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Edited Transcript of FEC.TO earnings conference call or presentation 8-Nov-19 3:00pm GMT

Q3 2019 Frontera Energy Corp Earnings Call

TORONTO Nov 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Frontera Energy Corp earnings conference call or presentation Friday, November 8, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* David A. Dyck

Frontera Energy Corporation - CFO

* Gabriel de Alba

Frontera Energy Corporation - Independent Chairman of the Board

* Richard Herbert

Frontera Energy Corporation - CEO

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Conference Call Participants

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* Anish Kapadia

Hannam & Partners (Advisory) LLP, Research Division - Analyst of Energy Research

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Presentation

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Operator [1]

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Good morning. My name is Brent, and I will be your conference facilitator today. Welcome to Frontera Energy's Third Quarter 2019 Results Conference Call. (Operator Instructions)

This call is scheduled for 60 minutes. I would like to remind you that this conference is being recorded today and is also available through audio webcast on the company's website. After the speaker's remarks, there will be a question-and-answer session. Analysts and investors are reminded that any additional questions or concerns can be directed to the company at ir@fronteraenergy.ca.

This call contains forward-looking statements which reflect the current expectations or beliefs of the company based on information currently available. Forward-looking statements are subject to a number of risks and uncertainties that may cause the actual results of the company to differ materially from those discussed in these forward-looking statements. Factors that could cause actual results or events to differ materially from current expectations are disclosed under the heading Risk Factors and elsewhere in the company's annual information form dated March 13, 2019.

Any forward-looking statement speaks only as of the date on which it is made, and the company disclaims any intent or obligation to update any forward-looking statements.

I would now like to turn the meeting over to Mr. Gabriel de Alba, Chairman of the Board of Frontera Energy.

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Gabriel de Alba, Frontera Energy Corporation - Independent Chairman of the Board [2]

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Thank you, operator, and thank you, everyone, for attending today's conference call to review Frontera's third quarter 2019 financial results and provide an update on operational and shareholder return initiatives.

I'm happy to report that Frontera continues to deliver solid financial results and shareholder returns, while sustaining core production and developing its long-term growth and exploration assets. Thus far in 2019, Frontera has delivered CAD 1.44 in dividends, a 13% yield based on the recent share price, and has repurchased 1.4% of the shares of the company through our normal course issuer bid. Additionally, the company announced a record date for the first regular dividend of 2020 in the amount of CAD 0.205 per share, representing an annual yield of over 7%.

For those new to Frontera and to put it in context, these returns are a cornerstone of Frontera's 2019 objectives of maximizing cash generation and delivering shareholder returns by establishing a long-term production path with the optimal amount of capital while driving company-wide efficiencies. Third quarter operating EBITDA of $126 million, generated cash provided by operating activities of $113 million compared to $90 million of cash used in investing activities. This $23 million of free cash flow is (inaudible) than the required for the regular dividend of $50 million per quarter, which the company pays when Brent averages $6 per barrel or higher. The strong operating and financial metrics so far in 2019 are expected to generate full year results towards the favorable end of 2019 guidance for average daily production, operating EBITDA, operating costs and transportation costs. Capital expenditures for 2019 are expected to be within the original 2019 guidance range, even with the impact of the consolidation of CGX and abandonments.

Frontera Board continues to focus on cost savings and is pleased with management's achievements over the past year, with a 16% reduction in operating costs, a 13% reduction in transportation costs and a 20% reduction in G&A costs, compared to the third quarter of 2018. The company continues to implement cost savings and efficiency initiatives that will not only result in lower breakeven cost for the company, but are also targeted to improve its carbon footprint as power is shifted towards more sustainable sources. The balance sheet remains very strong with $442 million of cash and cash equivalents and working capital of $125 million. The company continues to work to reduce the amount of its restricted cash with new credit facilities that are expected to be executed in the coming months. Capital discipline and balance sheet protection remain paramount for the Board. And as a result, the company has a solid cash position in place for the next 9 months with downside protection for Brent oil prices below $55 per barrel. Finally, as the company progresses towards finalizing the 2020 budget, from there remains committed to its objective of sustaining production, reducing costs and returning excess cash to shareholders, while also delivering on its exciting exploration initiatives, so much which will be drilled in 2020 as part of next year's capital program.

