DNO ASA (DNO) Earnings Call Transcript & Summary

Okay. So welcome to the DNO ASA Q2 Call. My name is Bjørn Dale. I'm the Managing Director of the DNO. Present is also Executive Chairman, Bijan Mossavar-Rahmani; and Chief Financial Officer, Haakon Sandborg. We will start the call with an introduction by Bijan, followed then by Haakon. Following this, we will have a Q&A session until 11:00 [Operator Instructions] With that, Bijan, please.

Good morning, everyone. This is Bijan Mossavar-Rahmani. Thank you for joining our call this morning. I hope you are, first, all well and your families are well in this very difficult period for all of us. Our releases today, I think, tell a very simple story. We went into the -- this market turmoil caused by the coronavirus and its impact on oil demand and the industry with -- I would say, prepared and that we have, as a company, have been through not exactly the same but similar challenges when our operations in Kurdistan were impacted by ISIS. So in a sense, we had drilled for something -- some similar challenges, and we're very quick to move to first secure our people, their health, their movements, to secure our balance sheet and -- but to position ourselves to come back out of the crisis, ready to hit the ground running again or to put the foot back on the accelerator, as we say. It's been a difficult few months of retrenchment, yet securing people and assets while preparing, and in June, we saw opportunity to step up our activities in Kurdistan with some plan but ready to execute well interventions, which were successful, thanks to a very dedicated team working under very difficult coronavirus restrictions in Kurdistan. And we were able to step up our production by about 15% in Kurdistan to what we're now running just a little bit over 115,000 barrels a day of production in the Tawke license. So that's been a significant part of our recovery story. That's a recovery story with respect to our cash position and our liquidity. And our balance sheet moving forward has also been greatly strengthened by the temporary Norwegian tax changes that will inject something in excess of $200 million, I think, our latest estimate based on expectations of exchange rates and so on. It's about $215 million for the rest of the year with other payments coming in and refunds coming in next year as well. So I think that's positioned us to now hit harder on the accelerator. You've probably seen from the numbers that we're going to step up activity in Kurdistan, we're going to step up activity in the North Sea. So we're back on a growth mode. The challenges continue, the coronavirus challenges [Technical Difficulty] the impact on demand, the impact on DNO will be much more -- much less, but manageable this time around, but we'll be ready for it. Our challenge now, again, is as we gear up and increase operations to make sure that our people and our communities in which we operate are kept as healthy and virus-free and infection-free as possible. Our ability to move fast in Kurdistan and hit the brake and hit the accelerator at the right moments, of course, has been -- is possible because so much of our operations are across the company, but all of our operations in Kurdistan are onshore. So it's much easier to move the people around, move equipment around, start-stop as appropriate. So the onshore nature of our operations, in fact, as we've been through these operational challenges before have been helpful. But also, we've -- we have like -- in Kurdistan, we have like-minded partners. Genel Energy, of course, is our partner long-standing in our license at Tawke. And we're thrilled that we have supportive and engaged like-minded partners that make all this possible. I will turn to our CFO, Haakon Sandborg, who will now go into somewhat more detail on the financials. But of course, I'm available. And again, I'll just note that we are able to start-stop, ease off, accelerate in Kurdistan, in particular, as circumstances dictate, and that's always been our strength as an operator in our reserve portfolio. Haakon?

