Gran Tierra Energy Inc. Q4 FY2022 Earnings Call

Good morning, ladies and gentlemen, and welcome to Gran Tierra Energy's Conference Call for Fourth Quarter and Year End 2022 results. My name is Andrea and I will 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 securities analysts and institutions. Instruction 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, Wednesday, February 22nd, 2023, at 11 A.M. Eastern Time. Today's discussion may include certain forward-looking information, oil and gas information, and non-GAAP financial measures. Please refer to the earnings and operational update press release we issued yesterday for important advisories and disclaimers with regard to this information and for reconciliations of any non-GAAP measures discussed on today's call. Finally, this earnings call is the property of Gran Tierra Energy, Inc. Any copying or rebroadcasting of this call is expressly forbidden without the written consent of Gran Tierra Energy. I would now like to turn the conference call over to Gary Guidry, President and Chief Executive Officer of Gran Tierra. Mr. Guidry, please go ahead.

Thank you, Andrea. Good morning and welcome to Gran Tierra's fourth quarter and year-end 2022 results conference call. My name is Gary Guidry, Gran Tierra's President and Chief Executive Officer. And with me today are Ryan Ellson, our Executive Vice President and Chief Financial Officer; and Rob Will, our Vice President of Asset Management. Yesterday, we issued a press release that included detailed information on our fourth quarter and year-end 2022 results. In addition, Gran Tierra's 2022 annual report on Form 10-K has been filed on EDGAR and is available on our website. Ryan and Rob will make a few brief comments, and then we will open the line for questions. Ryan, please go ahead.

Thanks, Gary. Good morning, everyone. We are very pleased to announce that Gran Tierra achieved several company financial records in 2022. Our excellent performance in 2022 was driven by our successful development and exploration drilling, water flooding programs, field performance, and disciplined cost management, combined with strong oil prices. Our many achievements during the year resulted in year-over-year production growth of 16%, strong reserves replacement ratio well above 100%, and the highest annual figure in the company's history for net income, funds flow from operations, and free cash flow. After reduced exploration activity during 2020 and 2021, the company made several key exploration discoveries during 2022, which provide confidence in our geological understanding of the basins. Through our successful results from development and exploration drilling, water flooding programs, and field performance, we were able to increase reserves in the 1P, 2P, and 3P categories, which Rob will describe. During 2022, our net income was $139 million, the highest on record, resulting in our earnings per share on both the basic and diluted basis coming in at $0.38 per share. Our adjusted EBITDA was $490 million and was $1.34 on a basic per share basis. Funds flow from operations were $366 million, resulting in free cash flow of $129 million, both of which were also records for the company. Funds flow from operations for the year was $1 on a basic per share basis. Gran Tierra's on-budget capital spend totaled $237 million for the year and was balanced between exploration and development activities, which resulted in reserves and profitable production growth year-on-year. In 2022, Gran Tierra continued its commitment to reduce debt, resulting in a reduction of $88 million in debt and $173 million in net debt. The company finished the year with $127 million in cash and a net debt to adjusted EBITDA of 0.9 times. The company also achieved a return on average capital employed of 27% during 2022. Gran Tierra's strong operating netback of $48.43 per barrel for the year was up 43% from $33.75 in 2021. Before I hand it over to Rob, I want to mention some of our Beyond Compliance initiatives, where Gran Tierra identifies significant opportunities and benefits in environmental communities. We voluntarily strive to go beyond what is legally required to protect the environment and provide social benefits because it's the right thing to do. We are very proud of the company's track record in all aspects of our environmental, social, and governance stewardship. In 2022, Gran Tierra, in partnership with the World Women's Corporation, carried out an anti-personnel demining investigation across approximately 4,300 hectares of land situated within four indigenous communities in several municipalities in the Putumayo Basin of Colombia. As part of the company's commitment to the United Nations Guiding Principles for Business and Human Rights, 95 human rights training sessions were held in Colombia and Ecuador in 2022, which included almost 500 employees, contractors, and suppliers. Gran Tierra strives to maximize local employment and development opportunities, which meet or exceed government requirements for local employment. Since 2015, Gran Tierra has created approximately 26,000 labor opportunities in Colombia. The company also created roughly 470 labor opportunities in Ecuador in 2022. Gran Tierra has also committed to working with the Colombian, Ecuadorian national and local governments, and local communities to further their peace-building efforts. In 2022, the company invested over $4.6 million locally in projects in Colombia and Ecuador identified by the communities themselves to meet their needs. The projects include the improvement of agriculture production capabilities, entrepreneurship support, community strengthening programs, and infrastructure improvements to schools, homes, and community centers. These are just some of the initiatives we completed in 2022, and I highly recommend that you take a look at our 2022 Sustainability Report, which will be available on our website in the second quarter of this year. I'll now turn the call over to Rob Will to discuss some of the highlights of our current operations.

