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Edited Transcript of VII.TO earnings conference call or presentation 7-Nov-19 4:00pm GMT

Q3 2019 Seven Generations Energy Ltd Earnings Call

Calgary Nov 27, 2019 (Thomson StreetEvents) -- Edited Transcript of Seven Generations Energy Ltd earnings conference call or presentation Thursday, November 7, 2019 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Newmarch

Seven Generations Energy Ltd. - VP of Capital Markets & Stakeholder Engagement

* David Holt

Seven Generations Energy Ltd. - COO

* Karen Ann Nielsen

Seven Generations Energy Ltd. - Chief Development Officer

* Marty L. Proctor

Seven Generations Energy Ltd. - President, CEO & Director

* W. Derek Aylesworth

Seven Generations Energy Ltd. - CFO

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Conference Call Participants

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* Amir Arif

Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research

* Curtis Bell

RBC Dominion Securities Inc. - Vice-President of Investment & Wealth Advisor

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Presentation

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Operator [1]

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Good morning, ladies and gentlemen, and welcome to Seven Generations Energy Ltd. Q3 conference call. After the presentation, we will conduct a question-and-answer session. (Operator Instructions) Please note, this conference is being recorded today, November 7, 2019, at 11:00 a.m. Eastern Time.

I would now like to turn the meeting over to your host for today's call, Brian Newmarch, Vice President, Capital Markets and Stakeholder Engagement. Please go ahead, Mr. Newmarch.

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Brian Newmarch, Seven Generations Energy Ltd. - VP of Capital Markets & Stakeholder Engagement [2]

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Thank you for joining us for the Seven Generations Energy Third Quarter 2019 Conference Call. With me, I have President and CEO, Marty Proctor; Chief Financial Officer, Derek Aylesworth; Chief Operating Officer, David Holt; Chief Development Officer, Karen Nielsen; as well as other members of our management team. We will review our results for the quarter ended September 30, 2019, and then open the line to questions.

All statements made by the company during this call are subject to the reader advisory set forth in the news release issued this morning and the company's corporate presentation. All dollar amounts discussed today are in Canadian dollars unless otherwise stated. The complete financial statements and MD&A for the period ended September 30, 2019, were published this morning and are available on www.7genergy.com as well as the SEDAR website.

I will now pass the call over to you, Marty.

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [3]

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Thank you, Brian. The third quarter was another strong quarter for 7G. Our business continues to evolve as planned as evidenced by our ability to generate free cash flow of $56 million this quarter, our improving cost structure and continued strong execution. Resilience and the concept of creating an anti-fragile organization is infused throughout all of our decision-making processes and is reflected in our results. We have built and strengthened our business through periods of depressed commodity pricing, market access constraints and challenging capital markets. As we work through our ongoing risk mitigation and opportunity capture process, we see environmental and social headwinds facing our industry. While some perceive these issues as threats, we see opportunity. Responsible development and stakeholder service are core to 7G and are part of our founding principles.

For example, in 2019, we continued our efforts to reduce our environmental footprint by improving our pad design with equipment to reduce flaring, which has eliminated 1.3 billion cubic feet of flare gas this year, creating $2.6 million of additional revenue and removing 97,000 tonnes of CO2 equivalent. We see our approach to resource development as being differentiated, and ultimately, as we continue to be recognized for our business practices, we see our stakeholders benefiting, including our shareholders.

Our Q3 and year-to-date 2019 achievements drive our strategic planning for 2020. As predicted, our decline rates are moderating, and in turn, lowering sustainable -- sustaining capital requirements to drive greater opportunity for free cash flow growth and a more resilient business.

Consistent with our expectations, a combination of cost reductions and decline rate moderation has reduced sustaining capital requirements for 2020 to about $1 billion, a 10% reduction versus 2019. We see declines averaging just above 40% for 2020 and continuing to progress downward in 2021 and beyond. Our sustaining capital estimate reflects our analysis of the optimal capital allocation strategy for this asset at this time, which blends development of all Nest areas, including the lower Montney, to maximize the net present value of the asset while generating free cash flow. Our evolving understanding of the lower Montney and the advantages of co-development led us to target nearly 30% of our pads with upper and middle and lower locations in the 2020 program. We will continue to fine-tune full stack optimization of our resource and will likely increase our lower Montney development over time.

