GeoPark Ltd Q3 FY2021 Earnings Call

Good morning, and welcome to the GeoPark Limited conference call following the results announcement for the third quarter ended September 30, 2021, and the 2022 work program and investment guidelines. If you do not have a copy of the press release, it is available in the Investor Support section on the company's corporate website at www.geo-park.com. A replay of today's call can be accessed through this webcast in the Investor Support section of the GeoPark corporate website. Before we continue, please note that certain statements in the results press release and on this conference call are forward-looking statements rather than historical facts, and are subject to risks and uncertainties that could cause actual results to differ materially from those described. Regarding these forward-looking statements, the company seeks protections provided by the Private Securities Litigation Reform Act of 1995. These risks include various factors, including competitive developments and the risk factors listed in the company's SEC reports and public releases. These lists aim to identify some principal factors that could lead to actual results differing materially from those described in the forward-looking statements but are not meant to represent a complete list of the company's business. All financial figures included were prepared in accordance with IFRS and are stated in U.S. dollars unless noted otherwise. Reserve figures correspond to PRMS standards. On the call today from GeoPark are James F. Park, Chief Executive Officer; Augusto Zubillaga, Chief Operating Officer; Andrés Ocampo, Chief Financial Officer; Martin Terrado, Director of Operations; and Stacy Steimel, Shareholder and Director. Now I will turn the call over to Mr. James Park. Mr. Park, you may begin.

Thank you, and welcome, everyone. We are joining you this morning with our executive team in Colombia and the U.S. to report on our achievements and financial results during the third quarter of 2021. Firstly, we would like to recognize and thank the women and men of GeoPark for their resilience and commitment, as proven again by our performance in this last quarter. Production was up compared to last quarter as we continued low-risk development in the Llanos 34 block. Our growing low-breakeven production generated strong free cash flow. Revenues doubled from a year ago and adjusted EBITDA was 54% higher, with a net profit of $37 million, the equivalent of $0.61 per share. Every $1 of invested CapEx yielded $2.80 in adjusted EBITDA. We continue to manage and consolidate our project portfolio by divesting our economically marginal and high-carbon assets in Argentina, expecting to close by year-end. Our Brazil asset divestment is also underway, with expectations to close during the first half of 2022. Our relentlessly passionate focus on SPEED, our internal value system we refer to as ESG+, included a concrete road map with an accountable schedule to reducing greenhouse gas emissions. Already with a peer-leading low carbon intensity, we embarked on immediate actions to further reduce Scope 1 and 2 emissions by 35% to 40% in the next 3 years, 40% to 60% by 2025 to 2030, and net zero by 2050 or sooner. And of course, we continue to return tangible value to our shareholders through our active dividend and share buyback programs. A new development involves GeoPark shares being included in the S&P Global BMI Index and 4 S&P subindexes, which represents an expansion of our investor base and opens the opportunity for being included in additional indexes. During the quarter, we carried out our capital allocation process to develop the work program and budget for 2022. This represents a healthy opportunity to review every asset in the portfolio and make them compete for investment on rigorous technical, economic, strategic, social, and environmental criteria. Our outcome was a new 2022 investment program of $160 million to $180 million, which targets drilling 40 to 48 wells composed of 25 to 28 development wells to develop our reserves and increase production, and 15 to 20 exploration wells to test a powerful portfolio of high-impact, low-risk prospects on adjacent acreage, which can generate cash flow quickly if successful. It also includes a significant pickup in activity on our CPO-5 block. As always, this is a flexible work program that can be easily adjusted up or down depending on oil prices. We are giving guidance of a 5% to 10% production increase after divestments on the producing assets, but this does not include a single barrel from the 15 to 20 exploration wells we are drilling next year, all with a chance to find and open up new promising fields. So for 2022, we will be generating significant free cash flow that will self-fund the full enchilada. This includes tangible shareholder returns; balance sheet strengthening, including potential deleveraging; a real emission reduction plan; continued efforts to expand scale by acquiring new projects; a growing high-return production base and an aggressive low-risk, big potential exploration campaign. We believe that being able to self-fund from cash flow and simultaneously achieve these objectives represent the right business model for our industry today and provides GeoPark with a comparative advantage in an energy transitioning world. Thank you, and we would be pleased to answer any questions you may have.

