Pengrowth Energy's CEO Discusses Q3 2013 Results - Earnings Call Transcript

| About: Pengrowth Energy (PGH)
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Pengrowth Energy Corp (NYSE:PGH) Q3 2013 Earnings Call November 7, 2013 5:30 PM ET

Executives

Derek Evans - President, Chief Executive Officer, Director

Marlon McDougall - Chief Operating Officer

Analysts

Kyle Preston - National Bank Financial

Dirk Lever - AltaCorp Capital

Gordon Tait - BMO Capital Markets

Operator

Good afternoon ladies and gentlemen. Welcome to the Pengrowth Energy Corporation's Third Quarter Results Conference Call and Webcast. I would now like to turn the meeting over to Mr. Derek Evans, President and Chief Executive Officer. Please go ahead.

Derek Evans

Thank you, Patrick. Good afternoon, ladies and gentlemen. I am Derek Evans, President and CEO of Pengrowth. Joining me today on the call are Chris Webster, our CFO; Marlon McDougall, our Chief Operating Officer; Bob Rosine, our Executive VP, Acquisitions and Divestitures, Andrew Grasby, our Senior Vice President, General Counsel and Fred Kerr, our Vice President of Investor Relations.

Before we begin, I remind you that certain information presented today, may constitute forward-looking statements. Such statements reflect current expectations, estimates, projections and assumptions of the company.

These forward-looking statements are not guarantees of future performance and are subject to certain risks, which could cause actual performance and financial results in the future to vary materially from those contemplated in the forward-looking statements.

For additional information on these risks, see Pengrowth's Annual Information Form under the headings Risk Factors and Forward-looking Statements.

Let me begin by reiterating as we do every quarter, that we intend to maintain Pengrowth's dividend at the current level of $0.04 per share per month. This afternoon, I will describe Pengrowth's strategy and highlight some of the recent milestones we have achieved as we executed that strategy before moving to reviewing our third quarter results. I will conclude by describing Pengrowth's outlook for our business.

I want to leave you with a number of key messages today. First and foremost, Phase 1 one of our Lindbergh project is fully funded. We have closed on over $985 million of the $1 billion disposition program.

Number two, the Lindbergh pilot continues to achieve expectations from a production rate and ultimate recovery perspective. Engineering analysis and type curve forecast suggest that production rates from that pilot from the pilot wells will soon commence their natural decline and as expected Instantaneous Steam Oil Ratio will start to increase.

Drilling and facility construction at Lindbergh has started in mid-September and that the Lindbergh project remains on budget and on time. Finally, our conventional business, our cash flow generating engine continues to deliver strong production and funds flow from operations that continue to exceed expectations.

Let me continue with a brief review of our strategy and our segment (inaudible). We believe that the Western Canadian Sedimentary Basin has fundamentally changed. The natural gas business in North America is challenged by low prices as our industry has become a victim of its own success in expanding the supply of that commodity. The light oil business offers quick payback but is challenged by high decline rates that makes achieving real growth a huge challenge.

The majors have come back to our basin, competing in a liquids rich gas business and taking on large oil sands projects. They have very long time horizons and we cannot go toe-to-toe with them and hope to be successful. In this environment, we do not only believe that hoping for return to better commodity prices amounts to a strategy.

Pengrowth is one of the few companies that applied a differentiated strategy to address this new paradigm. We want to operate small thermal oil projects that have low decline rates, low capital reinvestment requirements and long reserve life. The advantages of the lower decline rates offered by thermal oil is that it will allow us to reduce the amount of oil we have to invest just to keep production flat, which should allow the company to generate more free cash flow, which in turn makes it easier to fund our dividend as well as providing cash to pursue profitable growth opportunities.

We have identified a niche for a medium-sized player like Pengrowth already generating meaningful cash flow to enter the thermal oil business with the right team and the right approach, developing projects that are too big for the single play juniors to fund and too small for the majors to consider.

That is Pengrowth's niche. Thermal oil projects offering up to 50,000 barrels per day per project with low steam oil ratios, low declines, low sustaining capital requirements, long reserve life and high probability. While we hope to someday operate several of these thermal oil projects, our first thermal project is Lindbergh.