We look forward to delivering the 2020 plan to the market in the first week of December.

I will turn the call over to Richard Herbert, our CEO, for additional detail on our operating and financial results so far in 2019 as well as some additional detail on current operational initiatives.

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Richard Herbert, Frontera Energy Corporation - CEO [3]

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Thank you, Gabriel, and good morning, everybody. Thank you for joining our call today.

Frontera continues to perform strongly in 2019 from both an operational and financial perspective. We are delivering on our commitment to sustain production with a year-to-date daily production of just over 71,000 barrels of oil equivalent per day, above what it was in 2018 and above the high end of the company's guidance range for 2019. Current production is over 73,000 barrels of oil equivalent per day.

This time last year, we set out to improve our cost structure, and with the help of dependable operations from Colombia and a weaker peso, we are delivering, with G&A cost down 20%, operating costs down 16% and transportation costs down 13% compared to the third quarter of 2018. Although we have had some success, our work is not done. And we remain vigilant to continue our cost reduction and efficiency improvement efforts. Our financial results, which David Dyck, our CFO, will expand on shortly, were robust, despite Brent oil prices that were 18% lower than a year ago and 9% lower than the last quarter. Results this quarter were impacted by a build of inventory in both Peru and Colombia, which we expect to reverse in the coming quarter.

I'm going to focus on 3 of our key initiatives. First, I will provide an operational overview where we have had successes from an exploration and development perspective. Next, I will provide an update on our strategic initiatives, including our upcoming exploration plan, and lastly, I will talk about the ongoing cost control and efficiency improvement initiatives undertaken throughout our operations. From an operational perspective, production has remained stable and consistent throughout the year, with production levels consistently over 72,000 barrels of oil equivalent per day during the period when Block 192 production in Peru is uninterrupted. Our heavy oil business in Colombia is delivering well. Quifa continues to produce at close to 50,000 barrels of oil per day gross, levels which we last experienced in 2015, despite a reduction in active rigs operating on the block. We have now started our annual vertical drilling and step-out campaign at Quifa that replenishes our horizontal well inventory in the field and looks to replace the produced reserve.

We will also start drilling our first multilateral well this quarter, which could open up new opportunities for how remaining reserves in the field developed. We continue to use water diverting AICD units downhole at Quifa, which have shown real promise in the pilot phase. Quifa is a world-class asset, which provides the large stable base of Frontera's production and generates significant annual free cash flow that funds the other parts of our business.

In the CPE-6 block, we continue to drill the combination of deviated vertical wells and horizontal wells, with a target of increasing production to over 3,000 barrels of oil per day by the end of this year. We recently completed the drilling of an additional water injection well, which will help with the water treatment and disposal necessary to ramp up production during the fourth quarter and into 2020. We also recently completed drilling at the (inaudible) one exploration well, as a follow-up appraisal well to the successful Coplero-1 exploration well, which was discussed with our second quarter results. This new well has encountered 10.3-feet of net reservoir pay in the Carbonera C7 B reservoir and is expected to be completed as a producer. These reservoirs have shown excellent permeability of over 2 darcy. Assuming continued success from the horizontal well program at Hamaca, the company expects to grow production from the CPE-6 block in 2020 to over 5,000 barrels of oil per day.

Our light and medium oil business continues to perform better than expected, with production only 1% lower quarter-over-quarter, despite very little drilling activity on our key light oil blocks at Guatiquia and Cubiro. We are in the process of permitting a new well pad on Coralillo field in the Guatiquia block, which will see increased activity early in 2020 to help maintain our light and medium oil production. The Lower Magdalena Valley is a natural gas prone area of Colombia where we have over 80 million cubic feet per day of spare natural gas processing capacity. We are looking to our exploration blocks in this region to increase the share of natural gas within the production mix of the company. We have recently received the permitting required to drill the SI1 exploration well at Guama in early 2020, with civil works and site preparation starting soon. This is in the same area as VIM-22, the block that we added during the ANH Bid Round earlier this year.

