Vermilion Energy Inc. Q4 FY2023 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Vermilion Energy Q4 Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. This call is being recorded on Thursday, March 7, 2024. I would now like to turn the conference over to Mr. Dion Hatcher. Thank you. Please go ahead.

Thank you. Good morning, ladies and gentlemen. Thank you for joining us. I'm Dion Hatcher, President and CEO of Vermilion Energy. With me today are Lars Glemser, Vice President and CFO; Darcy Kerwin, Vice President, International and HSE; Brandon McCue, Vice President, North America; Jenson Tan, Vice President, Business Development; and Kyle Preston, Vice President of Investor Relations. We'll be referencing a PowerPoint presentation to discuss our 2023 Q4 and year-end results. The presentation can be found on our website under 'Invest with Us' and 'Events & Presentations.' Please refer to our advisory on forward-looking statements at the end of the presentation, as it describes forward-looking information, non-GAAP measures and oil and gas terms used today, and outlines risk factors and assumptions relevant to this discussion. Production during the fourth quarter averaged 87,597 boe per day, which was at the midpoint of our Q4 guidance range of 86,000 to 89,000. This represents a 6% increase over the prior quarter, primarily driven by the Wandoo platform in Australia and Corrib Gas in Ireland, which were online for the full quarter, while the maintenance downtime in the prior quarter. Wandoo and Corrib are high-margin assets and both continue to perform quite well in Q1. We generated $372 million of fund flow and $225 million of free cash flow in Q4, which represents a 38% and 59% increase over the prior quarter, respectively. With this amount of free cash flow, we were able to reduce net debt by $164 million and returned $45 million to shareholders during the quarter, comprised of $16 million in dividends and $29 million in share buybacks. Looking at the full year results on Slide 3, we achieved the midpoint of our annual production guidance of 84,000. We achieved it despite wildfire-related downtime in Western Canada and planned maintenance downtime in Australia. Our ability to meet annual production guidance despite these issues illustrates the strategic advantage of operating a diverse portfolio, as we're able to reallocate capital to offset the production impacts in Canada and Australia. We generated over $1.1 billion of fund flow in 2023, representing the second strongest year ever for the company. Capital expenditures of $590 million were in line with guidance and resulted in free cash flow of $550 million. This free cash flow was used to fund the closing costs associated with the Corrib acquisition, and asset retirement obligations allowed us to reduce net debt by $266 million and returned $160 million to shareholders, representing about 30% of our free cash flow. We exited the year with net debt under $1.1 billion, the lowest level in a decade, representing 0.9x our annual fund flow. This is a key milestone for the company as it aligns with our internal leverage target of 1x net debt to fund flow or less and positions us for increasing shareholder returns. Moving on to the operational updates for the quarter. Production from our North American operations averaged 54,216 boe per day in Q4, a decrease of 4% from the previous quarter due to natural declines. In the Deep Basin, we drilled and completed five wells and brought on production four Manville liquids-rich gas wells. At Mica, we drilled the initial four Montney wells on our BC lands as part of our winter drilling program in advance of the expected completion and start-up of our 8 to 33 BC battery in mid-2024. Slide 5 includes a map of our Montney position. As you can see, our land is in the oil window and the results of our first two BC wells validate our geological assessment and development plans. On Slide 6, you can see that 16 to 28 wells continue to produce at very strong rates, 800 boes a day per well after 11 months on production. These two wells went on production in March 2023 and produced nearly 700,000 boes combined to the end of February, including over 215,000 barrels of liquids, which is mainly oil. Given the relatively shallow decline profile, we believe this presents an opportunity for downspacing, which could add further drilling locations and is something we will be testing this year. The eleven wells we plan to drill this year will be on or offsetting the 16 to 28 pad. We have drilled six wells on the first pad and commenced frac operations on this pad in late February. We expect these wells will be ready for production and tie-in by Q2 in time for the mid-year start-up of the 8 to 33 battery. We're also currently drilling the second pad, which we expect to finish in mid-Q2 and should complete fracking operations on that second pad in Q3. Slide 7 shows a picture of the new 16,000 bbl/d battery being constructed in our Mica Montney lands. Construction is progressing as planned and remains on schedule for a mid-year start-up. Once operational, this battery will more than double our Montney infrastructure capacity to approximately 20,000 boe per day and allows us to move forward with the growth phase of the Mica asset. Production from our international operations averaged 33,381 boe per day in Q4, an increase of 29% over the previous quarter, mainly due to the full quarter of production from our Australia and Ireland operations following maintenance downtime in the prior quarter, as well as increased production in the Netherlands due to new production from our 2023 drilling program we brought online in the quarter. We continue to advance our deep gas exploration plans in Germany. We commenced drilling of our first deep gas exploration well at the end of November and expect to reach total depth in the upcoming weeks. These wells are over 5,000 meters deep and typically take 100-plus days to drill. We will then move the rig to our next location where the second well of our program will be drilled during Q2. We are excited about the exploration plans in Germany, as we see this as a natural extension of the successful drilling campaigns we have executed over the past two decades in the Netherlands. We have approximately 700,000 net acres of undeveloped land in Germany located approximately 300 kilometers east of our producing fields in Northern Netherlands. The exploration targets in Germany are on trend with our Netherlands plays, where we have drilled 29 gas wells over the past two decades with an average success rate over 70%. The German exploration targets are deeper and have higher risk, but they also have a much larger resource potential than the Netherlands. We believe our land base can support a multi-year drilling campaign, providing Vermilion with years of organic production growth of high-value European gas. In Croatia, installation of the gas plant on the SA-10 block is progressing as planned and remains on schedule for startup mid-year. A 15 million cubic feet per day gas plant will facilitate production from the SA-10 block. We have gas behind pipe from previous discoveries. Subsequent to year-end, we commenced drilling on our first exploration well in the SA-7 block and reached total measured depth of 2,371 meters, discovering hydrocarbons in multiple zones. We are currently evaluating the results and plan to test the well during the second quarter by commencing drilling operations on the second of four wells planned on the SA-7 block. In addition, we recently signed a formal agreement with the INA Group to jointly develop the SA-7 block. INA is the largest integrated oil and gas company in Croatia and brings local expertise along with access to existing infrastructure that will play a critical role in developing these assets. We're excited about the future European gas potential in Germany and Croatia and look forward to providing updates as the year progresses. We included our updated reserve evaluation with our Q4 release. Our 2023 PDP reserves decreased by 8% from the prior year to 173 million boes, while our total proven plus probable (2P) reserves decreased by 18% from the prior year to 430 million boes. The decrease is primarily due to dispositions, production and technical revisions, including technical revisions resulting from capital allocation decisions. It reflects the divestment of non-core assets in Saskatchewan and other non-core assets in the U.S., and it also incorporates updated capital allocation decisions as a result of our asset high-grading over the past couple of years. Given the greater focus on our Mica Montney development and Germany exploration program, we have removed or divested reserves associated with undeveloped locations that are not prioritized for investment under our current plans. Assets most impacted by these capital allocation revisions are located in our U.S. and Saskatchewan operating regions. Approximately 40% of the 2P technical revisions relate to the capital allocation decisions, and therefore, some of these reserves could be recognized at a future date if they align with our capital allocation parameters at that time. In addition, we expect to recognize additional reserves over time from our Mica Montney and Germany exploration program as we develop these assets. Our Montney asset is in the early stages of development and is conservatively booked today, while the potential multi-year German exploration program is largely unbooked at this time. The PDP and 2P reserve life index as of December 31, 2023, is 5.6 and 14 years, respectively, both of which are in line with our long-term average and reflect the conventional composition of our asset base. I will now pass it over to Lars to discuss our financial outlook and updated return on capital targets.

