Peyto Exploration & Development Corp. (PEY) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Peyto's First Quarter 2023 Financial Results Conference Call. [Operator Instructions] As a reminder, today's program is being recorded. And now I'd like to introduce your host for today's program, Mr. JP Lachance, President and CEO. Please go ahead, sir.

Well, thanks, Jonathan. Good morning, folks, and thanks for joining Peyto's First Quarter 2023 Results Conference Call. I'd like to remind everybody that all statements made by the company during this call are subject to the same forward-looking disclaimer and advisory set forth in the company's news release issued yesterday. In the room with me today, we have the entire management team: Kathy Turgeon, our Chief Financial Officer; Riley Frame, our VP of Engineering; Tavis Carlson, our VP of Finance; Todd Burdick, our VP of Production; Derick Czember, our VP of Land and Business Development; and Lee Curran, our VP of Drilling and Completions. Before we get into the details, I'd like to acknowledge and thank the Peyto team for their efforts over the past quarter and especially our people in the field for their extraordinary commitment to Peyto. Many of these folks were evacuated from their homes, and they had to get themselves and loved ones to safety during last week due to the wildfires burning near Edson while also taking care of Peyto's assets in the field. So on behalf of the entire management team and the folks here in the office, know that you're on our minds, and we appreciate what you do. We'd also like to acknowledge the great efforts of the wildfire emergency responders and those who continue to be displaced from their homes. The recent cooler weather has provided some reprieve for those fighting the blazes. But we know the forecast contain some hot, dry weather in the future, so we're thinking of you as well during this difficult time. Despite the rapid drop in prices throughout the quarter, Peyto managed to deliver strong operating margin of 71%, coupled with a profit margin of 32%, that delivered earnings of $9 million, and we declared $58 million in dividends. Funds from operations was obviously quite strong, considering where prices were, thanks in large part to our disciplined hedging program. When we look back at the past 10 quarters, we've increased production by 32% from 78,000 up to 103,000. We paid out $184 million to shareholders in the form of dividends, and we paid down $300 million worth of debt, too. Quite impressive. Unfortunately, we did not participate in the Malin price frenzy this winter. But we still have 40,000 MMBtus pointed in that market over the next year, and we'll take advantage of any future price spikes there. Operating costs were up in the quarter, which is usually the case in the winter when we use a little more methanol and power costs are higher. But we also had many supplies and services that were up due to inflation. We expect these costs will come down throughout the year. And despite these increases, we still have the lowest cash cost in the industry. As far as capital activity in the quarter, we ran with 4 rigs through the end of March, and we drilled our longest drilling program -- well program ever using our extended reach horizontal design across several formation targets. And perhaps later, we'll get Riley to expand on the results of that program. We drilled more wells on the lands we acquired last year in Brazeau. And we've increased production on those assets by tenfold, which has filled the new Aurora plant after we did some gathering and sales pipeline optimizations. In the first quarter, we also built a large diameter pipeline from our Swanson plant down to the Cascade power plant, which is under construction. We're proud to be a supplier -- a gas supplier of 60,000 GJs a day. That's about half the natural gas requirements for the plant to what will be the most efficient power plant -- generation plant in the province when it comes onstream later this year. We can't share the confidential pricing agreement we have, but if power prices are anywhere close to where they were in 2022 or even 2021, we'll be very pleased relative to what we would sell that gas at AECO -- for what we'd sell at AECO. And speaking of AECO, we don't have any exposure to that market this summer or next since we've got a broad diversification portfolio to other markets where our gas will be sold. We recently received our long-awaited tranche 5 service that has -- that was part of that 2021 NGTL expansion and -- which was delayed and delayed over the last couple of years due to COVID and construction problems. So we have ample service now to ensure our gas gets out of the province and then some -- a little bit extra on top of that. We also have more than enough NGTL firm receipt service in case there are curtailments due to summer maintenance this year. We also -- this also allows us on top of that to get -- to grow our future volumes without fear of the system being full and having to wait on future expansions. So we're well positioned there, too, on our service. We currently have 3 rigs running now through breakup. And although it's obviously relatively dry out there now, we're all too aware how wet June can get. And so we've made sure these rigs are positioned on sites with good access. We're drilling multi-well pads and minimizing the moves. After that, we'll see where prices are and where costs are at, and we'll determine how aggressive we go after the back half of the year. In the short term, we need to navigate through this current wildfire situation. And as we said in the release, we've actually been able to restore essentially all of our production from the 2 plants that we shut down as a precaution. And I think now all we're really waiting on is this -- the nonoperated production to come back onstream, which should be shortly. And we've also learned some things, and we've shut -- we've put in place some responses in case this flares up again. But at this time, we feel the impact on quarterly production is minimal, providing we don't get hit again with another evacuation or something like that. And we're working with our third-party liquids egress operators to ensure we have contingency plans as well. Ultimately, we believe that natural gas is the fuel of the future. We have a real opportunity to displace dirtier fuels around the world if we continue to build out our LNG export capacity here in Canada and in the U.S. because nobody does it better than Canadian producers when it comes to responsible low-emissions development. Renewables have a place, but natural gas has proven to be the most reliable energy source, especially in harsher climates, where -- when solar and wind just can't meet demand when you most need it. And we believe Peyto is well equipped to supply that gas as we go forward with our low-cost structure, our low-emissions intensity production, our price risk management and our disciplined approach to shareholder returns. Okay. Before we turn it over to questions, I'd just -- a reminder that our Annual General Meeting is next Wednesday, May 17 at 3 p.m. here in Calgary. And you can get the details on the venue at the bottom of the press release. And before we go to the phone for questions, I think I'd just like to address a few comments or questions about the hedging loss in Q1 that came in overnight. And I might ask Tavis to give me a hand with this. But I think we just want to remind folks that -- why we hedge, and I guess another reminder of what we should expect going forward on our -- with our hedging program under the current strip. So maybe, Tavis, if you could elaborate a little bit more on that and also on the fact that what other market diversification, how we've been able to get this quarter and then how is our approach going to be on hedging that as well.