Additionally, in the VIM-1 block, the La Belleza-1 exploration well, currently being drilled by our joint venture partner Parex resources, is progressing on time and on budget, with results expected by year-end. This well is targeting a primary objective of a fractured basement gas and liquids play. Production in Peru has been stable since July at approximately 10,000 barrels of oil per day. Following a number of outages on the North Para-Maranhao export pipeline in the past year, which resulted in force majeure events being declared, expiry of the current service contract has been extended to March 2020. We remain actively engaged with both Perupetro and Petroperu to demonstrate our commitment to Block 192 and the process required for a new long-term contract on the block.

I'll now turn my attention to our strategic initiatives. These are projects which have been added to the portfolio in 2019 and to which we expect to allocate capital in 2020. Offshore Guyana has become one of the world's most exciting offshore exploration provinces in the last 4 years. Frontera is moving forward with a joint venture with local partner, CGX Energy, in 2 offshore exploration blocks, Corentyne and Demerara. A 3D seismic acquisition program on the northern parts of the Corentyne block has just been completed. With both blocks now largely covered by high-quality 3D seismic, we are working to select locations in each block for drilling in the second half of 2020. Recent nearby positive drilling results from 2 exploration wells drilled on the Orinduik Block on the slope offshore Guyana, immediately adjacent to the Demerara block, have also de-risked a number of high-quality exploration prospects on our blocks.

In Ecuador, we continue to work with the government, with local communities and with our partner, GeoPark, as we progress the environmental impact assessments and permitting required to drill a well in late 2020 on the Frontera-operated Perico block, which was awarded as part of the Intracampos Bid Round earlier in 2019. Additionally, Frontera intends to participate in the next Intracampos Bid Round expected before the end of this year.

In Colombia, a second 2019 bid round is taking place in November, and the company expects to be active in selecting opportunities to high-grade the portfolio near existing areas of operations. Additionally, on the strategic front, the company continues to evaluate a selection of divestment opportunities in both its upstream and midstream assets. Frontera is looking to simplify its operating footprint and package some upstream assets, which would form a solid base for some of the new entrants looking to establish themselves in Colombia. The company continues to evaluate and pursue opportunities related to its ownership in the ODL pipeline and Infrastructure Ventures Inc, which owns Puerto Bahia, deepwater port facility in Cartagena Bay.

Finally, I would like to address some of the cost savings and operational efficiency improvement initiatives we have undertaken in the past year, where we are starting to see results. On October 1, the company moved to a new asset operational model in Colombia, with a view to further decrease operating and capital costs and improve operational efficiency. Production costs during the third quarter of 2019 of $11.60 a barrel was 16% lower than in the third quarter of 2018, and transportation costs during the third quarter of 2019 of $12 a barrel were 13% lower compared to the third quarter of last year. We are tracking below the low end of guidance for both operating and transportation costs. However, with additional cargoes expected to be sold from Peru in the fourth quarter, these costs should trend back up within the low end of guidance. As part of a larger overall initiative, to reduce Frontera's carbon footprint, the company continues to identify and evaluate a number of energy cost savings initiatives, which include tying more field into the grid, which, in Colombia, is largely sourced from hydroelectric plants, the potential use of solar power generation in some of our larger fields and switching fuel sources from oil to natural gas where possible. We look forward to updating investors on our progress with these initiatives in the future.

I'd now like to turn the call over to David Dyck, our CFO, who will take you through our financial results in more detail.

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David A. Dyck, Frontera Energy Corporation - CFO [4]

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Thank you, Richard, and thank you to everyone who has joined our call today. It was another solid quarter from a financial perspective, with operating EBITDA of $126 million on the back of an operating EBITDA margin of 47%, up from 31% during the third quarter of 2018. Year-to-date, we have generated operating EBITDA of $452 million, which is above our original full year guidance range of $400 million to $450 million.

