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

[Audio Gap] 2022 results webcast, and we're coming to you from our office in Salvador Brazil. I'm Corey Ruttan, President and CEO, and I'm joined by Alison Howard, our CFO; and Frederico Oliveira, our country manager here in Brazil with -- I'll just turn it over quickly to Alison.

Hi, Good morning, everyone. Thank you again for joining. Just a reminder that this webcast will be recorded, so there will be a replay available afterwards. And just also, as with our last earnings call, we do have a Q&A session at the end of our presentation. So, you can use the Q&A button located at the bottom of your screen to submit the answers, and we will get to them after we go through our presentation. If you are dialing in, you can email your questions to social media @alhopetro.com.

All right. Thank you, Alison. We'll look to read the cautionary statements at your leisure. They're also within our corporate presentation posted on our website. So, to start, we announced this earlier, but we did complete a gas plant expansion and our UPGN, Cabure in July. The capacity is now a minimum of 18 million cubic feet a day. What that's led us to is another record quarter of production in the third quarter, 2,642 barrels of oil equivalent per day. That's up 12% from the second quarter. And you can see we had another very strong month in October with sales up to over 2,700 barrels of oil equivalent per day. So, I just wanted to show this slide again, we've shown it in past calls. It shows how our gas pricing mechanism within our gas sales agreement works. The grey dash lines are the 3 benchmark prices in the forecast period on the right-hand side of this dotted line, the futures prices are based on the futures market, November 11. And then to the left of that red dotted line, the historical prices. The dark black line that you see is the calculates the Alvopetro realized price, and it overlays the green line here. So, what that means is that our price based on these price projections, it's forecast to stay at the ceiling within our contract for the foreseeable future here. The ceiling, as you recall, does inflate based on U.S. inflation. So, we would expect increases based on that. Another thing to point out is that this dark blue line the distance between that dark blue line and the black line is something of note. The blue line represents had we not had the ceiling within our contract, that's the theoretical price calculation. So, what it means is that this gap represents the amount [indiscernible] the futures prices or commodity prices can drop before we start to see a reduction in our sales price. So, it really is an effective hedge, and it underpins the strong results that Alison is going to walk you through here shortly.

So yes, just following up on what Corey was talking about with our realized price. We had another strong quarter of our operating netback, which measures our profitability per expressed in barrel of oil equivalent. So that's the height of the green bar there, so just under $60 in Q3. There was a bit of a decrease from Q2 of just over $4 per BOE, and that was mainly on our realized pricing. So, the very tough number you see there, we went from 73.5% to 689. Our natural gas price was the same price in local currency, but due to a devaluation in the period compared to Q2, the realized price in U.S. dollars was slightly lower. That's a bit offset by lower production expenses, which you see in the gray bar and royalties were relatively consistent. So overall, this just shows the strength of our operations and the profitability. We expressed that as our operating netback margin, which is 87%, which is the netback as a percentage of the realized price. And if you look to the next slide, which we would have seen before. Again, this compares Elbow Petro to other peers operating in Latin America and also companies -- and gas companies operating in Canada. And again, we're best-in-class here compared to other companies' average netback of 65%. We're over 33% higher. And when you combine that with our very low tax rate, obviously, this is before tax, but we have a very low tax rate in Brazil as we benefit from the CDD tax incentive, bringing our tax rate to 15%. So, if we look at this after tax, it just shows the strength of the fiscal regime that we are operating here in Brazil. And that leads to another record quarter of funds flow. So those are strong volume or higher volumes in the period, even with our slightly lower realized price -- we ended Q3 with over $900,000 higher of funds go from operations, which is our cash flow from operating activities before working capital. And again, this was another quarter for Alvopetro -- another record quarter for Alvopetro, sorry. And then similarly on the net income with those inferred funds for our net income was higher in the quarter. In addition to the higher operating income, our foreign exchange losses were lower in the period compared to last quarter. So, we had losses of about 0.7 million this quarter versus 3 million -- sorry, $2.3 million last quarter. Sorry, 2.3 million lower this quarter compared to last quarter. So that improved our net income and partially offset by deferred tax on those foreign exchange losses. Again, most of that is virtually all of that is noncash, and the largest portion of that relates to accounting for our interest company loans between Canada and our Brazil subsidiary. Those improvements were partially offset in addition to the deferred -- higher deferred tax with higher depletion and depreciation, mainly due to higher production levels in the quarter. I'm sure everyone saw that we repaid our credit facility in September. So, we are now fully debt-free as of September 30. So that's that online that you see there that goes to 0 as of now, which is excellent. And our -- the green bar there is our working capital. That increased also in the period to 12.2 million and strong cash position ending the quarter at 17.4 million.

