Q2 2022 Vermilion Energy Inc Earnings Call
Good morning, My name is some merit and I will be your conference operator today at this time I would like to welcome everyone to the Vermilion Energy Q2 conference call. All lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be a question and answer session. If you would like to ask a question. During this time simply press Star then the number one on your telephone keypad. If you would like to withdraw your question. Please press Star then the number two thank you. Mr. <unk> you may begin your conference.
<unk>.
Thank you Samira.
Good morning, ladies and gentlemen, thank you for joining US do you have at your President of Vermilion Energy with me today are Larry <unk>, Vice President and CFO , Jessi Kerwin, Vice President International and HSE Grace.
<unk> <unk>, Vice President North America, Joseph Vice President of business development called Preston Vice President of Investor Relations.
We will be referencing a powerpoint presentation to discuss our Q2 2022 results in a return of capital framework, we announced this morning.
Presentation can be found on our website under invest with us and events and presentations.
Refer to our advisory on forward looking statements at the end of the presentation describes forward looking information non-GAAP measures and oil and gas terms yesterday and it was always the risk factors and assumptions relevant to this discussion.
As shown on slide two we delivered another quarter with record fund flows of 453 billion and record free cash flow of $340 million just over $2 a share that's up 16% and 12% respectively from the previous quarter.
The increase was mainly driven by strong commodity prices as global oil prices in North American gas prices strengthened during the quarter.
European gas prices remained strong in Q2 relatively consistent with the prior quarter with GT.
Yes in excess of $30 Canadian Caribbean Btu.
Over the past several months European gas forward prices have nearly doubled which will bode well for really all of it.
The fundamental drivers for this later in my presentation.
Production during Q2 averaged 84868 today, which is down slightly from the previous quarter, mainly due to planned and unplanned downtime.
Key notable events during the quarter was the closing of the <unk> acquisition on May 31, we have some.
Access the integrated lacrosse assets into some of the mic as a team now focused on completing a six well pad that was drilled in Q2.
Excited to have these high quality assets in our portfolio and look forward to scaling up our developments.
So the Claude acquisition was mostly funded with free cash flow generated in the quarter. As a result net debt increased only slightly in Q2 $1 6 billion. However, our net debt to funds flow ratio decreased to one one times as a result of our increasing.
Operations.
And on track to achieve our next debt target of one 2 billion by the end of 2022, what is clear line of sight, we were pleased.
Our return on capital framework.
Before I get into the details of our return of capital framework slide three reduce some of the key strategic objectives. We accomplished over the last few years well position for BLA to deliver very strong returns over the long term. These objectives were part of the strategic plan, we developed during the 2020 Delta.
Our number one financial priority was to reduce debt and strengthen the balance sheet, we have reduced debt by approximately $1 billion relative to Q2 2020 by the end of this year, while also funding over $1 billion with strategic acquisitions without issuing any equity.
We increased our international waiting in European gas exposure through the <unk> acquisition, which we expect to close in Q4 this year.
National assets now represent over a third of our production base to contribute approximately two thirds of our free cash flow.
International diversification is what differentiates vermilion from our peers.
We reinstated a base dividend in Q1 of this year at today, we're excited to announce a 33% increase in our Q3 quarterly dividend eight cents per share the dividend is very resilient at less than 3% of our fund flows. It leaves ample room for ratable increases over time.
We completed <unk> acquisition in Q2, as Mike as it significantly increases the depth and quality of our North American inventory, which will further enhance our free cash flow profile and underpin our long term return on capital and finally, we said that we would increase our return of capital and we achieved a line of sight to our $1 2 billion mid cycle that.
Target.
Less than two quarters remaining in 2022, a robust outlook for 2023, Let me now return review return of capital framework.
Slide four.
Everyone has a long history of returning capital to its shareholders in the past. This has been primarily through base dividends, which we've delivered over $40 a share.
Going forward based dividends will remain a key component of our return of capital framework. However want to ensure the base dividend is resilient over the long term through the commodity cycles, while allowing for ratable increases overtime when they place the burden on our business or the balance sheet for.
This philosophy in mind, we plan to limit the annual base stupid.
