Q3 2022 Vermilion Energy Inc Earnings Call
Good morning afternoon evening My name is Elaine and I will be your Cratia today at this time I would like to welcome everyone to the Vermillion Energy Q3 conference call.
As a reminder, today's conference is being recorded.
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 the Star then the number two on your telephone keypad. Thank you Mr.
Suzanne Hatcher you may begin your conference.
Well, thank you Elaine.
Ladies and gentlemen, thank you for joining us at your President of Vermillion Energy with me today are <unk>, Vice President and CFO Darcy carbon Vice President International HSE brace criminal Vice President North America.
I said 10, Vice President business development and call Preston Vice President of Investor Relations.
What are you referencing a powerpoint presentation to discuss the Q3 2022 results presentation can be found on our website under invest with us and events and presentations.
Please refer to our advisory on forward looking statements at the end of the presentation. It describes the forward looking information non-GAAP measures and oil and gas terms yesterday and outlines the risk factors and assumptions relevant to this discussion.
As shown on slide two we generated $508 million of fund flow of Q3, which is a 12% increase over the prior quarter.
Another quarterly record for Vermillion for perspective, this quarterly funds flow is more than we generated for the full year of 'twenty 'twenty.
Free cash flow of 324 million was down slightly from the previous quarter due to higher capital expenditures associated with our Australia drilling program, which we successfully completed during the quarter.
The majority of Q3 free cash flow was allocated to debt reduction our.
Net debt decreased by 11% to $1 4 billion, representing a debt to trailing 12 month funds flow ratio of one eight times.
Late last quarter with our formal return of capital framework is our intention to return more free cash flow to our shareholders as that decreases in Q3, we paid a cash dividend of eight Canadian per share and repurchased two 3 million shares under our in CIB for $72 million combined it's about two <unk>.
<unk> $85 million returned to our shareholders, representing 26% of Q3 free cash flow.
Pro forma Q3 funds flow and free cash flow incorporating the incremental 36, 5% ownership in core was 611 billion.
426 million respectively.
Q3 production averaged 84237 Boe's per day, which was in line with the prior quarter as we previously guided to.
Electing planned turnaround activity in Canada, and the forest fire related downtime in France, which offset the new production added from the crowd acquisition, which closed at the end of May.
As I mentioned on the previous slide our net debt to trailing fund flow ratio decreased four eight times as can be seen on slide three this is our lowest leverage in over 10 years. We have made significant progress on debt reduction in the last few years, we turned on maintaining this discipline going forward, we operated with a leverage ratio near one time.
Or below for 10 straight years 2003 to 2013, we will target lower leverage going forward, while commodity prices have helped drive this ratio lower well manage our debt targets based on mid cycle pricing assumptions, which at one times one flow implies an absolute debt target another billion or less.
Okay.
Contributing to our strong Q3 financial results wasn't robust European gas prices, which nearly doubled in Q3 compared to the prior quarter.
As shown on slide four T. T. F reached an all time high of $120 per M. B to you in late August falling various supply disruptions and growing concerns regarding europe's ability to meet winter energy needs demand.
Energy security and inflation have become a focal point for many countries and citizens around the world, especially in Europe .
Energy security situation in Europe , which is really the result of policy decisions over multiple years have been amplified by the ongoing devastating conflict in Ukraine.
Prior to 2022, Europe lineup, Russia for approximately 40% of its gas supply, Russia imports have significantly decrease in recent months as key infrastructure was taken offline.
Yeah, I mean, just to the North Sea one pipeline in the Baltic Sea late September as removed approximately six bcf of supply capacity, which brings a total supply loss 10 Bcf per day year over year.
At this time it is uncertain if or when this capacity will come back.
Despite these challenges Europe managed to source enough gas over the summer months essentially fill storage ahead of the winter heating season, even with partial Russian gas supply prices averaged approximately $60 per and then btu for the injection season period.
We will discuss some of the underlying fundamentals driving European gas and it was like why we are bullish on this commodity is important to understand how Europe was able to fill stores. This past year and how the situation may be different next year.
Slide five illustrates the year over year change in LNG imports versus China, and the rest of the world.
As you can see over 50% of Europe's increase in LNG imports. This year was due to reduced LNG demand in other countries. The global LNG supply did not materially increase it was rerouted to Europe .