All right. Thank you, Alison. So, I think as many of you saw in our press release, just walk through our dividend history. We started the program about 6 months ahead of plan after 2 quarters of dividends at USD 0.06 per share. We increased that by 1/3. And then in our announcement yesterday, the Board has approved another 50% increase in our dividend from 0.08 to up to USD 0.12 per share. In addition to that, I'm sorry, before I move on. That does represent an annualized yield just based on the current share price. When I look just at a few moments before the call, around 10%. In addition, just to increase our flexibility with respect to our returns to stakeholders. The Board also approved us to pursue a normal course issuer bid, and we'll complete the applications for that in short order. So just to talk about that, our disciplined capital allocation model. Again, we're roughly looking to take half of our cash flows and return it to stakeholders, the other half, reinvesting in our organic growth. So, the chart on the left-hand side that you see here, distract since we came on production, our funds flow from operations is in the black dotted line there. You can see we had another record quarter, as Alison pointed out at $13.3 million of funds spoke from operations. But you can also see during each quarter how we allocated those funds out to stakeholders and/or invested. So, at the very beginning part of the project, I think everyone knows we aggressively repaid debt. As Alison pointed out, we're now debt free. We then started the dividends on top of that, which is in the dark green wedge on top of that in the third quarter of last year. The yellow represents the investment in our organic growth. You can see that was quite low while we were repaying debt at the beginning and then it has increased more recently. We thought it would be useful to show this pie chart on the right-hand side that represents -- since we came on production from our Cabure project on July 5, 2020, and how have we allocated those funds out to these various spots. So if you look at the various shadings of green, you can see about 51% of that has been returned to stakeholders through read their share repurchases, dividends, interest, debt repayments and our capital lease. And then about just over 1/3 of that has been invested in organic growth. There is a fairly significant wedge there representing 14% that represents that balance sheet strength that Alison showed you in our increasing working capital position that certainly positions us well for future flexibility. So just to update you on our organic growth plan, I think we're closing in nicely on our near-term goal of 18 million cubic feet a day. To reiterate, we do have a longer-term vision to basically double that. And our plan is to do that from 3 different places, basically. There's our core assets. As we mentioned, we've already expanded the gas plant with our partner. We've also drilled a new unit well. So, our hope is that we can continue to expand our unit capacity. And then recently, we've announced -- obviously, we've successfully drilled 2 -- our 2 exploration prospects that we had planned for this year, and I'm going to walk you through that. As a reminder, GLJ did assess those prospects in advance of drilling them and had a signed unrisked prospective recoverable best estimate resource of 4.6 million and 5.9 million barrels of oil equivalent. So, these have the potential to be quite significant for us. I'll walk you through where we're at with the testing, but that did commence here in October. And then the third piece is our Murucututu or Gomo project, and I'll walk you through how that looks today. And again, DLJ did assess this asset as well and assigned a combination of 2P reserves, risk and contingent -- risk contingent and prospective resource to that asset. So, like I said, we successfully drilled our 2 exploration prospects. To remind you, we drilled these into the pre-rent formations. These are the deeper formations in the -- in this part of the basin into 200 [indiscernible] blocks. We have multi-zone discoveries in both of the wells. And what I wanted to do is review the results from the wells side by side with the open hole logs and I know the scale is quite small, but I'm just trying to put it in perspective and contrast the 2 wells. So, the first one that we'll talk about is the lower most owned surgery formation. In the left-hand well that you see here, the 183-B1 well, this is actually a picture of the equipment on site conducting the testing operations from our field trip yesterday. We did announce from the 37.5 meters of pay that we identified here, a 72-hour production test result where we recovered close to 60 barrels of light oil. And the reason that we're excited about this is if you contrast that over here to the surgery in the 182-C2 well, where we actually drilled through the whole surgery section through the basin and we demonstrated this with this year, the Sergi section tends to be about 220 meters thick. So, this is a massive amount of resource. To put that in perspective, 220 meters is about a 65-story office tower, if you think about that. So the one thing we only drilled through the upper Sergi with the first well in our next well test, we've got about 121 meters of net sand here with a 6% cutoff with a more conventional cutoff for oil that we found in the Sergi in the 183-B1 well. We've still got 83 meters of net sand in this well. So, between this, we think we've got a big resource on our hands. There's an awful lot amount of resorts that can be jammed