Hi to approximately 10% of our mid cycle upon close for reference this would equate to approximately $100 million based on the current asset base, but could increase if our asset base grows or we see a fundamental shift in our mid cycle commodity price assumptions.
In conjunction with our Q2 release, we announced a 33% increase to our Q3 quarterly dividend too.
<unk> per share Canadian this equates to an annual dividend of <unk> 32 cents Canadian per share or approximately $53 million based on the current number of shares outstanding at this dividend per share level, we have the capacity to increase the base dividend and we look forward to provide ratable increases over time.
With our debt approaching target levels, we will pivot from allocating free cash flow for debt reduction to the return of capital.
Maintaining a strong balance sheet is a core principle of Vermillion, and we will remain focused on that going forward.
We plan to enhance our return of capital to shareholders going forward, while continuing to reduce debt to a target of $850 million by the end of 2023, which implies approximately another $350 million of further debt reduction beyond our year end 2022 target.
It also implies will be undrawn on our $1 6 billion credit facility, leaving just are termed U S notes outstanding.
The amount of free cash flow available for return of capital will increase its debt levels decrease based on the illustrative grid outline a slight for the grid is not intended to be prescriptive quarter to quarter, but we will use as a tool to guide near term return of capital allocation decisions will take into account other capital requirements, such as further debt reduction asset retirement.
<unk> and acquisitions as you can see from this great near term debt targets I discussed a significant portion of our future free cash flow will be available to the return to shareholders based on a return of capital allocation grid recent commodity strip and internal estimates.
We anticipate returning up to 25% of free cash flow in the second half of 2022.
And up to 50% to 75% of free cash flow of 2023, while achieving our debt targets.
Our goal is to return capital to the most beneficial method to shareholders. We will consider various options to return capital, including share buybacks to the normal course issuer bid regular and special dividends and potential substantial issuer bid.
Based on our review of a number of data points. We will initially allocate the vast majority of this capital return to share buybacks.
Improvements in our business combined with the strong fundamental outlook for clothing.
Commodities, we believe Vermilion is very well positioned to generate significant free cash flow in the years ahead.
We do not believe this value proposition is accurately reflected in our share price today and therefore at this time, we view share buybacks as the most compelling use of free cash flow that will benefit long term shareholders.
In early July we announced the approval of our normal course issuer bid for the purchase of up to 16 million common shares representing approximately 10% of Vermilions public float to date, we have repurchased 1.25 million common shares or for $35 million.
As we reduce our share count. This will also enhance our ability to increase the base dividend why adhering to our annual dollar limit of 10% mid cycle levels.
We look forward to providing continued updates on our return of capital initiatives in the second half of this year through 2023, as we carefully weigh capital allocation decisions against various uses of excess free cash flow with a view of acting in the long term interests of our shareholders.
Slide five is from an Investor relations presentation, where we provide an updated financial outlook for 2022 based on the actuals to date and our estimates for the balance of the year using the current commodity strip as you can see on a pro forma basis, including a full year impact from the <unk> acquisition, we are forecasting pro forma bundles of 2.4.
Billions in free cash flow of $1 8 billion or approximately $11 per share.
Also show our year end debt target of $1 2 billion, which incorporates the return of upwards of 25% of free cash flow in the second half of this year.
We have not yet provided any formal guidance for 2023, but if you assume production is held flat at our exit rate forecast of 95 to 100000 views a day and your honor the backwardation in the commodity price forward strips were looking generate similar amounts of free cash flow in 'twenty 'twenty, three which is consistent with the analysts estimates.
As outlined on slide six looking at our cumulative free cash flow or three year period from 2022 through to 'twenty 'twenty four assuming flat production from existing asset base and applying the forward pricing, we expect vermillion to generate over 5 billion of free cash flow over this time.
Represented by the Blue bars, this amount of free cash flow equal to our current market capitalization. The gray bars show the cumulative free cash flow. We currently plan to allocate to debt reduction and as you can see the majority of the free cash flow was allocated to debt reduction in 2022.
The funding of over 1 billion of acquisitions, whereas for 'twenty 'twenty, three 'twenty or we'll pivot and majority of the free cash flow will be available return of capital to shareholders now that we have a much stronger balance sheet.
Okay.
As I mentioned in my earlier remarks, the fundamentals for European gas or very strong slide.