Our first question for today comes from Ricardo Rezende from JPMorgan.

A couple of questions on my side related to your 2022 work program. So Jim, as you just mentioned, if things go according to the plan, you're going to have a very strong free cash flow generation next year. And then one of the questions that I have is would you consider looking at M&A as a potential use of this cash flow? Or you're mostly focusing on developing your current areas? And then the second question, I think it's more to Andrés, it's on the 2024 notes. As you mentioned in the release, those notes became callable in September. Just a question here would be, are you looking more upon your liability management as reducing your nominal amount of debt? Or it's mostly a liquidity exercise that you could be doing with those notes?

Ricardo, Andrés here. I mean, the priorities for our free cash flow generation during 2022 have not changed from historically, what we do every single year. The first priority is to fund the development of our reserves; second is our activity and fund our exploration campaign; and then third, it's always a combination of debt reduction, deleveraging, and shareholder value return. We do have M&A as part of our business model and is part of what we do and always consider it in the context of always funding our portfolio and deleveraging our company. I would say probably the priority for 2022, given that earlier this year we did the liability management transaction to organize our debt in a way that can be gradually repaid, probably in 2022 with such a busy drilling campaign. The priority is going to be for any excess cash to be used for deleveraging and shareholder value returns. And then to your second point, the fact that the bonds became callable in September means that now we can actually exercise the option to repay them in full or in part at any point in time over the next years until maturity. So that is what changed. When we did the liability management transaction, our bonds were not callable. So that was the way we needed to do it to actually repay a significant part. But with this new structure, it means that we can exercise the call at any point in time to pay them down.

Our next question for today comes from Phil Skolnick from Eight Capital.

My first question is with respect to your exploration program, the 15 or 20 wells, how do we think about that in terms of the positive impact it can have on the 2022 program? I guess how many of those are short-cycle nature to allow for it?

Thank you for your question. As you mentioned, we have a significant exploration campaign planned, with 15 to 20 wells. Much of this work is our core activity, something we've been engaged in for many years. This type of exploration resembles what we were undertaking when we began discovering fields in Llanos 34 back in early 2012. Most of these prospects are designed to be short-cycle. In the case of a discovery, we expect that nearly all these prospects, which have the potential to become fields, can be brought into production relatively quickly after discovery. A good estimate for this is about a month, with potential delays of up to two months for specific events. However, this timeframe is much quicker compared to the typical offshore exploration, which often takes significantly longer. Therefore, I would categorize our entire exploration portfolio in 2022 as short-cycle.

Okay. Great. That's perfect. And then in terms of the flexibility around the program, you laid out the $50 to $80 Brent pricing. How do we think about that in the context of your 2022 production guidance? If we go to $50, what does that mean? If we go to $80, I mean, obviously, the $80 would be an upside potential, but $50, how do we think about that?

What stands out is that our production and work program are quite resilient. We provided our guidance using $65 to $70 Brent, which is approximately $15 to $20 lower than current oil prices. Our work program indicates that we can fully execute it in nearly any oil price scenario, even with prices as low as $60. Below that threshold, we might consider postponing some exploration, but all production and development efforts would continue. Essentially, we are maintaining a similar production curve across a broad range from $50 to $80. If oil prices rise, there are numerous exploration opportunities, which could lead to additional capital expenditures in the event of a new field discovery. Thus, capital for development and the potential for discovering new fields could be introduced in a higher oil price environment.

Our next question comes from Stephane Foucaud from Auctus Advisors.

I have two questions. The first is about the full year 2022 production guidance and the contributions from Llanos 34, CPO-5, and Putumayo. The second question concerns the capital expenditures. I was comparing the number of wells to be drilled in 2022 with 2021, and it seems there might be some inflationary pressure. For example, in Colombia, in 2021, the expenditure was between $95 million and $150 million for 30 to 34 wells, while in 2022, the range is between $145 million and $165 million for 36 to 41 wells. I'm curious if this is due to inflationary pressure, a different type of well, or if the Putumayo well is included in the 2022 guidance.

