the 2012 mix is the relative increase in Falher and Bluesky horizontal wells, both of these don’t give us excellent success in 2012 then we have a solid inventory in both formations. The Cardium component will stay about the same.

Our 2013 wells we’ll see us test two new deeper Wilrich play, a deep Notikewin play, a new Falher play and given our better than expected success in our relatively deep Bluesky drilling in 2012 we like to test both the Bluesky and the Cadomin again in a few different sweet spots.

Now Jim, at a 100 horizontal wells per year, Peyto has a 10 year drilling inventory, we’ve been more than replacing our drilling inventory annually, we tested new plays each year and we keep a close eye on the cost so we can continue to drill for gas and others have to cut back. And I’m looking forward to a really busy 2013.

Jim Grant

Okay. And should we following up on that, can you provide some measure of the overall economic success of this used drilling program as compared to previous years? I know it is still too early in the production life where new 2012 wells but I trust we have a reasonable amount of performance state especially for those wells drilled in the early part of the year?

Jean-Paul (JP) Lachance

Yeah Jim, it is still early to predict this year’s overall economic performance but you’re right, we have some data from the wells every year and it looks great. Dave, eluted to this earlier that the production performance looks to be very consistent year-over-year but when you coupled out with the reduction of well capital I mentioned earlier, it yields better returns in the program last year on a price neutral basis.

When we run these number or run these wells out using actual cost and the realized prices 2012 with the current strip going forward we’re predicting a full cycle rate of return of about 28% on our 2012 drilling program.

Jim Grant

Okay. Scott, we’ve filled a delay in the start up of the Oldman deep cut facility expansion, can you provide us with some details on the nature of this delay, it’s impact on production and where we are at with the project, can you also comment on those deep cut project status which we previously reported would have an estimated startup in Q1?

Scott Robinson

Yeah, our original estimate for the Oldman deep cut was that we have it running by the early parts or beginning of October, and in client side that was probably too optimistic obviously we’re not there right now, it’s not on stream but we’ve attribute this to a combination of the project complexity, we probably understated how long it would take to put everything together to get everything build.

So that complexity combined with the fact that there were fad shops delays on delivery of some of these pieces of equipment. At present, all the equipments on site and it’s all in place and we’re just completing the connected piping and the electric work which will put us in a position to start it up at the end of this month. So that’s where we’re headed here a start up at the end of the month, it’s important to note that none of these delays that have amounted have caused any kind of variation in our expectation of the final costs when the project expected to come in on budget.

In terms of the impact on production the project is still expected to deliver us, to take us from about 25 up to 40 barrels a million and give us an uplift of 700 plus barrels a day of production just on the existing feed stream, that uplift is just simply been delayed in time but is expected to occur once we’re up in running and at our designed conditions.

Now when we focus on in return to Nosehill, the Nosehill deep cut, we’ve completed the engineering design for that project it’s a little bit different putting that one together as compared to Oldman but it’s all done and we’re positioned to order equipment. But based on what we now understand and about five to six month timeline from our Oldman experience that puts us if we had to order right now on Nosehill that put us right in the middle of break up and that’s really no good, the weather conditions and construction conditions do break up and are not optimal.

So what we’re opting to do is to target for a full break up startup on Nosehill. So that’s later then what we’ve communicated in the past and in order to achieve that we’ll be looking at order this equipment in early December right after we get to Oldman up in running.

Jim Grant

Okay. Turning to Kathy Turgeon, our CFO and VP of Finance, not only is this year seen our first acquisition but we also moved from borrowing exclusively on revolving credit to issuing 7 and 10 year notes for some of our debt. Looking at a Q3 numbers, it seems like the cost of our credit is improving despite the length of the term, how is our changing debt structure benefiting the company and what can we expect to going forward?

Kathy Turgeon

Well in 2012, we issued a total of $150 million in Senior Secured Note, $100 million a seven year and $50 million of ten year note and that’s part of our strategy to diversify our debt structure and that will allow us to better manage exposure to accepting future interest rate increases. We were able to do this with no significant additional short-term cost, just given the good rate as you can see from our interest expense in 2012 when you compare to 2011 cost that we incurred when 100% of debt without short-term.

