Gran Tierra Energy Inc. Q3 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to Gran Tierra Energy's Results Conference Call for the Third Quarter 2022. My name is Kathy, and I'll be your coordinator for today. At this time, all participants are in a listen only mode. Following the initial remarks we will conduct a question and answer session for security analysts and institutions. Instructions will be provided at that time for you to queue up for questions. I would like to remind everyone that this conference call is being webcast and recorded today, Thursday, November 3, 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. Any production volumes are based on working interest sales before royalties. Finally, this earnings call is a property of Gran Tierra Energy Incorporated, any copying or rebroadcasting of this call is expressly forbidden without the written consent of Gran Tierra Energy. I'll now turn the conference call over to Gary Guidry, President, Chief Executive Officer of Gran Tierra. Mr. Guidry, please go ahead.

Thank you, Kathy. Good morning, and thanks for joining Gran Tierra's third quarter 2022 results conference call. My name is Gary Guidry, I'm 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. On Tuesday, November 1, we issued a press release that included detailed information on our third quarter 2022 results, which is available on our website. Paul and Ryan will make a few brief comments and then we'll open the line for questions. I will now turn the call over to Ryan to discuss key financial highlights from our third quarter results.

Thank you, Gary. Good morning, everyone. Gran Tierra achieved a strong quarter by delivering $94 million of funds flow and $37 million of free funds flow, while drilling three exploration wells: the Bocachico well in Ecuador and the Gaitas and Rose wells in Colombia. Over the last 12 months, we generated net income of $168 million, adjusted EBITDA of $462 million, funds flow of $350 million, and free cash flow of $146 million. This free cash flow allowed us to execute our share buyback plan and strengthen our balance sheet via bond buybacks and the complete pay down of our former credit facility. During the quarter, we strengthened our balance sheet while reducing the overall outstanding shares to 358 million shares, representing a reduction of about 2.9% in our total outstanding share count during the quarter. The company exited the quarter with $118 million of cash on the balance sheet and net debt of $462 million with our new credit facility remaining completely undrawn. During Q3, the Brent oil price averaged $97.70 per barrel, up 33% from one year ago but down 13% from the prior quarter. The company's quality and transportation discount widened to $13.37 per barrel in Q3, up from $13 per barrel in the prior quarter and $11.50 per barrel one year ago. The increases in this discount were driven by the widening of the Colombian oil price differentials relative to the Brent oil price. During Q3, we achieved net income of $39 million, up 10% from the third quarter of 2021. Q3 earnings of $0.11 per share were down from $0.14 per share in the prior quarter. Gran Tierra's total average production in Q3 was 30,391 BOPD, up 5% from the third quarter of 2021 and approximately flat with the second quarter of 2022. During the quarter, the Suroriente Block in Colombia's Putumayo Basin experienced occasional disruptions due to localized blockades. The impact of these blockades lowered the company's total average production in Q3 by approximately 920 BOPD. Gran Tierra generated Q3 oil sales of $168 million, up 24% from one year ago and down 18% from the prior quarter. Funds flow from operations was $94 million, up 36% from one year ago and down 10% from the prior quarter. The company's Q3 operating netback was $44.26 per barrel, up 28% from one year ago. Cash netback per barrel was $33.42 compared to $37.71 in the prior quarter, which was only an 11% decrease despite a 13% decrease in the Brent pricing. Compared to one year ago, cash netback per barrel increased 31% from $25.50. In terms of CapEx, during Q3 we incurred $57 million of capital expenditures, which were lower than the prior quarter's level of $65 million, as the majority of Gran Tierra's capital development programs in both Acordionero and Costayaco were completed during the second quarter of 2022. During Q3, Gran Tierra drilled three exploration wells, the Bocachico well in Ecuador and the Gaitas-1 and Rose-1 wells in Colombia. Subsequent to the quarter end, we drilled and cased the Charapa Norte well in Ecuador, and testing will commence shortly. As part of our ongoing commitment to reduce Gran Tierra's net debt, during Q3 we bought back approximately $20.1 million face value of Gran Tierra's 6.25% senior notes due February 2025, for an approximate cost of $17.3 million, representing a discount of about 14% to the face value of our 2025 bonds. Purchases of bonds will generate interest savings of about $3 million over the remaining term to the maturity of the 2025 bonds. During the quarter, we repurchased 10.7 million shares, representing about 2.9% of our shares outstanding for a total price of $14.4 million, which was at an average cost of $1.34 per share. With current production of approximately 32,000 BOPD, we look forward to finishing 2022 on a strong note and are excited about our plans for our 2023 development and exploration capital programs. As many of you are aware, there have been numerous proposals for changes in the tax regime in Colombia. Given the uncertainty on what the ultimate changes will be, we don't have any comments on the proposed changes other than Colombia's long history of providing a stable environment for long-term investment, and we expect that to continue in the future. I'll now turn the call over to Paul to discuss some of the operational highlights from our third quarter results.