Yes, sure, JP. So we're really hedged to secure revenue. We want to protect our balance sheet. We want to protect the project economics, and we want to stabilize our funds from operations quarter-to-quarter so we can fund our -- under dividend. I know we've had some significant hedging losses over the last number of quarters as gas prices were strong. But going forward, we're now modeling substantial hedging gains for the next 1.5 years. Our mark-to-market hedge position at the end of March was $149 million, which increased from a liability of $111 million at the end of last year. And really, that's about those Malin contracts rolling off and then the falling natural gas prices has created that position for us. In terms of diversification, in 2023, we've added around 90,000 MMBtu a day of basis deals on NYMEX and Chicago. And those are in 2025, '26 and '27. So we're getting ahead, securing various markets. So that's going to provide exposure to good prices. We like the basis deal, and we can get basis at or below pipe costs. And the other benefit is we don't have long-term commitments with those.

Right. So when we talk about hedging at those markets, I think it's safe to say we're going to leave some of these more volatile markets over [ to Malin volume ] obviously. Right now, it's come back in, but it usually -- we used this back again. It wasn't just 2 years ago in the winter where we had the Ventura really pay off, and we had left that exposed. I think we made $25 million over a weekend. So it's safe to say that as we look forward here, we are going to leave some of these more volatile markets exposed as we hedge those -- the Malin volumes 2 years ago. At that time, that was a superior price to what we could get at AECO at the time. So that was why we did. Again, so what you said is important. It's about securing revenues, and we can't predict the price. So a loss opportunity value here, but again, the security of the revenue is important. So maybe we'll open up to questions from the phone. Operator?

[Operator Instructions] And our first question comes from the line of Chris Thompson from CIBC World Market.

This one is just regarding the $100 million note that you have come and do. Just wondering, at this point, if you have any plans for that, or what are some of the scenarios that could play out that we should be thinking about?

Sure. Okay. I'm going to ask Kathy to address that one. You're referring to the note that comes up in October of this year, it's $100 million at 3.7% interest rate. Yes, go ahead, Kathy.

So we are going to be flexible on that. I mean it's a bit too early to talk to the noteholders -- the existing noteholder. But we have strong relationships with that noteholder. It's one noteholder. And so we may roll that note over if we can get reasonable terms. Otherwise, we do have the ability and capacity on our bank credit facility to just pay it down. So it's really going to be whatever interest rates we can not secure.

Okay. And just remind me, average interest rate on your credit facility right now.

Our average interest rate right now is probably about 6%, 6.5%.

Okay.

And that's 4% on the long-term notes, which we roughly $400 million -- a little over $400 million over the long term. It is 4% and then a couple with the revolver, right? The remainder...

Yes, the revolver alone. Yes, about 6.5% right now.

All right. Okay.

Underlying interest rate, 5%.

Okay. Great. And then on my next one, just with respect to dividend sustainability, a lot of investors are -- have been asking the question. How should we be thinking about the way you look at your dividend, stress testing it down to certain commodity prices? What are your thoughts around that?

Yes. I think that we have, as mentioned it earlier, the reason that I did, too, the reason why we do the hedging program is to help secure those revenues so that we can be comfortable with the level of dividend we set. When we look back at November when we set this dividend level, we were cognizant of the fact that prices could fall, and we looked at the sensitivity around that. And I think as long as prices -- the strip plays out, everything was going to be just fine. And I think we look at that from 2 perspectives. One is not only the dividend sustainability, but also the capital program that we're drilling. We want to make sure that when we -- that the decisions we're making on deploying capital is giving us a return. So we're cognizant of the fact of where the prices are. And we continue to hedge the future. I think that's a thing to remind everybody. Our hedges don't roll off. We're continuing to hedge. What's our hedge level now for -- or hedge level now for [indiscernible] is already up to...

[ 50% ] of gas.

50% of gas. So we are securing those revenues because prices are in contango, and we can take that off the table. So it gives us confidence to continue to sustain the dividend.

Okay. Great. One other question for me, just with respect to inflation. I noticed in your note, you talked a bit about drilling cost per meter coming down a bit, completion costs per meter up a little bit. In terms of line of sight to a bit of relaxation in inflationary pressures going forward, I think we've seen a bit of an improvement, but it's still there. Can you give us a bit more color on your outlook for the next 3 quarters?

Yes. I think we feel that inflation has tapered off here and that we're not going to see significant increases like we did last year. Prices, we'd like to see them come down, but I don't think that, in the short term, is realistic. But we'll see what happens with activity levels here come post breakup when that changes. I think on the operating cost side, we've seen some inflation that -- it was a bit of a lag to seeing those costs go up. I think on the drilling and completions side, we saw costs go up quite quickly earlier on and then operating costs seem to lag a little bit and saw more inflation here this quarter. But our outlook for inflation is it's -- I don't -- we don't see -- we're not planning to have it -- to see it increase. I guess it will depend on the activity levels we see going forward.

[Operator Instructions] And our next question comes from the line of [ Gerald Mackay ] from -- self-employed.