Yes. Thanks, Bijan, and good morning, everyone. Are you hearing me okay? Good? Yes. Thanks for attending the conference call today. I'll just kind of start to summarize some of the main financial points that you will have seen maybe in our releases this morning, that our second quarter results, of course, reflect the extremely weak oil prices. And that came up with the price collapse in March as the global oil demand dropped as we have seen. Now we saw that the oil prices were especially low in April, and we did see some price improvement in May and June, but the average Q2 realized oil prices were still only about half of what we achieved in Q1 this year. So that's had a big effect. So if you look at the numbers, we -- the drop in revenues from Q1 to Q2 is a difference of $134 million to a lower level of $72 million in Q2. And this is predominantly driven by the lower realized oil prices that we have estimated account for in the $90 million of the reduction from Q1 to Q2 is due to oil prices. If you look at the remaining difference in the drop in revenues from Q1 of [ $44 million ], as explained by a situation with lower lifted volumes for our North Sea production, that has an estimated revenue effect of $37 million in Q2 from the lower lifted volumes. So on top of that, to explain all the drop in revenue, we had a $6 million effect of a bit lower entitlement volumes in Kurdistan. But you will realize that the lower oil prices and the lower lifted North Sea volumes explain the substantial revenue reduction in the second quarter. I talked to some of the analysts this morning, and I think that once you add back the effects of the lower lifted volumes, you have that estimated $37 million, we're quite close to the expectations from the analyst side. I'd like to mention also on the cost side, our cost of goods sold were down by $42 million in Q2 from the first quarter this year. And this is as we reduce or adjust our production cost by $24 million for the increase in the North Sea and the lift position. So on top of that, we have a reduction in our depreciation, our DD&A cost of $15 million from -- in Q2. And that's mainly from the lower production but also some effects from updated depreciation assumptions. So we're down then on the costs. But despite the lower cost in the second quarter, the large revenue drop is the main reason for the decline in what you see in the results and cash flow throughout our reports. As we normally do, we provide a lot of detail in our P&L and the quarterly report. I won't go through all of that. Just maybe there's a point to that we have a bit of an increase in exploration expense in the quarter, that's due to one dry exploration well in the North Sea by $10 million called the Gabriel well, but you will also see that we have a significant increase in tax income to $44 million. That is due to higher tax losses and also include the effects of the new Norwegian temporary tax rules in the second quarter. But despite that tax income, we still have a net loss of close to $64 million for the quarter. And then we have, as normal, provided some updates on our projected spending levels. We have provided some slides on that in the presentation in what we call the operational spend. It's largely in line with what we have discussed in the previous quarter, but there is some movement and some increase from the level of $520 million last time to a projected $550 million for the year. So it's still a reflection of the recovery we have seen in the oil markets, oil prices and then more readier KRG exports payments. That gives us the, I think, the reason why we want to carefully increase some of the planned spending to a bit higher level this year. It should be said, of course, that this spend level that we show on a $550 million level is before the applicable tax refunds for Norway, that these cash spend amount in Norway will be quickly now recovered through the tax refunds under the new Norwegian tax rules. Yes. I think I'll just move over to the cash flow that you see in our reports. And we had a cash flow from operations in Q2 of $67 million, which I think stands out as quite a positive highlight but pertaining relative to the other results in a difficult quarter. So a fairly good cash flow driven mainly by positive working capital changes, the $59 million. This comes from a reduction of our receivables, reflecting the payments of $117 million that we received in Q2 from the KRG net to DNO in the second quarter. So these covered some of the previous invoices from October last year but also for entitlement in March, April and May this year. We have received now the -- this month in July, we have received the net entitlement payment for June at an amount of $22.6 million net to DNO, and this amount, of course, will be included in our Q3 accounts. Otherwise, on the cash flow, we show our spending flexibility in reducing investments to a low level of $40 million in lieu of the market development. And we -- as the other main item on the cash flow, we have, within the net outstanding amount of $138.5 million on the DNO01 bond at maturity in June. So mostly due to the debt repayment, our cash balances were reduced to $427 million at the end of the quarter. We have a presentation slide on the new Norwegian tax rules, and we welcome this as a major positive development in June. So we show that based on the tax changes and including the tax refunds from last year from 2019, we will now project a receipt of $206 million in tax refunds in Norway this year in the second half. And on top of that, $9 million in U.K. tax refund. So for a total substantial tax refund of $215 million to be received before year-end this year. You will -- maybe I'll get back to a lot the detail around the new Norwegian tax incentives, but we will have in addition to refund of exploration losses, now also refund of all tax losses 6x per year, starting in August this year. So for instance, half of the losses for 2020 will be paid out in the second half of this year, and the balance will be paid out in the first half of next year. In the same structure, payment structure will go for tax losses for 2021. We have projected these new programs, so meaning tax refund effect of $140 million to DNO for 2020. And as I said, half of that, $70 million, to be paid this year and the rest next year. We will further receive $51 million for the association tax losses in DNO North Sea Norge area, following the consolidation that we have done on the 2 Norwegian companies for -- after the Faroe acquisition. We also have the normal exploration tax refund for 2019 in an amount of $85 million. That will go mostly more towards repaying the loan balance under our exploration financing facilities. So again, all in, tax refunds of $215 million this year will provide significant positive cash flow for our North Sea business. We also potentially receive significant tax refunds in Norway for 2021, but the estimated refund amounts will be determined after we have finalized our budget and plans and the assumptions that are needed. I think the main point here is to say that the accelerated tax refunds will significantly strengthen cash flow and liquidity for our Norwegian operations in 2020 and 2021. Finally, to just complete some initial summaries from my side. On the capital structure, we have still a good solid cash balance of $427 million. As we show in the slides. I think we're in good shape on the leverage, with net interest-bearing debt at $537 million at the end of the second quarter. We see that we will be mostly fully funded on the Norway, with the new tax rules over the next 2 years, but we also have good headroom on our long-term RBL above the current utilization. In view of the new tax rules, there's also a question whether we will need to use bank financing for exploration, though that will probably be less needed now for the next couple of years. It's worth noting that now that we have repaid the short-term maturity on bonds, we only have long-term bonds with maturities 3 to 4 years out, that adds further to our [ previous thing ]. We also show a slight increase in our equity ratio in Q2 to 33%. So I think that concludes some of these comments from my side. Of course, it's been a very difficult quarter in Q2. Good to be done with that. And hopefully, we now will look forward to return to more normal market conditions through the second half of this year. I think we then, Bijan and I, have made some initial comments. We want -- have time to go through a lot of detail on top of what we have done, but maybe then open up for the questions at this moment.

