Equinor Energy Ireland Limited (VET) Earnings Call Transcript & Summary

Good day everyone. Welcome to the Vermilion Energy, Corrib Acquisition and 2022 Budget Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Curtis Hicks, President. Please go ahead, sir.

Thank you, operator. Good morning, ladies and gentlemen. Thank you for joining us. I'm Curtis Hicks, President of Vermilion Energy. And with me today are Dion Hatcher, Vice President, North America and incoming President as of January 1, and Lars Glemser, Vice President and CFO; Darcy Kerwin, Vice President, International and HSE; Jenson Tan, Vice President of Business Development; and Kyle Preston, Vice President of Investor Relations. This morning, we announced the acquisition of an incremental 36.5% interest in our operated Corrib project in Ireland, along with our 2022 budget and guidance as well as plans to reinstate a quarterly dividend. During this conference call, I will be referring to a PowerPoint presentation that can be found on our website under Invest with Us and Events and Presentations. Slide 2 in the presentation refers to our advisory on forward-looking statements. These advisories describe the forward-looking information, non-GAAP measures and oil and gas terms referred to today and outline the risk factors and assumptions relevant to this discussion. While it's certainly nice to see oil prices recovering this morning after Friday's sell off, before I get into the presentation, I just want to point out that all the financial forecasts included in the press release and presentation were priced using the forward strip closing prices from last Friday. With that, let me start off with a summary of the Corrib acquisition. As we announced this morning, we have entered into an agreement with Equinor to acquire its wholly owned subsidiary, Equinor Energy Ireland, which owns a 36.5% interest in Corrib, for total consideration of $556 million before closing adjustments and contingent payments. The acquisition is expected to add 23 million barrels of 2P reserves and approximately 7,700 BOEs per day of high-margin, low-decline, low-emission production. This production is forecast to generate approximately $365 million of fund flows from operations and $361 million of free cash flow in 2022. The purchase price equates to an FFO multiple of 1.5x and has a free cash flow yield of 65% at current forward strip prices. The transaction has an effective date of January 1, 2022, and is expected to close between the second half -- close during the second half of 2022, after all requisite approvals have been received. Between the effective date and the closing date, all of the free cash flow generated by the asset will be netted off the purchase price and will reduce the cash payment to close, which we estimate will be between $200 million and $300 million depending on the actual closing date. We expect to self-fund this acquisition with free cash flow generated in 2022. As part of the transaction, we have entered into an agreement with Equinor to hedge approximately 70% of the production for 2022 and 2023. For reference, the NBP forward price is currently trading at approximately $23 per MMBtu in 2022 and $15 in 2023, which are the price levels we expect to hedge out over the next few days. Given the recent volatility in European gas prices, we have also agreed to a contingent payment on a portion of the 2022 revenue if European gas prices exceed a certain level. The details of the contingent payment structure are outlined in the press release, but I will point out that the the contingent payment is capped at USD 25 million. And based on the forward strip today, we estimate the contingent payment would amount to approximately CAD 13 million payable in 2023. The structure of this transaction, including the deal contingent hedges, allows us to lock in the majority of cash flow for the next 2 years during a period of unprecedented high European natural gas prices, providing high certainty of an approximate 2-year payback period. Vermilion has a long history with Corrib. We first acquired a nonoperated 18.5% interest in the project in 2009. In 2018, we increased our ownership to 20% and took over operatorship of the project. With the closing of the acquisition we announced this morning, our ownership will increase to 56.5%. As part of our M&A strategy, we are always looking for accretive acquisitions that consolidate or complement our existing asset base. This acquisition ticks all the right boxes. It consolidates ownership in an operated asset with high margins, low decline and low emissions at an attractive price. Corrib has an estimated 2022 operating netback of about $130 per barrel of oil equivalent and an annual decline rate