Frontera Energy Corporation (OTC:FECCF) Q3 2018 Earnings Conference Call November 8, 2018 10:00 AM ET
Gabriel de Alba – Chairman of the Board
Richard Herbert – Chief Executive Officer
David Dyck – Chief Financial Officer
Duncan Nightingale – Corporate Vice President, Operations, Development & Reservoir Management
Jason Wangler – Imperial Capital
Jenny Xenos – Canaccord Genuity
René Burgos – CarVal
Good morning. My name is Jude and I will be your conference facilitator today. Welcome to the Frontera Energy’s Third Quarter 2018 Results Conference Call. All lines are currently on mute to prevent any background noise. This call is scheduled for 60 minutes. I would like to remind you that this conference call is being recorded today and is also being webcast on the Company's website.
After the speakers' remarks, there will be a question-and-answer session. Analysts and investors are reminded that any additional questions or concerns can be directed to the company at email@example.com.
This call contains forward-looking statements, which reflect the current expectations or beliefs of the company, based on information currently available. Forward-looking statements are subject to a number of risks and uncertainties that may cause the actual results of the Company to differ materially from those discussed in the forward-looking statements.
Factors that could cause actual results or events to differ materially from current expectations are disclosed under the heading Risk Factors and elsewhere in the Company's annual information form dated March 27, 2018. Any forward-looking statement speaks only as of the date on which it is made and the Company disclaims any intent or obligation to update any forward-looking statement.
I would now like to turn the call over to Mr. Gabriel de Alba, Chairman of the Board of Frontera Energy.
Gabriel de Alba
Thank you, Judy and good morning, everyone. Thank you for attending today's conference call to review Frontera's third quarter 2018 financial results, and provide an operational update.
I'm joined by Richard Herbert, our CEO and David Dyck, our CFO. I’ll start by saying that from the Board's perspective the company's position and outlook are strong and improving. Despite production interruptions last quarter current net production has now turned to over 65,000 barrels of oil equivalent and is expected to grow to the fourth quarter.
Based on these as well as successful cost management and the expiration of our hedges at the end of October we are now going to be able to benefit from robust rent prices in November and December. With is we are re-affirming our guidance for EBITDA. The board continues to believe that Frontera is trading at a significant discount to its true value.
On the basis of multiple metrics, on the board and management are 100% committed to realizing full value for shareholders. We have deals and an exceptional strong team of operators who are moving forward exploit the value for high quality focused assets in Colombia and Peru.
The company has also made significant progress in strengthening our balance sheet on winding legacy commitments and focusing on sustainable growth. Cash flow generation is important and improving and overall the capital efficiency of the country is very strong.
We still believe there are opportunities here especially opportunities focused on the shareholders, who are making progress improving the liquidity of the Company's equity as David will describe and we continue to be very careful about how we use our robust balance sheet and cash resources to enhance shareholder value.
In addition to our spending on growth and maintenance projects we intend to continue to buyback stock and we'll evaluate further shareholder value creation options for the company. I would like to also provide now a brief update on some exciting additions to our board of directors.
We have added Orlando Cabrales a former Vice Minister of Energy in Columbia and Head of the ANH to our Board. Orlando is an integral figure within the oil and gas industry in Colombia. Orlando replaces Camilo Marulanda whose recent appointment as President of ISAGEN consumes more of his time and has caused him to step down.
I would like to express my thanks to Camilo for his valuable introduction to the board over the past few years as we will position Frontera to be the leading publicly traded upstream oil and gas company Latin America.
We are also very excited to welcome Veronique Giry to our board. Veronique is the V.P. and Chief Operating Officer of ISH Energy in Calgary. And she brings with her an impressive technical carrier in the global oil and gas sector which will complement the other technical members of our board. Her deep experience will also provide additional insight and perspectives for the company as we continue to pursue growth opportunities over the medium and long term.
I will now turn it over to Richard, who would go through the operational updates of the company.