Thank you, Ryan. Good morning, everyone. Gran Tierra continues to drive efficiencies at its major fields. As Ryan mentioned, our production for the quarter was 30,391 barrels of oil per day. So far, during the fourth quarter to date, our production is averaging 32,291 barrels of oil per day. Our waterflood projects in our core fields continue to yield stable and expected results with low natural declines. During Q3, we commenced our enhanced oil recovery, polymer injection project in the Acordionero field. This pilot injection test is a milestone. After several years of laboratory work and modeling indicated the Acordionero reservoir's suitability for polymer injection. We are also excited about the initial exploration results that the company has achieved in both Colombia and Ecuador. Bocachico-1 was the first well that we drilled in Ecuador. After the previously disclosed initial production testing of the deepest zone, the T Sand, the company moved uphole and tested the U Sand, which was water-bearing. We now plan to go back to the T Sand to stimulate it and place it on a long-term test before moving uphole to test the Basal Tena formation. Gran Tierra's second Ecuador well, Charapa Norte-1, has finished drilling and is being cased to the total depth of the well. A core was cut in the Hollin Sand which had oil shows throughout the 60 feet of core, with 40 feet of potential oil pay identified. We plan to production test Charapa Norte-1 during November of 2022. In Colombia, we drilled the Rose-1 well in the Putumayo Basin. The company production tested the N Sand over a 72-hour period, and during this period, the well flowed naturally without a pump at average stabilized rates of 242 barrels of oil per day of 15 degree API gravity and two barrels of water per day with a gas-oil ratio of 10 standard cubic feet per barrel. In the Middle Magdalena Basin, based on the encouraging results of the Gaitas-1 exploration well, we moved a drilling rig to the Gaitas pad and on October 27 we spud the Gaitas-2 exploration well. We expect Gaitas-2 to target multiple reservoir zones in a location that is structurally higher than the Gaitas-1 well, in a planned effort to test the Lisama Formation and the deeper Umir Sand further away from possible oil-water contacts. I'll now turn the call back to the operator, and we'll be happy to answer any questions.

Ladies and gentlemen, we will now conduct the question-and-answer session for our securities analyst. Our first question comes from the line of Oriana Covault from Balanz.

Hi, good afternoon. Can you hear me?

Yes, crystal clear.

Perfect. Thanks for taking my question. This is Oriana Covault with Balanz. I had three questions. If we may go one by one, that would be great. First, starting on the lifting costs. We noticed that lifting costs year-to-date continued to be well above the high-end of your full year guidance. So just wanted to understand what drove this increase in the third quarter? And if you're sticking to this range and how you plan to reach such reduction by the fourth quarter?

Yes. I think part of the lifting cost is obviously, there's a set amount of inflation globally. But also in Q4, Paul had mentioned that we're over 32,000 barrels a day. A substantial amount of our lifting costs are fixed. So as we ramp up production during the quarter, that per unit cost will decrease.

Understood. And perhaps take into that guidance for production in the fourth quarter, just to understand better the impact that you saw during the quarter due to these operational disruptions and contingencies in the third quarter. So if you could perhaps provide more detail on what drove this impact in production levels in Colombia, the nature of the issues, and how should we think of this going forward?

