Horizon Oil Limited (HZN) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Horizon Oil 2020 Half Year Financial Results webcast. I would now like to hand the webcast over to Mr. Chris Hodge, Chief Executive Officer and Managing Director; and Mr. Richard Beament, Chief Financial Officer, who will take you through the presentation. [Operator Instructions] Please go ahead, Mr. Hodge.

Thank you. Good morning, ladies and gentlemen, and welcome to the Horizon Oil Half Year Results Presentation. My name is Chris Hodge, the company's newly appointed CEO; and with me is Horizon Oil's Chief Financial Officer, Richard Beament. As I've been in the job for just 2 weeks, I will make some introductory comments particularly addressing recent events, before handing over to Richard to run through the half year results and operational performance of our assets. I will also cover our strategic outlook and direction towards the end of the presentation before opening up for questions. The events of recent weeks following the articles printed in the Australian Financial Review dating from the 10th of February have been challenging for the company and had a significant impact on the company's share price. The Board and management have taken the allegations in these articles very seriously as is being demonstrated by the strong, decisive and proactive response, which you've seen in an investigation commenced by Herbert Smith Freehills and Deloitte. This has been overseen by an independent board committee, and ultimately, the former CEO's employment terminated, with myself appointed to the role. As the investigation is ongoing, I won't be making any further comments on these matters today. But notwithstanding the strong response, the allegations have the potential to exacerbate preexisting commercial challenges faced by the company operating in Papua New Guinea. Accordingly, in light of these matters and uncertainties and with regards to comparable transactions, the group has impaired its Papua New Guinea exploration and development assets at 31st December 2019, resulting in a noncash charge to the P&L of $67.3 million. Whilst recent events undoubtedly have been destabilizing, I would like to emphasize that our base business is strong. It's very strong, with material cash flow generation forecast to continue until late into this decade. Accordingly, the company is poised for seizing growth opportunities which is to be my priority. I will now pass it over to Richard to run through the half year results and the continued outstanding operational performance of our assets.

Thanks, Chris. Before I start, I'd like to welcome Chris to the management team. Chris has a wealth of technical knowledge and knows Horizon well, having been a nonexecutive director for almost a year. Accordingly, he is well placed to lead the company. Before I go through the results, I'd like to emphasize that all references to dollars are U.S. dollars, as this is the group's functional currency since all revenues are generated and received in U.S. dollars. Whilst the headline result is dominated by the $67 million PNG impairment charge, it's important to recognize that this is noncash and represents an accounting judgment made due to the material uncertainties which persisted this time with regard to our PNG portfolio. Importantly, the base business is very strong as can be seen in the key financial highlights for the half year, with both the Maari and Beibu producing assets performing well. As anticipated, sales volumes were just over 770,000 barrels and they reverted to being materially in line with the group's net working interest share of production, owing to the full recoupment of the company's remaining Block 22/12 exploration and development cost recovery entitlement. This was expected and foreshadowed in previous releases. Accordingly, sales revenue and EBITDAX were lower than the prior comparative period. However, all other metrics were broadly in line with or better than the comparative period. In particular, the group's free cash flow generation enabled a material reduction in net debt to a modest $7.4 million. The half year results continued to deliver on the objectives set earlier in the year with continued strong production and cash flow generation providing a pathway for future growth. The strong production and cash flow was underpinned by high-margin production at both Maari and Beibu, where cash operating costs were maintained at approximately USD 20 a barrel. This cash flow allowed for progressive debt reduction with a further $20 million of voluntary debt repayments. With net debt reduced to a modest $7.4 million, the [indiscernible] proactively in a net cash position by the end of the financial year. We were also encouraged by exploration drilling success in Block 22/12, which was led -- has led to the company seeking to pursue further infill, appraisal and exploration opportunities. With the progressive de-gearing and continued strong cash flow generation, the company is poised for growth and has commenced evaluation of inorganic growth opportunities within the Asia Pacific region. On the HSSE front, Horizon Oil's operated and nonoperated assets performed well with no loss of containment incidents during the period. And in terms of safety, the company's operated assets achieved a total recordable injury frequency rate of 0 for the 2019 calendar year, with no recordable injuries at an operated asset in over 5 years. The current group performance, which includes non-operated assets