Vermilion Energy Inc. Q4 FY2022 Earnings Call

Please standby. We're about to begin. Good morning. My name is Jess, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Q4 Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Mr. Dion Hatcher, you may begin your conference.

Thank you, everyone, for joining us today. I'm Dion Hatcher, President and CEO of Vermilion Energy, and I’m accompanied by our leadership team. We will reference a PowerPoint presentation for our Q4 full year 2022 results, available on our website. Please review our advisory and forward-looking statements at the end of the presentation, which detail forward-looking information, non-GAAP measures, oil and gas terms, and relevant risk factors. In 2022, we achieved our strategic goals and positioned Vermilion for long-term success while maintaining financial discipline and reducing net debt by $300 million. We capitalized on strong European gas prices due to our diversified international asset base and completed significant acquisitions that enhanced our European gas exposure. Our financial results for the year included record fund flows of $1.6 billion and record free cash flow of $1.1 billion, reflecting increases of 78% and 99% year-over-year, respectively. These results were achieved despite significant hedging losses and temporary windfall taxes in Europe. Our free cash flow supported over $500 million in strategic acquisitions, further debt reduction of over $300 million, and over $100 million returned to shareholders through dividends and share buybacks. We initiated a return of capital framework in 2022, including a quarterly dividend and a share buyback program, returning a total of 11% of our free cash flow. We ended the year with net debt of $1.3 billion and a net debt to fund flow ratio of 0.8 times, the lowest leverage in over a decade. In the fourth quarter, we reported $284 million of fund flows, which included the full-year impact of the temporary EU windfall taxes enacted retroactively. Excluding these taxes, our Q4 fund flow would have been $507 million, consistent with the previous quarter. Our Q4 free cash flow was $115 million after taxes or $338 million excluding them. Production for the quarter was 85,450 BOE per day, slightly higher than the prior quarter, despite challenges such as unplanned downtime and cold weather. Production from North America averaged 58,499 BOEs per day, a 2% increase attributed to new contributions from our Montney assets and the US drilling program. We focused on integrating our new Alberta Montney pad, which produced approximately 7,500 BOEs a day in December. In Q1, we drilled an additional three-well pad in Alberta set for early Q2 production. Recent agreements in British Columbia provide positive guidance for future resource development, allowing us to continue permitting efficiently. Production from our international assets averaged 26,953 BOEs per day, slightly lower than the previous quarter due to natural declines, and we experienced temporary shutdowns for maintenance in Australia, which will impact production in Q1. Looking at our 2022 reserves, we increased our proved plus probable reserves by 9% to 523 million BOE, primarily from the Leucrotta acquisition and positive economic revisions. The net present value of these reserves rose 36% to $8.9 billion. Our reserve replacement on a proved plus probable basis was strong, with a recycling ratio of 4.4 times. European gas prices averaged $48 per MMBtu, despite the temporary windfall tax and a drop in prices recently. Our forecast suggests continued strong fundamentals for European gas with high competition for LNG. We successfully divested approximately 5,500 BOEs a day of non-core assets to focus on our long-term strategy, strengthening our asset base, increasing free cash flow, and improving operational efficiency. Overall, these changes, coupled with lower debt, enhance Vermilion's position. Now, I will hand it over to Lars.

Thank you, Dion. As Dion mentioned in his earlier remarks, our Australia production will be offline for the first quarter and is expected to restart in Q2. As a result, we expect our Q1 production to be in the range of 80,000 to 82,000 BOE a day. We are also revising our full-year 2023 guidance to a range of 82,000 to 86,000 BOE a day to reflect the planned Southeast Saskatchewan asset sale and the impact of the Australia downtime. We have also updated our financial guidance within the table on the right-hand side of this slide. Most notable would be an approximate $1 per BOE reduction in our operating costs due to the planned asset sale and lower European gas prices. Our cash taxes and windfall taxes are also expected to be lower as a result of weaker European gas prices. On an absolute basis, we now expect the temporary European windfall tax for 2023 to be $200 million or less, compared to the $300 million guidance we provided with our budget release in January. Slide 11 provides a historical and forward-looking view of our Funds from Operations (FFO) in the red bars and debt levels in the blue bars, and serves to illustrate the significant improvement in the resilience of our business. When you look at our results prior to 2022, you can see that our business was generating annual FFO in the $800 million to $900 million range, excluding 2020, while operating with $2 billion of debt implying leverage of over two times. As you look at our 2022 results and forward projections for 2023 and 2024, you can see that we are generating significantly more FFO even after factoring the impact of the temporary windfall tax. We have benefited from strong commodity prices, specifically European gas, to proactively derisk the business with lower debt. As Dion just noted, we have also enhanced asset resilience over the last two years through an active high grading of our portfolio. As a result, we are on track to achieve our stated debt target of $1 billion by the end of 2023 or early 2024. And although we have not provided a debt target for 2024, we believe we have the capacity to balance further net debt reduction in 2024 with increasing shareholder returns based on forward strip pricing. We are a more resilient company today with a higher-quality asset base, enhanced long-term inventory, and a much stronger balance sheet. Slide 12 further illustrates the progress we've made on debt reduction and our commitments to increasing the return of capital to shareholders. In the first quarter of 2022, we reinstated a quarterly dividend. In the third quarter of 2022, we increased the dividend and commenced the share buyback program. In the first quarter of 2023, we then increased our base dividend again and resumed our share repurchases following a brief pause in the fourth quarter of 2022. Over this time period, absolute debt balances have guided our pace of shareholder returns. As we outlined in our 2023 budget release in January, we are targeting to return up to 25% of free cash flow to shareholders until we achieve our next debt target of $1 billion. Once we achieve this debt target, it is our intent to increase shareholder returns. The amount of the increase will be determined once we achieve our debt targets, and we expect the incremental return of capital to be in the form of an increase to our base dividend and share buybacks. With that, I would like to pass it back to Dion to provide some closing remarks.