The disruptions we experienced during the quarter were mainly in the Suroriente Block, which affected around 920,950 barrels a day. These disruptions were primarily due to blockades, mostly directed at the central government rather than Gran Tierra. Unfortunately, we found ourselves caught in the midst of this situation. We are working closely with the government to address these blockades moving forward. It is challenging to predict, so while we are not expecting blockades in the upcoming quarter, it remains difficult to anticipate.

Understood. And maybe just my last one. We saw in your corporate presentation that you're guiding for a cash position for year-end of about $190 million roughly in the midpoint with about $70 million coming from working capital and other cash items. So just if you could share more details on how do you plan to achieve this target?

Yes. I think when you look at the quarter, obviously, it's a pretty constructive oil price environment right now. Our CapEx is dropping during the quarter, clearly compared to the past quarters, a lot of the development program is behind us. And so, we have a free cash flow build just on our operations. But then also, we expect our 2021 tax refund in the range of $20 million to $25 million to come in during the quarter as well.

Thank you. Our next question comes from Werner Riding of Peel Hunt. Your line is now open.

Hi, guys. There is no FY '23 guidance yet, but I guess we're only weeks away from being in the final month of this year. And so the outcome for 2022 is largely known. So to the extent possible, could you perhaps give us a feel for future production expectations next year? And then following on from that, I was just wondering on which year you see peak production being achieved from your current assets?

Yes. The short answer is we meet with our Board of Directors annually to discuss our long-range plan, the lifespan of all our assets, and a five-year outlook. This discussion informs our budget for 2023, which we will release in early to mid-December, providing you with the guidance we expect. This year, we focused on a few key areas. First, our balance sheet, which is in great shape. Second, we concentrated on expanding our waterfloods in our major fields. Lastly, as Paul mentioned, we initiated a pilot test on polymer. Combining all these efforts gives us clear potential to increase production by expanding waterfloods and enhancing recovery. Additionally, as Ryan mentioned, we have some exciting exploration well successes to appraise. While we'll provide guidance for 2023, we have a lot of opportunities to increase production over the next couple of years.

Thank you. Our next question comes from the line of Josef Schachter.

Good morning, Gary, Ryan, and Paul. Thank you for addressing my questions. I would like to discuss the balance sheet, particularly with you, Ryan. Earlier, you mentioned $118 million in the U.S. now and projected figures of $180 million to $200 million by year-end. Given your comments on how you arrived at those numbers, it seems you may not need more than $100 million. Are you planning to capitalize on any market disruptions in Q4 or Q1 to acquire bonds at significant discounts, similar to your recent actions? Are you considering being more aggressive with your NCIB or exploring acquisition opportunities for additional assets that align with your core focus? Could you clarify your thoughts on how cash will be utilized, or do you intend to maintain that level of cash on the balance sheet moving forward?

Thank you, Josef, for your questions. When we examine our capital allocation for Q3, it was relatively balanced. We allocated funds for development and exploration, along with share and bond repurchases. We anticipate that share and bond repurchases will continue in Q4, always depending on market conditions. We continually assess our portfolio, focusing on optimizing it, which may involve selling assets rather than buying them, all while ensuring we maintain long-term value. To summarize, our focus will remain on exploring and continuing with share repurchases and bond buybacks.

Okay. And just to clarify, you mentioned the NCIB was at $1.34 per share. Is that Canadian or U.S.?

U.S.

That was U.S. Okay. Good. That's it from me. Thanks very much.

Thank you.

Our next question will come from the line of Matias Castagnino of BCP Securities. Your line is now open.

Hello. Can you hear me?

Yes.

Okay. Thanks for taking my question. I just want to ask about Petro's remarks of allowing the exploration on existing contracts and not allow new contracts. I know that is not yet defined. Don't want to ask about your view on that. Just two questions. The first one, I understand if that happens you will still have full access to your 2P reserves, right, those are from existing contracts and you are freely to explore and develop them. And the second question is that, I have the sense that private players in Colombia were not granted a lot of new contracts in the recent past. So can you tell me how many of your existing contracts were granted in the past, let's say, three to five years?