[Operator Instructions]

It's Al Stanton. Can you hear me?

Yes.

I've got 2 questions. One on revenues. The other is on operations. The first is, I'm tracking the mostly numbers that are coming out from your partner, in fact. And my model is not quite working. I always assume there's 3 variables, the oil prices, the entitlement and its production. And my numbers are running too high, even when I corrected today's given. So I'm just wondering if anything has changed, whether obviously the benchmark crude price that I start with on the screen is probably too high, but whether the $13.10 differential has changed. So I'm wondering if you can give any guidance on forecasting turnover, please, Haakon. And then the other question is on -- I'm very impressed with the increase in production to 115,000 barrels a day, but I'm assuming that's all Tawke. So the question is, should we be worrying about Peshkabir?

Bijan here. On the operations side, in fact, most of the increase is at Peshkabir. We focused on Peshkabir first. We had a similar well intervention program now being initiated at Tawke. And then both these fields we have plans by the end of the year to do more drilling and opening up of wells that have not been [indiscernible]. So the program is active. We're still -- I think split is still in favor of Tawke. Tawke is just at around 60,000 barrels a day, and the balance from Peshkabir. So no real change in the medium term, sort of mix return of the 2. But the focus, in fact, was on Peshkabir, some of the low-hanging fruits in terms of the nature of the interventions of the cost, whereas at Peshkabir, the work was done in a matter of 3 to 4 weeks. We did it, I think, for a total of maybe a couple of million dollars' worth of spend. The team has been terrific, especially working on these circumstances when we've had the coronavirus. It has been a big issue in Iraq, as you know. We've had to bring in expats, quarantined them for 2 weeks before releasing them to the field, and then they have to quarantine on the way back. So under extremely difficult circumstances, they did a terrific job. So proud of them, and we'll keep going. So we haven't, again, quantified or given any guidance on where we think we're going to land towards the end of the year, but we're back in spending -- in a cautious spending mood, looking for low-hanging fruits. There's still more to be done, but we also have one eye on oil prices, with very low incentive to do very much within low oil price months. That $13 plus is still unchanged. But there's very little, again, incentive to put more oil out of very, very low netbacks to us or to the governments. As that's changed, we'll change course and I'd step up. Because we were spending so little, Al, in -- and Haakon can comment on this too, in Kurdistan, we were not exhausting our cost recovery. We're spending little, so we were getting back less than 1 that we were getting historically because we weren't maxing out our cost recovery. So I know that some of the monthly payment levels have eased off not because the margin is -- not because the $13 figure had changed or the payments were somehow skewed, but because oil prices were lower, which you -- obviously, you were paying attention to, but also because we were spending less and getting less back in cost recovery. Haakon?

Okay. Thank you. I'll discuss with you, I guess, maybe off-line, Al, on the differences versus -- on the actual versus the model. But as Bjørn confirms, we still have a $13 discount for the deliveries in Kurdistan being the quality differential and also the tariffs in the pipeline to sum up to $13. As you have seen, there's been an unusual quarter in Q2, with much discrepancies between dated Brent and other Brent pure quotations and the oil price. It could be something there, I would think. But any specific reason why you would have that change or that difference from your estimates to the actual. So maybe we could look at that in more detail.