has a total recordable injury frequency rate of 3 for the 2019 calendar year, which outperforms the industry average for NOPSEMA-administered areas of just under 3.5. Turning to the detailed financial results. Production volumes were modestly lower than the prior comparative period as Beibu had flush production in the prior period from 2 infill wells which were completed in late calendar year 2018, and workover activities carried out in this half year also impacted production. This was partially offset by Maari production, which was actually 11% higher than the comparative period due to production enhancing workover activity and the continued production benefits associated with water injection into the reservoir. Sales volumes were 770,744 barrels, which as previously mentioned and as expected, reverted to being materially in line with the group's net working interest share of production owing to the recoupment of the company's remaining Block 22/12 exploration and development cost recovery entitlement. Sales volumes attributable to the cost recovery entitlement reduced to 2,474 barrels, whilst in the prior comparative period, they were almost 240,000 barrels. The strong sales and production, combined with higher oil prices, which averaged just over $68 per barrel after hedge settlements, drove revenue of just under $53 million after hedge settlements of just under $3 million. This revenue, together with the 12% lower production costs over the period, which averaged a cost of approximately $20 per barrel produced, underpinned EBITDAX of $31.3 million. The statutory loss after tax was $62.8 million, which after adjusting for the $67.3 million noncash impairment expenses pertaining to the group's PNG assets, which Chris mentioned and I mentioned earlier, and also for the -- if you adjust for the $1.7 million noncash unrealized loss on the revaluation of options issued under the 2016 subordinated loan facility, resulted in an underlying profit after tax of $6.2 million. The continued strong operating results drove $24.2 million in operating cash flow generation for the period, accelerating debt reduction and resulting in an 89% reduction in net debt to a modest $7.4 million or an undemanding 0.1x EBITDAX. Closing cash on hand was $22.1 million, providing ample liquidity for operations whilst ensuring the group's funding costs are optimized. Now dissecting cash flow. In this next slide, we can see that gross revenue of $50 million -- or roughly $50 million before hedge settlements of approximately $3 million and cash operating costs of approximately $19 million combined to generate net operating cash flow of $34 million for the half year. After deducting corporate, general and administrative costs, cash taxes and interest cost of approximately $10 million resulted in net cash inflows from operating activities of $24.2 million, which was almost entirely applied to the prepayment of debt facilities. A further approximately $4 million of cash reserves were invested in capital growth programs, the majority of which was spent on the successful China Weizhou 6-12 M1 exploration well during the period. Now to help dissect the results, the next chart shows the key elements which have driven the similar underlying profit result despite the significant reduction in revenues following the full recoupment of cost recovery volumes at Beibu. As can be seen, the approximate 25% reduction in sales volumes was substantially offset by an approximate $6 per barrel increase in realized oil prices and 12% lower production costs. The other contribution to the profit result worth noting included the substantial reduction in financing costs resulting from the material debt reductions made over the past year, which were in excess of $55 million combined with the successful refinancing completed in November 2018, which lowered funding costs from approximately LIBOR plus 5% to LIBOR plus 2.75%. Turning over to the next slide. We can take a look at financial highlights for the 2019 full calendar year compared against the previous 4 years. The first of these slides shows the material increase in base production levels for the last 2 years, owing predominantly to the successful acquisition of an additional 16% interest in the Maari/Manaia fields during 2018. Importantly, it also highlights the production contribution from both Maari and Beibu, with production at both fields sustained at similar levels over the past 2 years through a combination of infill drilling and production optimization activities. Pleasingly, this has led to oil sales volumes for calendar year 2019 being maintained above the average of the past 5 years of 1.55 million barrels. The chart also clearly shows the contribution of Beibu cost recovery volumes to sales volumes over the past 4 years, which will now cease as historical exploration expenditure amounts have been substantially recouped. The revenue chart also clearly shows the contribution to revenue of the Beibu cost recovery sales. Pleasingly, once we strip this away and despite the modest reduction in production volumes in calendar year 2019, revenues excluding the Beibu cost recovery sales were actually 4% higher for calendar year 2019, driven by the $6 per barrel higher realized oil price. This chart also highlights the improvements made in balancing Horizon Oil's production portfolio in recent years with the relative revenue contribution from Maari increasing from less than 24% in 2017 to approximately 39% in the current year, following the 2018 