Vermilion Energy - Q4 2023

Transcript

Operator (participant)

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. If at any time during this call you require immediate assistance, please press star zero for the operator. 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.

Dion Hatcher (President and CEO)

Thank you. 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 McQuaid, 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. Presentation can be found on our website under Invest with Us and Events and Presentations. Please refer to our advisory on forward-looking statements at the end of the presentation. It describes forward-looking information, non-GAAP measures, and oil and gas terms used today, and it 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 86,000-89,000. This represents a 6% increase over the prior quarter, primarily driven by the Wandoo platform in Australia and Corrib gas field in Ireland, which were online for the full quarter, following maintenance downtime in the prior quarter. Wandoo and Corrib are high-margin assets and both continued to perform quite well in Q1. We generated CAD 372 million of fund flow and CAD 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 CAD 164 million and return CAD 45 million to shareholders during the quarter, comprised of CAD 16 million in dividends and CAD 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 unplanned 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 CAD 1.1 billion of fund flow in 2023. This represents the second strongest year ever for the company.

Capital expenditures of CAD 590 million was in line with guidance and resulted in free cash flow of CAD 550 million. This free cash flow was used to fund the closing costs associated with the Corrib acquisition, asset retirement obligations, while also allowing us to reduce net debt by CAD 266 million and return CAD 160 million to shareholders, which represents about 30% of our free cash flow. We exit the year with net debt under CAD 1.1 billion, which is the lowest level in a decade and represents 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 BOEs 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 run on production, four Mannville 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 8-33 BC battery in mid-2024. Slide five 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 six, you can see the 16-28 wells continue to produce at very strong rates, 800 BOEs a day per well after 11 months on production. These two wells came 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 also believe this presents an opportunity for downspacing, which could add further drilling locations, and this is something we will be testing this year. 11 wells we plan to drill this year will be on or offsetting the 16-28 pad. We have drilled 6 wells on the first pad and commenced frack operations on this pad in late February.

We expect these wells will be ready for production and tie-in in Q2, in time for the mid-year start-up of the 8-33 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 seven shows a picture of the new 16,000 BOE battery being constructed on our Mica Montney lands. Construction is progressing as planned and remains on schedule for mid-year start-up. Once operational, this battery will more than double our Montney infrastructure capacity to approximately 20,000 BOEs a day and allows us to move forward with the growth phase of our Mica asset.

Production from our international operations averaged 33,381 BOEs 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 being 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+ 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 to our Netherlands plays, where we have drilled 29 gas wells over the past two decades, with an average success rate over 78%. The Germany exploration targets are deeper and higher risk, but have a much larger resource potential than the Netherlands. We believe our land base can support a multi-year drilling campaign, providing Vermilion years of organic production growth of high-valued European gas.

In Croatia, installation of the gas plant on the SA-10 block is progressing as planned and remains on schedule for startup midyear. The 15 million-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 on the SA-07 block and reached total measured depth of 2,371 meters, and we discovered hydrocarbons in multiple zones. We are currently evaluating the results and plan to test the well during the second quarter while commencing drilling operations on the second of four wells planned on the SA-07 block. In addition, we recently signed a firm agreement with the INA Group to jointly develop the SA-07 block.

INA is the largest integrated oil and gas company in Croatia and brings local expertise and access to existing infrastructure that will play a critical role in developing the asset. We are excited about the future European gas potential in Germany and Croatia, and look forward to providing an update 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 proved plus probable reserves decreased by 18% from the prior year to 430 million BOEs. 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, other non-core assets in the U.S., and also incorporates updated capital allocation decisions as a result of our asset high grading for 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. The 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 of capital targets.

Lars Glemser (VP and CFO)

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 83,000-85,000 BOE a day. As a result of progress made on debt reduction, we are pleased to announce an acceleration of our return of capital. As you recall, we previously planned to increase our return of capital target to 50% of excess free cash flow starting April first, but we will now apply that 50% target against full-year excess FCF. 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 ROC 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 FFO of approximately $1.25 billion, with resulting free cash flow of approximately $650 million. Under current strip pricing and applying our new ROC 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 FCF allocation over the past 3 years, we will have reduced debt by over CAD 1.2 billion by the end of 2024 over 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 time frame. We believe a 50% return of capital target is appropriate for our business, as it will allow us to provide ratable annual dividend increases and buy back shares, while also creating excess capacity on our balance sheet to be opportunistic. With that, I will pass it back to Dion.

Dion Hatcher (President and CEO)

Thanks, Lars. Our discipline focused on strengthening the balance sheet and high-grading the asset base, along with diligent capital allocation, has made Vermilion a much stronger and a much 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 price European gas, but 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 compound 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. With that, we'd like to open it up for questions.

Operator (participant)

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your telephone keypad. Should you wish to cancel your request, please press star followed by the two. If you are using a speakerphone, please leave the handset before pressing any keys. One moment, please, for your first question, and once again, that is star and one to ask a question. Your first question comes from the line of Greg Pardy from RBC Capital Markets. Please go ahead.

Greg Pardy (Managing Director and Head of Global Energy Research)

Yeah, thanks. Good morning, and thanks, Dion and Lars, for the rundown. Couple of questions for you, but maybe the first one is just on the net.

Dion Hatcher (President and CEO)

[uncertain]

Operator (participant)

Hello. May we, may I have Mr. Greg Pardy to press star one again? Thank you, and your line is now open.

Greg Pardy (Managing Director and Head of Global Energy Research)

Terrific. Can you guys hear me?

Dion Hatcher (President and CEO)

Yep, you bet you. We got you now.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay, all right. Let's listen, Lars, Dion, thanks very much for the rundown. Couple of questions. First one, maybe just on net debt thresholds in terms of opening up the 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? You know, 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.