Thank you Gabriel. And good morning everybody and thank you for joining our call today. I'm going to talk about three important areas of Frontera. Frontera’s business in this summary.
First I'll make some observations about our operations during the quarter. Second I will give you an update on some of the strategic initiatives that we're pursuing. And third I'll talk about the progress to build out our portfolio and position for Frontera for the long-term.
So, starting with the summary of the third quarter Frontera delivered strong results despite the quarter's production being down 9% due to the interruption of production in Peru from the force majeure event on the NorPeruano pipeline, which forced us to shut in block 192.
In total the pipeline was out of service for 92 days of which 62 days were in the third quarter impacting our quarterly production by an average of 5,700 barrels per day. As a result, of the pipeline outage our service contracts on Block 192 has been extended until September 2019.
Production in Colombia was impacted by higher PAP royalty volumes at Quifa, linked to higher oil prices and restrictions in our water handling activity at Casimena. I'm pleased to announce that production is now back on track at over 65,000 barrels of oil equivalent per day net after royalties and is expected to grow throughout the fourth quarter.
In line, with our plan we have recently started up the CMA water handling capacity expansion project in our main heavy oil field Quifa. When all phases of the project are operational at the end of this year, we will have nearly 40% of additional water handling capacity at the field.
Daily oil volumes are expected to increase through the fourth quarter by 2,000 to 3,000 barrels of oil per day. As we reactivate up to 80 shut-in wells. We remain focused on key relationships in the ways of working which make the natural partner for the governments and communities where we operate.
We seek to operate at the highest levels of HSE performance and ethical compliance to bring technological solutions and to be seen as a positive force in our interactions with communities where our assets are located. We were very proud recently to be awarded the Global Compact Canada award for our execution of sustainable development goals in Colombia.
Moving to my second theme, we continue to execute on our key strategic initiatives. Our balance sheet continues to improve and we generated cash flow from operations in excess of capital expenditures of $65 million, which helped our cash position grow to over $718 million during the quarter. This strong financial position is important for the execution of our longer term growth plans.
We continue to focus on improving the quality of our portfolio with investments in exploration and development that play to our core strengths in Colombia and Peru. During the third quarter, we had success with Acorazado-1 well on the Llanos 25 Block in Colombia which will be put on production in 2019.
The company plans to drill 36 wells in the fourth quarter, 22 of these wells are new development wells at Quifa. Four development wells will be drilled in our light and medium oil business unit. And two of the wells are at Zopilote Sur on the Cravo Viejo block as a result of technical reviews of the assets and the granting of new acreage around the block from the ANH.
We've recently finished drilling an exploration well at Coralillo-3 and this is encouraging preliminary results similar to those that we encountered earlier in the year in Coralillo-1. Wells at Jaspe and the start of a waterflood pressure maintenance project on the Orito and Neiva CPI blocks look to add additional reserves and improve the company’s overall decline rates.
During the third quarter, we also terminated two long-term ship or pay transportation contracts on the Bicentenario and Caño Limón-Coveñas pipelines for non-provision of service. The termination of these contracts has reduced our future transportation commitments. In addition, we have recently initiated a number of cost savings projects, which will improve the organizational and operational efficiency of the company in 2019 and beyond. The benefits of these projects are already being demonstrated. For example, last month the company reduced office headcount by 15%.
Moving to my third theme, we continued to work on realizing the company's medium to long-term growth opportunities. These projects include our continuing exploration program in 2019 licensing land opportunities in Colombia and Ecuador and the potential for new contracts in Peru on Block 192.
On this last block, we are in frequent contact with Petroperu and the Peruvian authorities on the developing process to return the block to the state company. And we remain interested in 2019 process to select the partner for the block, if the terms are competitive. I continue to visit Peru frequently and have been very impressed with the operations we have in the country including our offshore Z-1 block where we are in the process of testing the gas production potential from the Albacora and Corvina fields.