Thank you, Lars. As you can see from the presentation today, we delivered on strategic priorities over the past two years and continue to reposition Vermilion for long-term success. To summarize, we generated record financial results in 2022, largely driven by strong European gas prices, which demonstrates the value of Vermilion's international diversified asset base. European gas fundamentals remain strong, and we expect elevated prices to persist for the foreseeable future. The divestment of non-core mature assets within our Southeast Saskatchewan operations unlocks funds to accelerate debt reduction, reduce unit costs, and improve capital efficiencies. The combination of Corrib, Montney, and Powder River acquisitions enhances the overall inventory, profitability, and free cash flow of Vermilion's portfolio. Our focus on debt reduction and growing free cash flow over the past several years has made Vermilion a much more resilient company today. Finally, the reinstatement of a quarterly dividend and the commencement of our share buyback program in 2022 demonstrates our commitment to returning capital to shareholders and sets us on a path for increasing returns in the year ahead. That concludes my prepared remarks. And with that, I'd like to open it up for questions.

Our first question comes from Amir Arif from ATB Capital. Your line is open. Please go ahead.

Thanks. Good morning, guys. Just a quick question on the Montney development plans. Just with the shift back to BC, I think you have 10 wells planned this year. Could you just give us a sense of how many of those wells are on the BC side? And I know there's no guidance for 2024 yet, but you do have plans to ramp up to 13,000 barrels next year. Is that more of a second half weighted production outlook in 2024?

Thanks for the question. Yes. No, I'll just summarize. I'll pass it over to Bryce just to provide a summary of our activity in 2023 this year, the number of wells we're drilling. And then we can talk later about our current plans for 2024. But Bryce, do you want to summarize our activity this year and outlook for 2024 as well?

Yes, for 2023, thanks for the question. We're planning to drill nine wells in 2023, seven of them are in Alberta, and two of them are on the BC side of the property, thankfully because we've received some permits on the BC side. And really the plan for 2023 is to drill to fill our existing infrastructure capacity. We have a three-well pad in Alberta that we started in December, initiated completions in February, and we'll have those wells on production in April. The two-well pad in BC, we drilled in February, and we're going to initiate completion operations in March, and we'll have them on production in May of this year. Incidentally, the first well on that BC pad was the pacesetter well for the area. We drilled 6,000 meters measured depth in nine days, so we're very happy with that. And then we're going to pivot back to drilling the third pad in Alberta in March and April, completing that after breakup, and we'll be bringing that on likely in Q4 of 2023.

Thanks, Bryce.

And then just in terms of 24 plans, like I know you've talked about production getting up to 13 or an average of 13 next year.

Bryce, do you want to just summarize our plans for 2024?

Yeah, high-level, our plans for 2024 to drill 10 or 11 wells. Really the focus in 2024 is building out our BC infrastructure, which is the 8-33 battery that we're going to build out in 2024, targeting production in that 12,000 to 13,000 BOE a day level for 2024. All wells would be in BC right now for our plans for 2024 as well.

Got it. Appreciate that. And then just on the reserves, I noticed there were some negative technical revisions. Is that just reflecting the higher operating cost structures we're seeing in the industry, or is there anything else driving that?

Thanks. I'll pass it over to Jenson to address that question.

Yes. So, we did have some technical revisions mostly in Saskatchewan this year. Really, what we did is looked at our reserve book in the context of our capital allocation priorities. As we brought in the Montney, Mica asset, the other assets just weren't able to compete for capital. And so those were an opportunity for us to just take some of the locations in Saskatchewan off the book. That is aligned with what we talked about as high grading our portfolio. I would highlight that despite the technical revisions, our Reserve Life Index has increased over time, and this year, we're now sitting at 16.8 years.

Thanks, Jenson.

Yes. I appreciate the color there. And then just finally on the buybacks, I know you've become a little more aggressive year-to-date on the buybacks, but you've also bumped up the dividend, just in terms of your allocation of the 25% free cash allocation? Is it just to keep the dividend at a higher rate and allocate the rest to the buybacks?

Thanks. I'll pass over to Lars to address that.