Okay. I suppose the thing I was surprised by was the entitlement number was slightly higher than I envisaged. But I'll scratch my head and look at that.

This is Karl Fredrik from ABG Sundal Collier. Just wanted to ask you regarding your production since July volumes are substantially higher than what we saw in the second quarter. And on -- in the end of May, you provided an updated guidance saying that you indicate 90,000 barrels per day average for the second half of 2020, absent of drilling. How will this strong start to the second half of 2020 affect that guidance number? So that's the first question. And the second question is, should we expect the entire under-lift to be reversed in the third quarter of 2020?

I can address the Kurdistan side and leave it to Haakon and Bjørn to address perhaps the under-lift situation in the North Sea sector. In Kurdistan, again, there's -- we had indicated a more severe contraction of the Tawke production, driven in part by lower prices, in part by coronavirus-related restrictions and limitations to what we could do. One of the other challenges that we face and others face in this market is the contraction of the services industry, which we rely, and especially in Kurdistan, the number of service companies are limited, the ability to move people in an office and impacted by coronavirus restrict -- travel restrictions. So our assumption has been very, very little in the way of interventions or well work or workovers or drilling. And because of the natural field decline in these fields as is common in the industry, if you're not spending or you're not doing interventions and changing out pumps and the other things, production will drop off. So that is really a -- those numbers are driven by no activity, driven by low prices, payments were not regular from Kurdistan and also limitations caused by the market and by health conditions. As we've gotten more comfortable with payments and with oil prices stabilizing and there's rent for the dollar range of -- and again, conditions changing and are becoming more comfortable in terms of movements, we now feel confident to make these investments, and these investments will bear fruits. But the logistics are getting people in and out Kurdistan and leaving the need to quarantine over 2 weeks at a time, besides the airports in Kurdistan are still closed. We get people in, we've got from all over the world. We have expats from all over, bringing them in. We have to bring them to another location, charter flights to get people in and out of Kurdistan, with schedule [ visits ] the operating conditions are still very, very challenging. I won't make light of that. And that's why I said it's been a terrific job done by our people on the ground and our teams who coordinate these movements to get this work done, and we have a lot of experience during the ISIS crisis getting people in and out, securing them, dealing with sheltering and visas and how to get people in and out in a safe and efficient way. And that's been reflected now in these results. So that's on Kurdistan. And there's scope to do more. We want to do more. We want to do more drilling. We're active even with the -- when we start drilling in Tawke license, our activity level at our other exploration block, Baeshiqa, continues. We've indicated that we now consider the third exploration roll on that license, and we're going to be testing during the month of -- starting in month of August. So that activity continues, and again, under very, very difficult circumstances, and that location's, difficult security circumstances as well. So lots of challenges, but we've addressed it before. And hopefully, we'll be as successful in keeping people safe and the assets secure and -- as we were in the past, it's day by day looking at the challenges and trying to address them as they come in our direction. Haakon or Bjørn on the North Sea under-lift, lifting schedule?

Yes. Of course, this is a movement in the under-lift that we have seen in the lower-lifted volumes in the second quarter. It's not like just one field, it's spread across several fields. We can mention some of the fields in the Ula area: Ula, Tambar, Oda being Norwegian field names, are some of the areas where we have not lifted the share, and they also have the drug in the area and some other smaller fields. So when it comes to the question that we see that full -- and the risk realized in Q3, probably not because it's going to vary across this various field and how often may have cargo liftings that we will take share in. So I expect we get some of it back in Q3, but not all of it. So it will really have to be the sum of all the parts to get to that answer, Karl Fredrik. But it will be then realized that the market price when they are lifted. And hopefully, that will give us some positive effects that we also can -- that we can see if the oil prices stay up or improve again.

Makes sense. And just going back to Kurdistan, I'm trying to, call it, quantify the effects of the very strong July production. If you were to guide in a similar manner as you did in the end of May where you said absent of further drilling, it would be on average, 90,000 barrels a day. Has that number changed? And if so, to what magnitude? And is that also explaining the slight increase in operational spend for 2020 from the then projected $520 million to the current guidance of $550 million?

