Canacol Energy Ltd (CNECCL.SN) Earnings Call Transcript & Summary

Good day and welcome to the Canacol Energy Third Quarter 2020 Financial Results Conference Call. [Operator Instructions] Please note, this event is being recorded. I would now like to turn the conference over to Carolina Orozco, Head of Investor Relations. Please go ahead.

Good morning and welcome to Canacol's Third Quarter 2020 Financial Results Conference Call. I am with Mr. Charle Gamba, President and Chief Executive Officer; and Mr. Jason Bednar, Chief Financial Officer. Before we begin, it's important to mention that the comments on this call by Canacol's senior management team can include projections of the corporation's future performance. These projections neither constitute any commitment as to future results nor take into account risks or uncertainties that could materialize. As a result, Canacol assumes no responsibility in the event that future results are different from the projections shared on this conference call. Please note that all finance figures on this call are denominated in U.S. dollars. We will begin the presentation with our President and CEO, Mr. Charle Gamba, who will cover the operational highlights for the third quarter 2020. Mr. Jason Bednar, our CFO, will then discuss financial highlights. Mr. Gamba will close with a discussion of the corporation's outlook for the remainder of fiscal year 2020 and beyond. A Q&A session will follow. Mr. Gamba is joining us today from the line in Bogotá, and Mr. Bednar is joining us on the line from Calgary. I will now turn the call over to Mr. Charle Gamba, President and CEO of Canacol Energy.

Thank you, Carolina. Good morning and welcome to Canacol's Third Quarter 2020 Conference Call. Gas sales during Q3 were 163 million standard cubic feet per day, a 7% increase from the second quarter of 2020 and an 11% increase from the same period in 2019. Revenues during Q3 were USD 57.4 million, a 1% increase from the same period last year. Realized gas sales have been recovering from a low point of 136 million standard cubic feet per day in April to 168 million standard cubic feet per day in September of this year and 173 million standard cubic feet per day in October of this year, as demand is recovering after the countrywide lockdown related to the COVID virus. Production operations during the third quarter ran smoothly with no major interruptions. Drilling operations, which had been completely suspended from March 26 to May 27 due, of course, to the nationwide lockdown, were ramped up in the third quarter with a second rig commencing drilling operations in July. The second rig's first job was to drill our first significant exploration well in our 2020 drilling program. And in early September, we announced a new gas discovery with the Porro Norte-1 well. As announced in August, in a major show of confidence in the stability of Canacol's business model, our syndicated lenders extended our existing $30 million term debt facility at an approximately 2% lower interest rate than before and expanded us a further $121 million in new, low-interest term and revolving credit during a period when many oil and gas producers had their borrowing bases redetermined and lowered. Finally, during the quarter, we continued to deliver on our return of capital to shareholders via the continuation of our quarterly dividend with no cut to yield. In September, we also started actively buying back shares under the previously announced normal course issuer bid. I'll now turn the presentation over to Jason Bednar, our CFO, who will discuss our second quarter financials -- our third quarter financials, I should say, in more detail. When he is done, I will provide a detailed outlook for the remainder of 2020.