Dion Hatcher (President and CEO)

Okay, well, thanks, Greg. I'll pass it over to Lars to discuss our debt levels and return of capital.

Lars Glemser (VP and CFO)

Yeah, no, thanks for the question, Greg, and, you know, 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 gonna 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 CAD 500 million-CAD 1 billion range, we're quite comfortable in.

As you get closer to the CAD 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% of EFCF at this point. But, I think we're very comfortable with the 50% now.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay. Okay, that's great. That makes a lot of sense. I mean, you know, basic question, how fussed are you with the reserve revisions? And then maybe just related to that, given, you know, the shift in capital allocation that you're looking at, you know, do areas like the U.S. or even, you know, portions of your ops in Saskatchewan, if, you know, 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.

Dion Hatcher (President and CEO)

Yeah, no, I can take this one, Greg. Thanks for that. I mean, as you know, over the last couple of years, we put a lot of focus on debt reduction, asset high-grading with Corrib and Mica in particular, and actually selling some assets in the U.S., sorry, 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 and Croatia and as well, Mica, where we see a lot of running room. So, you know, 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, you know, 40% of that is capital allocation as we work through our permitting process, our budgeting process, and now our reserves process. And in Saskatchewan, you know, 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, you know, moved out of reserves has the potential to come back should we find ourselves, you know, changing our capital allocation in the future. So, you know, we like the option, we like the exposure to oil in Saskatchewan. In the U.S., you know what, what excites us about the U.S. is that oil stack. There's four oily zones....

We continue to look at all four zones, in particular, the Niobrara 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 where we see competitor activity in all four zones to determine, you know, how best to develop that asset. So at this point, you know, 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, where we've made those changes.

Greg Pardy (Managing Director and Head of Global Energy Research)

Yeah. Thank you very much.

Dion Hatcher (President and CEO)

Okay. No, thanks for that, Greg.

Operator (participant)

Thank you. Once again, should you wish to ask a question, please press star then the number one on your telephone keypad. Your next question comes from the line of Travis Wood from National Bank Financial. Please go ahead.

Travis Wood (Managing Director of Equity Research)

Yeah, thanks for taking the question. One question, but it's the same question for both Germany and Croatia. Dion, in your opening remarks, you talked about kind of 70% risk profile as you, as you look at drilling these exploration wells. What, as you think about the size of the prize and the impact from wells, how should we think about that potential production impact on success? What's the—can you remind us on the cost to drill and tie in these big wells? And then are there any kind of analog wells in proximity that you guys are using to kinda de-risk that, whether it's tests from yourselves or other operators in the area?

Dion Hatcher (President and CEO)

Thanks, Travis. So definitely we can get excited to talk about Germany upside potential. You know, when we look at that land base, and the teams working it for five/six years, you know, we see a TCF of gas on our land base. We've got 700,000 net undeveloped acres. We've got 3D seismic across that land base, and we've got two decades of drilling 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 well as still are very much needing gas to replace about a third of their energy, which comes from coal and lignite.

As to the targets themselves, you know, what we see are targets that are in that 30-40 Bcf, typically, and costs that are in similar 35-40 million dollars wells to drill. So if you zoom out, how I think about it, it's, it's CAD 1 Mcf. If we can drill these wells and get exposure for CAD 1 Mcf, and then sell that gas still at 5-6x AECO at, you know, CAD 10-CAD 12 in Germany, we like that, that trade-off on a risk reward. Of course, the dry hole costs, if you're not successful, are much lower than the total, you know, CAD 35-CAD 40 million to drill. So what we see right now, and we see, you know, two wells per year, we see a multiyear program on that.

With success, we can more than double the German production, and we're quite excited to get these first couple wells drilled and to be able to come back to and provide an update later this year. But there is an element of exploration here. We, you know, want to make sure that, and we talk about that with our success rate in Netherlands; it's been about 70%, and we think that's a reasonable number to use for our German program. As the analog wells, I mean, we're drilling in pools, where we're offsetting wells within those pools that have done 30, 40 Bs. And so we're surrounded by producing wells or producing, you know, plays that are very similar and have wells in the structure.

And so that gives us more confidence to be able to put this capital work and assess that upside. So we're excited, but we do recognize that, you know, it's we're gonna have to look at this as a program versus individual wells, and we look forward to providing more updates in the next couple of months here.

Travis Wood (Managing Director of Equity Research)

Okay. And would that be similar commentary as you think about de-risking and exploring Croatia?

Dion Hatcher (President and CEO)

Yeah. Okay, shifting to Croatia, you know, Croatia is interesting. We've got two blocks. So SA-10 is the area where we've drilled and tested, and we've got gas behind pipe. And with the gas plant that, you know, you can see the pictures, the unit is built. We're just finalizing the pipeline tie-ins. Gas behind pipe, and this will be basically dry gas, that we'll produce into that unit. That's the SA-10 block. The SA-07 block is an area where we're surrounded by known producing fields, oil and gas, and we did the partnership with INA, who has a lot of that infrastructure and offsetting production. So we're in the first of four wells that we've drilled there. First well looks encouraging. We've seen hydrocarbons, multiple zones.

We'll drill the next three wells and then progress after that. As for size of the prize, you know, it's really early days in SA-07, so I would say too early to comment, but we can come back once we get these four wells in the ground. SA-10, you know, it'll be a couple thousand BOEs a day of high netback gas, that we'll produce through that compressor.

Travis Wood (Managing Director of Equity Research)

Okay. Appreciate all that color and detail. I'll turn it back.

Dion Hatcher (President and CEO)

Thanks, Travis.

Operator (participant)

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

Dion Hatcher (President and CEO)

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

Operator (participant)

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