Alvopetro Energy Ltd. (ALV) Earnings Call Transcript & Summary

Good morning. Welcome to our third quarter earnings call. I'm joined today by Alison Howard, our Chief Financial Officer, and we will be having a question and answer session following the presentation. So I encourage you to log your questions into the Zoom platform using the Q&A button, or alternatively, you can e-mail your questions to [email protected]. I'll let you read our cautionary statements at your leisure. So the third quarter was another great quarter for us. It was a record quarter, both operationally and financially. Our results are really underpinned by our strong production performance to date. Third quarter, we averaged 2,459 barrels of oil equivalent per day. That's up 39% year-over-year, and up 4% quarter-over-quarter. We had just a slight decrease in October that you can see just shy of 2,400 BOEs a day, but again excellent production performance. And with that, I'll turn it over to Alison.

Thanks, and good morning, everyone. I'll jump right into some financial highlights, starting with our operating netback. Our operating netback is our overall profitability per barrel of oil equivalent. That's reflected in the green bars, and you can see a steady increase kind of similar to production, a steady increase in our operating netback since we commenced operations last July. At the top of the bar is our realized sales price. So you can see Q3 was a record realized sales price per BOE as well at $44 -- just over $44 per BOE. So that was up close to $6 from last quarter, and that explains the main increase in our operating netback this quarter as well. Our gas sales increased just over $1 per Mcf, which was about 17% compared to Q2, and that was as a result of our natural gas sales price redetermination on August 1. And condensate was up as well. Our production expenses are reflected in the yellow bars there, and that was fairly consistent, and overall, has been under $4 per BOE since we started production. And royalties were up marginally this quarter just because our royalties for natural gas are tied to Henry Hub. And with increasing Henry Hub prices, our royalties as a percentage of sales has gone up. Moving on to funds flow from operations, which is the green bar here. Our funds flow from operations is our cash flow from operating activities before adjusting for working capital. And similar to our operating netbacks, we've seen a large steady increase in that as well. This quarter is up $2.5 million. I'll walk through the details of that on the next slide. But just touching briefly on capital expenditures, which we've just shown here, just to show the percentage of our capital expenditures -- percentage of our funds flow spent on capital. This quarter was just under $1.3 million. The bulk of that is for our Gomo/Murucututu tie-in pipeline that we're building right now. But overall, as a percentage of funds flow, we've been fairly low at roughly 17% year-to-date and 16% this quarter. So moving on to funds flow. We saw -- as you saw on that previous chart, we saw an increase of $2.5 million in our funds flow from operations. That's mainly due to increased revenues of $1.8 million, with about 80% of that due to that realized price increase that I spoke about earlier. As I mentioned, royalties were marginally higher this quarter. Production and G&A were fairly consistent. We did see a lower current tax expense in Q3. As we noted in our Q3 financials, we did receive approval for the SUDENE tax incentive, which is a Bahia state tax incentive on our natural gas profits. And it reduces our inherent tax from the 34% statutory rate in Brazil to 15.25%. So overall, year-to-date, our current tax is just under $4 million and is quite low relative to the earnings that we've reported, which is great. The other item impacting funds flow was we did have recognition of just over $900,000 of other income in the quarter. A large portion of that is nonrecurring and relates to retroactive tax legislation change that improved some tax credits that we are eligible for. So there was a bit of an increase there compared to -- a large increase there compared to last quarter. Just thought I would explain our net income in a bit more detail because despite that improved funds flow, we did see a decrease in our net income. And virtually all of that, you can see there is due to foreign exchange. We do have some larger foreign exchange gains and losses that go through our income statement, and it's all basically sort of an accounting phenomenon relating to intercompany loans. And if you look at our statement of cash flows, you'll see that the bulk of any foreign exchange loss or gain is generally adjusted out from a cash position. So it just has to do with accounting for intercompany loans because our subsidiary in Brazil owes us U.S. dollar funds, there's an inherent foreign exchange fluctuation on that despite the fact that those eliminate on consolidation and it's noncash, but that's the main reason for kind of the fluctuating net income that you see in our statements. The other item was our depreciation and depletion did increase a bit this quarter with increased production levels. So that explains that there. And then the other thing is turning to our balance sheet and our overall leverage position. So this chart here, the height of the orange bars reflects our net debt. And we define net debt as our credit facility balance, less any working capital surplus. So you can see last year, as of September 30, we had net debt of $13.1 million. And what happened as of September 30 this year, our working capital surplus of $6.8 million actually exceeded our credit facility balance. So we end up with that. A recovery there, $300,000, you could think about it net cash. Overall, our actual cash balance has been increasing. We ended the quarter with $8.1 million. We have $9 million of our credit facility balance and brought that balance outstanding to $6.5 million as of September 30. And as I mentioned, our working capital at $6.8 million is -- after some pretty significant adjustments in Q3 for our share repurchases, which we spent $1.1 million on, and then we declared our first dividend, that was another $2 million. And despite all of that, our working capital surplus was still above that credit facility balance, which is great.