Slide seven shows historical pricing of European gas in Asian, LNG, which are traded in a similar band since 2015 compared to the Canadian benchmark price of equal.
The blue bars represent the average premium that vermilion receives on its total gas cells relative to equal as premium was approximately $6 an mcf in 2021 and is forecast to be approximately $19 in 2022.
We also show the port pricing for the balance of 2022, and 2023, which has increased significantly from historical levels.
Our second half 2022 T. T F is $75 permit btu in 2020 threes now over $70 Canadian premium Btu.
The dollar increase in Europe gas prices, that's adds an incremental $37 million of bundles to vermillion on an annual on hedge fees.
Our hearts thoughts and prayers are with the Ukrainian people and our hope is that a negotiated settlement can beat you quickly the tragic events in Ukraine, or a deadly contributing to the price increase however, the funnel to fund the underlying fundamental drivers for high European gas prices were placed prior to the invasion.
Chart of slide eight shows the 2023 and 2024 Ford price for T. T F. How much it has increased since the beginning of the year.
Calendar year 2023 T T at price has increased from under $20 at the beginning to year to over $60 today.
This will have a significant impact on Vermillion funds closed in 2023, we've been adding more your European hedges in 2023 in recent weeks.
We believe the structural drivers will be supportive for European gas prices for many years to come Europe consumes approximately 45 to 50 Bcf a day of natural gas with approximately 40% of that being supplied from Russia in 2021 and.
The recent events use now trying to significantly reduce its dependence on Russian gas.
You recognize natural gas as a transition fuel, which we believe will help facilitate the permitting and development of domestic supplies over time as countries increased use of natural gas for power generation.
Apples of this transition include Germany, shutting down nuclear and accelerating the phase out of coal 2038 to 2030, the Ireland committing to build nine gas fired power generators in by 2024.
The domestic supply in Europe continued to decline the only viable option to replace Russian gas is to increase LNG imports, but there was limited new LNG supply coming on the market prior to 2025 and 2026.
New projects require significant and longer term contracts significant.
Significant capital so in order to attract LNG to Europe buyers need to compete with agent, which is driving European gas prices, even higher short term, we expect Asian LNG demand increase as they look to build inventories prior to this winter, but more importantly, mid to longer term Asian demand Realogy is forecast to significantly increase.
As mentioned, we are starting to layer in more 2023 European gas hedges to lock in some of our fund flows at these higher prices.
Slide nine since our last update we have increased our 2023 year old gas hedge position from 32% to 45%. Those recent hedges were executed privately with white collars with an average floor of about $40 and ceiling of about $70.
Due to the higher gas prices, we made further increase our 2023 year old gas hedge position to 60 per cent to lock in even more fund flows.
But level, given our low debt levels and current outlook, we tend not keeping our total hedge percentage at the lower end of our target range of 25% to 50%, which will leave us with exposure to sustained higher oil prices.
Going back to our Q2 results. We have provided a brief summary of our operational highlights on slide 10 11. Most notable activity in our international operations in Q2 was our offshore drilling program in Australia.
This program is scheduled to start early in the second quarter boats late approximately one month due to unexpected maintenance and repairs on a third party contracted rig.
Routine inspection prior to moving the rig to a location the operator identified some maintenance requirements needed to mobilize the rig in Singapore for repairs.
Commence drilling late in the second quarter and drilling operations are progressing or delay did result, some deferred production and higher costs. We expect to finish drilling in early September we will start the wells shortly thereafter.
It was a relatively quiet quarter in Europe as the teams focused their efforts on preparing for our second half 2022 drilling campaign, which will include two wells in the Netherlands, three wells in Hungary, two wells in Croatia.
Subsequent to the quarter, a forest fire near our castle field in Southern France resulted in approximately 1500 barrels of production being temporary shut in our staff in France worked closely with emergency responders ensure the safety and security of our employees contractors and installations shrink there were no HSE incidents.
The process of making the necessary repairs and bring this production back online. However, this will have an impact on our French production in the second half of 2022.
It was a relatively quiet quarter in Canada as drilling and completion activities in west Central Alberta, Southeast Saskatchewan was limited during the second quarter due to spring breakup.