acquisition I mentioned earlier. As foreshadowed, we expect that the split will further improve over the coming year as the cost recovery oil entitlement in China has now been substantially recovered, following which Horizon Oil's share of production in China will revert to approximately its net working interest. The next slide shows the significant improvements made over the recent years to earnings and profitability, with EBITDAX of $80 million for the full year and a record underlying profit before tax of just under $35 million for calendar year 2019. These strong earnings were not only generated from the continued strong production, but through material reductions in cash operating cost per barrel, which we'll maintain below $20 per barrel produced. These cost reductions were largely driven at Maari following a number of initiatives implemented by the operator. The company continues to maintain relatively low general and administrative costs which will further reduce during the current year. The next slide shows the sustained growth in free cash flow over the past 4 years, in particular, with disciplined investment in exploration and development activities over recent years. It is noted that the 2018 calendar year investing cash flows included the roughly $17.6 million investment in the acquisition of the additional 16% interest in the Maari field I mentioned earlier. This strong and sustained free cash flow generation has aided the company in accelerating debt reduction in recent years with an impressive 89% reduction in net debt in the calendar year to a modest $7.4 million. The significant debt reduction together with the continued free cash flow generation, places the company in a favorable financial position to pursue inorganic growth opportunities. Now turning to the outlook and portfolio updates. [indiscernible] here is the geographical focus area for the company, which continues to be the Asia Pacific region. As you can see, we currently have material joint venture interest in each of our licenses, which ensures we have an appropriate level of influence while still managing risk. Now moving to China. Detailed on this map is the Block 22/12 fields which are operated by CNOOC and in which the company has a 26.95% interest in the producing Weizhou 6-12 and 12-8 fields, and a 55% interest in any exploration areas. As you can see on the map, the oilfields are tied back to centralized CNOOC infrastructure where oil is metered for sale and transferred via pipeline to the Weizhou Island terminal. The remaining reserves and contingent resources as per the last reserves report at 30 June 2019 are detailed on the slide. And as I will further explain, the joint venture is maturing plans to develop the 2C contingent resources over the coming years through further infill drilling and the proposed Weizhou 12-8 East field development. The next slide provides further background on our China fields and shows the historical production performance from Block 22/12. Whilst these are conventional oil fields which ordinarily suffer from natural reservoir decline, impressively, the joint venture has managed to sustain gross production at an average of over 9,500 barrels of oil per day for over 6 years since first oil production commenced. Pleasingly, daily production over recent months is in excess of 10,000 barrels of oil per day, as can be seen in the green line at the end of the production chart. This sustained production has been achieved through infill and near-field drilling, installation of additional water handling capacity and production optimizing well workovers. Whilst our current reserves forecast shows base production declining, the joint venture is maturing plans for further infill drilling together with the expected FID of the Weizhou 12-8 East field development to offset natural reservoir decline. The objective of the joint venture is to continue to sustain production rates well into the future as has been successfully achieved in the past. Importantly, Block 22/12 production generates approximately 60% to 70% of Horizon Oil cash flow due to its low cash operating costs, which average below $15 per barrel produced and favorable fiscal regime. The current producing fields have a current contractual and economic production life until 2028, and field decommissioning costs have already been prepaid into a sinking fund. Accordingly, these fields are expected to continue to generate strong free cash flows for the group over the medium to longer term. The next slide highlights key operational metrics for the half year with production and sales volumes in excess of 400,000 barrels and cash operating cost maintained below $15 per barrel. Average daily gross production was just below 9,000 barrels of oil per day, which was impacted by workover activity during the period. As mentioned, production over recent months has returned to over 10,000 barrels of oil per day. The Weizhou 6-12 M1 exploration well was successfully drilled during the period, intersecting oil-bearing sands nearby the Weizhou 6-12 production platform. Given the recent drilling success, the joint venture is maturing plans for evaluation of nearby prospects during the 2020 calendar year with the intention to integrate any commercial discoveries with the Weizhou 6-12 M1 discovery and other infill targets in the adjacent 6-12 North and 6-12 South producing fields. Looking forward, the expected FID for the Weizhou 12-8 East field in Block 22/12 is anticipated later this financial year. This