Excellent. Thank you, Alison. So we had our most recent semiannual price -- the gas price redetermination happened on August 1, 2021. Our price increased about 24% to over USD 7 per Mcf. So obviously, our third quarter results included 2 months of that new price in Q4. We'll have a full 3 months. And then looking forward on February 1 of next year, so just less than 3 months away, we expect another much larger price increase, about 46%. So that will bring us up, we're expecting over USD 10 per Mcf. So in February, that will be the first time our price formula uses the benchmark prices from the second half of this year. And obviously, we've had pretty significant appreciations in all 3 of the benchmarks that are used in our price formula being Henry Hub gas, U.K. NBP gas and Brent oil equivalent. If we use our independent evaluators price forecast as of September 30, you can see in the dark black line going forward we have several periods of pricing at our ceiling, and it compares quite favorably to the price in brown that you can see below that, which was the price forecast used in our last reserve evaluation effect at the end of last year. So we've had certainly a nice uptick there. Moving on to our capital program. As Alison outlined, we've had a pretty great first 15 months of production and cash flow. We're now extremely well positioned to execute our organically funded growth plan. And to be clear, our next objective is to completely fill our midstream assets and take us up to a new production plateau of 18 million cubic feet per day. It's kind of a multipronged program first. We have given notice to increase our gas plant capacity up to 18 million cubic feet a day or 0.5 million cubic meters a day, which is about a 25% increase from the current capacity. On the conventional exploration side, we're getting close to spudding our first -- of 2 exploration wells, starting with the 182-C1 location and then followed by the 183-B1 location. And as you can see, those sit almost immediately north of our UPGN Caburé, which is our gas plant. And with success, we would tie that in through a new pipeline connecting directly to the plant. Next, on our Murucututu development plan, this is our Gomo project. The red pipeline that you see on the eastern side of the map connecting from the hub area within the Caburé unit area to tie in the 183 well is well underway. We expect that, along with the surface production facilities, to be in place to allow that well to be tied in early next year. And then we really have the infrastructure in place to start a broader development plan starting with the 197(1) stimulation and tie-in through that orange pipeline that you see there. And then following that, we have a plan to drill our first fit-for-purpose Gomo development well with the MURS1 location, which the well pad sits just to the south of 183(1). It's right along the pipeline right of way. The well will be drilled in a deviated fashion almost straight south. And the nice thing about this location is we have some pretty interesting uphole conventional exploration potential that we drill through on the way through to the Gomo target. So -- well, the other nice thing is because it's along the right of way is we can tie it in pretty much immediately. So just in summary, obviously, we've delivered some pretty strong results since coming on production, I think certainly well ahead of expectations. Our funds flow from operations in the first 15 months has been USD 26 million. Obviously, our third quarter was our best quarter yet, with funds flow from operations of close to $8 million. On the debt side, not only did we extend the maturity, we lowered the cost of that facility, and we've been really aggressively repaying debt in our first year of operations. As Alison noted, as of the end of the quarter, we actually flipped over into effectively a net cash position. So despite having declared a dividend, despite doing our share buyback, we've been able to basically eliminate our debt as of the end of the quarter. So a pretty strong balance sheet. As for the share restructuring, not only was that, I think, an accretive transaction for us, it really helped pave the way to -- for a much more cost-effective dividend plan. We only bought back about 1.3% of our stock, but it eliminated close to, I think, 80% of our shareholder accounts. All this together allowed us to start our dividend program about 6 months ahead of schedule in the third quarter at USD 0.06 per share, which is a current yield of just over 6%. We're certainly looking forward to our next price redetermination in just under 3 months' time. Like I said, we're really well positioned to start the second part of our balanced capital allocation model. As Alison noted, we've been significantly under investing in the capital part of our business and doing a lot on returns to stakeholders focused on debt primarily and now shareholders. But we really, I think, not only have a lot of strong catalysts in the very near term, but we've really created a unique yield plus growth investment opportunity for our shareholders. So with that, we're going to turn it over to the question-and-answer session. And just to remind you, you can click on the Q&A button, or alternatively, e-mail your questions into [email protected].

Okay. The first question is related to the Enerflex expansion notice. What does that entail? And when will it be on stream?

Yes. So very simply, it just involves -- this is something we had envisioned in our original contract. So it's one extra compressor. There's also an overhead compressor and a Joule-Thomson valve that very simply expands the plant capacity up to 0.5 million cubic meters a day. The fee is another USD 35,000 per month under our pre-existing agreement, and we expect that to be on stream by June 1 of next year.