Yeah, that's right, Amir, to our strategy here. What we will look to do is return that incremental capital to shareholders in terms of that up to 25% through share buybacks. And we think we have ample room to increase the base dividend over time. But we have made the increase here in the first quarter of 2023. So our focus will be on share buybacks.

Terrific. Thanks, guys.

Thanks, Amir, for the questions.

We will go next to Menno Hulshof with TD Cowen. Your line is open. Please go ahead.

Thanks, and good morning, everyone. I'll just maybe start with a follow-up on shareholder capital returns. I'm just looking at your December slide deck, and you had a detailed table for return of capital, outlining how you expected to transition from 25% to 50% and eventually up to 90%. But I don't think I've seen that table since. Is that still the plan, or could we see you take a more measured approach?

Thanks, Menno. I'll pass it over to Lars to address that question.

Yeah. Thanks, Menno. The focus for 2023 will be on achieving that $1 billion absolute debt target. What we are managing between is debt reduction and shareholder returns through buybacks. Our view at the end of the day is that both of those allocations of capital will increase equity value for the shareholders. I mentioned in my prepared remarks that we have not set a debt target for 2024. But what shareholders can expect is as we achieve that $1 billion absolute debt target, we would then move into the 25% to 50% range that we illustrated earlier today versus the up to 25% this year. So that's the direction that we're providing to shareholders in terms of continuing to have those debt balances guide our pace of return on capital.

Okay. Thanks for the confirmation, Lars. And the next question I'm going to ask because I'm getting the question, just on the $570 million budget for 2023, it's unchanged. Despite the drop in production guidance, in the release, you talked about the key driver being minimal capital being spent on the Saskatchewan assets that you sold. So the question is, does that explain all of it, or were there other moving parts that we should be aware of?

Thanks, Menno. So you're speaking to production or capital? Capital, yes?

The $570 million.

Yes, as mentioned in our prepared remarks, we have been working on the process to divest those assets for some time. Our expectation was to successfully divest them, but until it is finalized, we cannot be certain. Therefore, we did not allocate much capital to those assets, which corresponds with our strategy of not attracting capital. That is why there is effectively no change to our capital budget, even with the divestment of those mature assets in Southeast Saskatchewan.

Thanks. I'll turn it back.

Okay. Thanks, Menno.

We’ll go next to Josef Schachter with Schachter Energy. Your line is open. Please go ahead.

Good morning, Dion and Lars, et cetera. Just wanted a question about what's going on in Europe with Germany now having its first LNG import and others money coming in, are they still keeping their coal-fired and nuclear plants open, or are they going to be closing those in the next year or two to meet their climate goals? And does that build up a potential bigger opportunity in natural gas for LNG imports in the States and, of course, higher prices for you in Europe and if you have higher volumes and much greater returns?

Thank you for the question, Josef. We've discussed the outlook in Europe before. Recently, the main focus has been on how to source LNG to compensate for the volumes we previously received from Russia, which is quite significant. The volume in question is comparable to the total LNG export capacity of the U.S. Gulf Coast, explaining the heightened attention on LNG supply. Regarding LNG imports, Europe has been active in establishing new import facilities, but they face competition for LNG due to rising global demand. I agree with your outlook on the future; gas is increasingly recognized as an essential transition fuel in Europe. For instance, Germany, being the largest economy in Europe, plans to phase out older facilities and shut down its nuclear operations. Currently, 40% of its energy comes from coal, lignite, and nuclear, which is a substantial portion of their energy mix that will require replacement with other energy sources. We believe natural gas will play a significant role in that transition. Our land position in Germany is attractive, with nearly 1 million acres covered by 3D seismic data and existing infrastructure from acquired mature assets. We are developing larger prospects and have been working with local stakeholders to advance necessary permits, aiming to kick off our drilling program later this year. We are optimistic about Germany's demand for gas and the future growth potential of our assets there.

Glad to hear that. Anything changing in the Netherlands where they were at one point trying to close down farms and methane gas from the animals and the issues of permitting? Is Netherlands getting worse or better to work with?

I would say the NOx emission is something that we're monitoring as well. We're able to mitigate that with our systems. For example, that's not a new issue. So when we select rigs and equipment, those kind of things are all geared around managing NOx emissions. We're drilling in the Netherlands right now. As part of our drilling program, we referenced a well that we drilled earlier as well. So we continue to get permits in the Netherlands. We continue to drill two to four wells a year. We're drilling now. So it's an area that we'll continue to work with, again, all stakeholders there. They've got what they call a small field development, so a policy in which we are looking for tools that are in that two to 10 BOEs of gas, and those are the ones that we target for our drilling program. It's got a strong track record of being able to bring that gas to market.

Sure. Thanks very much, guys for answering my questions.

Thanks, Josef.

And with no other questions holding, Mr. Hatcher, I'll turn the conference back to you for any additional or closing comments.

Well, thank you again for participating in our Q4 results conference. With that, we'll close the meeting.

Thank you. Ladies and gentlemen, that does conclude today's call. We thank you for your participation. You may disconnect at this time.