Following the announcement of the crowd acquisition in late March we Senator Mike asset team and focus on integrating the assets working closely with the product team and drilling the first six well Montney pad drilling was successfully completed during the second quarter and the team is now focused on completion activities that is pretty pressing as per plan.
In the U S. We drilled four wells of our plants six operated Turner wells and completed two wells in the second quarter. One wells brought on production during the second quarter, where are the remaining wells will be completed brought up production during the third quarter. Overall results to date are in line with expectations subsequent to the quarter, we successfully executed drilling and completion activities at three tomorrow.
<unk>, which are significantly more economics than the one mile laterals.
Moving to slide 12.
Our Q3, 2022 capital Perm is well underway and in Europe, We will start our drilling campaign later this month and continuing through the fourth quarter as mentioned a forest fire Jarrod Castle field in southern France resulted in approximately 1500 barrels a day of production being temporary shut in and we expect to have most of it back online by the end of the year.
Looking at our Q3 production forecast, we will benefit from a full quarter contribution from the La Croda acquisition and new production from the U S Southeast Saskatchewan drilling programs, partially offset by the Australia drilling program delay and far related downtime in France, taking all of this new account, we expect Q3 production to be in line with Q2.
As a result of the forest fire related downtime in France offshore drilling delays in Australia combined with inflationary pressure.
Increasing our 2022 capital budget by $50 million to $550 million.
We're maintaining our annual production guidance of 86 to 88000, excluding the core acquisition volumes, we plan to update our production guidance, which we have greater certainty on the timing of the close which we expect to occur in Q4.
Our exit rate forecast of 95 to 100000 views a day, including core acquisition funds remains unchanged.
Okay.
Before we open it up for Q&A I want to make some closing remarks on her upcoming leadership changes as we announced earlier this year Vermilions executive Chairman and cofounder Lorenzo Dominique will be retiring from the company effective September one.
Rather was instrumental in creating what vermilion is today, along with creating significant value for our shareholders. During his tenure.
The organization I would like to thank Oriental for his leadership and guidance of the company over the 27 years.
You will be greatly missed by everyone at the $1 billion, but if anyone deserves a long happy and fulfilling retirement as Lawrence We wish you all the best look forward to providing a regular quarterly updates as a meaningful shareholder upper <unk> for many years to come.
As previously announced Mr. Bob Mack Alexi will assume the role of independent Chairman I'll Lorenzo's departure, almost 41 years of experience in oversold permanent pipeline transformation.
<unk> built a base oil company into one of North America's leading integrated energy transition service companies.
<unk> is the president and CEO for 13 years. He joined Vermilion Board in 2016, I was appointed the audit chair of the audit Committee in 2020 right. The Executive Committee structure will continue and will fill the role we will fill the role of Chief Executive Officer that will led by myself, while crude all the existing members well that concludes my prepared remark.
With that we'd like to open it up for questions.
Thank you if you would like to ask a question. Please signal by pressing star one on your telephone keypad.
If you are using a speaker phone. Please make sure. Your mute function is turned off to allow your signal to reach our equipment again press star one to ask a question and we'll pause for just a moment to allow everyone an opportunity to signal for questions.
And we will take our first question from Menno <unk> with TD Securities.
Please go ahead.
Yeah, Yeah. Thanks, Thanks, and good morning, everyone I'll start with a question on Corrib, if we assume that it does close what is your best guess in terms of the purchase price net of accrued free cash flow. We've run some numbers on this end and our estimate is very low but any thoughts here would be would be helpful.
Thanks, Matt Thanks, Matt I'll I'm going to pass it over to Larry to address the outlook yes.
Yes, good morning Menno.
No I think you're thinking about it the right way in terms of cash to close at December 31 of this year from a modeling perspective, and then obviously a full access to the cash flows in 2023 I think the number that is good to use for year end. This year would be a purchase price of $100 million to $150 million Canadian if it were to close it.
The end of 2022 and that would be inclusive of the contingent payment that is in the money for 'twenty two 'twenty, three which was U S $25 million. So I think that's the best way to model. It in a good way in terms of how youre thinking about it.
Terrific. Thanks, Lars and then on acquisitions in the past you've talked about smaller euro gas packages potentially becoming available and I know there is there are limits to what you can say here, but like at a high level what are the boxes that need to be checked to to pull the trigger on another euro.