Lindbergh is well suited to supporting a dividend. It is expected to allow Pengrowth to boost its production or its proportion of oil and liquids from just over 50% today to over 80% by 2018. More importantly, has the Lindbergh potential to almost double Pengrowth cash flows by 2018.

On the disposition front, the first phase of Lindbergh is fully funded, thanks to the successful $1 billion asset disposition program. In the first quarter, we closed the sale of our non-operated Weyburn unit interest for gross proceeds of $316 million. During the third quarter, we announced the sale additional assets, mainly the Southeast Saskatchewan assets comprising approximately 5,700 BOEs a day of non-core production for proceeds of $510 million. We also announced that we have sold or signed letters of intent for non-core assets which were expected to generate additional $203 million in disposition proceeds. While these were good assets, we want shareholders to remember that we are trading them for lower declines, longer life, lower maintenance cost assets at Lindbergh.

Following the closing of the non-core dispositions, Pengrowth had approximately $580 million of cash on hand as at September 30, 2013. These proceeds will be used to provide the capital for the development of the first 12,500 barrel a day commercial phase of Lindbergh, as well as provide Pengrowth with a balanced cash flow profile through 2014 whereby cash outflows are equal to cash inflows and cash on hand. As a result, Pengrowth expected no additional debt will be acquired through 2014 prior to anticipated funding requirements for future phases of Lindbergh.

At Lindbergh, with the receipt of Environmental Protection and Enhancement Act approval on July 15, civil construction of the first 12,500 barrel a day commercial phase commenced in August with $170 million total project capital being spent by the end of the third quarter. Engineering is 90% complete. All major equipment has been ordered and skid fabrication is underway. Mechanical construction of the central processing facility and the drilling of 23 additional well pairs to supplement the two well pairs currently producing at the Lindbergh pilot commenced on schedule in September.

Pengrowth also been investing in multiple transportation options at Lindbergh to ensure market access and best price. This includes negotiating access to neighboring pipeline infrastructure, building a truck terminal with excess capacity and taking advantage of rail. Approximately half of the first phase investment has been committed and the project remains on budget and on schedule.

Pengrowth expects first steam in the fourth quarter of 2014 and first oil in early 2015. Operations in the pilot continue to show strong results during the quarter with combined field production from the two well pairs averaging approximately 2,000 barrels per day of bitumen with an average Instantaneous Steam Oil Ratio for the quarter of 1.8 times.

Since steaming commenced in February of 2012, cumulative production from the two well pairs had been in excess of $840,000 barrels of bitumen through September 30, 2013 or 35% of estimated ultimate recovery of reserves for the pilot at a Cumulative Steam Oil Ratio of two times.

Pengrowth expects the two Lindbergh pilot well pairs to achieve a cumulative production of 1.2 million barrels per well pair and achieve a recovery factor in excess of previous expectations prior to pilot results.

With significantly higher than expected production rates and the greater level of reserves recovered to-date, engineering analysis and type curve forecasts suggest that production rates from the pilot well pairs will soon commence their natural decline. As expected, the Instantaneous Steam Oil Ratio will start to increase.

Recovering Lindbergh reserves sooner than originally forecast, enhances the net present value of the project. Total Lindbergh project decline rates are expected to remain in the range of 10% annually, as previously disclosed, due to the commercial project's production being spread over many wells of various ages.

For the third quarter, Pengrowth reported solid production of 83,275 you BOE per day and funds flow from operations of $0.31 per share, both of which were above expectations. Third quarter operating expenses were higher than anticipated largely as a result of significantly higher than budgeted power prices, higher non-operated partner expenses and increased fluid trucking costs.

As many of these items are expected to continue to impact operating costs in the fourth quarter, Pengrowth has revised its 2013 full year operating guidance to $15.70 per BOE. The primary driver of the increasing operating costs is power. Since 2010, Pengrowth's power costs have increased operating cost by approximately $2.00 a barrel, as realized generating and transmission costs in Alberta have almost doubled in price.