Now that we are recognized our participants in this market, we have an NIC rating and that will make it easier and less expensive for us in the future to access this market again if we want to.

Jim Grant

Okay. Now turning to Tim Louie, VP of Land, I would like to say despite this being your first year here you’ve certainly been very busy, the Over Range acquisition has not been the only land that we’ve acquired rates, our third quarter news release mentions more than 40 sections of land rates acquired this year beyond the Open Range lands. Can you comment on these acquisitions and do you see the impact of low gas, natural gas prices on these acquisitions.

Tim Louie

Thanks, Jim. As we’ve reported in our third quarter release, 17 sections were acquired during Q3 and this is primarily in the greater Sundance area. So from January to September 41 in the quarter sections were acquired. However, a subsequent to the end of Q3 Peyto also acquired an additional 21 sections. So this brings our year-to-date totaled to 62.25 sections. And I just want to clarify this total specifically refers to lands acquired at crown sales. Jim, part of your question touched on the impact of lower gas prices on this year’s acquisitions. And to answer that, all we need to do is compare this year’s acquisitions to last year’s, so thus far in 2012, $9.2 million were spent to acquire 62.25 sections and this works out an average of about $2.30 per acre.

For last year in 2011, 63 sections were acquired. We spent about $20.9 million and that was an average of about $515 per acre. So you can see of that Peyto’s average acquisition cost has significantly dropped this year. It’s important to note that a large part of the 2012 acquisitions are within a new area for Peyto and we’re confident that this will develop into new core area. I can’t really see that much more at this time because of upcoming sales, but I well let on that we’ve assembled the land-based in excess of a township. And more information will be released in future quarterly reports in conference calls.

Jim Grant

Okay, Jean. There is reference to another small property purchase in our report. Can you give us some details on the nature and size of that purchase in terms of the land size and location of (inaudible)?

Jean-Paul (JP) Lachance

Sure Jim. In early September, we sold some asset deal whereby Peyto acquired seven growth sections, 5.1 net sections and this is in the heart of our Sundance blocks. So there is multiple targets on these lands, primary targets are Falher to upper and middle, but there is also secondary potential in the Wilrich, Notikewin and Bluesky. So we see potential for up to 17 locations on these lands.

We’ve already drilled two upper Falher wells on these newly acquired lands and these wells are being completed this week. And while we were drilling, we’re very encouraged with the samples and gas detector readings and this enthusiasm was upheld with the really tough results so far from our depletions.

Jim Grant

Okay. Darren, looking ahead to next year, our third quarter news release suggest that we are looking to build significant production organically by bringing what could be our largest ever capital budget there on the amazing inventory perspective locations. How are we going to approach funding this growth?

Darren Gee

Well that’s great question, Jim. We are growing rapidly and we have these large capital programs. So I think that’s a question that’s probably pertinent and portals in the minds of a lot of investors. But I think stepping back, we managed to deploy $0.5 billion in 2013 that’s going to be our biggest year ever which is an amazing ramp up really. When you think about three years ago, our capital program was $73 million, but there are the couple of things that are allowing us really to fund such a big capital year.

First I think a lot of it is based on the success we’re having with the drill bed. Our production and our cash flow are both growing faster than our debts growing. So that’s allowing us obviously to fund a lot with cash flow and with gas prices improving then as we go into 2013, there could be cash flow strengthening even more.

But secondly I think and this is something I think people forget about it, is the fact that we’re growing our asset base, which means our bank lines can keep growing too. We get more borrowing capacity each year, which in this environment kind of rare, I mean most companies aren’t really doing enough to keep from shrinking and so of course their bank lines are also shrinking even though they’re adding debt and that’s unsustainable and so shareholders get a bit and investors get a bit nervous when companies are growing their debt but they’re not growing their asset base.