Package and do you see these opportunities being able to compete with with buybacks at the current share price.
Well, thanks, Benno I'll pass it back to Larry to address how we're thinking about that relative to our return of capital framework, yes, Thanks Dion and.
Maybe I'll, just rewind a little bit metal with the return of capital grid. What we really wanted to do was shift focus back to the $11 per share of free cash flow that we're generating Dion mentioned 1.8 billion of free cash flow in 2022, that's on a pro forma basis, that's probably not a bad proxy.
To think about free cash flow for 2023, and then what the return of capital grid is going to do is create discipline in terms of where we are allocating capital.
There's flexibility in there in terms of how we return capital at this point in time, we will be doing it through share buybacks and as importantly.
In terms of acquisitions when it comes to North America, nothing Big we think that we have done the heavy lifting in terms of high grading the inventory here in North America, it'll be more tuck in bolt ons in terms of our existing position within North America, and then Europe .
We've had good success a good track record there of making acquisitions now that those acquisitions will continue to compete with returning capital to shareholders. We will be looking for you I'd call. It deep value type opportunities in Europe as we move forward here.
Some acquisition or a series of announcements have a meat in the past in terms of potential opportunities in jurisdictions like Netherlands, but again, it's going to have to be competitive in terms of where we return capital.
Thank you.
Okay.
Our next question from Greg Pardy with RBC capital markets. Please go ahead.
Yeah. Thanks, good morning, Thanks for the rundown Dion and Lorenzo just all the very best in your I guess since your second shot at your at your retirement.
Perfect.
Couple may be just one any modeling question is is what.
What kind of book tax rates should we sort of think about.
On a consolidated basis and in Lars I wanted to ask that just that tax question is it still I don't know 11, 12% or so of pretax.
Yeah, So I think for 2022 and I'll sort of correlate these tax rates to the pro forma pro forma numbers. So we're referencing 2.4 billion of cash flow for 2022 in the context of that 10% to 11% is still a good way to think about it Greg.
For 'twenty 'twenty, three I would say that rate has gone up in the context of current strip pricing I would sort of peg it at 13% to 15% for full year 2023.
Okay, what about book sort of like 30 odd percent or so this is a book tax rate.
Sorry could you repeat that great.
Just your your book tax rate, what would you sort of do you think I know, you're giving me the cash taxes that just is a book tax rate.
Yeah. So I think a good way to think about it is in that 30% range.
Okay.
Okay, great and maybe just sort of related to meadows question.
With Europe now with Europe , now kind of thinking very differently about gas as a transition fuel as you mentioned are there or U R. Policymakers are governments now starting to come to you as well.
One of the longstanding.
Developers in Europe in terms of just encouraging.
Our domestic supply growth as opposed to just relying upon imports.
Okay.
Thanks, Greg I'll take this one I think what's happening when you look over the last several quarters with the crisis I'll leave it as an energy crisis in Europe .
The policymakers of triage their approach with starting with allergy, which is material, albeit a longer timelines Mexico. It's been discussions are in offshore and that leads us to your question around onshore. It. So yes, we are having continued engagement in both Netherlands, and Germany in particular.
All questions that would be framed around you know what what could vermilion as a as an operator of some of those jurisdictions for decades I'll be able to offer with increased activity.
What we've done we always focus on what we can control. So we've added staff in both Netherlands, and Germany technical staff to be able to prepare for higher levels of activity.
I would caution that timelines are longer in Europe , and so the time from our conversation to.
222 actually the drills.
It is longer but I would say, it's encouraging and somewhat logical that you would see some.
Increased activity associated with the.
The current situation of the need for more domestic supply from responsible producers like Vermillion.
Okay terrific, thanks very much.
Okay.
Thanks, Greg.
And we will take our next question from Patrick O'rourke with <unk> capital. Please go ahead.
Hey, guys, good morning, and congratulations to Lorenzo I'm, obviously, a long and storied.
Storied career here at Vermillion, So appreciative of all your work guys, maybe just to build on Greg's question. There you talked about sort of the regulatory regime in timelines in Europe .
As we get into the 2023 budgeting cycle.
And as you look at the portfolio, what sort of what are the other.