To mitigate some of the power price volatility in operating cost structure, we continue to hedge power with 65% of expected 2014 power consumption hedged at $56.30 a megawatt hour. In addition, we continue to advance internal power generation projects in Swan Hills, Olds and Lindbergh.

In closing, we know that the market. We will this year on how well we maintain our cash flow, on Lindbergh milestones and on our continued ability to execute on our strategy. Pengrowth remains on track to execute on differentiated strategy of becoming a sustainable, low decline thermal bitumen producer. We continue to deliver solid operational results from our conventional program. We have realized significant value from our disposition program in a very challenging market and our Lindbergh project continues to surpass expectations.

Pengrowth is poised for the next phase of our strategy, the development 12,500 barrel a day, first commercial phase of Lindbergh and we look forward to providing shareholders updates on construction of the first phase in the coming months. We will continue to place a strong emphasis on improving sustainability, which implies balancing cash inflows and outflows, slowing down the decline in treadmill, generating meaningful growth in cash flow per share and shifting production decisively toward oil and liquids over the next few years.

That concludes my prepared remarks. Patrick, do we have any questions in the queue?

Question-and-Answer Session

Operator

Thank you. We will now take questions from the telephone lines. (Operator Instructions) The first question is from Kyle Preston from National Bank Financial. Please go ahead.

Kyle Preston - National Bank Financial

Yes. Thank you and good afternoon, guys. Just a couple of questions. So your first one. Just given the strong performance you continue to see out of this pilot project, does this change any of your outlook assumptions for the commercial project going forward? In particular, the long-term SOR rate?

Derek Evans

Kyle, no, at this juncture, what we are seeing when we talk to strong performance, obviously strong performance in terms of production rate and instantaneous steam oil ratio, but we haven't actually seen the decline kick in yet. From what we have seen and we have recovered approximately a third of the barrels that we expect to recover, the rates have been higher and the amount of production that we have recovered is larger than we think. So we think those are both very positive sign that could lead you to believe that the recovery factor is going to be substantially higher than what we are currently modeling in our forecast.

Kyle Preston - National Bank Financial

Can you remind me again what SOR you are modeling?

Derek Evans

We are modeling an SOR of somewhere in the neighborhood of 3.6 in terms of the design of the facility.

Kyle Preston - National Bank Financial

Okay. Thank you, and just a couple other questions. First one the op cost. You have increased the guidance there. How should we be thinking about op cost in 2014 as your conventional production continues to decline? I assume there is some fixed cost built in there?

Marlon McDougall

Yes, Kyle, it's Marlon. We certainly see a few one offs that are driving Q4 op cost up, I think with our hedging program into 2014 and are build out of some of our cogen, we are going to able to mitigate some of the peaks we have seen in the power side. So we think the 2014 op costs will be obviously a little better than what we exit out of Q4. So we will update you with that here when we get to our guidance at the end of the year.

Kyle Preston - National Bank Financial

Okay, and that cogen plant that you building at Swan Hills in Olds, is that all third-party funded or do you guys participate is that?

Derek Evans

It's funded third-party.

Kyle Preston - National Bank Financial

Okay, thanks. That's it for me.

Operator

Thank you. The next question is from Dirk Lever from AltaCorp Capital. Please go ahead.

Dirk Lever - AltaCorp Capital

Hi. That's very much. Actually Kyle asked exact question I was going to ask on the outlook. So I am good. Thanks very much.

Derek Evans

All right, Dirk.

Operator

Thank you. The next question is from Gordon Tait from BMO Capital Markets. Please go ahead.

Gordon Tait - BMO Capital Markets

Thanks. Just wondering, with your capital spending and your conventional, a lot of it seems to be going into you Cardium program and stack allocation, not much going into Swan Hills or Judy Creek, which used to be pretty important area for Pengrowth. Is it the cost structure up there? Is it lack of opportunity? Or am I missing something? Is it still a pretty important area from your conventional capital perspective?