of approximately 15%, while delivering best-in-class Scope 1 and 2 emissions intensity of 4.2 kilograms of carbon emissions per barrel of oil equivalent. Because we already operate the asset, that means there is essentially 0 integration risk and very little incremental go-forward costs. This is a highly accretive acquisition. Based on forward strip pricing, we estimate a 2022 pro forma FFO and FCF per share accretion in excess of 30% and 50%, respectively, with additional accretion expected in 2023 and beyond. The acquisition is self-funded and reduces our leverage in 2022 by 11%, with further deleveraging expected in 2023 and beyond. This is achieved without the need of issuing equity. And as a result, it will serve our long-term shareholders well by minimizing dilution and enhancing our ability to return capital to shareholders. The acquisition significantly increases our exposure to premium priced European gas and rebalances the international weighting of our portfolio. On a full year pro forma basis, our production base will be 22% exposed to Eurogas, while our FFO will be 42% exposed to Eurogas. Our international production and FFO weighting will increase to 39% and 60%, respectively. As the acquired asset will generate netbacks for 2022 in the order of $130 per BOE, you can understand the value of having Eurogas in the portfolio. We believe our expertise as an operator in Ireland and our relationships with the key regulatory and government bodies was a key component of our winning bid. This transaction aligns with our historical value-driven strategy of acquiring from majors, which typically results in outsized returns for Vermilion. The Core acquisition delivers a very high IRR of 41% and is expected to reach payout in approximately 2 years. This level of return and payout would be very difficult to achieve on a North American transaction. As I've mentioned As I've mentioned, 1 of the key attributes of this acquisition is the increased exposure to premium priced European gas. On Slide 6, we show you the impact from this acquisition on our commodity mix. On a '22 pro forma basis, European gas will represent approximately 22% of our production base and approximately 42% of our FFO. The increase in FFO weighting relative to production illustrates the significant margin expansion we get from this increased European gas exposure, as driven by the high netbacks we received. Vermilion's international diversification and exposure to global commodity prices has always translated into strong operating netbacks even when compared to some of our oil-weighted peers. On Slide 7, using RBC's comp sheet, you can see that Vermilion has the highest netback amongst our peers despite having a relatively balanced portfolio between oil and natural gas. I want to spend a little time talking about the European gas market fundamentals. In the chart on the right-hand side of this slide, we show you the historical and forward prices for the NBP benchmark in gray compared to [AECO] benchmark prices in orange, with all prices referenced in Canadian dollars per MMBtu. We overlay this with Vermilion's average corporate realized natural gas price for each of the years in the chart. There are 2 key takeaways from this chart. First, the Eurogas prices trade at a significant premium to North American gas prices and remain elevated for '22 and '23. Second, as a result, Vermilion receives a substantially higher gas price compared to [AECO] and the acquisition will significantly enhance our corporate realized gas price going forward. There are several market fundamentals supporting the high European gas prices we see today. And while prices may not remain at the current prop level above $30 per MMBtu forever, we believe that many of these factors will support above-average pricing over the next several years. To expand on some of these factors, I'll move to Slide 9. Declining European domestic production. The North Sea is a mature basin and is in decline. Onshore production in Europe is also in decline and the Dutch government is still committed to shutting in the Groningen field in October 2022. This is a field that was producing over 2 Bcf a day a year -- a few years ago and around 5 Bcf a day a decade ago. The rising use of gas in the power sector. Coal-fired plants are being phased out, which is increasing the dependence on gas-fired power plants. The German government, for instance, recently accelerated the phaseout of coal power generation from a previous target of 2038 to 2030. Natural gas is increasingly being recognized as a necessary transition fuel, while renewable infrastructure gets built out. Rising carbon prices. European gas prices are highly correlated with the price of carbon. And as you can