Thank you, Dion. We released our 2024 budget in early December, and the execution of our capital program to date is progressing as planned. Our 2024 full year guidance remains unchanged, and we are also providing Q1 production guidance of 83,000 to 85,000 boe per day. As a result of progress made on debt reduction, we are pleased to announce an acceleration of our return on capital. As you recall, we previously planned to increase our return of capital target to 50% of excess free cash flow starting April 1, but we will now apply that 50% target against full year excess free cash flow. To date this year, we have purchased 1.4 million shares and we plan to increase the pace of buybacks going forward to align with this increased return of capital target. We continue to believe share buybacks represent a very compelling return of capital option, which will result in the majority of our return of capital for this year going towards share buybacks. We have updated our internal forecast with the latest strip pricing and are forecasting annual fund flow of approximately $1.25 billion, with resulting free cash flow of approximately $650 million. Under current strip pricing and applying our new return of capital allocation target, we would expect to return approximately $250 million to shareholders through our base dividend and share buybacks, representing approximately 10% of our market cap, while continuing to reduce debt, which is also an indirect form of returning capital to shareholders. We believe this is an appropriate allocation of capital as further debt reduction will make us an even stronger and more resilient company. Looking back on our free cash flow allocation over the past three years, we will have reduced debt by over $1.2 billion by the end of 2024 based on the time period shown here. This is value that accrues directly to our equity shareholders. At the same time, we have increased our return of capital to shareholders each year over this timeframe. We believe a 50% return of capital target is appropriate for our business as it allows us to provide ratable, annual dividend increases and buyback shares while also creating excess capacity on our balance sheet to be opportunistic. With that, I will pass it back to Dion.