Marlon McDougall

I think the way the opportunity stack up is, I would say, Gordon, it's Marlon, that the risk profile is a little higher than what would be in the Cardium. So the return, as far as the projects go, is better in the Cardium than it is in the Swan Hills area. It's a huge piece of business for us but we like to think of it more in terms of managing decline. There is large oil in plays. We have got bit water plugs. We have got miscible floods going on there and it will continue to be a significant cash flow generator with a low decline but we just see that the drilling inventory and the risk associated with it is higher than the other parts of our portfolio. So we will be funding more of the Cardium style of opportunities.

Gordon Tait - BMO Capital Markets

Okay, and then the pilot pair at Lindberg, it seems to me it has been producing 2,000 barrels a day for quite a while. What does that profile look like? You are now saying you expect it will start to fall off a bit and the steam ratios will pick up, but how long was it at that level for?

Marlon McDougall

So it has been producing in there. I think if you took the noise out of the turnaround that happened where you had a large piece of your production afterwards, you could probably look at the profile and see that it was peaking around 2,000 barrels a day sometime in May or June. How long it goes for is the million dollar question right now, but we certainly expect with the higher than anticipated deliverability and the larger recovery to-date, that the decline will kick in reasonably soon and start going to its natural decline in to the last third of the life of the well, if you will, or half of the life of the well, which will take another five to seven years to achieve. Right.

Gordon Tait - BMO Capital Markets

Okay. Then lastly, power cost [issue], so I was just wondering what sort of power requirements are you going to have at Lindbergh once you get your commercial project?

Derek Evans

I believe, we are going to build cogen in stages similarly to how we are doing the commercial project out there. So we are going to have 13 to 15 megawatts built for the first stage and you will see that the additive as we build out to 30,000 and 50,000 barrels a day, so you can look to see that go from that 15 to 30 to 40 megawatts of power that will be required at 50,000 barrels a day.

Gordon Tait - BMO Capital Markets

You will build that on your own?

Derek Evans

Yes. We will build that coincident with the expansions as they come along.

Gordon Tait - BMO Capital Markets

Okay. Thanks.

Marlon McDougall

Sorry. Derek, I just wanted to add on and talk a little bit more about some of the other things that we are doing on the power side. I think you will see in the press release that we are talking about 26 megawatts of power that we are involved with at third-party trying to provide a little more not only lower price power, but also reliability.

As you think about the Lindbergh. It isn't only just about making sure that we have got a little power costs. It's also making sure that we have got good transmission, system reliability or that we are not relying on their transmission system to provide the power, so the big projects lying on Swan Hills area, which is our biggest power sink as well as a project we are about to get initiated in the Olds area, so we are attacking this power issue very seriously.

Gordon Tait - BMO Capital Markets

All right. Thanks.

Operator

Thank you. (Operator Instructions) Next question is from (Inaudible), private investor. Please go ahead.

Unidentified Analyst

Yes. My question is about the maintenance of current dividend of $0.04 per share. Is it 2013, 2014? Is there any approximate projection on that?

Derek Evans

Thank you very much for that question. I think in my opening remarks, I made the comment that by reiterating as we do every quarter that we intend to maintain Pengrowth's dividend at the current level of $0.04 per share per month.

Unidentified Analyst

Thank you.

Derek Evans

Thank you.

Operator

Thank you. There are no further questions at this time. I would like to turn the meeting back over to Mr. Evans.

Derek Evans

Thank you, Patrick, and thank you everyone for taking the time to listening on our third quarter call. We are very excited with prospects that await Pengrowth and its shareholders. We achieved several significant milestones this past year, which support our long-term goal of becoming a sustainable, low decline dividend paying thermal energy producer.

Pengrowth's business plan is now fully funded, our Lindbergh project is de-risked and is already making a meaningful contribution to our improving profitability. I invite all of you to mark January 16th on your calendars as this is the day when we will host our Annual Investor Day in Calgary, which will include our 2014 guidance on production, finance and investment plans. Those of you who can't join us in person will be able to view that presentation www.pengrowth.com, our Pengrowth website.

Thank you all for your participation today and that ends my prepared remarks.

Operator

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

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