Gran Tierra Energy Inc. Q2 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to Gran Tierra Energy Results Conference Call for the Second Quarter 2022. My name is Justin, and I will be your coordinator for today. I would like to remind everyone that this conference call is being webcast and recorded today, Tuesday, August 9, 2022 at 11 a.m. Eastern Time. Today's discussion may include certain forward-looking information as well as certain non-GAAP financial measures. Please refer to the earnings and operational update press release we issued yesterday for important disclaimers with regard to this information and reconciliations of any non-GAAP measures discussed on today's call. Per barrel of oil equivalent or BOE amounts are based on a working interest sales before royalties. Finally, this earnings call is the property of Gran Tierra Energy, Inc. any copy or rebroadcasting of this call is especially prohibited without the written consent of Gran Tierra Energy. I will now turn the conference over to Gary Guidry, President and Chief Executive Officer of Gran Tierra. Mr. Guidry, please go ahead.

Thank you, Justin. Good morning, and thanks for joining us for Gran Tierra's second quarter 2022 results conference call. My name is Gary Guidry, President and Chief Executive Officer; and with me today are Ryan Ellson, our Executive Vice President and Chief Financial Officer; and Paul Baker, our Director of Asset Management for the Northern Putumayo region in Colombia. Yesterday, our press release included detailed information about our second quarter 2022 results, which is available on our website. Ryan and Paul will make a few brief comments, and then we will open the line for questions. Ryan, please go ahead.

Thanks, Gary. Good morning, everyone. Gran Tierra has had another strong quarter where we were able to deliver on our development campaigns in both the Acordionero and Costayaco fields, while continuing to make progress on work required before drilling our exploration wells in both Ecuador and Colombia. During Q2, Gran Tierra generated net income of $53 million, up 275% from the prior quarter and versus a net loss of $18 million in the second quarter of 2021. This resulted in earnings of $0.14 per share, which is up from $0.04 in the prior quarter. We achieved material production growth for the second quarter 2022 oil production averaging 30,607 barrels per day, up 4% from the prior quarter and up 33% year-on-year. This is the highest quarterly production that Gran Tierra has achieved since the fourth quarter of 2019. The company's operating net back of $59.62 per barrel was the highest since the third quarter of 2014, which was up 14% from the prior quarter and up 81% year-on-year. This strong annual increase was driven by Gran Tierra's 33% increase in quarterly oil production year-on-year and strong growth in the Brent world oil price. Q2 2022 funds flow from operations increased by 345% to $104 million compared to a year ago and was up 19% from the prior quarter, again due to higher oil production volumes and strong Brent pricing. Our Q2 funds flow was the highest achieved since the first quarter of 2013. On a diluted per share basis, funds flow from operations was $0.28 per share, which is up from $0.06 in the second quarter of 2021 and up from $0.23 in the prior quarter. In terms of capital expenditures, approximately 65% was incurred during Q2; $65 million was incurred during Q2, which was higher than the prior quarter's level of $41 million. This was a result of the majority of Gran Tierra's capital development programs in both Costayaco and the Acordionero being completed during the second quarter. Gran Tierra has fully repaid its credit facility. In only two years, Gran Tierra fully paid down its credit facility balance from $207 million to zero, which clearly demonstrated our commitment to rapidly reduce debt with the company’s free cash flow. As of June 30, 2022, the company added a cash balance of $109 million and net debt of $491 million. Our annualized Q2 net debt-to-EBITDA ratio was below one times. And over the long term, we are targeting a net debt-to-EBITDA ratio of under one times, assuming a $60 per barrel Brent case. With our credit facility now fully paid off, we plan to maintain a cash balance of $75 million to $100 million in order to maintain liquidity. We plan to deploy excess cash over and above our targeted cash balance to strengthen our balance sheet, buy back shares, and pursue accretive opportunities to continue to strengthen our portfolio. I'll now turn the call over to Paul to discuss some of the operational highlights from our second quarter results.