I will now turn the call over to David Dyck, our CFO who will review the financial highlights of the third quarter.
Thank you, Richard and good morning. Frontera reported a very positive financial result in the quarter. We generated net income of $47 million or 0.47 per share during the third quarter. The first time the company has generated net income since first quarter of 2017. As previously mentioned we generated $65 million in free cash flow in the quarter with cash flow from operations of $189 million, exceeding capital expenditures of $124 million. This was contributed to the growth in our cash balances by over 7% to $786 million in total cash and by over 6% on an unrestricted basis to $587 million.
In October, $45 million restricted cash became unrestricted with the satisfaction of terms relating to the sale of PEL. Additionally, $64 million of standby letters of credit were drawn relating to the Bicentenario transportation commitments. This amount will be a use of cash during the fourth quarter but the company is pursuing actions to reclaim that money over time.
Working capital remains stable at $331 million, an increase of $14 million compared to the second quarter of 2018. General and administrative costs decreased 12% quarter-over-quarter as we have simplified the organizational structure and made the company more operationally efficient. Further cost savings are expected to be realized in the coming year as operational processes in the field are streamlined and we continue to look for additional ways to simplify our business.
The balance sheet remains very strong at Frontera, as we are focused on maintaining conservative and manageable leveraged metrics for the company. Net debt to trailing 12-month EBITDA is zero times, debt-to-book capitalization is 22.7% and interest coverage is at 12x EBITDA on a trailing 12-month basis. It is important to note that these conservative metrics have been maintained during a period when the company was negatively impacted by our legacy hedge positions and higher transportation costs. Based on the strength of our financial condition, S&P has reaffirmed its BB- credit rating with a stable outlook on both the company and its long-term debt.
As we move into 2019, the company is updating its hedging strategy with our hedges rolling off at the end of October. We are unhedged for the remainder of 2018. For 2019, our goal now is to hedge sufficiently to protect Frontera’s capital expenditures and financing costs through a combination of financial instruments while retaining the upside benefit from higher brent oil prices.
Finally, the company is reaffirming its annual guidance for operating EBITDA of $400 million to $450 million and per barrel transportation costs of $12.50 to $13.50 per barrel. Other guidance targets have been updated for year-to-date results, capital expenditures for the full year are now forecast to be between $440 million to $460 million, down 5% at the midpoint from the previous range of $450 million to $500 million.
Additionally general and administrative costs have been have been decreased by 5% to reflect savings from organizational efficiency programs. Annual production guidance is reduced 5% at the midpoint between 63,000 to 65,000 Boes per day reflecting the loss of production in Peru and higher PAP royalties that we mentioned earlier.
As a result of lower production volumes, production cost per barrel is now forecast to be $14 to $14.50 per barrel for the full year, an increase of 10%. Lastly, I would like to highlight the improved trading liquidity of the Company’s equity. Over the past six months, following the two for one share split and the implementation of a normal course issuer bid to buyback the Company's stock, the average daily liquidity has nearly quadrupled to approximately 200,000 shares per day, reflecting the benefit of these actions.
To date we have purchased 480,561 shares and we have spent $6.7 million on that program. We believe that there is room for continued improvement and we are exploring options to help increase trading liquidity. I will now turn the call back to Richard for some closing comments.
Thank you David. As you have heard Frontera is making progress on numerous fronts. Production from our core assets remains strong and we are near to completing a major infrastructure project at our most important field Quifa. We're simplifying our business and reducing costs with significant progress made in 2018 in transportation costs and in G&A.
Our 2019 budget will reflect the ongoing efforts to reduce our field operating and capital costs. We continue to position for new opportunities to strengthen our portfolio and provide new production in the medium and long-term, which we are well positioned for with our strong balance sheet.
And as the Chairman said in his introduction we continue to look at other options, which help to create value for our shareholders. With that I'd like to turn the call back please to our operator Judy who will coordinate any questions that you might have.