Can you give an update on the drilling status of the new Gomo wells?

Yes. So in order of what I talked about there, the 183 well has already been drilled. Obviously, the pipeline is getting very close to completion, and then we have some surface production facilities that we're installing as well. So that's well on track, to be on stream in the first quarter. The 197 well is also a pre-existing well that we drilled. And then once we have that infrastructure in place, we're then positioned. We need to get a permit for the additional pipeline, which is underway, and then we would stimulate that well and tie that in. Our target would be to have that happen sometime probably later in the first half of next year. And at the same time, we're -- we have an application in to drill and stimulate the MURS1 location. So it's subject to permitting. But ideally, we would be spudding that well sometime mid next year.

And then when would you expect the volumes to come on?

Yes. So the volumes from 183(1), in the first quarter, ideally, we would have the volumes for 197(1) for the second half of the year, and then the volumes for the MURS1 location. Again, all of this is subject to the permitting timing, but we're hoping to have that on for the fourth quarter.

What sales price do you see for Alvopetro in 2022?

Yes. So right now, based on our -- and keep in mind, the benchmark pricing, the way it works is we use historical blender average. We're almost all the way through. We're 5 -- what, 4.5 months through the second half of the year here. So we've only got 1.5 months left of actual prices that will then dictate our February 1 price. So that's almost been determined. And as you can see, it's pretty much -- it's at the ceiling within our contract. If you use our reserve evaluator's price forecast that you saw on that prior slide, we would expect to continue at the ceiling price through the entire period of 2022. Sorry, to be clear, that's the price of about USD 10 per Mcf.

Right. Please expand on the volume and pricing. Both have been gradually increasing. Is the increase in volume due to demand or capacity? This has numerous parts. But let's start with this.

Okay. Thank you. Yes. So keep in mind, we originally had a gas sales agreement with -- and I'll have to pick units here, but roughly 5 million cubic feet a day was our initial firm capacity. So we negotiated that up to basically 11 million cubic feet a day. That's been the firm volume within our gas contract. But we do have a price advantage relative to Petrobras, and there's been strong demand on the electricity thermal power generation side as well as overall demand. And all that together has allowed us to deliver not only firm volumes to Bahiagas, our offtaker, but flexible or interruptible volumes as well. And then in parallel, our initial capacity with Enerflex under our gas processing facility was actually a similar level. So the 11 million cubic feet a day. What we did earlier in the year is we did a higher rate test, and this is partly because of our gas composition and partly because the plant is performing, I think, quite well. We were able to -- despite that contractual limit, we were able to test the facility up to 11 million or just over 11 million cubic feet a day of capacity. So that's allowed us to increase that. To go further, obviously, we need this plant expansion that we're talking about. So the limit lately has really been our gas plant capacity, but it's been pretty coincident with I think what's worked well for our gas sales agreement today as well as from a unit production perspective. I would say the units actually been -- our partners also have been dispatched into their thermal power project. So together with our partner, we've actually been able to produce well above the original planned production plateau from the unit. So it's really those 3 things all together.

And with the ramp up to 500,000 cubic meters a day at the Enerflex facility, will that occur discretely all at the same time or increase in steps from now until mid-2022?

No. It should be all in one big step on June 1.

Great. The next question is the total amount of dollar sales from condensate in the quarter, and I'll answer that one. So we had just under $10 million of total revenues in the quarter and just under $800,000 of that. So $779,000 came from our condensate sales. The next question is, are you currently selling gas at the floor price? Due to the changing variables, FX rates, et cetera, can you provide the current ceiling prices as of October or September month end? And I think that you went through that in the slide, and we expect to be at the ceiling early next year.

Yes. Starting February 1, based on GLJ's price forecast, the ceiling price actually extends for -- past the end of 2022. So I encourage you to look back at that slide. And if you have any remaining questions, certainly, feel free to reach out to Alison or myself.

With your improved balance sheet and strong cash flow, do you see any M&A activity as possible in 2022?

Yes. I think M&A activity is always possible, but it's something that we don't talk about it until it's done. To be fair, there's been some very large Petrobras packages that have been selling at very high prices. So I would expect, certainly in the onshore industry in Brazil is going to be -- it's changing rapidly. All of a sudden, you're going to have all independent parties. No Petrobras involvement. This will be a slow process. But over time, I think you're going to start to see much more activity than you have historically. So something that's hard to comment on, though.

We did have a question about our buttons. And in Canada, it is Remembrance Day, tomorrow, November 11. And in November, we wear poppies in remembrance of veterans that served on behalf of our country. So that is what these are. And we actually have no further questions.

Excellent. Well, thank you, everyone, for attending. Look forward to our next call. And if you think of any questions afterwards, certainly, again, reach out to Alison or myself. And thanks again for your attendance.