Thanks, Charle. Although impacted by the global pandemic, Q3 2020 was another strong quarter for Canacol, both operationally and financially, as we continue to execute our plan and drive our growing natural gas business forward. Focusing on the third quarter of 2020, financial highlights include revenues increasing very slightly by 1% to $57.4 million compared to $56.6 million for the same period in 2019, cash flow from operations increasing 36% to $50 million from $37 million, adjusted funds flow from operations decreasing 8% to $33 million from $36 million, cash CapEx decreasing 11% to $27 million from $31 million, EBITDAX decreased 8% to $42 million from $46 million, our cash position increasing 127% to $94 million from $41 million at September 2019. Net income increased 294% to $2.6 million from $0.7 million. Gas sales increased 11% compared to the same period last year as the commissioning of new pipeline infrastructure and associated ramp-up in sales volume was still ongoing in the third quarter of last year. That said, increased gas sales were offset by lower interruptible realized gas prices as compared to 2019, mainly due to lower demand for spot sales as a result of the COVID-19 pandemic. July and August 2020 had the lowest interruptible prices of the year for Canacol. However, those prices rebounded sharply in September to average $4 per Mcf. While Q3 funds flow from operations was slightly reduced relative to Q3 2019, capital expenditures were also lower as we were working on completing and commissioning the Jobo 3 gas plant expansion in the third quarter of 2019. Our capital spending this year has been somewhat constrained by COVID-related restrictions, particularly in the second quarter of 2020, as Charle just mentioned. And the capital program has benefited from cost savings stemming from lower drilling rates than we had originally budgeted for, amongst other things. As a result, we were still able to generate $6 million in free cash flow before interest payments, relatively unchanged from the same period last year. That free cash flow supports our unchanged quarterly dividend that was initiated in the fourth quarter of last year, which currently represents an annual dividend yield of approximately 5.5%, with the last dividend being paid in October. With respect to our share buyback program, we began actively repurchasing shares for cancellation on September 10 and bought 462,000 shares at an average price of CAD 3.50 in the month of September as reported in these Q3 financial statements. During the month of October, we repurchased an additional 763,000 shares at an average price of CAD 3.47, bringing total purchases to approximately USD 3.2 million over that 2-month time frame. We remain actively repurchasing shares in November. Our net debt-to-EBITDAX ratio is 1.7x at September 30, 2020, reduced from 2.3x at September 30, 2019, obviously, well within our financial covenants of 3.25x. To compare Q3 of 2020 to Q2 of 2020, during the second quarter of 2020, Canacol felt the peak of the impact on gas demand from COVID-19. Q3 results showed an uptick in gas demand. As such, revenues increased 6% in Q3 as compared to Q2. Cash flow from operations increased 32% quarter-over-quarter. Adjusted funds flow from operations increased 7% to $33 million from $31 million. Cash CapEx increased 129% to $27 million from $12 million in Q2, as we were able to reengage in drilling and other operations. EBITDAX increased 5% to $42 million from $40 million. And ending cash increased 60% to $94 million at September 30, up from $59 million at June 30, 2020. Our operating netback decreased slightly to $3.47 per Mcf in the 3 months ended September 30, 2020, compared to $3.86 per Mcf for the same period in 2019. Once again, this decrease is due to lack of premium price spot market gas sales as a result of the lower demand driven by the COVID-19 economic downturn. Despite the reduction in netbacks caused by the lower gas demand, it's worth noting that we maintained relatively high and stable netbacks as well as strong operating margins of 79% during the quarter, which speaks to the strength and stability of our business and the value of our sales contracts, in particular. The financial strength and stability of our operations is giving us increased financial flexibility. We've -- and what we've done to make sure it isn't just theoretical is to reprofile our debt as announced in August. We were able to lower our cost of capital and secure substantially increased financial flexibility during the third quarter. Although I did go through these initiatives on our last quarter's call, I'll briefly touch on 2 of the components that closed in Q3, on July 31 specifically, as outlined on the right-hand side of this slide. We put in place a new $46 million revolving credit facility, which is at approximately 5% if and when drawn. Given Canacol ended Q3 with approximately $94 million of cash, this facility remains undrawn. Although Canacol can fund its capital and dividend programs with existing cash and cash flows, we thought it prudent given the favorable rates to add to our financial flexibility. We also completed a $75 million bridge term loan at approximately 4.5%, which resides inside the company that will build the Medellin pipeline. The first $25 million was drawn in August and will be used to fund expenditures such as engineering and environmental permitting through to mid-2021. The remaining $50 million could be used to order long lead time items such as pipe when the timing is appropriate. We anticipate that during the term of the bridge, Canacol would divest between 75% to 100% of the shares of the subsidiary to an equity partner while maintaining up to 25% working interest in the ownership of the pipeline project. Once the equity partners and bank syndicate agreements have been signed and any applicable conditions precedent have been met, we anticipate the long-term funding will be advanced and the bridge will be repaid in its entirety. For clarity, although the $25 million draw appears as debt on our balance sheet at September 30, along with the corresponding cash amounts, we do expect this debt to no longer be on our balance sheet once partner deals have been finalized on this project. We're seeing our cost of capital decline as market participants come to understand the value of our business. On the debt side, that is clearly reflected in these new terms and expanded debt capacity, while on the equity side, it is reflected in a very stable share price compared to many other oil and gas producers. During the remainder of 2020, the corporation plans to use excess cash: Firstly, to maintain our quarterly dividend payment, $7 million a quarter, which is CAD 0.052 a share, represent approximately 5.5% dividend yield at current share prices; and secondly, to continue to repurchase common shares of the corporation under its normal course issuer bid. In closing, our Q3 financial results were strong and relatively stable despite the challenges that the coronavirus pandemic presented. And now we are under an increasingly enviable position of financial strength with increased flexibility to ramp up investment levels when we think it makes sense to do so and if operational restrictions don't prevent us from doing so. At this point, I'll hand it back to Charle. Thank you, everyone.