Thank you. [Operator Instructions] Your first question comes from the line of Jason Wangler of Imperial Capital. Your line is open.
Good morning. Wanted to ask as you start talking about 2019, I think the beginning of this year you started to say that we're going to start to deploy some this cash that we've built-up and obviously the strong balance sheet. Really the balance sheet has only gotten better throughout the year as you guys cut costs and oil prices have been helpful, not just to continue with the hedges rolling off, as you look at 2019 and then obviously you talked about a bunch of different things that you guys could be doing financially and operationally, how do you think about kind of positioning that? And do you expect to kind of deploy more capital I guess into those initiatives given where you sit in?
Yes, Jason, thank you for the question. I mean, as you observe we've been able to build our cash position during this year. Thanks to the strong cash generation that we've had from the business. I think in terms of what we're going to do in 2019, it's a little bit premature to talk about that at this stage. I think we are still in the process of finalizing our plans for 2019. And obviously once those final and signed off by our board, we will be we will be sharing them.
But I think directionally – I think what you can expect to see is a strong capital program to help sustain our business. But in addition, we're looking at other ways that we can deploy our cash to ensure that we are rewarding our shareholders. And so that's what we're currently involved in.
Okay. And you talked about obviously in the release as well as in your prepared remarks but I believe you put on some floors for hedging. Is that kind of the strategy going forward now with the balance sheet where is that just basically protecting the downside and then allowing you to participate in outsiders, should you look for some other initiatives on that side?
Yes, Jason, let me ask David to address the hedging policy going forward.
Hi, Jason, it’s David. Yes, that’s the way we're looking at our hedging program as we move into 2019. We're just at the beginning part of it and we're continuing to evaluate how we balance our hedging program with our capital expenditure program. But given where we've come from in 2018, looking at buying insurance through a throughput program is the initial part of our hedging program as we execute in 2019.
I appreciate. I’ll turn it back.
Your next question comes from the line of Jenny Xenos of Canaccord Genuity. Your line is open.
Good morning, gentlemen. In your press release and just during your remarks, you mentioned you’re evaluating additional strategic initiatives designed to enhance shareholder returns. Now you did give a little bit of color saying you will continue to buyback stock and improve stock liquidity optimize your portfolio. What other strategic initiatives are you considering? And what specifically are you doing to further improve stock liquidity?
Jenny, thank you very much for your question. Of course, when we talk about strategic initiatives, we can’t talk in detail about things that haven’t yet been finalized or we’re still working on. I think what – let me I’ll say that in a minute to just talk about some of the initiatives we’re looking at around our buyback program and other way that we’re thinking of potentially rewarding shareholders. But I think the core focus at the moment obviously is heading a plan for 2019 that will maintain the strong operating performance of the company and the strong cash generation that comes from our business.
But with that, let me just hand over to David to give you a bit more color on some of the thinking that we’ve got around the other strategic initiatives.
Hi Jenny, it’s David. Yes, you mentioned the share buyback program and it’s been very successful as I noted in my earlier comments. To-date, we’ve been participating I think very modestly in that program and we’ve seen a tremendous success. So as we move into 2019, we’ll continue that program. And if it makes sense, we’ll look at options to increase or expand that share buyback program through 2019. And I guess the other part is just striking a balance between our organic initiatives within our core business and providing near-term returns for shareholders. But as Richard said, it’s premature to be any more specific at this point in time.
Okay, that’s fair enough. With regard to the production guidance, you were previously forecasting 3,000 to 4,000 barrels a day of additions at Quifa by year-end. And you lowered that by 1,000 barrels. Why is not considering that your water handling capacity conditioning is on schedule? And what is the inventory of the shut in wells that you could bring online and take advantage of this additional water handling capacity?
Yes. Thank you for the question, Jenny. Let’s ask Duncan Nightingale who runs our operations to address the production forecasts for the new CMA project and what the plans that are.