While the quality of our asset and our market access initiatives provide us with multiple options for our capital, right now, we believe that it is prudent to focus on growing our free cash flow profile. We will continue to allocate free cash flow to share buybacks and/or net debt reduction.

I will now pass the call over to our Chief Financial Officer, Derek Aylesworth.

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W. Derek Aylesworth, Seven Generations Energy Ltd. - CFO [4]

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Thanks, Marty. We continue to track in line with full year 2019 expectations, with production averaging about 202,500 BOE per day, with a $1.25 billion capital program and second half production averaging between 205,000 BOE to 210,000 BOE per day. Looking toward 2020 and our guidance released this morning, we anticipate similarities in terms of the overall shape and level of production relative to 2019 but at a meaningfully reduced level of capital. For 2020, we are focused on keeping shareholder interests front and center, with an alignment to spending at sustaining capital levels for production, with discretionary capital focused on high-value items with long-term benefits to our business and a more modest delineation and expiry management program. We anticipate fully funding this budget at a $50 per barrel WTI and $2.50 per MMBtu Henry Hub price environment alongside historically low NGL prices. Commodity prices above these levels are anticipated to drive free cash flow that will be targeted at increasing shareholder value through ongoing buybacks and potentially net debt reduction.

Relative to 2019, a somewhat wider production range in the first half of the year primarily reflects the impact of a handful of additional offset well shut-ins during the first half completion operations. The wider upside potential in the second half reflects the opposite trend. Overall, corporate production rates should be seen as stable on a full year basis.

Through 2020 and the next few years, we expect our total liquids and condensate mix to remain similar to 2019 levels. But with 3 development regions, our core Nest 2 development area, the high deliverability but lower condensate gas ratio Nest 3, and the ultra-rich condensate region of Nest 1, the timing and location of pads coming on stream can lead to moderate quarter-to-quarter movements in our product mix. With Nest 3 being a larger driver of the 2019 exit rates, 2020 will see a higher initial gas mix with higher condensate from Nest 1 development contributing later in the year and into 2021. We also executed a land swap agreement in the fourth quarter of 2019. This transaction was very important for future development, notably in the Nest 1 area. While our previous working interests in Nest 1 were very high, they were inconsistent on a section-by-section basis, which posed challenges for our development in that region as it necessitated shorter lateral wells and suboptimal pad configurations. Having normalized our working interests, 7G can now proceed with development in key areas of Nest 1 with an optimized development program that meaningfully reduces future development capital in the region. This transaction also allows 7G to better manage the pace of future development to align with our own priorities elsewhere in the Nest.

I'll now pass the call over to our Chief Operating Officer, David Holt.

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David Holt, Seven Generations Energy Ltd. - COO [5]

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Thanks, Derek. I'm pleased to report that our operating teams have continued to demonstrate outstanding execution, which can be seen in our results and in our projections for 2020. On the capital cost front, we are pleased with continuous improvement efforts to date and continue to pursue improving capital efficiencies as a normal course of business. With completions, our teams are driving improving efficiencies and cost controls on a daily basis. Hours per day spent pumping sand have increased from 15 hours per day in 2018 to over 18 hours per day in 2019, reducing the days on location, improving cycle times and reducing costs. Seven Generations' field engineers have worked hard to make small modifications to our designs, resulting in placing the same amount of sand but with less water, further reducing capital costs and reducing our water footprint. Less water in means less water out, reflected in our lower water-handling operating costs.

Our drilling operations have also strived for efficiency by reducing our days per well from 29 in Q2 to 25 in Q3. Our drillers continue to chip away at small wins on cost and time to move the needle in aggregate. Changes in bits, bottom-hole assemblies, wellbore architecture and connection times all contribute to improving capital efficiencies.

Operating expenses improved relative to the second quarter, and at $4.81 per BOE, are coming in below our guided range for the year. This improving performance also tracks into 2020, where we have set operating cost guidance for next year at $4.75 to $5.25 per BOE, a further 5% reduction to the lower end of the range relative to 2019.