Thanks, Jason. Stability provided by our fixed take-or-pay gas sales contracts have allowed us to continue weathering the financial effects of this pandemic, and we have maintained robust cash flow and operating margins, as just discussed by Jason. We've also maintained our return of capital to shareholders via the continued issuance of dividends with no change in yields, and we have been actively buying back shares since September. Our lenders, as Jason has just discussed, have renewed our existing bank facility at reduced interest rates and have extended new lending and revolving credit facilities to put us in a position of strong liquidity. All of these aspects reinforce the long-term stability of our business model. Mainly due to the 2-month delay in the drilling program related to the lockdown in the second quarter and to the implementation of COVID protocols in the field, we anticipate drilling 8 of the originally planned 12 exploration and development wells this year, with the remainder being pushed into 2021. We anticipate commencing the drilling of the Flauta-1 and Siku-1 exploration wells shortly here in December. In October of this year, the corporation tested the Arandala-1 exploration well, which was drilled in late 2019. The well encountered 30 feet of pay within the Porquero sandstone and was tested with a final production rate of 13 million cubic feet per day. The well is currently tied to the production manifold and ready for production. The corporation also plans to add 2 new exploration and production contracts to its portfolio: The VIM-44 block, which is located in the Lower Magdalena Basin, adjacent to our main gas-producing areas; and the VMM-47 block, located in the Middle Magdalena Basin, which complements our large existing gas exploration position in this basin, where we are chasing a major new conventional gas play. The corporation is having ongoing discussions with our partner, Promigas S.A., with respect to ship-or-pay contracts and expects to reach an agreement in the very near term. I would like to thank the entire Canacol team as well as our contractors, lending partners and clients for their support and hard work during these very uncertain times, which have allowed us to continue operating safely, sustainably, reliably and profitably while investing for future growth. We're now ready to answer any questions that you might have.

[Operator Instructions] The first question is from Josef Schachter from SER.

Congratulations on a very nice quarter and the financing changes. Can I get a little more light shed on the Celsia expansion, the 200-megawatt power plant? You have, in the presentation, estimated start date December '21, but it has a "subject to COVID-19." And then there's a comment about firm energy obligation December '22 to QEF. Can you walk us through a little more in detail on that? And also, how much delay do you see potentially happening because of COVID? And yes, that would be much appreciated.

Yes. The Tesorito power plants, which we are part of a joint venture with Celsia and Proelectrica here in Colombia, is a 200-megawatt power plant located approximately 7 kilometers to the southwest of our Jobo facility. That facility or that project was awarded in March of last year as part of a 2,500-megawatt bid round that the government orchestrated. It's operated under the Cargo por Confiabilidad system here in Colombia, primarily to act as backup generation at times of need. The project itself is well underway. The EPC contract for the motors was awarded in June of this year. The civil works started in July of this year. It's anticipated that the civil works will be completed in the first quarter, late first quarter 2021, and the motors should be arriving to be installed midyear of 2021. All environmental permits related to the connection of the power plant to the adjacent substation have been received this past summer. So there are no permits pending with respect to the connection of the station to the main power grid. So at this particular moment, the project is on schedule. And the consortium anticipates that the project will start to generate December 1, 2021.

And the firm energy obligation, QEF, December '22, could you walk us through that?

Yes. So as I mentioned, the project was awarded under a 2,500-megawatt bid round for something that's known as the Cargo por Confiabilidad in Colombia, which is essentially a backup generation to be called upon should there be a need for additional electrical generation in the country related to decreased hydroelectric generation, particularly during the dry seasons. So this plant has that -- how should I put it? It has that condition. It will receive a daily tariff from the government to be in standby mode, to be ready to instantly start-up should power be generated. So that's one component of the project. The plant is free to generate on its own under market conditions to sell electricity into the grid, into the regulated and unregulated grid. And that's where the majority of the generation will occur. So essentially, the plant will gain a revenue from the government, a 15-year PPI -- PPA, I should say, on a standby basis. And then separately, will generate revenue on its own, dispatching under normal operating conditions. And it's that there -- it's that standby that takes effect in 2022. That's when it starts to receive that particular revenue.

Right. And then lastly for me, how much is the shortage of electricity in the area right now, so that how much of that 30 million capacity or impact for you, for Canacol, are we looking at, based on the shortage of electricity at this time?