Hurdles to bringing on production in Europe , where could you allocate capital to survey.
Capture this windfall gas price that we're seeing over there in sort of the quickest manner or is it in the Netherlands is it in the C E.
What are sort of the infrastructure constraints I don't think that you would have any.
In the Netherlands there.
Okay.
Thanks, Patrick I think first of all the ex the acquisition with core and you have to bring on that 7700 views a day is probably the most impactful thing.
But that Gil and I say it was very well timed and are excited to close that are in there.
This year, so getting that 7700 <unk> there from organic point of view I. You know we're focused on every bu to look for opportunities I think in Germany. We.
We do have a deep inventory of drilling prospects that again, we've added resources back to look at some of the more I would say larger targets, but a little more higher risk. So that's something we're reviewing all see he is an area. Once we get these permits in place like S. E 10, we're able to.
Follow through and drilled wells in shorter timelines in the Netherlands, we used to drill for.
To six wells in Netherlands, we're drilling two in the second half of this year. So no our view would be less work back to those higher levels of activity. So I would say all jurisdictions, a Netherlands does have the potential to increase activity as well as Germany.
Drill three wells earlier this year and we're looking at on the gas side, what we might be able to do in late 2023, and then into 2024 so.
Quite quite excited to be having those conversations and to get our near term focus is getting more staff in those be used to be able to.
React whats it aligns with the regulatory framework to be able to put more capital into those business units.
Okay, and then maybe shifting over to the return of capital framework here.
And in particular, the dividend you guys referred to ratable dividend increases.
Pro forma math that we have on the <unk>.
Hey.
Dividend increase would you know.
Certainly sub.
4% of 2023 free cash flow. So I wonder in terms of maybe you can provide some goalposts around what you mean.
With respect to ratable and also sort of a cadence or review period like how frequently you plan to review the dividend going forward here.
So I'll pass that went to alert talk about our thoughts on the base dividend.
Yes, Thanks, Patrick the way, we have framed the base dividend component is not look to not exceed 10% of our cash flows at mid cycle pricing and I think that's some discipline that we want to continue to have in the business to ensure that that base dividend is resilient.
Based on our current numbers with the increase today, we're about $50 million to fund the increased dividend that we did announce today. So that is where there is ample room to continue increasing that and still be in line with our not to exceed 10% now in terms of the cadence or how we will do that.
I'd say at this point, we're looking for ratable tight increases over time.
We think that also with the return of capital framework that we announced to date there is flexibility in terms of how we return that capital the base dividend will be.
One mechanism that we use a one medium that we use it will not be the majority of capital that will be returned through that so that's where we have flexibility in terms of share buybacks.
Variable dividends special dividends, we will err towards buybacks at this point in time, just based on the data points that we're reviewing where we think capital was best.
Allocated so hopefully that provides a little bit of clarity in terms of the fixed base dividend will be one component of our return of capital, but we truly want to make sure that that base dividend is fixed and resilient in prices that are much lower than what we're seeing today.
Thanks Lars.
Okay. Thank you.
Thanks, Patrick.
And as a reminder, its star one to ask a question we will take our next question from Josef Schachter with Schachter Energy Research. Please go ahead.
Good morning, everyone and thanks very much for taking my question in Europe , we're seeing a lot of demand management.
Our U K talking about preparing for blackouts.
Germany, telling certain industries, you may get cut back certain percentages of gas assuming the Russians are aggressive in terms of cutting back is there anything going on on the supply management side, where they're asking you to hold back and put it into storage near near consuming areas gas to bring on later.
Or you have new wells coming on and bring them on closer to the winter is there any supply management stuff going on that would impact or a $1 million in Q3 Q4.
Q1 of next year.
Hi, Joseph I'll take that one not quite quick answer is no. We're selling all the gas that we're producing and theres no discussions around us storing or restricting our production.
Okay, great. Thanks, that's it.
Thanks Marie.
Okay. Thanks Joseph.
So with that I think that.
Okay.
But we have no more questions. So I guess tomorrow, we would like to thank everyone again for participating in our Q2 conference call and look forward to future updates.
Thank you and this concludes today's call. Thank you for your participation you may now disconnect.
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Yes.
Okay.
Yeah.
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