But for us, we’re moving the yardstick down the field. We’re getting it first down every time and we’re growing our asset base and we’re growing it materially. So it’s logical that our borrowing capacity has also been a growth. And even if we use a little bit of depth to fund a very aggressive capital program, but we aren’t getting more levered. If you look at our debt to cash flows over time and they’re not increasing.

So as I look out into the future, yeah there is probably going to be some limits in terms of how much capital we can deploy at some point and when we hit those limits, I mean we’re only 41 people at Peyto, so I hope we continue growing our capital program like 30% or 40% a year, probably that’s not realistic. When we start to hit the limits of our capital spending then all of a sudden our cash flow growth really catches and we start paying back some of our debt or conversely we’ve already started to taste this cold winter that’s coming and if it gets really cold everywhere then gas prices are going to spike and we’re definitely funding everything with cash flow and maybe we’ve even got a little left over to feed it down.

But I think what investors have to keep in mind is that we fund our capital programs and we think about our growth over the long-term. I put a table in last year’s annual report where I told it up all the capital that we spend in our history, $2.3 billion worth and all of the cash flow we generated of $2.2 billion worth. And really what that says is over the long-term, Peyto funds is growth in its company, in its asset base from its cash flow, which that’s exactly what you want. But in some years, we spent more than we made and in some years we spent less than what we were bringing. But over the long run, we grew business on our base cash flow.

Commodity prices, industry activity, the capital efficiency that we see, they don’t always allow us to funded in a very balanced and linear way and that’s what, I know that’s what investors want. They want this nice linear growth that self-funded that the reality is just doesn’t happen like that. So this year, our growth and our capital programs, they’re coming in big spurts this year and next year. But that isn’t always the case obviously and so I don’t think we should think about the funding of a big capital program like this year in such short-term sort of perspective.

Jim Grant

Okay. So Darren, as we approach the end of the year, we’re seeing the gas prices recover to a level similar to the end of the year last year and we’re seeing your phase decaying as you shaped up the (indiscernible) even came in place until we saw $3 a gas again. What’s your outlook for the future, both the Peyto and just the natural gas industry itself here in Canada?

Darren Gee

Well that’s going to come as a big shock, but I guess I’m a gas bull although arguably I was supporting that rally drill for longer than I had really intended. Yeah, the arc we’ve got right now between North America natural gas prices and the rest of the world is huge. The arc between oil price from heat equivalent basis and natural gas is large too, I mean, it’s just too great. Sooner or later that’s going to have to close and I think it’s going to result in higher natural gas prices.

It may also result in lower oil prices, but you just can’t have that much value difference going on between the two energy sources. So whether its LNG exports out of North America, whether its gas to needle conversion, whether – or maybe it’s just increased natural gas demand long-term, I’m still very optimistic about higher prices for natural gas. But in the mean time, we still make great returns at Peyto at these gas prices, I mean JP was talking about earlier in the call how we’re making between 30% and 40% IRRs. Those are great returns at $3 gas.

So part two of your question, it probably comes in no surprise that I’m a big bull when it comes to Peyto too. Our business strategy just continues to perform. Our business is simple. It’s repeatable. We’ve got a dedicated team that’s very well aligned with the same objectives as our shareholders and that’s to generate real returns.

And look what we’ve done over the three years, I mean we’ve gone from 20,000 barrels a day of production to exit this year, close 60,000 barrels a day in just three years time. Now I’m getting questions from investors saying so you’re going to drill to 100,000 barrels a day which, Scott is rolling his eyes. It sounds crazy, but look at where we come from and where we’re going. I mean it’s just been amazing. So yeah that’s a region to the future. For right now, we focus on the next eight or nine wells that we have to drill and how do we drill those and bring those on production as efficiently as possible and how do we continue to be the lowest cost producer in the industry.

Those are the strengths that we have and the advantages that we enjoy. We’re going to worry about all those little things and we’ll worry about the little stuff and the big stuff, it’s going to work out just fine.

Jim Grant

So operator, I’d like to turn the call over to questions from investors and representatives of investment businesses now.

Question-and-Answer Session

Operator

Certainly, thank you. (Operator Instructions) And our first question comes from the line of Robert Bellinski from Morningstar. Please proceed with your question.