into a very small area when you're talking about hydrocarbon columns this thick. And we think with some good engineering on the drilling side, the completion side and with the stimulations, we think this has the opportunity to be very significant for us. If we move up hole, this is the zone that we're just about to test are in the process of testing now in the Agua Grande formation. In this well, we've got 11 -- at almost 11.5 meters of potential net pay with average porosities of close to 12%. Similarly, thick zone in the 182-C2 well with porosities about 9%. And then the last thing to talk about in the well that we're on testing right now. We've got this bonus zone at the top of the well in the [indiscernible] formation, 5.3 meters of net pay with porosity up to almost 16%. If you look also, one other thing to note about that the zone we're testing right now is at the very top of this zone. There's a 3-meter section that also has over 17% porosity. So, it looks like we've got some good reservoir quality, and we're looking forward to being able to announce some results on these 2 zones over the coming weeks. So, I thought we'd do something a little bit different on this call, just talk through our Murucututu/Gomo project in the context of kind of how we built our natural gas business in Brazil, going to use some Google or images here on the progress that we've made. So, a reminder, if you go way back in time, the first 2 wells we drilled in Brazil were the 197(1) and 183(1) wells. We encountered what looked like a very nice gas resource here. And then we embarked on a -- we made the Cabure discovery, which is in the blue outline that you see right here. As you recall, we completed a unitization process for that. And then that set the stage where we could build a commercial solution and a midstream solution to monetize all this gas. So as everyone knows, that included an 11-kilometer transfer pipeline from the unit over to the West, just to the north of the municipality of Mata de São João. And that's where we built the Cabure gas plant, the picture that you saw earlier in the presentation. And again, that infrastructure now provides the platform for us to unlock the rest of the natural gas potential in the area that sits immediately north of these assets. So, we've talked about this today. What we've done this year is we did a 9-kilometer pipeline extension from the unit hub area, a little bit to the east, but mostly straight north. It's about 9 kilometers in total to tie in the 183(1) well. We built the surface production facilities here for this, and we've also completed the 3-kilometer tie-in of the 197(1) well part. So, this is really the start of our global development plan. This is a picture -- a recent picture here of our 183(1) facility. It's a pretty simple facility, but it allows us to process up to about 300,000 cubic meters of gas a day. You can see the 183 well [indiscernible] this location, and we brought this well on production in the month of October. So that takes us to our multiyear development plan for the global now that we've got all these assets in place. Our plan next is to tie in our 197 well -- complete the 197(1) well and bring it on production through our facility. And then we've got a plan to drill deviated wells, directional wells off centrally located pads that you see in the white squares. The volume or locations for the wells or the white circles with the black circle inside. And you can see this is, again, a multiyear plan. And the objective is to convert reserves, contingent their prospective resource in the production and cash flow over the coming years. In addition, you can see the 2 exploration wells that we drilled off these pads immediately to the west of this with success on testing. We've got a plan to tie those wells. If we've got natural gas to tie those wells back down almost directly sell directly into our UPGN. If we have oil production, we can truck that and monetize it pretty quickly. So, we're pretty happy with how our business is evolving, and we're looking forward to the next steps here. So, in summary, we've said this before, but maybe more than ever, I think Alvopetro really offers an attractive investment proposition no matter what your investing focus is. I think our results speak for themselves. We continue to deliver production results ahead of pre-commercialization expectations. Third quarter was another record quarter for us in terms of production and cash flow. October, as you saw, was another solid month of production for us. We've got attractive gas prices, as Alison pointed out, industry-leading operating margins or profitability per unit of production, strong balance sheet with no debt and great free cash flow generation capacity, which all that together really underpins our balanced reinvestment and stakeholder return model. For value investors, we're trading at a significant discount to our 2P net asset value for yield investors with the increased yield that we just announced yesterday at the close -- or at the training price before this call, again, about a -- just over a 10% yield. So lastly, for growth investors, the things that we're investing in these exploration prospects and our Gomo development plan, when you compare that to our market capitalization, I think our investors get a lot of leverage to some relatively low cost but high-impact opportunities. So, look forward to getting everyone on those. And I think we're probably ready to open up for questions. Just a reminder, you can hit the Q&A button on the bottom of your screen to ask questions.

