Vermilion Energy Inc. Q3 FY2021 Earnings Call

Good day, and welcome to the Vermilion Energy Quarter 3 Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to President, Curtis Hicks. Please go ahead, sir.

Thank you for joining us. I'm Curtis Hicks, President of Vermilion Energy. With me today are Dion Hatcher, Vice President, North America and Incoming President; Lars Glemser, Vice President and CFO; Darcy Kerwin, Vice President, International and HSE; and Kyle Preston, Vice President of Investor Relations. We will discuss the Q3 2021 results we announced yesterday afternoon, referring to a presentation available on our website. The presentation includes an advisory on forward-looking statements, outlining relevant risk factors and assumptions. In summary, we delivered strong third-quarter results, averaging 84,633 BOEs a day, slightly down from the previous quarter due to planned maintenance. The third quarter is typically busy for maintenance in Canada, and we also had a significant turnaround scheduled for the Corrib facility in Ireland, which was successfully completed. Higher production in the Netherlands, Germany, Australia, and the U.S., including from a small acquisition in Wyoming, partially offset the impacts of these turnarounds. On the financial side, we reported funds from operations of $263 million and free cash flow of $196 million, representing significant increases from the previous quarter, driven primarily by higher commodity prices. Our globally diversified asset base allowed us to take advantage of these price increases, improving our revenue and reducing cash flow volatility. Year-to-date, we've generated $369 million of free cash flow and expect to exceed $500 million for the full year 2021. This free cash flow generation has allowed us to accelerate debt reduction, reducing net debt by 5% from the previous quarter to $1.8 billion, down 12% since the start of the year. We anticipate exiting 2021 with net debt around $1.65 billion, resulting in a net debt to trailing funds from operations ratio of approximately 1.8x. Regarding our international operations, production averaged 27,612 BOEs a day in Q3, down 1% due to the turnaround in Ireland, but offset by new production in the Netherlands and Germany and strong uptime in Australia. In Europe, we focused on completing the Nijega and Blesdijke wells in the Netherlands, as well as the Burgmoor Z-5 well in Germany. We're progressing exploration initiatives in Europe with additional seismic acquisitions and expect to begin production from successful gas wells in Croatia in early 2023. In North America, production averaged 57,022 BOEs a day, a decrease of 2% mainly due to maintenance in Canada. However, strong performance from the U.S. business unit, including a recent acquisition, partly compensated for this decline. We drilled and completed several wells in Saskatchewan and identified strategic acquisition opportunities. The recent U.S. acquisition involved 20,000 net acres near our Hilight field in Wyoming, with current production of about 1,500 BOEs a day. This acquisition adds 40 locations to our Turner drilling inventory and positions us to optimize our operations in the area. As a result of our strong production and the U.S. acquisition, we've increased our annual production guidance to 84,500 to 85,500 BOEs a day. Given the stronger-than-anticipated commodity prices, we've exceeded our debt reduction targets and raised our capital program from $300 million to $375 million. This additional investment will focus on our Alberta and Saskatchewan programs and align with the sustaining capital needs of our assets. For 2022, although still in finalization, our preliminary outlook suggests a capital program of $400 million to $450 million to support ongoing initiatives and accommodate anticipated inflation. We expect to generate over $600 million in free cash flow based on this capital and production range. Regarding our debt position, we have accelerated debt reduction, expecting to exit 2021 with net debt of about $1.65 billion, with projections for 2022 to be around $1 billion. This would indicate a ratio of less than 1x, placing us back in our targeted leverage range. We plan to reinstate a dividend in Q1 2022, subject to Board approval, with a fixed quarterly dividend of 5% to 10% of FFO, while continuing to focus on debt reduction. We look forward to sharing more on our 2022 budget and capital return framework soon. That concludes my remarks, and I welcome any questions.

We can now take the first question from Harp Singh from Harp Investments.

What are the debt covenants currently on the hedges with the $1.8 billion still outstanding?

It's debt covenants, I think.

Yes. So your question there was related to covenants?