European LNG imports were up significantly as Europe starts to wean yourself off of Russian gas. This is a very large undertaking as Russian gas represent approximately 18 Bcf per day of Europe's gas supply.
Europe achieved higher LNG imports by opening the rest of world for LNG. However, this was also during a period, where China had lower demand due to stringent COVID-19 lockdown policies.
In addition, the ordinary one was an operation that supply in Europe for over half of the injection period.
Storage, especially for Europe is expected to have enough gas to meet demand. This winter assuming average weather conditions. However, refilling storage capacity next year. It may prove even more difficult with Nord stream, one, presumably offline and Chinese demand potentially returning to pre COVID-19 levels.
Europe has become structurally more dependent on LNG imports to meet current natural gas needs to put it in perspective, the volume of Russian gas that was supply to Europe before the war represents approximately a third of the world's current LNG supply.
Another way to think about it is you would need to more than double the U S. LNG export capacity to replace the Russian volume supply to Europe .
The increase LNG demand will require direct competition with Asia.
LNG demand is also expected to increase over the coming decades.
There's very limited new LNG supply coming online over the next two years new projects require significant capital underpinned by long term contracts, which many European countries that had been reluctant to commit to.
The recent weeks the guitar energy Minister I know Qatar is the largest supplier of LNG in the World stated that negotiations with the European countries are new LNG supply are challenging Europe's unwillingness to commit to long term contracts, which are typically 15 to 20 years.
This scale are expected to structurally change long term pricing of European gas to higher than what it was before the war.
Given this global LNG backdrop, and the underlying supply demand fundamentals developing in Europe , we expect LNG in European gas prices to remain elevated.
So as I mentioned in my earlier remarks European gas was a meaningful contributor to remain strong Q3 financial results and we expect to be a key driver for future results. The chart on the left.
Slide six shows historical and forward price for T. T F. J P. M. In April the Blue borrowers Vermilions average corporate realized price premium to equal.
Pro forma basis, including the Corp acquisition volumes European gas represents about a quarter of Vermillion production base and contributes over 40% of our funnel.
Vermillion is approximately $3 8 million net acres of undeveloped land in the prospective basins across Europe , and we believe there's an opportunity to increase gas production with government support and the appropriate regulatory frameworks in place.
Our European gas prices and the prospect for higher energy costs in the years ahead has become a front and center concern of all stakeholders in Europe , including politicians over.
Over the past several months there have been various government policy issue ideas debated on how to contain energy prices in your old range.
Ranging from voluntary demand reduction to price caps to windfall taxes.
Vermillion has been actively engaged with government officials in the countries, where we operate to identify opportunities, where we can contribute to domestic gas needs.
I think natural gas is an important energy source.
Could be produced locally where possible to ensure security of supply. This is consistent with Europe , having recognized natural gas as a transition fuel.
Late in the third quarter European Union announced several proposals and attempt to address high energy costs or the proposals, which was subsequently approved the temporary wasteful tax measure aimed at you companies with activities in the hydrocarbon sector.
This windfall tax is calculated as a percentage of earnings above a baseline of 120% of the average of taxable earnings the subject company.
Between 2018 and 2021.
We have provided an estimate for 2022 windfall tax impact of 250 to 350 million within our Q3 release there.
There continues to be many unknown variables related to the following implementation of the tax however, our current estimate of the potential two year exposure for 2022 and 2023.
The tax was implemented as rain, but you would be approximately 650 750 million again over two years based on the current strip pricing this estimates and inclusive of the incremental working interest.
As shown on slide seven we have updated our 2022 pro forma finance, where I would look to incorporate this windfall tax and now forecast pro forma fund flow of $2 1 billion and free cash flow of $1 6 billion or over $9 per share, which implies a free cash flow yield excess 3%.
Getting back to our Q3 results. We provided a brief summary of our operational highlights on slide eight through 11 production from our international operations averaged 27095 Boe's per day in Q3 and increased 1% from the prior quarter production increase in Australia.
Germany, which is more than offset far related downtime in France, and natural decline and other jurisdictions.
The most notable activity in our international operations in Q3 was a successful completion of an offshore drilling program in Australia.
Highlighted last quarter. This program was scheduled to start earlier in the second quarter, but it was delayed approximately one month due to unexpected maintenance and repairs on the third party contracted rig.
Drilling program was a success and the wells were brought on production in September .