Hi Jenny, good morning. This is Duncan speaking. Yes, the guidance has been lowered a little bit, not because we haven’t got the well inventory to reactivate or production potential for that matter. It’s really now that we have the full implementation of the build out of the facilities. There is a staged implementation of three pumps each comp has about 167,000 barrels a day of water handling capacity, each has to go through different stage of commissioning, the facilities have to go through different stage of pressure testing upon the implementation of each pump.
So for 2018, the guidance that you’ve been given is more applicable to the staged implementation and the opening up of the wells. As Richard said, we expect to open up about 80 reactivates – sorry, 80 wells in addition to bringing on new wells, which we’re currently drilling. And on a net basis that should contribute between 2,000 and 3,000 barrels a day probably closer to the 3000 end. So we get those facilities fairly commissioned, the pumps fairly activated, which is being a little bit cautious in our approach to the production.
Understood. And what is the total kind of estimated inventory of wells that may be reactivated as a result of this additional capacity, in addition to that 80?
We have – as the current water handling capacity is about 1.3 million barrels of water per day. The new water handling facilities will bring in spring, we’re bringing on gets as another 450 and there is some potential optimization depending on the pressures and water cuts, et cetera, beyond that. So that will allow us to reactivate additional wells in 2019. I can’t give you the exact number at the moment yet, but we do have an inventory probably somewhere in the region of about 120 to 130, so the beyond the 80 that we’re reactivating in 2018 that could potentially be another 50.
Great, thank you. And finally could you shed some light on the water injection restrictions that Casimena, how temporary are they?
Yes. The water handling restriction issue that we have at Casimena is temporary. We had a production there of about 1,400 barrels a day. Unfortunately, we had to cut that production in half due to a dispute between the ANLA, which is the sort of the environmental regulatory arm and the ANH. We have two conflicting permits which allow us – which both stipulate two different injection volumes. So we currently trying to resolve that dispute between the two regulatory agencies at the moment, which is most likely going to result in the submission of a new water injection permit. So at the moment, we have to abide by the lower water injection limit, which basically in terms of powers of output, they cuts us back from about, say, 1,400 back to back about 700 barrels a day. So there's an additional 700 barrels will be recovered in the early part of 2019.
Great. Thank you, Duncan. That’s it for me. Thank you.
Thank you, Jenny.
[Operator Instructions] Your next question comes from the line of René Burgos of CarVal. Please go ahead.
Hi, can you hear me?
We can, René. Yes, good morning.
Hi, Richard. Hi, David. Good morning and thank you very much for the conference call, very encouraged by the result. Three things, number one that I wanted to just address, your adjusted EBITDA for this year – year-to-date would have been what, $470 million adjusted for the net effect of the hedges. Is that fair just to back out $167 million?
Yeah, that's right.
And if I were to assume, for the remainder of the year, you guys are assuming $100 million to $150 million to be generated by the end of this year. Is that right?
There are – 300 city end of the third quarter. And if that in around that’s yes, that’s correct, René.
Right. I just wanted to pick your brain, because – based on where oil prices are I felt that your assumptions were a little bit lower at the beginning of the year. I just want to understand where the 100, 150 came in, a large difference there. Second I'm assuming that if that is the number then your EBITDA for the full year unadjusted for and just would have been $620 million, right.
Yes, that’s about right. On an adjusted for hedges little higher actually.
Okay. So any comment as to the main reasons why – you also increase in production in another quarter – that just seems a little bit low to me.
Well, we've looked on our fourth quarter fairly conservative relative to oil price assumptions and as well as we've noted we've got increased in costs we've got with increased oil prices, we've had – we’ve seen double-digit inflation. With respect to our production costs and so that kind of offsets some of the potential positive impact that you're talking about, okay.