is slightly later than expected due to the impact of the coronavirus. Nevertheless, basic engineering has been completed with the development plan, with a new wellhead platform tied back to the existing 12-8 West platform as illustrated in the schematic. The development is planned as an extended production test of the field such that upfront capital costs have been minimized through leasing of the platform. First oil is expected to commence in mid-calendar year 2021, with the initial forecast incremental production volumes expected to materially increase overall Block 22/12 production. Horizon Oil's share of overall development costs are forecast to be less than $20 million phased predominantly throughout the 2021 and 2022 calendar years. Accordingly, costs can be readily funded from forecast free cash flow. Now turning to the Maari field in New Zealand. Detailed on the map is the Maari and Manaia field, which are currently operated by OMV and in which the company has a 26% interest. The remaining reserves and contingent resources as per the last reserves report at 30 June 2019 are detailed on the slide. And as I will further explain on the coming slides, the joint venture is seeking to mature plans to develop the 2C contingent resources over the coming years. The next slide provides further background and shows the historical production performance from Maari over the past 3 years. Whilst these are also conventional oil fields which suffer from natural reservoir decline, initiatives implemented in recent years primarily involving water injection and production-enhancing workovers have reduced field decline, and daily gross production has returned to an average of approximately 7,000 barrels of oil per day for the last 3 years. And pleasingly, it's currently about 7,000 barrels of oil per day at present, as can be seen in the green line at the end of the production chart. This has been achieved following production optimizing well workovers completed during the period. Whilst our current reserves forecast also showed base production declining, continued water injection into the field is expected to continue to reduce decline such that production rates are sustained over the long term. Importantly, Maari production generates approximately 30% to 40% of Horizon Oil cash flow. The current producing fields have a production license term and current reserve forecast until the end of 2027 but with potential to extend. Accordingly, these fields are also expected to continue to generate strong free cash flows for the group over the medium to long term. The next slide highlights key operational metrics for the half year with production and sales in excess of 300,000 barrels. Average daily gross production was just below 6,500 barrels, which was 11% higher than the prior comparative period, owing to well-optimization activities and continued water injection into the reservoir to maintain pressure support. As mentioned, production over recent months has returned to approximately 7,000 barrels of oil per day. During the period, Jadestone Energy announced that it had executed a conditional sale agreement to acquire OMV's 69% interest in the Maari project. We are encouraged by the potential value to be unlocked by a new operator and JV partner in the Maari project. Jadestone have strong operating capability and appear to have good alignment with Horizon Oil on further production potential at Maari. Jadestone have also indicated further potential operating cost optimizations and potential field life extension into the next decade. Completion of the transaction remains subject to JV and New Zealand government approvals. OMV will continue as operator of the Maari project until and subject to completion of the proposed transaction. Now turning to PNG. Detailed on the map are Horizon Oil's condensate-rich gas resources, which as can be seen, lie south of the ExxonMobil and Oil Search's P'nyang gas field, which is planned to provide threshold volumes for expansion train 3 of the PNG LNG scheme. The planned pipeline route from P'nyang to the PNG LNG facilities, which is detailed on the map, passes within 20 kilometers of the Ketu field in PRL 21. Horizon Oil's PNG joint ventures have been encouraged by government support for third-party access to the pipelines, providing a potential commercialization pathway for the gross-appraised resource of 2,200 petajoules of gas and 64 million barrels of associated condensate in the 4 key licenses: PDL 10; PRL 21; PRL 28; and PRL 40, in which Horizon Oil has an interest. Horizon Oil holds an approximate 30% interest in the resource and is operator of 2 licenses constituting the majority of the resource. During the period, negotiations for the planned expansion of PNG LNG continued. Unfortunately, on the 31st of January 2020, the Prime Minister of PNG issued a media release stating that negotiations on the P'nyang gas agreement had stopped as the parties were unable to reach a mutually acceptable commercial arrangement. The strong stand taken by the PNG government with a desire for an increased stake take in the project may have significant ramifications for future projects. In light of the above, coupled with the lack of progress in commercialization of the discovered resources, comparable market transactions and continued unresolved license tenure issues which have been exacerbated by the recent allegations raised in articles in the media from the 10th of February 2020, the group has impaired its exploration and development