In Europe , we focused on restoring production in France that was impacted by the forest fire and expect most of that production to be restored by the end of the year during the quarter three wells were drilled in Hungary, but none of these walls encounter commercial hydrocarbons. The capital spend on this program was minimal while the findings will further enhance our knowledge and understanding of the geology in this region.
We're in Europe , we continued with support work for our Q4 drilling campaign, which will include one well in the Netherlands, One wall, Germany, and two wells Croatia.
Netherlands, and German program continues into early 2023 for a total of six wells combined.
As mentioned, we had a very successful drilling campaign in Australia, we drilled the <unk> 17 be 18 wells for a total of 6500 meters horizontal well length drilled between the two wells. The 360 degree well path with planned sidetrack and the B 17, well resulted in accessing new reserves.
Wells that produce over 300000 barrels Jim to date, our wandoo crude is currently sells and approximately $14 U S premium to Brent, resulting in a Q3 Australian operating netback of approximately $96 per Boe.
Current pricing. These two wells have generated approximately $30 million of operating cash flows recovering 40% of the invested capital in the first two months of production.
As in previous years, we will limit the production of these wells to manage our marketing contracts are currently evaluating the results to identify potential new targets and plan for our next drilling campaign, which we expect to occur in 2024 or 2025.
Production from our North American operations averaged nice sort of 57140 to be used per day in Q3, a decrease of 2% from the prior quarter, primarily due to third party downtime in Canada, a delayed start up of our Turner wells in the U S.
Canada, we wrapped up our southeast Saskatchewan drilling program, we brought on production 14 wells and completed the six wells of our first Montney pad at Mic, which were drilled in Q2.
In the United States, we completed and brought on production the remaining five wells. The six well term program three of the wells were drilled with extended reach two mile laterals, and we executed lower intensity fracs across the wells, which resulted in approximately $2 7 million of total cost savings while the initial production from these wells is lower than our previous higher intensity completions were.
We're monitoring performance to determine the impact of longer term decline profiles, well recovery and overall capital efficiencies.
One of our primary partners drilled and completed two commitment wells testing the Parkman formation. The performance of those wells has exceeded our internal type curves, which will we will continue to monitor while accessing the potential of this play on our lands.
Admiral Rebase asset similar to other North American assets has multiple stack targets, including the parkman, the Niobrara and the mall rate, which represents significant upside beyond it hurt.
Okay.
As a reminder, we closed the <unk> acquisition at the end of May and took over operations. During the six well drilling program that was initiated by the crowd on the Alberta Lance <unk>.
We completed the wells executing over 1000 Fracs.
The testing was limited due to fact flare restrictions over we are nearing completion of the initial build out of the facility and are excited to bring the wells on production. Shortly we'll be kicking off another three well pad in Alberta in Q4 late in the third quarter, we received approval to restart a one mile well at B C, which is now producing over 1000 barrels a day for over the last.
<unk>, which is in line with our expectations.
We have prepared detailed development plans for both our blurred up at BC lands, although our preference is focused on the BC development. We will continue to maintain flexibility in terms of infrastructure development across the asset, including a drill to fill option on the Alberta lands utilizing the existing infrastructure, which would result in approximately seven to 8000 Boes a day of production in 2023.
This option manages our near term capital by deferring additional Alberta infrastructure and instead building the BC infrastructure, where the majority of our drilling inventory is located.
As part of our corporate allocation, we are optimistic that we can also increase capital to European gas Rolling in 2023.
Our 2022 capital budget production guidance remains unchanged. However, we expect annual production to be at the lower end of the range due to the fire related downtime in France, and delayed onstream timing of the Australia and U S wells.
Closing of the Corp acquisition is nearing the final stages and we now anticipate acquisition to close in Q1 2023 due to administrative delays. That's crazy noted all free cash flow generated by the acquired interests in Corp. A Jan one 2022 until close well crude vermillion it'd be netted off the final purchase price.
Glad to announce our 2023 budget in early January as we require additional time to assess the impact of windfall tax will work with our regulators in Europe to facilitate additional drilling and continued timing firm timing on the Corp acquisition close.
We will remain disciplined in 'twenty three as we continue to focus on debt reduction.
At this time, we anticipate a capital budget similar to 2022 investment levels with potentially a greater portion allocated to European gas.