see on Slide 9, carbon credit prices have increased over 200% in the last couple of years. The uncertainty with respect to gas flows from Russia into Europe increases the current demand for LNG in Europe, further exacerbating the upward pressure on LNG and Euro gas pricing. Lower LNG imports due to competition from Asia. Many of you would have seen the headlines a couple of months ago about China ordering top energy firms to secure supplies at all costs. Europe competes directly with Asia for LNG, which is contributing to the elevated price of both LNG and Euro gas. One of the key differentiating features of Vermilion relative to our peers is our international diversification. We came a little bit more weighted to North America over the last couple of years as we expanded our business in these regions, but we were always committed to our international business, and we continue to invest in our international assets while screening various acquisition opportunities as they become available. There is not much deal flow in Europe compared to North America, and it requires patients to find the right opportunity that fits with our strategy. The Corrib of acquisition is a perfect fit, as it meets all of our acquisition criteria. The acquisition will also rebalance our international [ weighting ] and commodity diversification, which is a unique differentiator in our business model. We now project that about 39% of our production will come from our international assets and 60% of our 2022 FFO will be derived from our premium priced European natural gas, Brent oil in Europe and Brent premium priced oil in Australia. We see this contribution weighting continuing beyond 2022. -- As I review the next 2 slides, keep in mind that these per share metrics are being achieved while accelerating deleveraging. These slides illustrate the strong FFO and FCF per share accretion metrics, which I've already outlined: 33% on FFO and 53% on FCF. One of the reasons this acquisition delivers such strong per share accretion is the fact that we did not have to issue any equity to complete the deal. With the unique structure of the deal, whereby approximately 70% of production is hedged for 2 years, combined with the long closing period, we're able to lock in the majority of cash flow over the next 2 years, which will grind down the purchase price, reduce the amount of cash required to close, enable us to achieve the acquisition economics we quoted earlier. From a corporate perspective, this high-return acquisition accelerates our deleveraging and increases our FCF, which will allow Vermilion to accelerate and increase the return of capital on a per share basis. Vermilion avoided issuing equity and selling assets into a difficult market during the initial phase of the most recent downturn in order to avoid significant dilution. This acquisition is self-funded and reduces leverage without the need of issuing equity. As a result, it will serve our long-term shareholders well and will ensure per share return of capital is maximized. Vermilion was trading at one of the highest free cash flow yields prior to announcing this acquisition, which you can see on the next 2 slides using research from Peters & Company. Given the significant free cash flow accretion from this acquisition, our free cash flow yield increases to well over 50%. To put this into perspective, we are forecasting 2022 full year pro forma free cash flow in excess of $1 billion, which compares to our market cap of about $1.9 billion based on Friday's close. If we look at it on a capital structure neutral basis, using debt-free adjusted free cash flow as a percentage of enterprise value, as shown on Slide 14, again, using Peter's Research, we still screen as having the highest yield across this peer group, approximately 34%. Corrib is a very low emission intensity asset with a best-in-class Scope 1 and 2 emissions intensity of 4.2 kilograms of carbon emissions per BOE. This chart puts it into a better perspective comparing Corrib and Vermilion against our industry peers, which are shown here segregated by their oil or gas weighting. Moving on to our '22 budget guidance and -- budget and guidance. Our Board has approved a 2022 E&D capital budget of $425 million with associated production guidance of 83,000 to 85,000 BOEs per day. This is in line with the preliminary outlook we provided with our Q3 2021 release a couple of weeks ago. This guidance does not include any impact from the Corrib acquisition due to the uncertain closing date. As soon as we get confirmation of the closing date, we will update our 2022 guidance. We have updated the following financial figures based on market closed strip pricing from last week and have therefore incorporated