Yes. I think the short answer is President Petro has clearly said no new exploration contracts. Gran Tierra is in a very good position. We're focused in all three of the basins in Colombia. The Putumayo is the big one for us, but we also have lands and exploration in the Middle Magdalena and the Llanos basin. We've also come through a couple of years here where we refocused our exploration efforts. We went through the regulatory process. So we have an inventory of lands that we currently have to drill over the next couple of years. President Petro has not said anything about existing lands, and we found that the regulators and the governments are business as usual cooperating in what we're doing. But having said that, we've also had some early success in Ecuador as well. It's the same basin as the Putumayo, we have some exciting things to do in Ecuador. And so the short answer to your question is, we're continuing our focus on enhanced recovery in our big fields in Costayaco, Moqueta, Acordionero. And we have lots of inventory to continue drilling over the next couple of years, just speaking for Gran Tierra.

Okay. Thank you.

Thank you. Our next question comes from the line of Roman Rossi of Canaccord Genuity. Your line is now open.

Thank you very much. Good morning everyone. So I have a couple of questions. I will ask them sequentially, if I may. The first one is related to the new marketing agreement you have in place. So, of course, you can have a positive or negative impact depending on the next month's price change. So I just wanted to know if you are thinking about any type of hedging in order to mitigate the impact of these prices changes?

Yes, I believe we are not currently hedging the existing structure. However, we are exploring additional hedging options for overall price protection, rather than focusing on the monthly fluctuations. In the long term, whether we price at M or M+1, we will essentially arrive at the same price. For instance, in October, assuming production volumes remain stable, we will see the price align with the average Brent price of November, and then in November, it will align with the average Brent price of December. This highlights the minor month-to-month variation that we are not prioritizing for hedging. Nevertheless, we are collaborating on our capital program related to price production, anticipating continued price volatility, and ensuring we have protection against downward price movements so that we can maintain consistency in our capital program without interruptions.

Perfect. The second question is about the exploration campaign, which has so far shown positive results. I wanted to know what you expect for next year, especially regarding the focus on Ecuador. Additionally, what is the pending commitment in Ecuador?

Yes. Our total commitment in Ecuador is 14 wells. And we're just in the process of converting one of those to a seismic program. And those 14 wells will include some appraising work, and that is part of the process. And so, we're quite comfortable with what we're doing in Ecuador and where we're going prospectivity-wise today. And in terms of what are we planning for next year, we're planning for an additional four wells in Ecuador, that's our plan for the year. That could increase certainly with the success that we're having, and several wells we have planned in the Putumayo as well as the Middle Magdalena Valley. We'll disclose our firm plans in December, as I mentioned, after we've gone through our planning process with our Board.

Thank you. Our next question comes from Jose Maria Silva of BTG. Your line is now open.

Hello. Can you hear me?

Yes.

Thank you very much. I have a couple of questions that I would like to ask, and I would like to go one by one. Let's begin with Ecuador. When can we expect the first significant oil production from there? Is all the necessary infrastructure in place to export the oil once production begins? That's my first question.

Yes. We already have the test barrels from Bocachico in the pipeline, so we can quickly get our barrels to market. As you recall, all our barrels from the Putumayo Basin are currently being sold in Ecuador. We are well-versed in the trucking, offloading, and regulatory processes in Ecuador, so that won't be a bottleneck. Regarding the production ramp-up, we're focused on isolating the Upper T sands before moving to the Basal Tena, which corresponds to the N Sand in the Putumayo. We'll also be testing Charapa Norte in November. If the test results are positive, we expect things to ramp up quickly. Additionally, as Gary mentioned, we already have four wells planned for next year, and this number could increase with success. Therefore, the upcoming test results and capital allocation for next year will be crucial.

I know this is quite preliminary, but what level of production should we expect from Ecuador next year?

I think we're going to have to wait for the test results.

Perfect. Regarding the bond repurchases, you mentioned that you expect those to continue into this quarter and next year. Do you have any target in mind for how much you want to repurchase? Is there a point at which assets would require you to make a tender offer for the bonds to all the holders?

Yes, the main constraint is ensuring we don't violate the tender rules. We collaborate closely with those managing the bond repurchases, and there's no clear guideline on what that involves. We also consult with legal advisors and banks to avoid any issues. This is the primary limiting factor. In terms of the amount, if there were no restrictions, we aim to balance our free cash flow among share buybacks, bond repurchases, optimizing the net present value of our existing assets, and investing in exploration, particularly given our recent results.