Okay. All right. And the second point that I wanted to address was on decent scenario and I think it's a little funny, you guys are working with Ecopetrol and Quifa and then fighting them on Bicentenario. Can you – you mentioned that they were draws on your – on some liquidity lines or some LCs. Can you share with me what the quantum is any bit in that discussion. Any feedback from them or anything that you can share with this point. I know that it's a very delicate situation.
So, René, it's Richard here. Yes, I mean, I think the first thing I’d say is that, Ecopetrol is an important partner of ours in a number of areas in Colombia and we continue to work in a very constructive way with them in Quifa and in our other joint venture projects. The fact that we elect to terminate our pipeline contracts that was a contractual decision we made. And as part of that as we have announced in the press release today, we did have in place some standby letters of credit to a total of about $64 million, which decent scenario has now drawn on and which will be reflected in our third quarter and fourth quarter financial results.
And that is something that is obviously totally outside our control, is something that – in our view this is money that we will be seeking to recover in the future once there is more clarity over the termination of the contracts. But I think other than that there's nothing else to say on this situation at the moment. We continue to work normally with Ecopetrol on our other projects. And then on the pipelines, there's no development.
Well, again, that’s encouraging. David, you did mentioned it in a couple of conference calls, they didn't reversing the flows. So are you really expecting to see any sort of pickup on income from that type of activity from the pipeline or how would that affect your investment in that pipeline?
Well, I mean the Caño Limón-Coveñas pipeline, so it continues to stay out of operation, even since July, early July, when we cancelled our contract on it. It's only worked for a few weeks since then. And it's down at the moment. So in order to evacuate oil from the Caño Limón area, the pipeline is being reversed. And that's something that obviously does just feed into the financial results from the pipeline.
Okay. And probably similar things on the reserves, can you use ballpark share with us what is that you are expecting. I mean, is it – can you at least give us an indication, are you expecting the reserve of this year to be – with the work you done today to replace the consumption would be greater or would be lower. And maybe just ballpark it at – to a percentage, you cannot give specifics, I just want to directionally understand where should we be thinking about reserves for next year considering the investment that's been done on the development side.
Yes. No, Rene. I mean that's a very valid question. Obviously, Frontera, like a number of companies in Colombia has a relatively short reserve of production lines. But that's sort of the nature of the business here in this country and what we have said, we will intend to do each year is reflect of 100% of our production with new reserves. In terms of the actual numbers for 2018, I can’t share any numbers with you yet, because we're in the middle of all of our reserves ordered in purchase with regard to [indiscernible], obviously, that will need to finish their work and we will then update everybody on our reserves 31 December.
I would just reiterate that we intend wherever possible to replace 100% of our reserves. And through the year, we have been announcing a number of successful projects. We had discovered in the Guatiquia block at Alligator and Coralillo in the Quifa area. We try new heavy order project that has – we've made Acorazado discovery and obviously, a very significant development well drilling program across assets also brings new reserves. So we have confidence that we're going in the right direction but we don't have the numbers yet.
Okay. My last question is and this time it goes to David, As an avid follower of the story and as an investor, I can think you guys have done a lot of terrific things since you they took over. But I would just remind you that the stock continues to trend lower and when you reference successes in some of the share buybacks and other initiatives, someone sitting on this other end, it’s a little bit tough to swallow. We will like to see more action being taken because I am a firm believer of the market and I really recognize true value in this company on hedge basis, you just confirmed would have generated $600 plus million of EBITDA and have $800 million in cash and you have the stock sits where it sits. So I'm sorry, you cannot just let you guys go with that comment but just be mindful of – I think there's been some good operating successes, the share buyback may have worked operationally, but clearly the stock is not reflecting what I believe is the true value. So I will leave you with that comment and as always thank you very much for the hard work and looking forward to catching up on the next call.
Thank you very much Rene. And please understand that those issues are not lost on us and we're working as hard as we can to try to have positive impact on our share price.
There are no further questions at this time. Should you have any further questions, please email firstname.lastname@example.org. This concludes the call. Thank you all for participating.