We have the ability and desire to drill more wells in euro and if I'm going to go into discussions with regulators are productive we would look to allocate additional capital to the region in 2023.
There we have several large grass prospects in Germany targets that are approximate 10 times larger than our recent <unk>. We have we're having very encouraging dialogue with local and state officials in Germany about the prospect of a seller drilling into late 2023.
That concludes my prepared remarks, and with that we'd like to open it up for questions.
Yes.
Thank you.
I would like to ask a question. Please signal by pressing star one on your telephone keypad.
You're 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.
Pause for just a moment to allow everyone an opportunity to signal for question.
We will take our first question.
From Greg Pardy from RBC capital markets. Please go ahead.
Hi team, it's Robert ban on here for Greg Pardy. My first question was just surrounding the corrib deal could you provide some guidance around what the net cost or benefit would be if it closed in the first quarter of 2023.
What's the probability of the deal is that the deal is not closed for some reason and if so how would the unwind to work there.
Okay, well, thanks, Robert I'll pass the dealers just to discuss the financial question and then Darcy to address the timing.
Hi, Robert.
<unk> mentioned, we have factored in the windfall tax impact of the 36, 5% interest on corrib into our analysis here as opposed to giving a hard number would I would guide you is a P O at some point in the second half of 2023 now that we would have to factor in.
The windfall tax obligation.
Which we will incorporate into the final purchase price effective Jan one 2022, so a payout at some point in the second half of 2023. The thing that I would highlight then is that includes the hedges that we put in place as part of the original transaction as you get into 'twenty 'twenty. Four you would then have.
All of that European gas are benefiting cash flows on an unhedged basis.
Thanks, Larry.
First of all on the second part of your question as it relates to the timing of the close.
We do expect that this deal would close originally we did expect it to close in 2022 that is still a possibility, but we think it's likely to slip now into Q1 of 2023 them all of the parties continue to work together to complete this transaction, we're all working through the administrative delays related to finalizing the documents.
With with the government and our partners.
It's worth noting that all cash flows are accruing to our benefit as of January one 2022 effective date. So the timing of the close really doesn't impact the financial contributions of the of the acquisition.
And kind of put things in perspective, when when we lost it is deal in Ireland to acquire an additional one 5% stake in court.
Okay.
Approximately 18 months to close and so we're used to this kind of <unk>.
Longer closure period, taking place in Europe . So we.
Do you expect to fully close that.
First quarter of 2023.
Thanks, Kirsten that's okay. That's.
That's great. Thank you and.
Just switching gears here a little bit if I can how should we be thinking about cash taxes in 2022, and 2023, not including the windfall tax as a percentage of pre tax cash flow does the 10% to 11% range in 'twenty two still seem reasonable.
Thanks, Robert I'll pass it back to Larry for that one yeah, Hey, Robert for 2022.
Forecasting our cash tax rate of 9% to 11% for the full year would be a reasonable range keep in mind that does not include any contribution from the acquired Corrib interest and then for 2023 pre any kind of windfall tax inclusion, 14% to 16% cash tax would be a reasonable est.
That does include the contribution of the 36, 5% acquired working interest from Ecuador.
That's great. Thank you. Thanks for talking my questions I'll turn it back to the I'll put it at all.
Thanks, Robert Our next question will come from Menno, how tough from TD Securities. Please go ahead.
Thanks, and good morning, everyone I'll start with the suspension of the M.
In CIB for Q4 does that mean, you're simply not electing to buy back stock this quarter or was there a filing submitted to formally suspend it I'm just not clear on the mechanics of that and then the second piece of that is it's why suspend it at all it's a it feels like if the upper end of the windfall tax range of 350 million.
<unk> per annum.
It would still be enough to go around for it.
At least some buyback activity so any thoughts on that would be helpful as well.
Thanks, Menno I'll pass over to Lars to address those questions.
Good morning metal on the first part of your question no. No formal submission has been made in regards to the N CIB and so what we really wanted to accomplish with this press release was being transparent with shareholders in terms of taking a pause here in the fourth quarter to reassess the impact of the windfall tax debt.
Is likely going to be retroactive in nature as well as potentially exposure to a two year period as well. So we wanted to take some time to prioritize that when we do our analysis around the appropriate way to return capital over the longer term every scenario that we run includes a strong balance sheet in terms of <unk>.