Okay. That's perfect. Regarding the production, can you guide us on the average quarter-to-date production? Do you have an exit production estimate for 2022 that we should expect by the end of the year?

Yes. The exit production is going to be in the 32,000 to 34,000 barrels a day range. We're just in the process of bringing on wells. And so that's our plan. And we'll give you a sense of where we plan to take that in 2023 in mid-December.

Okay. Perfect. At the risk of repeating myself, I will continue here a bit. At the start of the call, you mentioned that you do not want to quantify the impacts of the new tax structure yet. I understand this is a changing topic as the taxes were initially a 10% surcharge, which later became a dynamic one. However, could you provide an estimate of the potential impact, perhaps in the range of $10 million to $50 million, just to get a sense of how this might affect free cash flow generation for next year concerning the additional taxes you will need to pay? Can you offer some kind of range, or are you still hesitant to share this information?

Yes, we would be more comfortable providing a range once the legislation is passed. As Gary mentioned, when we release our numbers in December, we should have either finalized information or at least much clearer insights. We will share that information at that time.

Thank you. Our next question comes from Garrett Fellows of J.H. Lane Partners. Your line is now open.

Hi there. I'm just wondering if you guys could provide some more clarity around the use of the excess cash by the end of the year. I know you said for development, exploration, bond, and equity repurchases, but if you had $100 million of excess cash, how much of that would go to development and exploration, how much to bonds, and how much to share repurchases?

Yes, when we consider that there are only two months left in the year, we realize that our focus is not specifically on accumulating excess cash by year-end. Instead, it will align with the development of our 2023 plan and budget. Therefore, we may exceed our target by the end of the year, which will connect with our outlook for 2023.

Okay. But I guess just in terms of like what you guys will prioritize more so than others will be a 50-50 bonds in equity? Or how do you see that playing out?

Yes. On the bonds and equity, similar to what we had during the quarter, Q3 was fairly balanced between the bonds and the equity, and we would expect that to be the same in Q4 as well.

Okay. Thank you very much.

Thank you.

Thank you. Our next question comes from the line of an unidentified participant from Barclays.

Hello. Can you hear me?

Yes.

Okay. Good morning. Thank you for taking my question. I wanted to ask a similar question about the '25, and if you're planning on doing any liability management. Thank you.

Yes, liability management is I guess always a function of market conditions. Right now, we're carefully monitoring the market. But our base plan currently is just to continue to look at repurchasing the 2025's as well as the equity.

We have an additional question from Josef Schachter. Your line is now open.

Thank you for giving me the opportunity to ask another question. Gary, this question is directed at you and focuses more on the political landscape. We are observing a shift in relations between Colombia and Venezuela, with their leadership becoming more cooperative, alongside some refinery challenges. The United States appears to be easing restrictions, which allows Chevron to operate there and Repsol to supply products to Europe due to shortages. Do you envision any of the areas you are working in potentially extending into Venezuela? If conditions improve and the governments of Colombia and Venezuela come to agreements, could you see Gran Tierra getting involved in that region, considering the U.S. government lifts any sanctions or legal constraints affecting American and Canadian companies?

Yes. I think the short answer is, we always monitor what is going on in the regions that we operate. Venezuela is no different. The relationship between Colombia and Venezuela certainly will help from a humanitarian standpoint. There are quite a few refugees that are in Colombia and straining the system. So I think overall, that will be helpful if they can normalize relations between the two. In terms of business and business development for Gran Tierra, the short answer is, we'll continue to monitor what's going on. The skill set that we have in Colombia, the team that we have in Colombia and Ecuador would fit right in to Venezuela. But my view is that would be a very long-term transition, if it happens at all.

Okay. Thanks for the extra color on that. Thank you very much.

Thank you. Gentlemen, there are no further questions at this time. Please continue.

Thank you, Kathy. And I would like to once again thank everyone for joining us today. We look forward to speaking with you in the next quarter and updating you on our ongoing progress. Thank you very much.

Yes. Thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.