Perfect. We do have a few questions in already. Now that the capacity expansion of the gas processing facility was completed at the end of July, how much of the available 500,000 cubic meters per day capacity is being utilized? And are there any constraints on processing at that means plate capacity such as gas production from current wells, demand from local market, et cetera.

Yes. So, we've been producing between the 440 and a little over 500,000 cubic meter a day mark. Depending on the day, we've tested the facility up to over $500,000. So that's probably a good range right now. I would say the constraint probably going forward is going to be the pace at which we can bring new production on. Our partner, to the extent they get dispatched through their thermal power project that does have -- or has a potential impact on our production levels, but that's why we're investing in these new projects. From a market perspective, in our meetings with our offtaker, they continue to request as much gas as we can possibly deliver them. So, I don't see that as a key constraint right now.

And do you have any timing as to when it will take to reach the kind of consistent basis the 18 million a day.

Yes. Well, we've reached it pretty close here. But day in, day out, we probably want to add 2 or 3 demo wells to that. And then I think no matter what happens with our dispatch, we can probably be more consistently at that level. That would be the near-term solution along with a potential success at the unit [indiscernible]. Those are the things that could add production quicker. The successes from our exploration discoveries have a lead time associated with them just because we would need to finish the permitting and installation of that pipeline that I showed you. So that's probably about a year out from the production test.

So, on a [indiscernible] Q2, we had a little initial output on the 183(1) well when it was brought on production. Is that -- is there a concern on that? Will the production level ramp up?

Well, it's to be far low relative to the very high deliverability with wells we have in Cabure. It's actually fairly close to expectations. I would -- the one thing I would say is during the first kind of month of production year, we're still managing some commissioning items through the plant. So, the one thing we could improve is having much better onstream factors than we do today. But regardless, remember, we put a very small stimulation into that well because we had an offsetting well. Our plan with the 197(1) well would be to put a much larger stimulation into that well as along with our future development wells.

Okay thank you. And does this quarter's capital expenditures represent an increase in spending on a consistent basis going forward? Or does it include abnormal drilling spending? Is 8 million to 9 million a quarter expected going forward?

I would say right now, no, because the drilling rate that we had, we've let go [indiscernible] we can finish the testing get organized for a more continuous program to just get caught up on some permitting. So that, I would say, is a higher quarter just because we had drilling going on at the same time as well testing. And when we finalize our capital plan for next year at following the testing of these 2 wells, we can probably give some better guidance on the pace of those expenditures.

And just speaking of the capital expenditures in the quarter, there was a question about the current liabilities this quarter, and it was up about 2.5 million from June, and that was due to -- mainly due to increased capital spending in the quarter and then also our lease liability, our current portion of that went up as we had the facility expansion completed. So that's now pleased as a lease for accounting purposes. And consequently, our current liabilities are a little bit higher there. Back to the exploration wells, how long, let's take for all the testing to be done? Will it be done this year? Or will that be into 2023?

Our objective here is to get both those wells tested this year.

With new wells having a higher oil content, will that add to the BTU adjustment in the gas pricing mechanism? Or will the liquids be extracted and sold separately?