It does. We expect to do more. We've -- and you heard before that while our drilling has stopped, we have 2 rigs now stacked on the license, one at each field, and we'd like to drill. If everything stays the way it is now in terms of prices and the coronavirus challenges, with respect to movement of people and logistics, and if we have availability of service companies to support our activities, then our hope and expectation and plans are that we will start drilling again at Tawke. There are a couple wells we'd like to drill there this year that we started drilling this year and also at one that is at Peshkabir. So again, if everything else stays the same, which seldom happens, we will see more activity and our exit rate at the Tawke license will be something maybe a little bit less than what it is now, but not much. But it's hard for us to give guidance with a crystal ball and say what's the market is going to do, the movements of people and equipment and services. But we are -- that -- a more active drilling program, some of which is reflected in those numbers, is fully funded in Kurdistan this year. We have a funds, and we have the locations. And we know exactly what it is we want to do, subject to these external events and developments over which we have less control, no control. We have some ability to respond to them. But ultimately, if you can't really can't move. I'm taking this call, I'm in the United States now. I haven't been in Norway since the coronavirus travel restriction was put into place and it isn't clear when I can get back to Norway again. So I mean, we're all impacted by this. I'm sure many of you are impacted. All of you are impacted by these limitations, restrictions as well. But you're seeing that even though we haven't gone home for the summer, most of us, we've been active. And we'll continue to be active. And we're excited about what we do, and we're excited about the results. And as DNO comes through this very difficult quarter as well as we have, and we want more of the same. But we'll see.

If I could add, Bijan, you had a question earlier that mentioned the guidance on the spend level projected. Of course, we have a very dynamic situation when we put together exploration and capital OpEx elements. These estimates will shift throughout the year. We did provide some quite detailed guidance at the end of May this year in a stock exchange release. And when you look at the presentation from Q2 that you see this morning, you would recognize most of the numbers from our release in May on the guidance, but there is some variation. So we see some CapEx movement in, up in -- projected for Kurdistan and then a bit lower in the North Sea. Exploration is sort of where we were on the guidance, a bit up on OpEx at the moment. But these things are, I should say, quite a dynamic and will move around, right? We're largely keeping the guidance that we gave in the end of May, but with some increase and mostly due to the now expected or planned increased activity in Kurdistan.

If I could make one other comment. With respect to our activities in Kurdistan, there are no sort of -- in the sense artificial restrictions in what we can do in the sense that there are no limits placed on our production by the government. The government would like to see us produce more rather than less. Our partners in Kurdistan and Tawke are aligned with us. We all like to do more. We're able to do more. We'd like to do more. So there's no limitations like quotas or other artificial restrictions or bureaucratic barriers to decision-making and fast-acting. So in that sense, it again comes back to some of the other more global market-related limitations rather than to our interest and our desire to do more rather than less.

This is Christian Yggeseth calling from Danske Bank. Can you hear me?

Yes.

Yes.

Perfect. I have a few questions related to the temporary change of taxes in Norway. First of all, have you identified any projects in your portfolio that you can accelerate for sanctioning? And secondly, have you seen any changes to the asset pricing in the North Sea on the back of the change? And thirdly, have the tax change at all changed your prioritization of capital allocation between Norway and Kurdistan for the next few years?

All very good questions. Bjørn, start with you.

Yes. As to prioritized projects, of course, we operate the Brasse project here in Norway. And we are working hard to see -- we're really taking actions to see if we can move at speed here next year. As to other projects, of course, we are well-operated, but it seems that it's -- we're also working with our partners and the operators to accelerate our projects. As to asset pricing, I don't think we've seen any meaningful transactions yet that could benchmark asset prices.

I think on asset pricing, I mean, you're the experts on this. And I know we have a number of people from London, maybe you can chime in. And I think we're still seeing more assets available at the markets in the U.K. that have been available for some time and haven't moved very much. But we're also seeing a sort of separation in terms of assets between sort of mature and brownfield assets being more available under better terms. We usually are, but I think we're seeing more of a split on separation between greenfield projects and brownfield projects, with the latter being available to anybody who wants to take them. And there are pressures on companies to steer clear of those with good reason and then some not as good reason. But -- so we'll be watching that carefully as well. That's in Norway. And as Bjorn said I don't think we've seen anything yet on our side that would suggest a big shift, particularly when one asset sells probably that opens up the door to a flood of other deals. So when the changes come I expect -- on pricing come [indiscernible] asked, we'll see in other deals getting done. Haakon, do you have any other thoughts on how we see it?

Yes. Can you hear me okay? I had a problem, I thought I'd ask?