the impact of the 10%-plus drop in '22 full year oil prices. Based on these forward commodity prices, we forecast '22 full year pro forma FFO inclusive of the Corrib acquisition in excess of $1.45 billion and free cash flow in excess of $1 billion. Our base business is forecast to generate FFO and free cash flow in excess of $1.1 billion and $650 million, respectively, excluding the acquisition. The majority of free cash flow after dividends will be allocated to debt reduction and funding the Corrib acquisition. We forecast approximately $400 million of debt reduction in 2022 after funding the Corrib acquisition, resulting in year-end net debt of less than $1.3 billion and a net debt to trailing full year pro forma FFO ratio of less than 0.9x, which is 11% lower compared to what it would have been on a stand-alone basis of approximately 1.0x. Keep in mind, we will not be including the production or FFO from this acquisition in our financial statements or quarterly reports until the acquisition closes. But it is important to note that regardless of the closing date, the economic impact of this acquisition does not change. We plan to reinstate a dividend in the first quarter of 2022, starting with a base quarterly dividend of $0.06 per share. This equates to an annual cash outlay of approximately $40 million, which is less than 3% of 2022 full year pro forma FFO and approximately 5% of FFO under our mid-cycle commodity price assumptions. At this level, we believe the quarterly dividend is sustainable through various commodity cycles. We still have more debt to pay down, but we have line of sight to our ultimate debt and leverage targets and believe this dividend level provides the appropriate balance between providing a cash return to our shareholders at this time while allowing for further debt reduction. Our next leverage target is 1.5x net debt to trailing FFO at mid-cycle pricing, which implies an absolute net debt level of approximately $1.2 billion. As we approach this target, we will consider additional return of capital to shareholders through one or a combination of base dividend increases, special dividends and/or share buybacks. The Corrib acquisition we announced today significantly enhances the company's free cash flow profile and ability to return capital to shareholders in the future. Slide 18 shows our projected debt level and leverage for 2022, including the impact from the Corrib acquisition and budget we announced today. We expect to pay down approximately $400 million of debt after funding the Corrib acquisition and end the year with net debt of less than $1.3 billion and a net debt to trailing FFO ratio of less than 0.9x on a full year pro forma basis, which is about 11% lower than our base business of 1.0x. Lastly, we have provided you with a snapshot of our hedge position, including the impact from the Corrib acquisition hedges that will be put in place shortly. We will be about 24% hedged in 2022 on a corporate basis, comprised of about 22% hedged on oil and just above 50% on European gas for 2022, including the acquisition hedges. For 2023, we remain unhedged on oil; and for Euro gas, will be approximately 26% hedged, including the core of acquisition hedges. In summary, we believe the Corrib acquisition is a very positive development for Vermilion and our shareholders. It is deleveraging and and highly accretive on an FFO and FCF per share basis for 2022 and beyond, and enhances our ability to return additional capital to shareholders. The acquisition is self-funded with a quick 2-year payout and high 41% IRR. The fact that we are able to self-fund it eliminates the need for a dilutive equity issuance and and maximizes free cash flow per share on a long-term basis, which will provide for strong capital appreciation potential combined with increasing return of capital to shareholders over time. The Corrib acquisition increases our exposure to premium priced European gas and rebalances our international weighting. And the acquisition aligns with our corporate strategy as it consolidates interest in an operated high-margin, low-decline and low-emission assets. Our 2022 budget and guidance is in line with the preliminary outlook we provided and aligns with our go-forward sustaining capital requirements. Our plan to reinstate a 6% per share quarterly dividend will provide a sustainable base dividend for shareholders, while allowing for further debt reduction and capacity for future dividend increases, which will be evaluated as we achieve further debt targets. Putting this all together, we believe Vermilion is well positioned to provide strong shareholder returns. Operator, that concludes my prepared remarks. And with that, I'd like to open it up for questions.