In 2020, we have a once-in-5-year maintenance event planned for our main Karr processing facility. As part of this normal, course-of-business event, our operating team saw an opportunity to also enhance the reliability of the asset. With the current components and design of the Karr facilities condensate stabilizer, periodic 1- to 2-day maintenance events throughout the year resulted in reduced run times that lower our effective full year condensate capacity. More importantly, those small downtimes can increase condensate price penalties due to higher in-stream butane. The planned upgrade in conjunction with the plant turnaround will improve reliability and can improve our average condensate price realizations by between $0.25 to $0.50 per barrel. That's about $7 million to $14 million per year improvement in cash flow in perpetuity for an initial investment of $25 million. We believe that's good value and very accretive to our returns on capital employed.

I will now pass the call over to our Chief Development Officer, Karen Nielsen.

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Karen Ann Nielsen, Seven Generations Energy Ltd. - Chief Development Officer [6]

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Thank you, David, and good morning. This morning, we published our first major results out of Nest 3 following our infrastructure build-out that we have now completed. On the first 8-well pad, 120-day initial production rates averaged just under 2,000 BOE per day, which is in line to slightly above our expectations, but more importantly, with just under 700 barrels a day of condensate, which was 26% above our expectations. And with credit to David's operational team, the drilling and completion cost structure on those wells were also 12% below expectations at just $8.8 million versus a $10 million baseline. These results go a long way to bringing the economics of Nest 3 more in line with areas of Nest 2.

Also in Nest 3, we co-developed a lower Montney location. The well, which was just tied in during October, saw an IP initial production rate of 30 -- of 2,280 BOE per day, with condensate volumes of about 700 barrels per day. This initial rate is coming in above expectations for both volumes and liquids mix. And so future necessary activity will likely include lower Montney co-development going forward.

With these Nest 3 well results and with the lighter go-forward surface infrastructure footprint, we expect Nest 3 will be a very economic, full-cycle development area.

At our previously disclosed triple-stack pad located in the northwest region of Nest 2, per well average rates continue to hold at very strong levels and condensate rates compared to our Q2 disclosures, with a per well 120-day initial production rate of approximately 1,500 BOE per day, with over 900 barrels per day of condensate. Of the 3 lower Montney wells of that pad, the 2 stronger wells have continued to perform at about 85% of the upper middle average, which is ahead of our baseline expectations.

The third lower Montney well completed with higher sand intensity has lagged in productivity. However, the results are helping us to optimize our frac design, water usage and costs and to continue to improve capital efficiencies as we develop the lower Montney. With lower Montney present across nearly all of our acreage, we will continue to invest and develop it in 2020.

I'll now pass the call back to Marty for a few closing remarks.

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [7]

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Thanks, Karen. Seven Generations is seeing positive results from our strategic shift towards free cash flow generation, which has funded an 8% share buyback program and meaningful per share volume growth. Combined with strong operations execution and an improving cost structure, our free cash flow growth trajectory will continue as the company grows more resilient. We know sustainable development includes excellent ESG performance. Continuous improvements are required in the management of emissions, water and community and stakeholder relations. We are intently focused on improving our ESG performance and reporting.

Operator, I will now ask that you open the lines up to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Amir Arif from Cormark Securities.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [2]

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Congrats on a good quarter. Just a few quick questions. Just first, on the well costs, they came down nicely this quarter. I'm just curious what your well cost assumption is in your 2020 capital guidance. I think you...

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [3]

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Amir, you bet. I'm going to ask David to handle that.

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David Holt, Seven Generations Energy Ltd. - COO [4]

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Yes. Thanks, Amir. Yes, great question. So what we've actually used in our assumption for 2020 is an average well cost of $8.4 million, that's on D&C cost. It basically reflects what we saw in Q3. We believe those costs are real. We believe they're repeatable, and it is our basis for 2020.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [5]

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Okay. And what would that number have been for 2019? Was that -- would that have been closer to $10 million?

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David Holt, Seven Generations Energy Ltd. - COO [6]

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Yes, closer to $10 million.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [7]

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Okay. And then just a follow-up question. On the 2020 spending plans, you've mentioned that about 30% of the pads will be triple stack. Just curious if you can give us a rough breakdown of how much activity will be by region or just either capital or number of wells, just roughly in Nest 1, Nest 2, Nest 3.

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [8]

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Yes, great question. I'm going to ask Karen to answer that one.