Yes, I'm curious about the covenant related to the forward hedge that is currently running into 2022. I see that the hedges are locked in for six months. What is the rate at 30%?

Yes. So from a hedging perspective, we are about 20% hedged for 2022. Now we typically target 25% to 50% on a rolling 4-quarter basis and then we do have optionality within the various commodities. So for 2022, we're about 50% hedged on European gas, that will be about 60% for the first quarter and then it drops off from there, and then basically 20% hedged on the oil side. So the impact of those hedges are fully embedded in our free cash flow estimates of $500 million for 2021 and then in excess of $600 million for 2022.

Okay. And paying down the debt, getting it down to the end of the year down to $1.65 billion, what are you guys forecasting if everything basically stays, commodity prices start to behave and are in a multi-year bull market? What are we looking at? Like going forward are we looking at trying to get it down by the end of 2022 fourth quarter into the $1 billion mark?

Yes. No, great question, and ignore the multi-year impact on debt reduction. I think if you just look out to 2022, if we go into that year with $1.65 billion of debt, we've got free cash flow generation in excess of $600 million at current strip pricing. That takes us down to the $1 billion level. And I think something that we've been quite clear on with investors is we want to make sure that decisions are structurally sound. And when we look at debt to FFO and that target of 1.5x that we've been quoting, when you start to get down to that $1 billion of absolute debt, and if you look at our mid-cycle price deck, which is USD55 WTI, 250 North American gas, $8 Canadian-European gas, we see ourselves getting to that structural comfort level in terms of debt to FFO of 1.5x on that absolute debt number. And that has really given us the confidence here to accelerate our messaging around return of capital to shareholders. And messaging that first quarter of 2022, we will be looking to reinstate a fixed dividend. Now we are really trying to make sure that that is structurally sound as well and the 5% to 10% of FFO that we have quoted in our Q3 release here, that's attached to the same mid-cycle price deck that I quoted there in terms of $1 billion of debt. You do the math in terms of what 1.5x implies on FFO, let's call that in that $700 million range. That's not a bad way to think about sort of the quantum of the fixed dividend. And we think that that works quite nicely, with still a debt reduction strategy in 2022. And then it really unlocks further optionality around return of capital to shareholders as we make progress towards that debt target. So that was the messaging we really wanted to get across here in the Q3 report is, this is a first step in our return of capital strategy with shareholders. Because of the quantum of free cash flow in the system, we think that we're able to execute on multiple levels of initiatives in terms of return of capital as well as debt reduction.

Okay. Can I also get a little bit of color on just the impairment and the write-downs there? Just a little bit of color on that, please.

Yes. So 2020 was characterized by write-downs from an impairment perspective. I would say 2021 has been characterized by write-ups of those impairments, just as we've had a strong backdrop from a pricing perspective. So that has been the driver behind the impairment reversals that we've seen through the first 3 quarters here of 2021.

Okay. And how about any currency hedges? Is there any currency hedges impacted because of the international exposure?

No.

We can now take the next question from Menno Hulshof from TD Securities.

I just have one. What are you seeing in the Powder River Basin that gave you the confidence to do that acquisition? And what are you anticipating for activity levels in the Powder River in 2022? And then I guess longer term, how meaningful do you think that play could become?

Yes, this is Dion Hatcher. We have been operating in the area for a few years and have drilled over 20 wells. We believe it is still early in the process, and we see opportunities to optimize the play. This includes refining our completion and pumping strategies and extending well lengths to between 1 mile and 2 miles. These near-term optimizations are expected to enhance our free cash flows. Looking ahead, we anticipate drilling about 5 to 6 wells annually to maintain the asset's production. Given the current well counts and their lengths, we believe there is significant potential for growth in that asset over time.

This concludes today's Q&A. I'd now like to turn the call back over to your host, Curtis Hicks for any additional or closing remarks.

Thank you, operator, and thanks to all of you again for participating in our Q3 2021 results conference call. If there are any further questions, I would suggest that you reach out to our Investor Relations department and the information to reach out is available on our website. So with that, thank you all again, and have a great day.

This concludes today's call. Thank you for your participation. You may now disconnect.