[Operator Instructions] We'll first go to Menno Hulshof with TD securities.

Congrats on the acquisition. In some of your older slide decks, you talked about future development opportunities at Corrib, and they're notably absent in recent slide decks. Are any of those still on the table? And if so which look most interesting in terms of mitigating that 15% annual decline? And what is your best guess on how long you can economically produce from this platform?

Yes. Thanks, Menno. Darcy here. We're progressing a number of different optimization projects to ensure that we maximize the value of this asset. This includes low-risk projects, such as compression projects to reduce the field pressures with additional compression. In terms of development, there are several well workover candidates that we're looking at. I'd say at this stage, the development projects are still being evaluated and would certainly represent incremental upside to the transaction we discussed today. I think the second part of your question was around kind of life field there. Our current forecast shows production kind of out into that 2034 period. So we do have a pretty good runway of life of field there. And some of the compression projects that we are looking at kind of later field of fe would substantially or have the potential to substantially increase that field life as we reduce abandonment pressures.

Okay. That helps. And just in terms of -- I suppose this is a somewhat related question, sustaining capital looks extremely low this year. What's a reasonable expectation over the next, call it, 3 to 4 years? Is there any reason to think that some of those opportunities might make their way into the budget anytime soon?

Well, thanks, Menno, for the question. We'll be a larger -- this is Dion, by the way. We'll be a larger entity as a result of this acquisition. Our production in the second half of next year will be 90,000, 92,000 barrels a day. We're looking at the current year, we're -- we think the 4 to 5 is a good proxy for our base business with our guidance and our midpoint around 84,000. So if you look at 2023, again, still early days, but you're looking at that incremental decline from Corrib. And as Darcy would have mentioned, it's in the order of 14% to 15%. So it's a relatively small volume, let's make it at a 1,000 BOEs a day. So the question will be how much capital do we want to allocate, which type of projects do you backfill, for lack of better words. So I think it's going to be in the order of $15 million, maybe $10 million to $20 million. Now in saying that, we do have our CEE assets, and we've been investing there. We had those 2 wells in particular in Croatia that tested at 15 million and 17 million a day. And then 2022, we'll be working on our installation of our gas plant, which is now in country. So we'll have some volumes coming on in the CEE in 2023. So again, we'll work through those details as we get through the year. But as a conservative first-pass estimate, I would say, an incremental $10 million to $20 million for that incremental PDP associated with looking from '22 into '23.

Perfect. That's really helpful. And maybe I'll just wrap things up with an M&A question. You talked about the Euro gas outlook being extremely good. We can all agree on that. But you also mentioned limited deal flow in Europe. Are you seeing other natural gas acquisition or consolidation opportunities on the continent or is this likely the end of the line for euro M&A for the next little while? And I'm thinking of the Netherlands in particular, given the wind down of the Groningen field.

Yes. Thanks. This is Jenson Tan. I think we're always looking for opportunities in and around our current assets. We did have 2 German acquisitions that we had recently that were natural gas exposure there. It is true that it's hard to predict what's going to come to market in e natural gas commodities and exposure in Europe. But I'd say that we continue to build our relationships with the major as well as the other industry players around our assets. So I think it's hard to predict, but there are opportunities out there. There are some of the majors like Shell who have -- and Exxon who have disclosed that they are minimizing their portfolio in Europe. And we are thinking that some of those assets may be coming to market very soon. One of those might be the Netherlands and that's co-owned by Exxon and Shell.

[Operator Instructions] We'll next go to Jeremy McCrea with Raymond James.

Just a couple of questions here for me as well, too. I was wondering if you can give a bit more background on how this deal came together? Where you guys are sold better? I guess essentially, how did you manage to get this acquisition at such an attractive price? And then just a follow-up there, like what are some of the -- maybe the key risk that this may not close next year here?

Sure. Again, this is Jenson here. So this asset came about as Equinor looked at their portfolio and decided that it would be part of fit with their strategic intent to dispose of the asset. Corrib has been an important nonoperated project for Equinor in the last several years. And they did end up going to the market. It did involve several parties that were involved there. Now what I would say throughout that process is that Vermilion has been in a very unique position because we are the operator of the asset. We are a joint venture partner. We've known Equinor very well in that joint venture space for quite some time. And we think that provided a very unique advantage to us. As far as providing deal certainty on completion. Europe and specifically, Ireland, don't have a lot of players. Ireland, specifically, is not known for a very deep hydrocarbon basin. And so I think there is always a very limited set of people who might be interested or companies that might be interested in Ireland. I would say that given the volatility in gas pricing, that posed some challenges, but we did put in this very unique hedge structure that allowed both parties to get certainty on the pricing and really lock in economics that we find to be quite attractive. Let me just -- what was the other part of your...

Risk.

The risk of closing. Yes. So as far as the steps to get to closing, there's really 3 main conditions to get to closing. One is the Irish merger clearance. One is government approval and 3 is partner approval. We don't see any of these as being problematic. We know the government, we know the partners very well. We've been in the asset since 2009. We've been the operator since 2018. Initial indications are that they should be very supportive of the approvals and the transaction. Now getting deals to close in Europe and internationally do take longer than in North America typically. But I would say it's -- when we look at this transaction, we don't see anything atypical. So we don't see any major risk to get to close. Our base case right now is probably 6 months. but it's very difficult to predict the time lines when government approvals are involved. So that's just a base case at this point.