So it's important to say that the plant has a generating capacity of 200 megawatts, which is 40 million cubic feet per day. It's anticipated, the consortium estimates, that it will be generating at approximately 75% capacity under normal conditions, which is the consumption of around 30 million cubic feet per day. The bid round that was auctioned last year by the government, the 2,500-megawatt bid round, was done to cover a shortfall related to the significant delay of EPM's Ituango hydroelectric power generation project, which represents 2,500 megawatts of new hydroelectric power. That project was supposed to come onstream in December of 2018 but has been delayed due to significant issues associated with construction of the project. And the start-up of that project is anticipated now to be in 2024, at the earliest, and only at less than 50% capacity. So there is a shortfall of electricity in the market related to the delay of that very significant hydroelectric project. And for that reason, the government tendered this additional 2,500 megawatts, of which is Tesorito is 200 megawatts of that shortfall.

[Operator Instructions] The next question is from Daniel Duarte from Corficolombiana.

I just have 2 quick -- a couple of questions. So like what are you seeing right now in the spot market, since spot prices continue to push average gas prices down? So I guess, right, that's kind of the indicator of gas [ prices ] for this quarter, given that lockdown measures have been lifted since September. So I guess I would like to know like what level of production are you expecting to see in this last quarter? My second question is related to the Jobo-Cartagena pipeline. I would like to know if there is any update on the negotiations with Promigas regarding the transportation contract on this pipeline? And lastly, I would like to know how viable is the exportation of the Colombian offshore gas, taking into account fundamental gas prices in the Colombian market right now? I'd like to have your opinion on that.

I'm sorry, Daniel. I did not catch your first question, if you could please repeat it.

My first question has to do with spot prices. So I would like to know what's been the behavior so far this quarter on demand? And what can be the impact on that for gas prices on the last quarter? And in line with that, what level of production are you expecting to see in the fourth quarter?

Okay. I think Jason can -- Jason went over the spot pricing. But Jason, if you could just repeat the spot pricing recently and currently?

Yes, sure. So let's just deal with the production first. So of course, Q2 was 152 million cubic feet a day as reported. July and August were about 162 million cubic feet a day. September was 168. And we -- I think last week or the week before, we announced -- or last week, I guess, we announced October the 173 million cubic feet a day. So typically, we'll report November and December within a week or 2 of those months closing. But once again, October was at 173. There's another couple of questions in the queue which relate to the spot prices also. So I'll just sort of jump the gun on those and answer your question more fulsomely. So obviously, the COVID pandemic hampered -- hindered, rather, gas demand and with that, hindered the gas prices. Having said that, general terms, Q1 of 2020 saw those interruptible prices average slightly more than $4 an Mcf. Q2 of 2020 saw those same interruptible prices average slightly less than $3 an Mcf. And when we got to Q3, July and August averaged right around $2 an Mcf. Having said that, September bounced back to $4 and October was in line at the same $4 price.

I'm sorry, Daniel, was there a -- there was a -- I think there was a second question. If you could just repeat that as well, please.

Yes. Okay. So my second question is related to the Jobo-Cartagena pipeline. I'd like to know if there is any update on the negotiations with Promigas regarding the transportation contract on this pipeline?

Yes. As I mentioned during the course of the presentation today, we're currently in discussions with Promigas regarding the ship-or-pay contracts there. And we'll have an agreement -- we feel we will come to an agreement very shortly.

Okay. Again, and lastly, I would like to know your opinion on how viable is the exportation of the Colombian offshore gas that's been announced by Ecopetrol, taking into account fundamental gas prices in the Colombian market.

I think there have been a couple of potentially significant discoveries in the offshore over the past 5 or 6 years by Petrobras, by Repsol, by Ecopetrol, Anadarko. They are located in very deep waters, up to 2,000 meters of water depth. And they have yet to be fully appraised with respect to the drilling of additional wells to try and better estimate the size of those discoveries before a commerciality decision is made to invest in the infrastructure which will be necessary to develop those discoveries. So I would say that the first -- the initial results are encouraging with respect to the presence of gas there. The uncertainty lies within how large these discoveries are. So that's going to require additional drilling, which was supposed to happen next year but has been delayed into 2022, I believe, now. And then a commercial decision has to be made with respect to developing those discoveries. And these -- given the water depths of these discoveries, these would be multibillion-dollar offshore deepwater-type developments, which would have a significant impact on price, obviously, of cost of that gas coming to the market. So on the one hand, you're looking at a 7- to 10-year type of development scenario before that gas can be put into the Colombian market. And then the cost would likely be quite high compared to gas developed and produced onshore.

The next question comes from Nicolás Erazo from CrediCorp Capital.