assets in PNG to a carrying amount of $5.7 million. Whilst the group's PNG assets continue to have significant potential value, there remains challenges to realizing value in the short term. And this impairment has been recorded as an accounting judgment due to the material uncertainties which persist at this time. Turning to the outlook and guidance. Following such strong underlying results in the half year, particularly for Maari and Beibu, the financial outlook for the company is very positive as we expect continued strong cash flow generation, allowing for progressive debt reduction and a forecast net cash position by the end of the financial year. Barring unforeseen events and assuming current oil prices are maintained, we expect the continuation of strong production, revenue, cash flow generation and debt reduction throughout the financial year, notwithstanding some modest production reductions associated with natural reservoir decline. The company's hedging position remains favorable in light of recent oil price volatility. And the company has 270,000 barrels hedged through until the end of the 2020 financial year at an average price of $68.35 a barrel, protecting a material proportion of remaining financial year revenue from oil price movements. The material reductions in debt over recent years have significantly strengthened the group's balance sheet, making it supportive of future growth. Pleasingly, due to the strong forecast cash flow generation, the current pipeline of organic growth opportunities such as further infill drilling and the proposed 12-8 East development in China are all able to be funded from internally generated cash flow, ensuring gearing levels remain low. With this progressive de-gearing and continued strong cash flow generation, the company is poised for growth and has commenced evaluation of inorganic growth opportunities within the region. The company continues to focus on HSSE with an increasing focus on sustainability and climate change. Accordingly, the company has commenced work to enhance its disclosure in this area and work with operators of oil producing fields to examine ways to reduce our impact on the environment. On the next -- set out on the next slide is our full year guidance for the current financial year, assuming no material adverse operational or economic changes. Now before we open up for questions, I would invite Chris to provide some final closing comments regarding the outlook and the future direction of the company.

Thank you, Richard. Nice work. Now looking to the future, we have a challenging but achievable vision for the company to return to the ASX 300 within a 3- to 5-year period. So while the existing assets will underpin the growth in value required in order to achieve that vision, we will be looking to expand the portfolio to revitalize and refresh the portfolio by investing in new projects while still retaining our Southeast Asia/Oceana focus. Our primary strategic objective, however, remains the same, which is to acquire producing assets with cash flow, but we plan to do so carefully step-by-step, via a variety of means, ranging from field purchased in various stages of maturity at one end of the spectrum to high-impact exploration at the other end. A key element of the strategy is to focus on basins with prolific working petroleum systems of vital characteristics, which should give us diversity and optionality. Much of the background work to achieve an expanded portfolio has already been carried out in-house, and we have the capability to move quickly from here. At Horizon in my 2 short weeks, my strong impression is that we have an excellent technical team, strong financial management. We have a wide network of industry context, and most importantly, the backing of a cohesive and supportive Board of Directors. I look forward to being more expansive in communicating our strategic direction in the near future and to commencing the process of delivering on the vision we have set out for the company. And with that, Richard and I will now turn our attention to your questions.

Just got a couple coming through here now. The first one is, where in Southeast Asia do you limit M&A search? Look, at present, we're focusing on China, Southeast Asia, Australia and Oceania.

The second part of that is, given your current non-operated business model, will you consider operatorship? I think we -- at the moment, we're quite limited in terms of numbers. It's possible to quite easily upgrade to being an operator. But I would say, we'd only really consider operatorship if it would deliver some sort of value. We don't want to be operator for the sake of being operator.

We've got a question here around 12-8 East FID timing. Look, I covered that earlier in the presentation, but FID is expected in this financial year or before the end of the financial year. As I alluded to, there has been some delay as a result of the coronavirus, but we still expect it in this financial year. There's a question here, when can we expect the investigation by Herbert Smith Freehills and Deloitte to be completed? And do you expect to refer any findings to the Australian federal police? Look, Chris has largely already covered this. But the investigation is ongoing, and presently, we do not have a time frame for its completion. The company is not aware of any investigation being commenced by the federal police. Should the federal police commence an investigation, and as we've earlier announced, the company will cooperate.