Okay. Perfect, guys. And congrats on the transaction here as well.

Thank you.

[Operator Instructions] We'll now go to Travis Wood with National Bank Financial.

Yes. My question, I wanted to follow on, on something that Menno had brought up. And I just wanted to be clear, is it still safe to say that the base asset here at Corrib is declining at about 15%?

Yes, Travis, that's about right. Decline kind of over the next 2 years is averaging kind of in that 14% to 15%, and we expect that, that decline will continue to flatten as we get closer to the end of field life, and that's what provides that long tail of production that I mentioned answering Menno's question there. But yes, in the next couple of years, that 15% is right and then flattening over time.

Okay. Perfect. And then just staying on the asset side. But in Australia, it's been a while since there's been some wells brought on and been active there offshore. What are you budgeting for the Australia piece of the budget for those 2 wells, maybe for the drilling side of the equation.

Travis, this is Dion. Yes, for those 2 wells, we're budgeting $55 million. We've contracted the jack-up rig. We would look to pick up that rig in Q2. We'll time it to be post the cyclone season. That will set us up to first production kind of mid-year. As a reminder, these are very high rate wells, although come on in excess of 1,500 barrels a day and we out and restrict the production to optimize our crude marketing. If we look at the economics, like even at a mid-cycle $55 oil, we see these wells in excess of 100% and gosh, at current prices in excess of 20%. As a reminder, we do sell that crude for $11 premium to Brent pricing, which helps to drive those robust economics. But to answer your question, $55 million and midyear on production basis.

Okay. So not a lot of change in drilling costs or no real inflationary issues taking place on those, as I think about what they had caused in the past, pretty flat?

Yes. We've been able to -- I mean we -- these are long lead projects. We put a lot of effort into planning and securing the rig, and we've been able to lock in the majority of those prices, in particular in the rig rates. So we're comfortable with the $55 million.

Okay. And then last question, this might be for Lars. From a debt perspective, I mean, the focus has been on leverage. You're on pace to hit that target shortly here. This transaction shifts that a little bit. How are you guys thinking about, you purchased some free cash and some very good metrics. But what's the balance here to continue to look at acquisitions? And how you're thinking about debt targets and leverage targets as you look out through '22?

Yes. Thanks, Travis. Lars here. So I think the thing we would point out is the pro forma deleveraging we see for 2022 is actually 11% accretive relative to the base company. So I think that's the big point we're trying to get across is that this is truly deleveraging for 2022. We see that deleveraging persisting into 2023 and beyond as well. So as a result, this acquisition makes us a larger company on an FFO and FCF basis by more than 30% and 50%, respectively. And as a result of that, our absolute debt target can be increased to the $1.2 billion that we quoted in today's press release versus the previous $1 billion. And we actually forecast getting that target sooner as a result of this transaction. And just to put it into perspective, Travis, when we released our Q3 earlier this month, we were referencing hitting our debt target at the end of 2022. That was when oil was at $75 for full year 2022. What we've done here over the last couple of weeks is, we continue to update our forecast as oil has been quite volatile. And then as Curtis pointed out, the press release that we released this morning was using a $65 full year '22 WTI. So what we're actually seeing here is an acceleration of deleveraging in terms of being able to pivot to more of a return of capital focus as a result of this transaction. Now in terms of going forward around capital allocation, I think anything that we do from that perspective will be completely aligned with our objectives here around achieving debt reduction targets and ultimately getting to a point where we're returning more of our free cash flow to shareholders from a return to capital perspective.

[Operator Instructions] Okay. It looks like we have no further questions at this time. So I'd like to turn the call back over to our speakers for any additional or closing remarks.

No. No further remarks, but thank you all for participating in our Corrib acquisition and 2022 Budget Conference Call, and I hope you all have a great day.

That does conclude today's conference. We thank everyone again for their participation. You may now disconnect.