Robert Bellinski – Morningstar

Good morning everybody. Once again great quarter. Returning to your 2013 budget, I was just wondering if you could walk us through the scenario where you exit the year at 62,000. And just kind of, is that a function of worst than expected well performance or would you be shifting additional capital to plans and processing?

Darren Gee

Robert, we put out a, sort of a range for our budget. We’ve run sort of $500 million case but at the same time we’re pretty flexible at Peyto and we need to stay flexible. So the changes like last year for instance, we get a really warm winter, gas prices collapse, well then obviously we’ve got to react to that and we’ve got the luxury of being in control of all this capital that we’re spending. We’re the operator of all of these projects. So we can react to that very quickly. We can reallocate capital. We can shift our drilling schedule around. We can repopulate our drilling schedule with different species of wells that we’re better in different pricing environment.

So obviously we’re not going to pin the budget on a certain number and then say we have to stick to that with however high water, no we’re going to be flexible with it. So when we put out that guidance in terms of the base is going to go from 57,000 and it’s going to decline at 34% and then we’re going to build alleged with new. It’s, with the mind to somewhere between $450 million and $500 million at above the capital efficiency that we’re riding at. So that’s why we’ve given a bit of a range to next year’s exit numbers rather than sort of pin one number out there. Obviously we’re going to remain flexible with our program.

Robert Bellinski – Morningstar

Okay. And then second question, I was just wondering if you could give your kind of general thoughts on propane prices going forward?

Darren Gee

I’m going to turn it to Scott.

Scott Robinson

Yeah that, we have seen propane bottom out earlier this year after a fairly rapid fall from where it was in the past years down into the mid-teens dollars per barrel. But it has been recovering over the last several months and I think we’re up into the 20 some odd, $24 per barrel range right now. We don’t what prices – where prices are going. We do know that liquid propane does pay a premium over sending those molecules down the gas stream and I guess just take some of the risk out, we are layering in some hedges to this increasing propane price environment. So I guess from what we’ve seen recently, we would think that propane would continue to increase in value or at least hold where it’s at right now and we’re quite happy where it’s at right now in terms of some of the planned investments that we’re making and the returns that we’ll get from increased propane recoveries.

Robert Bellinski – Morningstar

Sounds great. Thanks guys.

Darren Gee

Thanks Rob.

Operator

And our next question comes from the line of Kevin Kaiser with Hedgeye Risk Management. Please proceed with your question.

Kevin Kaiser – Hedgeye Risk Management

Hey, good morning guys.

Darren Gee

Good morning.

Kevin Kaiser – Hedgeye Risk Management

So on the ‘13 CapEx budget you touched on this a little bit, but $500 million to $550 million that’s basically up $50 million year-over-year and considering the organic growth you guys have had in 2012 and the open range acquisition, it seems a little bit on the light side to me. What kind of impacts, is that just little bit cautious on winner gas and what has to happen for you guys to think about taking that rig count from eight in March to backup later in the year.

Darren Gee

We’re, obviously starting you’re looking at, Kevin, all the organic activity. We haven’t obviously budgeted any acquisition dollars and we don’t normally even though we are constantly looking at what’s for Peyto and whether there is an opportunity for us to generate competitive returns that way too. This year is a good example for instance where we’ve already spent $200 million on acquisitions, which isn’t normal for us. But opportunities presented themselves, so we jumped on them.

The $450 million to $500 million really is all just well related and facility related its all organic activity at this point. We’re confident with the activity level we’re currently at that we’re capable of executing and not losing any of our efficiencies that we’ve been enjoying over the last few years. And that’s something that we’re always very cautious about for sure. We’re always considered of, if we add two more rigs, what does that due to, how busy we are around here, we’re making the right decisions as we go along the way or are we allocating our capital in the most efficient ways or are we getting too busy to be able to make those calls as effectively as we were.