Thanks, Ryan. Good morning, everyone. Gran Tierra continues to drive efficiencies at its major fields. In Acordionero, a new pacesetter well was delivered in the quarter, which took only 3.9 days to drill. The time to drill a development well in Acordionero has decreased by a further 10%, with the average drilling time reduced from 5 days to 4.5 days. As a result of this reduction, the average per well drilling costs have decreased to $1.2 million, which is 9% lower than originally budgeted. We continue to deliver on our outlined development programs in the Acordionero with the delivery of the 16th well in the 2022 program. In the Putumayo, our Costayaco development program has been completed under budget because of cost reductions through optimization and the successful application of techniques utilized in our Acordionero development programs. All 5 of Costayaco's wells were completed during the first half of the year. Finally, our exploration programs continue to progress. In Ecuador, we are in the final stages of well site construction for the planned Bocachico-1 exploration well in the Chanangue Block in Ecuador's Oriente Basin. We expect to start drilling this well in the third quarter of 2022. In Colombia, in the Putumayo Basin, we continue progressing our exploration activities. The well site construction has started for the Rose-1 exploration well in the ALEA-1848A Block, which is planned to be funded in the third quarter of 2022. I'll now turn the call back to the operator, and we'll be happy to answer any questions. Operator, please go ahead.

Hi, good morning. Thanks for taking my question. I had a couple of questions, but I think that the main one would relate to the proposed tax reform that was submitted by Petro's government yesterday. So just trying to understand from the royalty tax exemption and the proposed new price scheme, how do you see the estimated EBITDA impact of this fiscal reform proposal at current price levels? And specifically, how do you see potential changes in your effective tax rate playing out?

Yes. It's a good question. We're still working through the tax reform and the implications. But as I'm sure you're aware, the tax reform is just a proposal; it still needs to go through two debates in the lower chamber and two in the upper chamber before it's actually signed into law. So we're currently assessing the impact.

Got it. I understand that might be too soon. But if there are any thoughts, more precisely perhaps trying to understand how the current tax exemption on royalties works? Does it flow through your net revenues? And how could it impact your bottom line, that would be perhaps your first thoughts on that? And just following up with that, given that it has to go through Congress and Senate? Are there any chances that E&Ps or some legal recourses could prevent it from going through the way that it's been proposed?

I think if you look at past tax bills that were put forward, very similar to what you just saw in the US, by the time it gets to the final bill, a lot of times it looks quite different than what was originally proposed. So that's why we're in a wait-and-see mode regarding the impacts. But we expect to see some changes; obviously, there's no guarantee on that. With respect to the royalties, our understanding is that a lot of the royalties we pay to the government are in kind; they take those barrels right from the wellhead. So we don't see that as a major impact to Gran Tierra at this moment, but again, we're still assessing that impact.

Perfect. That's very helpful. And maybe just one last question from your quarterly results. We noticed that there was still a jump in lifting costs owed to wells worked overseas. To just understand it and frame it in your full-year guidance, what should we expect for the next couple of quarters, given that you seem to be above the $11 to $13 per barrel that was targeted for the full year?

Yes. We expect that as we increase our volumes in the second half of the year, our per barrel metric will go down, and we still plan to remain in that range.

Perfect. Thanks for taking my question.

No problem.

Good morning. Just in terms of Ecuador, should you have some success in the exploration program later this year, how aggressive could you be in capital allocation to that country in 2023?

We're watching very closely Ecuador and watching very closely what President Petro will be doing in Colombia. As you know, we have a big portfolio in Colombia for exploration, but we also are very keen on Ecuador. So, to answer your question, if things do slow down in terms of regulatory processes, in terms of being able to execute the program in years two through four of President Petro's term, we would reallocate certainly to Ecuador. We have very prospective blocks and we have commitments. We're currently progressing those in the country. So for us, it really is about balancing the Putumayo into the Oriente and Ecuador, and we'll play that one year by year.

As far as regulatory requirements, we have the EIAs on the entire block. So we could, as Gary mentioned, be quite aggressive.

Thank you.

Thank you very much. Thanks for taking my question. Good morning, Gary and Ryan. Ryan, for you first. On the debt load, you mentioned $491 million in net debt, and then you mentioned wanting to be at a $60 debt level. Are we looking at another $100 million, $150 million? And then how do the levers work between that once you get down to that loan debt level, in terms of more spending on growth versus NCIB, and other ways to return money to shareholders? How are you guys looking at that whole metric given the strong cash flow you'll be generating over the coming quarters?