I just have one question. Actually, if you could please share with us if you are receiving any interest around the Promigas' open season for Jobo-Transmetano. And how could you -- this be related, this project, around the contract that is being actually renegotiated around the expansion of the 100 Mcf per day between Jobo and Cartagena, which is also with Promigas? Just around that.

Thank you, Nicolás, for the question. The 2 subjects are completely different. They're not associated with one another. As I mentioned earlier, we're currently negotiating ship-or-pays with respect to Promigas to Cartagena and Barranquilla and expect we'll reach an agreement shortly. And with respect to the open season, that is a new pipeline project that Promigas has proposed or put to the CREG with respect to a bidding process, an open bidding process, for a new pipeline from Jobo into the interior. But the 2 projects are very distinct.

The next question comes from Gabriel Barra from UBS.

I have 2 here. First, on these -- on Jobo and Medellin, following up here in the last question, there is any update on the EPC contract, that there is any news here? I remember that, as you mentioned here, that Promigas could be one of those EPCs. But if you could give us more color on this, it would be very helpful. And following up the other question about Promigas contract, there isn't any time line here, or could share -- I don't know if you could share this time line, could be very helpful for us. And the third one, very quick, looking to the demand for the next year, should we expect anything close to 200 million cubic feet here or the company are working with -- on a lower number than that?

Thank you, Gabriel. With respect to the Jobo-Medellin pipeline project, we have received offers from 3 different EPC contractors, which we're currently evaluating. And we will make a decision once we have executed the main offtake contracts into Medellin with respect to the sales. So that's the status of that project. With respect to the time line of the project, it's all dependent upon the execution of the primary offtake contracts to Medellin. So we're still waiting for that to occur before we move on to EPC award and funding. With respect to demand for next year, we're currently working on our 2021 budget. And as usual, we will publish our guidance, which will include gas sales as well as capital and whatnot, in early December of this year. So that will be coming out within the next 3 weeks or so.

There are no more audio questions in the queue. I will pass it over to Carolina Orozco for the webcast questions.

Thank you. The first question is from Daniel Guardiola from BTG Pactual: At which prices are you planning to roll over the take-or-pay contracts that expire this year?

At the highest possible prices.

The second question from Daniel is: Are you planning to record in your balance sheet a contingent legal liability related to the early termination of the transportation contract with Promigas for the 100 million cubic per day pipeline connecting Jobo to Barranquilla?

Yes. The answer to that is clearly no. As Charle pointed out, we're in discussions and expect to have an amicable resolution soon.

His third question is: How do you see gas demand in the spot market evolving, especially considering that the rainy season in Colombia has just started and water reservoirs are at record highs?

Well, typically, there's a dry season and a rainy season. We're currently just coming off the crest of the rainy season. The water levels are not at record highs. The water levels are at normal highs, not record highs, and should start to fall as they usually do through December, through the first quarter and into the early second quarter of next year, as they always do. That tends to be the highest level of thermoelectric power generation, as a matter of fact, is in the first quarter. So I expect that nature will repeat itself as it always does with respect to the course of the dry and rainy seasons.

And his final question is: What is preventing you from signing the take-or-pay agreement with EPM that will make feasible the pipeline project from Jobo to Medellin?

That is currently in the Board of Directors' hands at EPM.

Now we have another question from Percy Vega from CrediCorp: Are you able to continue with this legal process with Promigas? Or will you have a friendly agreement with them?

I think we've answered that a few times in this conversation.

Yes. The next question is from [ Andrés Castro ] from CrediCorp Capital: How have evolved the negotiations with Promigas? Why did you need to use the funds from the bridge loans? Could you give us some details about that?

Yes. I think we've covered Promigas, but I'll deal with the bridge loans. So the bridge loan, once again, is for early items on the Medellin pipeline project. That project is held inside a subsidiary company, a different company than Canacol legally. So essentially, we're just temporary custodians of those shares, right? So once we sign a private equity deal, when the pieces fall in place, we'll transfer them the bulk of the shares. The debt will be completely off our balance sheet as we can only hold a maximum 25% interest in that company, which is the maximum allowed for a producer under Colombian law. Just to round that out, I guess, obviously, the funds that are spent or the interest that will be paid, et cetera, falls inside of that Medellin company, right? So the intention is that it won't be on Canacol's books for long.

Thanks, Jason. Just give us 2 seconds to see if we have any more questions from the queue. I think with that, we finish our conference call today. Thank you all for participating in Canacol's third Q conference call. The call now has been concluded and have a great day.

Thanks, everyone.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.