Being able to support that return of capital over the longer term. If we ended up taking a quarter to ensure that we don't put that strong balance sheet at risk. We think that that is a pause that it's worthwhile over over the longer term.
In terms of the.
Second part of the question.
Yeah.
I think that really factors into taking a pause here in the FERC fourth quarter just to make sure that we do prioritize the balance sheet and we'll reevaluate the merits of capital allocation as we go into 2023 here incorporating this new information that we have.
As well as.
As we work through the budget and those other variables.
Thanks Lars.
Yes, Thanks for that and then then on windfall taxes did you now have a better sense of how each of the individual countries are going to manage the EU proposal and what is your best guess on when we can.
Have announcements from each company in which you operate and is there any risk of these announcements get pushed into 2023.
Thanks, Matt I'll, maybe I'll take this opportunity just to zoom out and talk a little bit more about the windfall tax and a capacity where the wires after that to talk about some of the mechanics.
You know, it's been an interesting times with the policy in Europe . It's during this energy crisis, it's discussions from price caps to windfall taxes and oil and gas companies I think it's important to note that the current situation is that solely the result of the war.
It really does that.
Policies that only resulted in declining supply and increasing demand created a pretty tight market.
Do you think about Vermillion over the last 25 years goes back to 97, we put meaningful capital at risk to provide secure energy in Europe and over that time, we've worked hard of our operations to ensure we are best in class.
So for our shareholders, we took some risks and redeploy capital into that market and where they were.
Cherokee's overturned it also during some pretty difficult periods here with the commodity price crash in between 2014 to 2019 as well as of course Covid here in 2020.
From 97, or 6000 barrels a day and if we look at where we're gonna be in 2022 were in excess of 31000 in those.
Reduction that we have in those jurisdictions to places they need to import energy from other areas, which of course from a full cycle.
<unk> point of view was actually lower.
Then you get to the economic benefits of producing in Europe , I mean, we're displacing the need again to two important energy, which means there's direct deployment. There's their support of the service sector and then there's the royalties and taxes that we pay to both communities and the federal level.
So if you look at 2022 across our portfolio like we're looking at cash taxes, plus royalties in excess of $550 million and that's prior to the additional windfall tax.
Put that in perspective, I mean, that's in excess of the $500 million of corporate cash flows we generate in 2020.
So I mean, our R S.
As we think about the policies in Europe is really we want stable predictable policies at two I'd say a recognition of two fold our business is cyclical and there's periods of low prices and there's periods of high prices and.
We need those periods of high prices to offset the lows of course, and then third again the benefits of having producers like vermillion in that market.
And data to ensure their secure lower mission energy, but with that I mean that that's our views just strategically looking at some of the things that we'll continue to navigate the near term here, but I'll pass it over to Larry to talk about some of the mechanics of the individual jurisdictions and how it will be applied.
Manuel just take this chance to reiterate what Don commented on we have this disclosure in our press release as well but.
So there's the EU regulation requires member states to levy that minimum 33% tax on in school companies for 2022, <unk> 2023 surplus profits surplus profit as defined in regulation is taxable benefit profits exceeding 120% of the annual average.
That 2018 to 2021 period.
EU member states are required to implement the tax or some kind of equivalent national measure by December 31, 2022.
So you know we're within weeks of having that Finalization at the end of the day, depending on the national measures that are adopted by the EU member states as well as the financial years, which measures will be applicable.
That's where we're basically just applying the EU framework at this point to get that estimate of $650 to $750 million of two year accumulative impact so no.
I think in short order here, we should have a little bit more certainty on at least 2022 in terms of that deadline.
We have a long answer their metal, but hopefully that answers your question.
Yeah, no that was great. Thank you.
Our next question.
Come from Dennis Fong from <unk>.
B C, whereas markets. Please go ahead.
Hi, good morning, and thanks for taking my questions. The first one really relates a little bit more towards North American operations.
Just wanted to understand a little bit in terms of how you're moderating the potential cost inflation impact exactly given ramping activity both within Micah and then if I think about powder River basin as well.
Thanks, Dennis all passenger price Kramnik, our VP of North Africa, just a touch on inflationary pressures in North America, Yes.
Yes. Thanks for the question Dennis Yeah overall inflation in North America on the capital side of things is in the range of about 20%, notably on the Opex side of things is much lower than the 5% range. So testament to all the work the team started on managing Opex and managing contracts.