I think on the first part of the question, yes, we think by the end of the year, if you look at our targeted net debt it should be around $400 million. We would be very comfortable at those levels. To your second question, we will get there by the end of the year, really by Q4. The second part of your question really comes down to capital allocation. As you correctly pointed out, we have a great portfolio in Colombia, both in development and exploration, and also exploration in Ecuador. It’s about getting the right balance of strengthening the balance sheet, growth capital, and share buybacks. When we look at growth capital, we're always looking at optimizing the NPV of our existing assets. If you look at where we're trading right now, we're trading, like most of the industry, at a substantial discount to net asset value per share. That makes it a pretty useful allocation of proceeds for share buybacks too. When you also look at our bonds, they've been trading at $0.85 right now, so that could be another potential use. It's really about finding the right mix in capital allocation.

Okay. Good to hear on that. Then one for Gary. There have been some articles from economists about disruptions with indigenous people in Ecuador and some issues with the government. Does that pose any risks to your program in Ecuador? Are you in the same area? How is the relationship with the local indigenous people living in the area where you want to work?

Yes. I think the answer is that the entire oil region is prone to disruption, but we've spent a lot of time, both before COVID, during COVID, and after COVID with our community relations, working with the folks in the area where we have operations. We believe that our relationships with the indigenous community allow us to make progress with what we're doing, and we're comfortable with our operability in Ecuador.

Okay, super. Thanks so much for taking my questions and congratulations on the very next quarter.

Thank you.

Thanks, Joseph.

Thank you. Good morning, everyone. So congratulations on the excellent results. And thank you for taking my questions. First, looking at the CapEx breakdown, you booked $10 million of exploration CapEx. I was wondering if this was related to the dry exploration wells you drilled. Where was that well drilled?

In our last press release, we mentioned drilling the Truco well, which unfortunately was dry. The $10 million in CapEx, I think a lot of that is just reallocating our budget from development to exploration and vice versa. That's what we focus on regarding the total capital program. The location of Truco was in the region of Costayaco Moqueta of the producing fields.

Okay, perfect. And regarding Ecuador, as you mentioned, you are progressing with the drilling there. So I assume that you have quite a long testing period there. When could we expect that you will start selling production?

We don't forecast any production from exploration, but what I can tell you is that similar to the Putumayo, the infrastructure is there that when we do tests, we can take that testing volume to sales. So we'll have long-term testing to gather the necessary information, but also generate revenue effectively immediately if we have success. Our long-term test will form the sales volumes.

Okay, perfect. Thank you. Just one last question. Regarding hedging, you currently don't have any hedges in place. I know you're considering some options, but do you plan to get anything during the second quarter?

We're currently working with some of our off-take providers on what sort of hedging arrangements we can put in place. It was a challenge before when the curve was in backwardation. We are currently assessing options and working on an optimal structure with our partners.

Okay. Thank you very much, and congratulations again.

Thank you.

Hi, guys. Good morning, congrats on the good results. I have a couple of questions, and just to pick up on the last one regarding hedges. Could you quantify what was the impact or if there was still any impact from hedges that you had in place during this second quarter? That's my first question.

Our hedging losses in the first half of the year were around $26 million to $27 million. So yes, there was an impact in the second quarter.

Okay. And the second one is, can you give me some guidance on production for the year? Can you also guide on the exit production you expect to finish 2022 with in terms of total exit production?

Yeah, it will be in the low 30,000s. We're currently focusing on developing the water floods that we have. So, we expect it to be around 32,000 to 33,000 barrels per day, and we plan to deploy capital to raise that plateau over the coming years. We have very high-quality, probable, and possible reserves. We discussed the polymer floods that we are pilot testing in Acordionero. Those will change our targets over the next 2 to 5 years. But to directly answer your question, we expect an exit rate within the 32,000 to 34,000 barrels per day range.