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Karen Ann Nielsen, Seven Generations Energy Ltd. - Chief Development Officer [9]

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Sure. In 2020 budget, in Nest 2, we've got about 55% to 60% of our development focused in that area. In Nest 1 and Nest 3, they're about 15% equally.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [10]

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Okay. And the reason to go to 30% of your pads to triple stack versus a little more aggressive move? Is it just because you're still learning and tweaking the approach?

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Karen Ann Nielsen, Seven Generations Energy Ltd. - Chief Development Officer [11]

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Yes, exactly. That's exactly it. We're very encouraged by the early results in the lower Montney, and we do -- we're continuing to invest in 2020 in that bench. But -- and we think it's a positive that we're going to the 30% in the triple stack in 2020 and as we continue to optimize that well design.

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Amir Arif, Cormark Securities Inc., Research Division - Analyst of Institutional Equity Research [12]

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Okay. Perfect. And then last question. Just -- I know you had a midstream review ongoing. Just curious if that process is finished and business is staying as usual, or if it's still under review.

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [13]

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Yes, great question. I'll take that one. It's still ongoing. I mean we are -- we have observed, of course, the Tourmaline-Topaz transaction. I commend Tourmaline for thinking about innovative solutions in these challenging capital market times. That one is interesting. I don't think that the spin-out of a GOR appeals to us. But the potential for recognizing better value from the infrastructure that they can do through that spin-out entity is interesting and intriguing. And so certainly, we're going to watch that.

Our process continues to go on. I mean really, our intent of the process initially was to better utilize our own processing capacity and our egress and to see if we could generate additional revenues from those investments that we have made. We were not seeking a simple transaction just to monetize them and exchange capital for a fee. We are looking for more strategic solutions. And we continue to look at that. And we do have some options and some opportunities that we're evaluating, I mean, for the long term. I mean David referred to the condensate stabilizer. It's a pretty significant investment for us. And for me, it's a bit problematic in that we have to take our condensate off of our super pads, which is almost pipeline spec, yet contains a small amount of butane. We have to make a big capital investment in the condensate stabilizer to strip out that little bit of butane. And then as our condensate travels from our Montney to Fort Saskatchewan, others spike that line with a little more butane, so it makes no sense. And part of what we're hoping to do is to see if there's a way to take our infrastructure investments and our large position in the Montney, which will drive future condensate and NGL supply for the province, we want to see if we can leverage that position into getting solutions that better suit the resource that's being developed in Alberta. So look, it's a -- maybe a bit of an ambitious goal. Maybe we won't find a midstream that wants to work with us in that way. But that's our ultimate objective. It's to generate more value from the investments that we've made. So we're not rushing to come up with a solution, we're looking for the right strategic solution that best suits our shareholders.

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Operator [14]

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(Operator Instructions) Your next question comes from the line of Curtis Bell from RBC.

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Curtis Bell, RBC Dominion Securities Inc. - Vice-President of Investment & Wealth Advisor [15]

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Just a quick question on some returns to shareholders. Given the market is not rewarding asset values and it's a difficult capital market, have you thought about, at some point, implementing a dividend return to shareholders?

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Marty L. Proctor, Seven Generations Energy Ltd. - President, CEO & Director [16]

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Of course, we've thought about it. We feel like, at this time, the best way to return to shareholders is through the share buyback program that we have in place and that we have been using. As you've seen in the release, we've bought back about 8% of the company in the year that we've had that program in place, and we've now initiated a new program for share buybacks. We feel like at this time, with the decline rates still around 40% in 2020, that we're probably better -- our shareholders are better served by us using free cash flow to buy back more shares or to reduce net debt. I think though, for the 2- to 3-year time frame, we will be going to our Board and discussing the potential for a dividend. It's just a little premature now, I think, Curtis.

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Operator [17]

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There are no further questions at this time. Mr. Brian Newmarch, I turn the call back over to you.

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Brian Newmarch, Seven Generations Energy Ltd. - VP of Capital Markets & Stakeholder Engagement [18]

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We'd just like to thank everyone for joining us on the call. Please don't hesitate to reach out to either myself or Ryan Galloway if you have any further questions, and our information is available on our website. Thank you.

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Operator [19]

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Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.