Just jumping over specific lead to the powder River basin.
Inflation, there is about 20% up year over year.
When compared to Canada.
Our Alberta assets are up about 20% and then Saskatchewan is probably up the most in the 30% range. So.
We've done lots of great work in the powder River basin execute our cost reduction strategies over the last few years and we continue to do that this year, we brought a worm crew down from Alberta, when we kicked off a program to help out its costs.
Continue to do the same.
And then with respect to mic up.
We got a good.
Few on our costs going into the later half of this year as we've had active operations into Q3, and then we're starting up a new pad into Q4. So we have a good handle on our costs going forward into 2023.
Thanks, Bryce yet and we're seeing again, it's interesting I think that's one of the advantages of our model that is to be able to deploy capital with different parts of the business head.
<unk> put a lot of thought into things like Saskatchewan drilling in the summer when costs were lower in the powder River basin again using crews from from Alberta, So again very thoughtful there, but we are seeing inflation to do what our best advantages as Bruce noted.
Great and maybe if I wouldn't mind on in terms of kind of an add on to that question. If there were if there was incremental activity within Europe .
How would you potentially think about contracting services I mean, obviously, it's less less busy over there, but how are you thinking about the cost.
Impacts of accelerating activity out there.
Yeah, I would say, it's less so I can pass over to Darcy just to touch on what we're seeing there for inflation on the on the <unk>.
Services side for Europe and.
It is in Europe , certainly, we're seeing lower inflation numbers on the on the service side of things, we're seeing in North America.
And the ranges.
Five up to 10%.
As you suggested that's that's kind of due to limited activity in Europe , and we've gotten a little bit of help as well from the exchange rate that even makes that a little bit lower.
So.
That's good.
Fully baked into into our plans next year because of the longer timelines in Europe too we do tend to.
Acquired tubular and enter into contracts earlier. So so we have a pretty good handle on what the prices look like in Europe for next year.
Great.
Okay and then my last question here is just around hedging I see like a small uptick in natural gas European natural gas hedges as we think about 2023.
As a percentage of total production can you just kind of reiterate your strategy. There, obviously theres a lot of volatility in the curve wanted to kind of understand if anything had changed on that side.
Yes, Travis I, just we work quite actively in August with some of these higher prices, but with that I'll pass it over to Larry to talk to you on our strategy and some of the recent hedges, we're able to execute.
So you can see there in the second half of 2022 European gas hedges got up to that 60% level 2023, we're at about that 50% level now those are probably pretty good bookends to think about in terms of where we could get European gas.
Hedging to we feel very comfortable with where we're at for 2023 at this point and it's probably a little bit more around looking to be opportunistic if we do go higher than that versus risk mitigation at this point.
Okay perfect I appreciate the question as well.
Okay.
Thanks Dennis.
Yeah.
We will take our next question from Travis Wood from National Bank Financial. Please go ahead.
Yeah.
Most of my questions were answered.
Our questions and the discussion on windfall, so that was super helpful. But maybe just in the context of.
The complexities of the windfall tax and maybe just how you guys are talking about stressing that.
Into 2023.
And then as you think about capital allocation you know the language was looking to spend more on on European gas projects.
If you see this.
Our policy language potentially pushed this into 'twenty, three and possibly 'twenty four would that change your decision political odd volumes or.
Cash flow out of the region disco ops.
Offset some of the insurer tax or how are you thinking about balancing that against a really strong kind of macro backdrop on pricing.
Thanks, Travis all passenger boilers to address that yes. So in terms of the first part of your question there Travis around sort of the complexities around the windfall tax.
If you just sort of rewind here the EU approved this legislation or the framework of the legislation late September .
If you think back to the early part of September there wasn't a lot of discussion around the EU led windfall tax regimes, so that that velocity the piece the scope of this legislation.
Don't know if it's unprecedented but it is it has been extremely rapid <unk>.
And as you introduced new legislation, that's going to impact 27 member states.
Theres just a lot of moving parts in terms of what that ultimately is going to look like within each of the countries that adopt it so.
We're monitoring it.
As the rest of our folks are in terms of what's available in the public domain.
But just wanted to emphasize that this this is legislation. This this is a new tax that has evolved very quickly here.