Thanks, Lars. Our disciplined focus on strengthening the balance sheet and high-grading the asset base, along with diligent capital allocation, has made Vermilion a much stronger and more resilient company. We ended 2023 with a strong balance sheet and continued our operational momentum from the fourth quarter into 2024. Our 2024 capital program is well underway, and we're very pleased with how things are progressing on our three growth initiatives in Canada, Germany and Croatia. The development of our gas prospects in Germany and Croatia will increase our exposure to premium-priced European gas, but the expansion of our Montney infrastructure in Canada will set the stage for long-term development and growth of this asset. We're excited about Vermilion's outlook and believe that we have a robust portfolio capable of generating strong compounded returns to our shareholders through a combination of modest annual production growth, a resilient and growing base dividend, and share buybacks. Well, that concludes my prepared remarks, and with that, we'd like to open it up for questions.

Your first question comes from the line of Greg Pardy from RBC Capital Markets.

Thank you, Dion, Lars, for the rundown. A couple of questions for you, but maybe the first one is just on the net. A couple of questions. First one, maybe just on net debt thresholds in terms of opening up return of capital. So I know $1 billion was the first trigger. Have you thought about what net debt floor you'd like to achieve for the business and then what the implications might be? Is it possible that you could see yourselves going to 100% payout? That would be question one. And then I've got a follow-up.

I'll pass it over to Lars to discuss our debt levels and return of capital.

And we're quite excited to get to this point here where we will be targeting that 50% for 2024. I would say at this point, we're comfortable not putting out guidance in terms of the next net debt level that would trigger a higher return of capital. I think what you're going to see here in 2024 is that 50% target still allows us to return potentially up to 10% of our market cap through the dividend, but primarily through the share buyback. The way we think about absolute debt levels is that $500 million to $1 billion range, we're quite comfortable in. As you get closer to the $500 million level, that represents the amount of debt that we have termed out to 2030. And so if we started to approach that, that may be a catalyst to rethink the 50% excess free cash flow at this point. But I think we're very comfortable with the 50% now.

I mean basic question, how fussed are you with the reserve revisions? And then maybe just related to that, given the shift in capital allocation that you're looking at to areas like the U.S. or even portions of your ops in Saskatchewan become non-core, or could those areas become non-core? I'm just curious as to maybe what the medium- to longer-term planning might be with those areas?