Yes. So probably differentiate between a few different types of liquids here. So, if we're talking about conventional oil production, like the light oil that we tested out of the 183-B1 Sergi zone, that type of production just gets sold into -- basically into a refinery directly. I think you're referring to the BTU content of the gas and maybe how much condensate yield we get, certainly, with the expansions we made to the plant we're in a better position to handle richer gas that is our America 22 project, basically. So not only are we able to manage that at a higher level, we can manage it more effectively. We can capture more condensate out of that process. We have an upper limit on the BTUs within our gas. So, there's -- we can only sell gas that's so hot. The rest of that energy effectively to simplify it comes out as condensate. And we sell that separately again by trucking it to end consumers.

And we had a few questions on the recent election results. Any insight and opinion regarding the Lula's election and potential social thought of resources becoming the property of the people and with Columbia putting in nondeducibility of royalties and higher taxes, do we see [indiscernible] government moving in that same way.

All right. So, I think I'll turn that over to Fred to give you the local perspective on that and if there's anything to add, I'll do so at the end.

Okay. Thank you, Corey. So, the election was the tightest mention Brazil is free... And as a result of this, Lula has a representative achievement in congress. The lower house, for example, we have only 119 Deputies, which is 23%. And in Senate has [indiscernible] which is 70%. So, we has [indiscernible] a lot and be very flexible in these actions. Lula sees this as [indiscernible] to clear his name and also that he [indiscernible] reputation because of the past is scandal. So he'll try not to make mistakes. And regarding his government and plan [indiscernible] election Lula did not disclosure his [indiscernible] plan. So we don't know [indiscernible] about his intention related to the oil and gas industry. But based on his speech, we can highlight some points. If you think [indiscernible] Petrobras it must be an integrated energy company, focusing the energy transition in this way Petrobras should be per new projects in natural gas, fertilizers, biofuels and [indiscernible]. These areas was exactly -- were example in the areas there Petrobras sold his assets in the last 5 years. And it's also part of Lula's, planning, the national -- the national self-sufficient in oil and [indiscernible]. In this way, he defends expansion of the refining part and also the production capacity. So, Petrobras [indiscernible] by investing in refineries will no longer take place. We also can mention that we are -- the market were waiting for the change in Petrobras price volume support fees. Which [indiscernible] happens soon, we believe because I'm quite [indiscernible] the fuel price must be [indiscernible] Brazilian real and not international prices, okay? But on each way, the disclosure of the government finance and to see things [indiscernible] change.

Yes. Thanks, Frederico. To summarize, I don't see the situation that's happening in Colombia repeating itself here. I think there's a recognition -- there's a strong desire for the new government to invest in social programs. I think that certainly, the oil industry and the economy in general is very important to be able to do that. So that's what Frederico meant by being very careful with the economic policies. And I think one of the other things that has been recognized is in an attempt to fund some of the activity, there's a desire to create public private partnerships to facilitate those types of investments in things like growth and highways, airports. If you're creating an environment that's not investor-friendly, it's kind of contrary to that. So, I think the general sense is I think it shows up in the currency that I don't think the rate of change is going to be that fast, especially given the low levels of support, like Fred said, in the 2 houses of the government.

Okay. And then the last few questions we have are around the NCIB. So, if we could give a little bit more description on how we expect that to work, what our overall intent is with the NCIB and the size and timing of the share buybacks.

Yes. So probably too much detail to be able to provide, quite frankly, but next step star will get this approved by the TSX like any other NCIB. And then I really look at this, this is another tool in our toolbox when we're looking at the stakeholder returns in our capital allocation model. So, I think at least -- I think our initial vision is to try to make sure we don't have anomalies happening in the market like we saw over the last several weeks, like to makes no sense that our stock was behaving in that way given the results that we've kind of manifested, I guess, in the announcement that we had yesterday. So, I think to start with, it's probably something more opportunistic and it will be balanced in the context of our overall mandate.

And with that, that is it no more questions.

All right. Well, thank you again to everyone for their support, and we're here to answer questions after the call as well and look forward to updating you in future quarters. Thank you again.