Thanks, Ryan. Good morning, everyone. I'll briefly cover a few operational highlights from yesterday's press release, as well as our recent press release regarding 2022 year-end reserves. Operationally, we are building off a successful year in 2022 to start off 2023. Down in the Putumayo Basin of Colombia, in the Chaza Block, we have commenced our Moqueta drilling campaign with the first well being drilled in late 2022, which was the first well drilled in the field since 2016. Moqueta-25, the second development well in the 2022-2023 Moqueta drilling campaign, reached its planned total depth on January 15th, 2023. This well has been completed and was put on production on February 1st. Producing on jet pump, the well has averaged 383 barrels of oil per day unstimulated. We plan to stimulate the well during Q2 of this year. The third Moqueta development well, Moqueta-26, was spud on February 9th, 2023, and is expected to reach its planned total depth before the end of February. In addition to Moqueta-25 and 26, the company plans to drill and complete one to two more development wells in Moqueta over the next four to five months. Also, in the Chaza Block, the first well, the Costayaco six-well 2023 development drilling program, was spud on January 25th, 2023, and reached its planned total depth on February 2nd. Reservoir quality was as expected in this planned down-dip water injection well. The second well was spud on February 7th, 2023, and reached its planned total depth. All wells in the Costayaco drilling program are expected to be drilled by late second quarter 2023 and completed and put on production or injection before the end of third quarter 2023. In the south of the Putumayo Basin, the Suroriente Block's production averaged approximately 8,620 barrels of oil per day growth in January 2023, marking the second highest monthly production average since the second quarter of 2015. This was achieved despite the fact that we've not drilled a well in Suroriente since the first quarter of 2018. Up in the Middle Magdalena Valley Basin of Colombia, the first well, the Acordionero's 10 to 12 well 2023 development drilling program, Acordionero-111, was spud on January 27th, 2023, and reached its planned total depth on January 30th. Well logs indicate that the reservoir pay zone came in as expected. The company plans to complete this well and put it on production before the end of February 2023. The second well, a planned injector, was spud on February 5th and has reached its total depth. The third well was spud on February 12th. All the planned wells in this year's Acordionero development program are expected to have been drilled, completed, and placed on production or injection by the end of second quarter 2023. Finally, we also plan to continue to focus on the appraisal of new discoveries and new exploration drilling during 2023, all while generating free cash flow to strengthen our balance sheet and return capital to shareholders through potential share buybacks. As for our 2022 year-end oil reserves, the company achieved significant growth in its 2022 year-end 1P NPV10 before tax, which increased by 26% compared to 2021 year-end. As well, we achieved significant growth in our 2022 year-end 2P NPV10 before tax, which increased by 25% compared to the previous year. These increases were driven by the company's successful development and exploration programs and a strong recovery in oil prices. After reduced exploration activity during 2020 and 2021, the company made several key exploration discoveries during 2022, which helped the company achieve excellent reserve replacement ratios. The ratios are as follows: 126% 1P with 1P reserve additions of 14 million BOE; 148% 2P with 2P reserve additions of 17 million BOE; 280% 3P with 3P reserve additions of 31 million BOE. The material 1P reserve additions were largely driven by success with development drilling and water flooding results at Acordionero and Costayaco, in addition to several exploration discoveries. Material 2P and 3P reserve additions were largely due to the success of the company's 2022 exploration program, which made several independent discoveries. By continuing to focus on a combination of reductions in depth and per well capital costs, maintaining low operating costs, and completing share buybacks, Gran Tierra was able to achieve net asset values per share before tax of $4.62 for 1P, up 77% from 2021, and $7.36 for 2P, up 56% from 2021. With the significant growth in our net asset values per share in 2022, we believe Gran Tierra is well-positioned to offer exceptional long-term stakeholder value. We believe our success on multiple fronts during 2022 demonstrates Gran Tierra's ability to be a full-cycle oil and gas exploration, development, and production company, focused on value creation for all our stakeholders. I will now turn the call back to the operator, and Gary, Ryan, and I will be happy to take questions.