I can take this one, Greg. I mean, as you know, over the last couple of years, we put a lot of focus on debt reduction and asset high-grading with Corrib and Mica, in particular, and actually selling some assets in the U.S. and Saskatchewan most recently. And what we're excited about is we're able to advance these growth opportunities in Germany, in Croatia, and as well Mica, where we see a lot of running room. So at this point, we're happy with our portfolio. As we look out to the running room, being able to deploy capital in those key growth areas. As to the actual reserves themselves, as noted, 40% of that is capital allocation as we work through our permitting process, our budgeting process, and know our reserves process. In Saskatchewan, we still have a rig going there. We've got a lot of inventory still on the book that we quite like, and the inventory that moved out of reserves has the potential to come back, should we find ourselves changing our capital allocation in the future. So we like the option, like the exposure to oil in Saskatchewan. In the U.S., what excites us about the U.S. is that oil stack has four oily zones. We continue to look at all four zones, in particular, the Nile where there's been a lot of industry activity, and it's material. This year, we did hit the pause button on drilling in the U.S., so we can really work through those four zones. We received competitor activity in all four zones to determine how best to develop that asset. So at this point, no changes to our portfolio with respect to the U.S. and Saskatchewan, and we've made these technical revisions partially due to capital allocation, and then partially due to performance. And you're right, the performance issues were in the U.S. and Saskatchewan, and we've made those changes.

And your next question comes from the line of Travis Wood from National Bank Financial.

I have a question that's the same for both Germany and Croatia. Dion, in your opening remarks, you mentioned a 70% risk profile regarding the drilling of these exploration wells. Considering the potential size and impact of the wells, how should we assess the production impact of successful drilling? Can you also remind us of the costs involved in drilling and tying in these large wells? Additionally, are there any nearby analog wells that you're referencing to mitigate risk, whether they're tests from your company or other operators in the area?

So definitely, we can get excited to talk about Germany's upside potential. When we look at that land base and the teams working it for five or six years, we see a trillion cubic feet of gas on our land base. We've got 700,000 net undeveloped acres. We have 3D seismic across that land base. We have two decades of drilling in similar formations just 300 kilometers away in the Netherlands. So we like the size of the prize. We also like the jurisdiction in which Germany is working with us to develop these wells as they are still very much in need of gas to replace about one-third of their energy, which comes from coal and lignite. As for the targets themselves, what we see are targets that are in that 30 to 40 boe typically, and costs that are similar to $35 million to $40 million wells to drill. If you zoom out, how I think about it, it's $1 per Mcf. If we can drill these wells and get exposure per $1 Mcf and then sell that gas still at 5x to 6x ACL at $10 to $12 in Germany. We like that trade-off on a risk-reward. Of course, the dry hole cost, if you're not successful, is much lower than the total $35 million to $40 million to drill. So what we see right now is we have two wells per year and see a multi-year program on that. With success, we can more than double the German production and we're quite excited to get these first couple of wells drilled and to be able to come back and provide an update later this year. If there is an element of exploration here, we want to make sure that we talk about that with our success rate in the Netherlands, where it's been about 70%, and we think that's a reasonable number to use for a German program. As for analog wells, I mean, we're drilling in pools where we're offsetting wells within those pools that have produced 30, 40 boe. So we're surrounded by producing wells or producing plays that are very similar and have wells in the structure. That gives us more confidence to be able to put this capital to work and assess that upside. So we're excited, but we do recognize that it's something we’re going to have to look at this as a program rather than individual wells, and we look forward to providing more updates in the next couple of months.

And would that be similar commentary as you think about derisking and exploring Croatia?

Shifting to Croatia, Croatia's interesting. We've got two blocks. So SA-10 is the area where we've drilled and tested and we have gas behind pipe. With the gas plant that you can see in the pictures, the unit is built, we're just finalizing the pipeline tie-ins gas billing pipe, and this will be basically dry gas that will produce into that unit. That's the SA-10 block. The SA-7 block is an area where we're surrounded by known producing fields, oil and gas. We did a partnership with INA, who has a lot of that infrastructure and off-setting production. So we're in the first of four wells that we've drilled there. The first well looks encouraging. We've seen hydrocarbons in multiple zones. We'll drill the next three wells and then progress after that. As for the size of the prize, it's really early days in SA-7. I would say it's too early to comment, but we can come back once we get these four wells in the ground. SA-10, will be a couple of thousand boes a day of high netback gas that we'll produce through that compressor.

There are no further questions at this time. Mr. Hatcher, please proceed.

Well, again, we want to thank you for participating in our year-end results conference call. Enjoy the rest of your day.

Thank you. Ladies and gentlemen, that does conclude our conference for today. Thank you all for participating. You may all disconnect.