We felt was important was to provide some disclosure here in terms of what the impact could be over that two year period, and we will look to update that disclosure here as we go forward and as we get certainty kind of going into the the end of the year here.
Thanks Lars.
Capital allocation.
Got it.
I think we understand that but he is there.
Took the status quo.
And expected this to kind of roll for another couple of years do you think that would impact the capital.
Decisions in the region or is the debt.
The bottom line there are just too large of a number to to position capital to avoid you know.
We're not avoid I wouldn't use that word but to mitigate some of the the tax impact in the short term.
Thanks, Travis I'll pass it back to Larry to talk about capital allocation and how we're thinking about that yeah, Travis as Dion mentioned earlier, we've been navigating.
Operations in Europe for 25 years here.
I think it has been a very good place to do business.
Absolutely, we're going to have to factor in any kind of windfall tax that would go beyond 2023 into our capital allocation decisions.
No I think what you heard from Dr and as well as Darcy today is we do have an incentive to allocate more capital to to Europe . Just in terms of we want to be part of the energy security.
A supply response, and we think that we do have a role to play into that well obviously have to make sure that we factor in anything here at this point. It is a temporary windfall tax the scope of it has been limited to 22% in 2023, if it were to extend beyond that we'd have to factor that into our decisions but.
We're in Europe for the long term.
Thanks, Larry.
Thanks, guys.
Thanks Travis.
Once again, if he would like to ask a question. Please press star one.
If you're using a speaker phone. Please make sure your mute button is turned off to allow your signal to reach our equipment.
We will take our next question from Neil Mehta from Hudson Bay. Please go ahead.
Okay.
Hey, guys can you hear me.
Yes.
Thank you. So just wondering if revisit that though the windfall tax I know that's getting a lot of questions. This morning, I guess just wanted to better understand I know, you're saying I'll see what I focus on the strength of the balance sheet.
First and foremost and then.
Look to reintroduce that.
The dividend at some point they know when they're in the prepared remarks, you guys expect it to end the balance sheet, our debt debt a little higher than expected.
I know it was one point towards the year end can you give a better sense of what do you think that lands and then another way to sort of dig around that too is just the I think someone asked a little bit earlier, but in a similar matter. If you have a sense of the total magnitude potentially being in that 600 to 700 range or whatever over two years.
And then what was the thought process spending it now given that we're all with this part of the quarter is the tax it retroactive for 2022 is that going to have to be paid like the day of the decision.
And therefore, there was a thought that that would impact the net debt higher because you know that.
Thats needed the cash flow from that like a one time payment or is it going to be paid over time for.
For the retroactive minimum 2002, and two and how does that also get paid for 2023 that added earned like what's the mechanisms there for the windfall tax payments.
Okay, Okay, Yeah I can.
So a couple of things just to clarify.
We suspended the share buybacks, we are paying and continue to pay the dividend and get our strategies for REIT ratable increases the dividend over time.
With respect to the mechanics of when the windfall.
Windfall tax would be accrued and paid I'll pass it back to Larry to talk about that.
I'll address that as well as your question around debt debt balances as well.
I think that the $1 $2 billion debt target was going to be a nice landing spot at the end of 2022 in terms of being able to go a little more than that in 2023, as well as being able to return capital. Our estimate now that incorporates the windfall tax would be about $1 $6 billion of exit 2022 net debt.
That's a segue into the third part of your question in terms of the accounting for the windfall tax ultimately, it's going to be subject to when legislation gets.
Finalized as I mentioned earlier, there is a mandate right now sort of member states to have legislation in place by the end of this year.
Assuming that comes to fruition and that is mats, we would expect that to trigger an accrual for the windfall tax 2022 exposure in the fourth quarter of this year. So that will get reflected in 2022, we've embedded that into that $1 $6 billion net debt estimate in terms of when those cash.
That tax would be payable that will be variable depending on the country, but I would expect it to range.
Anywhere from early to late first half of 2023.
Thanks Lars.
Thanks, and then just to sort of I guess related a little bit of a follow up I think he sounded like a couple of the countries that sort of come to a policy and an outstanding on a couple of other ones.
Mostly that Ireland and Germany.
On the on the countries that have come in so far on their sort of policies are on windfall tax how is it compared to what you guys were thinking and relative to kind of what the EU.