Thank you. We will now start the question-and-answer session for securities analysts. Our first question comes from Adam Gill with Paradigm Capital. Please proceed.

Good morning. Two questions for me. First off, on operating costs. We've seen escalation over 2022 given power costs rising and increased workover activity. That said, do you believe you've hit a plateau on op-ex? And what drivers could lower op-ex going forward?

Yes, thanks Adam. I think we have hit a plateau. We think our operating costs on a gross basis will be similar in 2023 compared to 2022. Our production will be higher, so on a per unit basis, we'll see those costs come down.

Okay, great. And the second question was just on Suroriente and the contract expiring mid-year 2024. Is there any precedence on contract renewal? And what could the upfront commitments look like to ensure that this asset stays in the portfolio?

Yes, there are multiple precedents in the country of contract renewal. We do have clauses in our contract for renewal, and we are in discussions with Ecopetrol on trying to achieve that before the expiry.

Any thoughts on timing of when that could be completed?

No, there is nothing significant just before expiry. We are working diligently, and both companies recognize the advantages of continuing the programs we initiated over the past couple of years.

Okay, great. Thank you, gentlemen.

Thank you. Our next question comes from Oriana Covault with Balanz. Please go ahead.

Hi, good morning. This is Oriana Covault with Balanz. I have three questions, and if we could take them one at a time, that would be great. First, regarding the pricing discounts for Vasconia and Castilla, I've noticed that they remained significant through the fourth quarter. I'm curious about what you've been observing this year and what is causing the larger discounts. Also, how are you factoring this into your guidance for 2022 and 2023?

Yes, thanks. I’ll take that. On the Vasconia and Castilla, they started to widen at the end of last year as pointed out and it’s continued into January. It’s starting to tighten a little bit in February. And the main driver is really just a lack of heavy oil demand, especially with China. And I think with China reopening, we started to see those differentials narrow, and it’s right around what we have budgeted right now. We expect them to be wide in Q1, Q2, and then narrow into Q3 and Q4. And that’s really what we forecasted.

Thank you. I noticed in the introduction of a new risk factor in your 10-K regarding the negative impact that certain acquisitions may have on the business. Could you provide more details on this? Specifically, are you considering new jurisdictions beyond Ecuador, and what types of transactions would be suitable for Gran Tierra?

Yes, I believe that's just a risk factor. Most exploration and production companies include that in their disclosures. For us, part of our role is to continually optimize our portfolio. We are open to acquiring new assets or selling those we currently have. We're always seeking ways to optimize, either within Colombia or outside of it, which presents opportunities for both buyers and sellers.

Perfect. And just one final one. We noted that ending cash position came a bit shy of the $190 million that you had guided with the third quarter report. So, if you could share any additional color on this?

Yes, there are two key factors to consider. First, Brent prices were significantly lower than our initial forecasts, and second, the differentials were much wider than anticipated. For example, in Vasconia, the historical five-year average was about $3, but it surged to $10 at one stage. Similarly, in Castilla, the five-year average was around $7 to $8, and it peaked at $18 or $19. This situation negatively impacted our performance for the quarter. The remaining variance can be attributed to movements in working capital.

Perfect. That would be from my end. Thank you.

Thank you.

Our next question comes from Josef Schachter with Schachter Energy Research. Please go ahead.

Thank you very much. Good morning, Gary, Ryan, and Rob. Congratulations on all the progress you made this year. A few questions. The first one will go with Ryan. Where do you see the target debt level that you'd like? You're down below 1:1 debt to EBITDA. If we see 85 to 90 on average for Brent in 2023, you'll generate $70 million to $100 million of free cash flow, plus you have the $100 million or so, $126 million on the balance sheet. How do you see debt in terms of where you want it to be going forward? Is there a target from the 589 that you have on the balance sheet on December 31, 2022? Is there a number you want to have? And at that point, you say that's the amount of debt that should be in this going forward? Or do you want to keep on knocking debt down to zero and not have debt at all? Just trying to get in my head how much money will be left over after that to increase growth via exploration and development, or by more stock buybacks, et cetera?