Perfect. Very helpful and very clear. My last question is about your excess cash or excess liquidity. When you look at your bonds trading in the '80s, which seem very discounted, especially given your strong results in generating free cash flow and lowering leverage considerably. Are you thinking about the advisability of using cash to purchase some of your bonds on the secondary market, given they look undervalued?

It definitely is one of the considerations. In the release, we mentioned strengthening the balance sheet, share buybacks, and potential accretive acquisitions or M&A opportunities. Any bond repurchase would be calculated as part of our strategy to strengthen the balance sheet. We agree that we think our bonds are undervalued.

That's perfect. Thank you very much, Ryan. That's it from my side. Congratulations on the good results, and speak to you next time. Thank you.

Thank you.

Thank you. One moment for our next question. And our next question comes from David Herzberg from Stifel. Your line is now open.

Hi. Thanks for taking my questions. I guess I have two this morning. The first is in July you had mentioned in your operations and financial update that you were looking to replace your credit facility with a smaller one. I was wondering if you had any developments or color on that and what we might expect in terms of the size? And the second question would be with respect to CapEx if you're still guiding towards a $220 million to $240 million full-year 2022 CapEx?

Yes. We will continue to advance a number of initiatives. As we finalize something, to the extent that we do finalize a replacement facility, we will announce at that time. I think the range we're looking at is in the $75 million to $125 million replacement facility. And on the second question about the CapEx, yes, we're comfortable with that $220 million to $240 million range.

Thank you. One moment for questions. Our next question comes from an unidentified analyst from Barclays. Your line is now open.

Thank you so much for taking my question. And congratulations on these great 2Q earnings. I have two quick questions. Especially related to the 2025 bonds maturing, my first question is trying to understand the logic behind the consent solicitation. Now that the consent has failed, what will your approach be going forward for 2025? And the follow-up question is, are you guys thinking about using free cash flow down the line, or are you planning on refinancing these 2025 bonds? I appreciate you already mentioned some of the key pillars that we're going to focus on for Gran Tierra - debt buyback or equity. So I'm just curious how you're thinking about this 2025 situation. Thank you so much.

I think a lot of it obviously depends on market conditions. If you look at the last two years, where we did experience quite a few hedging losses, and we were just ramping up production, we were able to repay $207 million off the credit facility while also significantly reducing our cash balance. We believe we substantially reduced our net debt balance during that period. Therefore, we feel comfortable with the free cash flow nature of our assets. If the market conditions are not favorable, we’d be in a good position to repay the bonds in full by 2025.

Thank you. Regarding the consent solicitation, could you provide some details on why you decided to go ahead with it? And what is your strategy now? Should we expect another potential solicitation in the same way?

Again, a lot depends on the market. The intent of the consent solicitation was to offer a more liquid bond for holders. We believed it was a fair offer, but it did not get the acceptance we hoped for before the offer expired. We’ll see where we end up with market conditions going forward, but we're very comfortable with our free cash flow and the assets we hold, which puts us in a great position regardless of conditions.

Perfect. Thank you so much.

You’re welcome.

Hey. Good morning, guys. You guys are wrapping up some exploration drilling in the back half. Just wondering if you could provide some individual details on expectations for each of those six or seven wells and the potential timing on when we will see results from them?

Yeah. The expectations, I think we have published, but we certainly can make that available. On average, our targets range anywhere from 8 to as high as 30 million barrels of potential on those exploration targets. In terms of timing, we're drilling now. We will test, and we will provide guidance as well. We don't have any results on that yet; however, we will keep shareholders updated throughout the year. We're quite excited about the quality of what we're drilling. After a long period being disrupted by COVID, we are finally drilling some of our best prospects.

Got you. So is it fair to say we will see some results around Q4 through early 2023 for the remaining program?

Yes, I think we should see some results in Q3 and Q4.

My question has been answered. Thanks very much.

Okay.

And there are no further questions. I would now like to go ahead and turn the call over to Gary Guidry for closing remarks.

Thank you, Justin. I'd like to thank everyone once again for joining us today. We look forward to speaking with all of you next quarter, and we will certainly update you as we make progress throughout the quarter. Thank you very much.

This concludes today's conference call. Thank you for participating. You may now disconnect.