It was implementing is it sort of in line with that or better et cetera, and are there any offsets that you guys have in those countries that may are factored into your estimates right now or are there at this point there are no offsets in the estimates.
And then also just back to the accounting and how it's paid all that stuff like again back to like the PD.
If you are exiting with one six this year on net debt and you're looking at sort of production you know into 2020, if it's at similar levels, I guess and kind of what people have out there for estimates the clip Catholic interesting should be fairly robust and given the total size of the windfall tax is estimated and the net debt you're exiting this year.
Does the is it still feasible for you to reach your net debt target next year that sort of sub $1 billion and you're back to sort of within that range of free cash flow generation and being able to pay out 50% or so of VP of cash flow into 'twenty 'twenty three once the buybacks resumed.
Yeah, I'll just paraphrase the question here and some of these again we can.
Year to meet with you off line, if you can get into some of the more modeling questions, but I'll pass it to Lars here around just to comment on maybe some of the offsets the mechanics of the windfall tax and then secondly, how we're thinking about debt targets for next year.
Yeah. So just just back to the windfall tax.
Without getting into each of the four countries that will we will have one full tox exposure. There are varying degrees. There in terms of certainty in terms of how the framework is gonna be employed I would say at this point, we have factored in all the information that we have today into that estimate of $6 50 to 750.
There is quite a bit of nuances once you get into each country. Both from a I'd call. It a front office as well as back office perspective in terms of how the calculation is ultimately going to unfold.
And then just back to your question or follow up question on that here. So if you start with that $1 6 billion at the end of 2022, just as a reminder, we have fully burdened that with our estimate for the core closing cost as well if that gets pushed to 2023 that that's something that will shift between 'twenty.
Two and 'twenty three.
Terms of net debt balance targeted debt target for 2023, that's something that we'll work through here.
A good landing spot could be targeting an undrawn credit facility revolver in terms of setting ourselves up strongly for 2024, and then navigating the uncertainties that are there regardless of windfall tax in terms of commodity price uncertainty.
But that is the pause that we wanted to take here in the fourth quarter is just to work through those decisions and what's the right capital allocation.
We have a firm belief that by taking a pause here in the fourth quarter. The fact that that free cash flow is still going to accrue to shareholders. It will accrue to shareholders through a lower debt balance in terms of where we exit this year as opposed to a lower share count and if that puts us in a position to accelerate buybacks in 2023.
We think that that's a prudent decision here in the short term.
Thanks Lars.
Got it yeah. Thank you and then I guess, maybe just a final one on that last one you said, obviously accruing to shareholders I guess, a big part of the store and I know, it's sort of like part of interest rates in general has been sort of a capital return story and I get that the pause near term given sort of the the windfall tax situation.
And I don't know if there's any relayed out the production cost side as well at any reading there, but how important is the capital return story remain as part of Vermillion sort of shoulder.
Story in general just given that the pause is happening here and obviously, there's going to be a reaction from shoulders to that so.
Yeah I can take this one I mean I think if you look back on the history of the company we've paid over $40 a share of dividends we are.
Our focus is to have a strong balance sheet.
And as debt levels decreased hearing to return increasing amounts of cash flow to our shareholders and again over the longer timeframe, we've consistently done that.
I think <unk> point.
We were about 25, 26% of our free cash flow returned to our shareholders with return of capital in Q3, we hit the pause in Q4 and I think it really just that tradeoff up near term gathering more data as well as prioritizing our year end debt balance and I think it just positions us to be that much.
Going into 2023.
If you look at where our debt level is going to be and where the strip pricing is currently four for all commodities again, we think we're positioned well there.
The next step for US is to continue to work through this in December and we look forward to releasing our our budget early in the new year and that I think that would provide us appropriate time to really get into the details around.
Spending levels free cash flow levels, our thoughts on return of capital, but just to be clear a pause in Q4 does not in any way for our.
Change our commitment to return capital to our shareholder to get we've got a long term track record of doing that it was truly up for this quarter to pause and gathering additional information and focus on a lower year end debt target.
Got it.
Alright. Thank you guys all fault later offline. Thanks.
Great. Okay I appreciate that thank you.
It appears there are no further questions at this time.
I would like to turn the conference back over to Dan <unk> for any additional or closing remark.
So I just wanted to say thank you again for participating in our Q3 release.
That will conclude today's conference.
Have a good day and you may now disconnect.
[music].