Stephane, this is Martin Terrado, and I will take the first question. So as Jim said, our production guidance for next year is 35,500 to 37,500 barrels of oil per day average. And that is 5% to 10% production growth when we exclude production from Argentina and Brazil, and that does not include any potential production that will come out of our very healthy exploration program. Now the split of that production is around 70% to 75% coming out of our Llanos 34 block; around 10% to 15% from CPO-5; and around 5% to 10% from Putumayo block.

In response to your second question, Stephane, regarding inflation, we are currently experiencing pressure on materials for our campaigns due to rising commodity prices. About 70% of our capital expenditures are denominated in dollars, and we anticipate inflationary pressure in the range of 1% to 2% for the upcoming year. We are exploring long-term contracts to mitigate this impact. However, the significant change you're observing is primarily linked to the type of wells we are drilling, specifically a higher proportion of exploration wells, which are generally more costly. Additionally, there is an increased focus on wells in the CPO area, where we are planning to drill using three-stage casing instead of the two-stage casing common in most development wells in Llanos 34. Consequently, the majority of the changes you're noticing are more related to the nature of the wells rather than inflation.

Great. And the $145 million to $165 million for Colombia, does that include the 3 to 4 wells in Putumayo? Or is it on top?

No, I think that's included in the other activities in the Putumayo section. So that Colombian part does not include Putumayo, even though it's in Colombia.

Our next question comes from Miguel Ospina at Compass Group. He asks, what are you going to do with the proceeds from the sale of Argentina?

Okay. Thank you, Miguel. Well, the proceeds of the sale of Argentina are going to add to the cash inflows, and we'll follow the same priorities for the rest of the cash inflows of our production base. There's no difference or no specific use for those proceeds other than merging them with the rest of the company's inflows and follow the same priorities, really.

Our next question comes from Gustavo Sadka at Bradesco. He asks, looking at the work program, we can see that the company should have a very healthy cash flow generation in 2022. What should be the main uses of this cash generation? Could we expect an acceleration of the share buyback program or should the focus be more on developing strictly?

Thank you, Gustavo. The uses of cash include funding the development campaign and the exploration campaign. In the event of any potential discovery, we would allocate funds for its development capital. Any excess free cash flow will be directed toward a combination of debt reduction and returning value to shareholders through share buybacks and dividends. While deleveraging is a priority, it is not our only focus. Therefore, following the first quarter, if cash flow and the work program develop as we have budgeted based on these prices, you can anticipate an acceleration of the buyback alongside our debt reduction efforts.

A follow-up question from Gustavo. Also on the work program, when looking at the $70 million to $80 million in CapEx destined for exploration, what kind of returns could we expect? And what would be a fair assumption to be made in terms of additional production entering in 2022? What are the prospects we are most optimistic about, and where is there a high level of uncertainty?

Thank you, Gustavo.

Thank you, Gustavo. I'll take part of that and then let Andrés close on it. So our exploration program for next year, it's something that we're really excited. Again, like Jim said, 15 to 20 gross exploration wells in the core areas of where we want to be. So we're looking forward to the results in CPO-5, Llanos 87, and the other blocks. When we look at CPO-5, we're going to have 2 rigs. One of the rigs is going to be drilling in the Northwest of the area and the other one is going to be in the Southeast. That's where there's seismic already with the prospects and leads, while our teams are looking at the recent seismic that was acquired. So we're very excited about that. The chances of success are similar to the wells that we've been drilling and discovering in Llanos, in the Jacana and Tigana for the Northwest of the block. So from that perspective, we will drill these wells. We have additional locations that have been agreed with the operator, and we're looking forward to those wells being drilled in the Llanos area.

In terms of production, we typically do not attribute any production to our exploration efforts due to the associated risks, and we do not factor any production from exploration into our guidance. The primary goal of our exploration campaign is not to generate production in 2022, but rather to create production opportunities over the next 3 to 5 years. We estimate that about 20% of our exploration portfolio will be targeted in the 2022 campaign, which represents approximately 150 million to 200 million barrels of prospective resources. This figure is gross, and our working interest would amount to roughly 70 million to 80 million barrels of unrisked mean resources. This is a considerable campaign with significant resource targets. As Martin mentioned, we anticipate that we will uncover something noteworthy in some of these activities.