And so that’s something that obviously we have to be very considered of as we move forward, but that’s not to say that if we don’t – if we see good purchasing power, we see great service costs, we see continued reduction in well costs, capital efficiencies continue to get better as we move into 2013 and definitely we would consider, can we do more. We probably will be doing more with the exact same amount of money at the end of the day and that would be ideal, in fact, if we’re getting more for the $500 million and even tough we were going to get.

I wouldn’t be surprised actually if we saw in 2013 our capital efficiency numbers even lower then 17,000 and 18,000 willing there off, just with some of the efficiency we’re seeing in this fourth quarter in terms of drilling times and those kind of things coming to bear most recently. So, we’re trying to be as aggressive as we can possibly be, we’re always sort of cautious about what that actually is, but to be honest like you, over the last two years, we’ve been very pleasantly surprised that how much busier we can get and while still maintaining the returns the capital efficiencies that we like to enjoy that obviously generate returns for our shareholders.

So I don’t know want to say there is a limit because I know where that is but we’re careful in expanding to that limit, just because we don’t wanted to impact obviously the returnings that we’re generating. We know we can generate great returns. And time is on our side really. We don’t – with these 1,000 locations that we’ve got in inventory, all these lands are basically continued, it’s not like we have to get it all drilled in the next couple of years to hold it or anything. And that’s the nice thing about the multiple stack formations in the deep basin is that we’ve got all these lands already continued with a lot of our vertical productions and so we can take our time a little bit and develop the side as efficiently as possible.

Kevin Kaiser – Hedgeye Risk Management

All right. And kind of a, in the same vein, talk up a little bit about the competitive environment recently with AECO back above $3. You mentioned how much lower the acreage costs are year-over-year and that competition is down, but maybe quarter-over-quarter or even more recently, have you seen any uptick in competitive pressure in the area?

Darren Gee

Well, definitely when gas like back over $3 a day price, we saw some shut in production I think in Alberta and in Western Canada come back on line. I think EnCana talked about bringing on some production that they’d had shut in for instance. We didn’t have any production shut in because our costs are low enough, so we’re making good cash flow even at the lowest part of December prices that we saw. We haven’t seen it yet in terms of rig count, especially gas directed rig count. I don’t think we’ve seen it even at the last sales that we’ve been at in October, as Tim alluded to me we picked up a good chunk of land in October. So those most recent sales were still at very good prices.

I don’t – we haven’t got an indication and I haven’t got an indication and you’re looking at it a lot of producers probably too that the capital budgets for 2013 are going to be a lot bigger for a lot of gas producers then they were in 2012. So, we’re not anticipating there’s going to be more activity and more competition. Even that a lot of the service companies that are reporting now are – they’re pretty cautious about 2013, pressure pumping services, even the gas reacted activity is expected to be pretty minor.

So I think we’re in a great position in going into 2013 even at these gas prices and even at the forward strip. Where that tipping point is, I don’t know, I mean we can speculate that maybe its closer to $4 in Western Canada. I’m not sure what the magic number is that gets a lot of people encourage to go back into the gas drilling and start doing a lot more gas development work. Even in the U.S. I don’t know think it’s there yet. And so this is, I’ve said this before, this is a sweet spot for us really, the $3.50 gas price, I think is a perfect environment for us where we generated 30% somewhat profit margin at $3.50 gas and we don’t have to compete with much of the industry because they just aren’t efficient at this level.

Kevin Kaiser – Hedgeye Risk Management

All right. And last one for me, I often hear that Peyto does not have enough land – the land basis aren’t large enough or the reserves, future locations aren’t large enough to justify valuation, yours respond to that.

Darren Gee

Yeah, I don’t – I think where that comes from is just the people’s misunderstanding about the deep basin. You have to think about our inventory of opportunities in the full three dimensions. It’s not just the surface area, for sure when you look down on Peyto’s land base, it doesn’t look very big especially compared to somebody who has got 1 million acres of money rights or something in Northeast BC. But it’s all these staked formations that we’ve got that really turns a small two dimensional space into a very large amount of acreage really. I mean, more than – when you break it up by zone or land base more than doubles. And the land that we have bought is very targeted lands like we sort of do at the reverse of the rest of the industry. We do all of our geotechnical work first.