Cash provided by operating activities in the quarter was $113 million compared to $90 million of cash used in investing activities in the third quarter of 2019. This generated $23 million of additional free cash, which exceeded the regular quarterly dividend of $15 million. These solid financial results were delivered in a period where oil prices were 18% lower year-over-year and 9% quarter-over-quarter. Our stable production base continues to deliver strong financial results even in a period of lower commodity prices, supported by the impact of cost reductions and efficiency initiatives. The most prevalent area of savings has been G&A, where costs were $18.5 million during the third quarter of 2019, 20% lower compared to the third quarter of 2018. A net loss of $49 million or $0.50 per share in the third quarter of 2019 was impacted by impairments related to long-term receivables from infrastructure ventures of $37 million, impairments of exploration and evaluation assets of $8 million and a tax charge of $25 million relating to a ruling associated with the legacy tax incentive program.

Third quarter EBITDA and other key financial metrics were impacted by a 43% quarter-over-quarter increase in crude oil inventory, which reached 2.7 million barrels at September 30. The increase in inventory is expected to reverse, but for the quarter, it resulted in daily sales volumes of approximately 8,700 barrels per day lower than production. In Peru, the timing of the sale of batch third-party shipments in the NorPeruano pipeline prevented the company from selling its oil during the quarter, increasing inventory by 500,000 barrels to 1.9 million barrels. It is expected that the company will reduce inventory in Peru by between 300,000, and 500,000 barrels during the fourth quarter of 2019. Inventory also built in Colombia by 300,000 barrels to 800,000 barrels as a result of the timing of nominations of the company's cargoes, which is expected to reverse depending on the timing of additional Colombia cargoes.

Total company inventory at the end of the year is expected to be lower than at the end of the third quarter of 2019. From a capital expenditures perspective, the company continues to trend within the 2019 guidance range of $325 million to $375 million on organic capital projects, and including abandonments and the impact of the consolidation of CGX. It should also be noted that the consolidation of CGX was not included in the original 2019 capital guidance. Quarterly CapEx has trended between $70 million and $80 million so far in 2019. However, costs associated with the annual abandonment program, expansion of production at CPE-6, exploration activities on VIM-1 and the seismic program offshore Guyana, means that we are likely to spend between $110 million to $130 million during the fourth quarter.

Cash and cash equivalents, including restricted cash, totaled $442 million as of September 30, 2019, a decrease of $43 million compared to June 2019, reflecting $55 million of shareholder returns and offset by $23 million of free cash flow. The company continues to work on various initiatives, expected to reduce its restricted cash balances, and we expect a further $20 million to $30 million to be released by year-end. Additionally, the company is working with a number of credit providers for new credit facilities, which would release additional restricted cash balances in 2020. In 2019, the company announced the renewal of its normal course issuer bid, pursuant to which the company may repurchase up to 6.5 million shares of the company, representing 10% of the public float, during the 12-month period between October 18, 2019 and October 17, 2020. During October 2019, the company repurchased for cancellation 317,700 shares at an average price of CAD 10.6 per share.

The company's financial performance continues to deliver strong credit metrics, with net debt to trailing 12-month EBITDA of 0.4x and debt to book capitalization of 23%. These strong credit metrics have led to the company's public bonds trading at over 106 or a 7.5% yield to maturity.

I will now provide a quick update on our hedging strategy. The company has hedged approximately 60% of fourth quarter 2019 production, 40% of first quarter 2020 production and 30% of second quarter 2020 production, using a combination of Brent oil price linked put options, 0 cost collars, put spreads and 3-way collars to protect the company's balance sheet and capital program within the hedging limits set by the Board of Directors. Frontera continues to evaluate various hedging strategies to ensure sufficient pricing to protect the capital program and the balance sheet.

I will now turn the call back over to Richard for some closing comments.