Our next question comes from Augusto Uribe from AIG Investments.

My question has to do with hedging. Generally, the market is bullish within oil prices for 2022. And I just want to get your thoughts about your hedging strategies or speaking with the number of barrels to cover your work program and any thoughts that you can provide us in terms of your hedging strategy for 2022?

Yes. Thank you, Augusto. Yes, as we do every year, we try to secure more or less 40%, 50% of our production for the following 12 months. We are more or less covered for the first half of the year with floor prices of around $55, $58 per barrel. And we have lower percentages for the second half, with higher floors more in the levels of $60. So our view is when markets are bullish like they are these days is probably the opportunity, the time of opportunity to be layering some of these additional hedges for the next year. So you should expect us over the course of the next 3 to 6 months to complete the hedging program for 2022. Obviously, always targeting to secure more or less those floor levels with the highest possible ceilings.

Our next question comes from Stephane Foucaud from Auctus Advisors.

I had some follow-on questions. The first one is, I think, as it was highlighted by a question on the call indeed, the program is very busy. There are different exploration phases in 2022. There are different risk profiles. And I was wondering whether there were any particular exploration wells that could be really more material than others and the one that we really need to look out for? And the second question I would have is I was wondering about the buyback. The cash on the balance sheet is pretty good. I think you have approval to do a bit more than what has been done. Why not have you done more buyback, say in Q3?

Thank you, Stephane. I'll begin with the second question, which is simpler. Your first question is akin to asking our technical team to choose their favorite project. Regarding the buyback, this year, we have accelerated our activity; we completed $4 million in the third quarter, compared to half of that in the first six months. In the fourth quarter, we are maintaining a similar pace to what we achieved in the third quarter. However, our buyback is constrained by the bond indenture, which limits our shareholder return activities. In straightforward terms, we have a free basket and builder baskets, where the builder baskets are contingent on profits and can offset some losses. Due to our impairments in 2020, those baskets were diminished. As we start generating profits again, as we did this quarter, and if our budget and work program progress as anticipated, we expect to begin rebuilding those baskets significantly next year. Our ability to return shareholder value should improve after the first quarter next year. Until then, we will likely continue at our current levels to avoid fully utilizing the free basket. Following the first quarter, assuming everything proceeds as expected, we should have more flexibility to increase our activity and potentially take a more aggressive approach.

And to add a little bit, again, on the exploration part, like we said before, we're really excited about the wells that our technical team has put together. They came from play concepts where some of these play concepts are originated by our team. We're bringing those play concepts to other blocks. The blocks are the blocks where we want it to be with a very good footprint in the Llanos, a good footprint in Putumayo and Intracampos, in Oriente. So they're very exciting projects for us. Like I said before, in CPO-5, right next to our Llanos block, we will have 2 rigs, one rig is going to start drilling early in December. And we will have a second rig following up in January. And so we're excited about all of them, and they are on the plan because we think that they have a good chances of success compared to what we've been drilling in the past. So it's a very exciting year for us.

And being a non-technical guy, I can tell you that the Northern part of CPO-5 and Llanos 87 include some play ideas that our team have been trying to test for a very long time.

We have a follow-up question from Ricardo Rezende from JPMorgan.

So Andrés, just a very specific question. On the Argentine divestment, do you expect to pay any taxes on the $16 million? Or that should be the total cash proceeds for your part?

Thank you, Ricardo. Yes, there's a small tax, it's around $500,000 to $700,000 more or less.

We have no further questions, so I will hand back to Andrés Ocampo for any closing remarks. Andrés, over to you.

Thank you, everybody, for your interest in GeoPark and your continued support of our company. As the world's borders begin to open again, we encourage you to please visit us, our operations in each country. Our shareholder value team has accelerated their interactions and is busier than ever with webinars, video conference, and direct calls and is available around the clock, as is our management team to answer any questions or listen to your comments. So thank you, and please stay healthy and strong.

Thank you for joining today's call. You may now disconnect.