We do all of our risk assessment first. We do all of our de-risking if you will in advance of going to land sale and then we buy little drilling islands with drilling locations on them with known drilling locations on them. So for us, we have a lot of inventory in a smaller amount of land because none of it is just speculative land purchase and that’s kind of offset, I mean, a lot of the industry works the other way with the growth by big tracks of land and then issued seismic in the drill export wells and they try to proof up, which parts of the land are perspective or not.

And in doing so, obviously they define sweet spots but at the same time, they’re basically rendering a lot of the land as non-perspective. And we just don’t want to carry the costs of that non-perspective piece, which can be significant. So we do at the opposite way and I think that’s worked out very well for us over the long-term. We don’t have big expiry issues that are trying to change how we would allocate capital around. We get to concentrate in smaller areas, return drilling into production in cash flow whereas a lot of other producers end up drilling a lot of step out exploratory type wells to de-risk their land but they never get that get it on production and so they’re not generating cash from that capital expenditure and that that becomes unsustainable over the longer term and it gets you into a dangerous place. So, I think they way we either approached it is the right way, it’s the more careful way and it’s definitely the way that yields real value quicker for shareholders than the opposite.

Kevin Kaiser – Hedgeye Risk Management

That’s good color. Thank you, guys.

Darren Gee

You bet. Thanks again.

Operator

(Operator Instructions) And our next question comes from Fai Lee from Odlum Brown. Please proceed with your question.

Fai Lee – Odlum Brown

Hi Darren, it’s Fai here. I just wanted to ask you about the open range, sorry, the open range assets peak, in the press release you mentioned the costs were higher for open range and I guess the Peyto assets. And I’m just wondering if that’s just a function of lower processing volumes through the processing facilities and also I’m wondering if there is opportunities to bring those costs down over time?

Darren Gee

Yeah, Fai, well they did have higher operating costs than us. They still actually had lower operating costs at most the rest of the industry. And they had made some moves sort of late in the life of open range if you will that had brought their costs down even further. So like that their second quarter which they filed so that they had much lower operating costs year-over-year even.

And a lot of that had to do with the second facility that they built. They pulled a lot of third-party processed volumes away from other facilities and brought them into an operated facility which now we’re enjoying because we’re obviously owner and operator of that facility and it had a bunch of capacity and it too, they’d over built it. So now we’ve got a bunch of room to bring on additional production and spread some of those fixed costs over and even larger base of production which obviously on a pretty unit basis that lowers operating costs on that asset.

So as much as they weren’t growing fasten enough to continue to drive their operating costs down, we are going that asset base much more rapidly and that in doing so we’re driving those operating costs down. Scott, do you want to…

Scott Robinson

No that’s, the fourth quarter or second quarter of this year their cost level has dropped to something right in the order of our costs and you’re right on with the volume increases we expect over the rest of the year. That element of our production will have some of the lowest costs that we have. So certainly the open range assets have not caused us anything in terms of cost structure burden, if anything and enhanced our opportunity going forward to continue to maintain low cost. We’ve said that element of our operations up with staffing and the operations philosophy very similar to our other areas and I wouldn’t expect its performance to be any different than our other areas.

Fai Lee – Odlum Brown

Okay, good. Thanks.

Operator

There are no further questions. I will now turn the call back over to you Mr. Jean.

Jean-Paul (JP) Lachance

Well, great. Thanks very much. This is a busy week of reporting as I know everybody is, probably there is another three or four conference calls at the same time here, but, thanks to those are tuned in but this was another great quarter for Peyto. I want to send out a thank you again to the Peyto team integration of the Open Range acquisition was a lot of extra effort to a lot of extra work and our team performed very adverbially in getting that done quickly and efficiently. So, thanks to all their hard work and dedication.

And as we talked about the pace of growth rate now is draft and furious. So stay tuned to the Peyto website and my monthly reports and to see how that growth is happening and this rapid pace that we’re undertaking how things move going forward and I guess we’ll talk to you in the New Year.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation. And ask that you please disconnect your lines. Have a great day everybody.

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