Yes, it's a good question. I think we're comfortable with net debt-to-EBITDA of one times. In the 0.8 times to one times is really our comfort range. I think when we look at our gross debt, right now we're about 580, our target would be between 500 and 550. And we think that will be a right capital structure for the company of our size currently.

Next question, in the releases in your government document on page nine, you mentioned the exploration blocks. You indicated that there are eight blocks marked with a single star, indicating that exploration is suspended due to licensing restrictions, security issues, or social reasons. Do you anticipate any changes to that situation in 2023? Additionally, do you receive extensions from the government to retain these properties for future use once circumstances improve?

Yes, the short answer is that we are continuously engaging with the government and the communities. The projects that are currently suspended are associated with community issues, and this is an ongoing process. We have not abandoned any of our top priority exploration projects, although there are some we might ultimately relinquish. I can assure you that none of these are among our top priorities moving forward. In summary, we are actively pursuing everything we want to achieve, and we expect to accomplish this within the next one to three years.

Okay. Lastly, Gary again, as a shareholder and as somebody who's been a fan of the company and the opportunity in Colombia and Ecuador, you see a lot of the stocks in Colombia have a discount to valuations. And as you highlighted with your colleagues in the presentation about the discount NAV, and as Ryan mentioned, selling or buying is possible. Is the barrel cheaper on Bay Street and Wall Street than spending money? And is there interest in potentially selling some assets and then doing a substantial issuer bid and waking everybody up to the underlying value that is currently being ignored?

Yes, the short answer is that we are continuously focused on how to create value. Ryan mentioned the debt levels, and if we identify long-term discoveries, we will make necessary adjustments to our balance sheet. We are also exploring opportunities in other basins worldwide. We have observed that larger companies are beginning to divest non-core assets, and we believe that a company of our size and portfolio can create significant value, regardless of stock price valuations. Our outlook is long-term, spanning the next five years rather than the next five weeks. We will concentrate our efforts on our current assets while also diversifying into new ones in different basins. Furthermore, we are considering opportunities to partner with others in ways that may dilute our interest. However, we are confident in our existing portfolio and believe we can generate value, and we aim to expand it further.

Okay. Thanks very much for taking my questions, and I'll be rooting for more breakthroughs in 2023. Thanks very much.

Thank you.

Thank you. Our next question comes from Alexandra Symeonidi from William Blair. Please go ahead.

Hi, thank you for taking my question. Most of my questions have been answered. I just have one. If you have estimated total tax in 2023, given your guidance for production and your estimate for oil prices and the discounts. So, tax that would include the surcharge and the non-deductibility of royalties. Have you made that calculation, that estimate?

Yes, we estimate tax based off of $85 Brent and again paid on differentials and what pricing used. But we'd expect our current tax to be $110 million to $130 million.

And this includes several royalties, or what you need to pay for the royalties? I mean the non-deductibility?

Yes, that our current tax bill for 2023, which will be paid in two installments in 2024.

Thank you. Our next question comes from Philip Skolnick with Eight Capital. Please go ahead.

Thanks. Good morning. Just going back to Suroriente. If you were to get the contract renewal, how do we think about the reserve adds with respect to that? And also, would there be any potential changes to this year's CapEx budget, maybe production target?

Yes, I think the answer, Phil, is our plans for Suroriente would be to expand the waterflood. We've done a lot of work over the last few years. In terms of the capital program, there would be some minor adjustments. But we would look more at a three-year type plan to expand the waterflood to increase some of the development drilling in the block. So, you wouldn't see a major change in the capital program this year. But over the next three years, we would focus a lot of effort on increasing reserves. We are taking a look at what would change in our reserve base going forward. But we don't want to be premature in waiting for the contract actually to be signed. And we're working mutually with Ecopetrol and trying to put that program together.

Got it. Understood. Just finally, just I know in the past, recent past, you've said that the environmental permitting process, it's basically been business as usual. Is that still the case?

It has. And we've been working very diligently with communities on blockades and other interruptions. And we've seen some progress, I think, is the way to say that. But in terms of permitting and environmental studies, it's business as usual in Colombia and in Ecuador. We're quite excited about our discoveries in Ecuador. As Rob mentioned, we see some real opportunity there to expand what we're doing across the border in Ecuador as well.