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Richard Herbert, Frontera Energy Corporation - CEO [5]

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Thank you, David. At Frontera, we are successfully delivering on our promise of maintaining Colombian production of between 60,000 and 65,000 barrels of oil equivalent per day, which is generating sufficient cash to maintain a healthy balance sheet, invest in our sustaining and growth capital expenditures and enhanced shareholder returns through dividends and buybacks. We have delivered on a number of initiatives, which are improving the medium to long-term outlook for the company, while taking costs out of the business and improving operational efficiencies. We continue to work on extracting value from our portfolio of high-value assets. Our efforts are ongoing as we make substantial progress transitioning Frontera, into the premium value, South American upstream oil and gas company.

We look forward to meeting many of you soon to go over our plans in more detail. As Gabriel noted, we will be releasing our 2020 guidance and plan during the first week of December. Thank you all for attending our call. I will now turn the call back to our operator, who will open up the call to any questions that you may have.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Anish Kapadia with Hannam.

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Anish Kapadia, Hannam & Partners (Advisory) LLP, Research Division - Analyst of Energy Research [2]

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I had a few questions, please. Firstly, I wanted to ask about the impact of the new IMO regulations that are coming in at the end of the year. I believe that your crude, although it's heavy, is relatively low in sulfur. So I'm wondering if you're actually going to see any benefits or any further benefit and how you see that light heavy spread trending over the next year.

Second question was -- relates to Guyana. You mentioned earlier on the call that there were some successes on the adjacent block. One of those discoveries appears to fairly clearly extend into your block, the Joe discovery. I was wondering if you could talk a bit more about how you see the potential for that discovery on your block and other look-alike prospects that you have on your block that you may be targeting.

And then the final question is on the buyback, I could see that you've restarted that. Can you just give some idea about what are going to be the parameters around how much you look to buyback? Is it oil prices? Are there other things that you're kind of thinking about over the next couple of months in terms of that buyback?

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Richard Herbert, Frontera Energy Corporation - CEO [3]

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Yes. Anish, it's Richard here. Thank you for your questions, and good afternoon to you because you're in London, I believe.

I think on the first question on IMO 2020, as you say, the Vasconia blend is relatively low in sulfur at around 1%. We're still evaluating what 2020 as a year is going to look like with respect to Vasconia differential. And I think we'll talk some more about that in December when we release our guidance for the year. But I think we've seen a number of recent trends, which have had an impact. One, of course, is the significant increase in shipping tariffs that has taken place with various sanctions that were imposed. So actually, working out the overall effect of what this is going to have is -- it's hard to predict at the moment. We've -- in general terms, we're predicting a slightly increasing differential into next year, but the actual numbers that we put into our plan will be releasing in December.

Just moving -- I'll answer your second question on Guyana, and then I'll hand over to David just to talk about what we're doing with our buyback program. As you pointed out in your question, our neighbor, Tullow has announced 2 discoveries in the last few months on their exploration block, which sits adjacent to our Demerara Block and in between our 2 exploration blocks. There hasn't been a lot of data released on those discoveries yet. But as you point out, one of them, the Joe discovery, has encountered oil in an up potential reservoir in a prospect, which is right on the block boundary with our Demerara block. So obviously, that's a very encouraging outcome for them and a very encouraging outcome for us. We're still in the process of working up our prospect inventory on both blocks, using the 3D seismic data that we now have and in current time, we'll be incorporating the new seismic data that we just acquired during the early part of next year. And we'll be able to talk more about what our specific targets and drilling plans for 2020 are in early next year.

And with that, let me just hand over to David just to talk about the buybacks.

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David A. Dyck, Frontera Energy Corporation - CFO [4]

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Anish, it's David. Yes, our buyback program has been reinitiated. And our plan is to buy back shares on a regular basis throughout the year. And to date, since we put the program back in place, as we said earlier, we purchased roughly 377,000 shares. And so that all has a very positive impact to all of our shareholders.

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Operator [5]

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(Operator Instructions)

There are no further questions at this time. Should you have any further questions, please e-mail ir@fronteraenergy.ca. This concludes the call. Thank you all for participating.