Great. Thank you.

Thank you. Our next question comes from Luke Davis with RBC. Please go ahead.

Thanks. Good morning. You guys have a pile of wells coming on this year. Just wondering if you can speak a little bit to the expected cadence of production volumes maybe quarterly and where you expect to exit the year at? And also, just wondering if you have any contribution expected from any of the exploration wells that are included in the program?

Thank you, Luke. Yes, as Rob mentioned, we're conducting significant development drilling in the first half of the year. These wells will begin coming online in the second quarter and extend into the third quarter. We anticipate a gradual increase in production throughout the year, expecting to finish around 34,000 barrels or so.

Got it. And anything from those exploration wells or is that just potential upside?

Potential upside.

Yes. Okay. The only other thing I was wondering about is just buybacks, how you're thinking about that? Is that going to be sort of a portion of free cash flow that you're sweeping into buybacks? Do you have an aggregate target that you're looking to hit or how are you thinking about that currently?

Yes, we bought back 6.2%, 6.3% of our stock last year, and we have approval currently up to around 10%. So, especially when we traded at such a substantial discount to our NAV, we definitely like to max out the NCIB and then look to renew.

Got it. That’s it for me. Thanks.

Awesome. Thanks, Luke.

Thank you. Our next question comes from Juan Cruz with Morgan Stanley. Please go ahead.

Hi, good morning, everybody, and thanks for the call. I just wanted to clarify just quickly, you guys were talking about debt levels going forward. And on the third quarter call, you had indicated to the market that you have bought back about $20 million worth of the 2025 bonds. It's my understanding that those are still outstanding. Just wanted to see if there's any reason for them not being canceled yet, considering your targets? If you can comment on that, that would be great.

Yes, we hold those bonds ourselves. And the only reason why we didn't cancel them is we want to make sure that there was no adverse impacts as far as index inclusion. So, from accounting treatment, and really the economic reality is we're holding those bonds, our debt is $580 million, and we used that to have the $300 million bonds assigned for index inclusion.

I understand. Okay. But from your perspective, there's no intention of reselling those bonds back into the market?

No. No. There is not.

They're in treasury and that would remain in treasury for index inclusion purposes?

Correct.

Thank you. Our next question comes from Roman Rossi with Canaccord Genuity. Please go ahead.

Thank you very much for taking my question. Just a couple. The first one is regarding the buyback program. I just wanted to check what happened if you reached the limit of the program? Are you able to initiate a new one? And the second one is, last year, you mentioned you wanted to have a cash balance of around $100 million. I just wanted to check if that's the guidance change? Thank you.

Yes, we can renew the program once we reach the maximum amount, and we plan to do that, which would last for a year. Regarding the cash balance, our target remains between $75 million and $100 million, and that has not changed.

Okay, perfect. Thank you very much.

Thank you.

Thank you. Our next question comes from Chris Dechiario with Marathon Asset Management. Please go ahead.

Yes, hi. Thanks for the call. Just wondering, I mean, what your current view is or outlook is on potential restrictions on exploration going forward? I know there's been a lot of talk from various people in Colombia. It's sort of hard to tell where it's going to end up. But I mean, how are you looking at that? And does that affect your plans? Is that affecting maybe your thoughts on acquiring assets outside of Colombia? Give your thoughts on that.

Yes, we have a great portfolio of exploration lands, and we have plenty of work in front of us for the next five to five years. We also have some very exciting lands in Ecuador as well. So, in terms of exploration, we realize there have been some announcements in Colombia about no new exploration lands. We get that. But it's no impact on what we're doing in our five-year plan as we go forward in Colombia. I mentioned Ecuador; the answer to your question is we are looking at some other basins. We have a very strict criteria in what we invest in globally. And we are looking at some opportunities in Africa and the Middle East, where we believe that we can not only expand our value portfolio but diversify and mitigate risk. And so, the answer to your question is we're very happy with our exploration in Colombia, but we're also looking at other opportunities in other basins.

Great. Thanks.

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

Thank you. Thank you, Andrea. I would again like to thank everyone for joining us today. We look forward to speaking with you over the next quarter and update you on our ongoing progress. Thank you.