Vermilion Energy Inc. (VET) Earnings Call Transcript & Summary

Good afternoon. Arun Jayaram again from the JPMorgan E&P research team. Welcome to day 2 of our conference. We're on the back 9 but thrilled to have Vermilion Energy to present today. For those who -- for those generalists on the line, Vermilion is a global E&P, has a global footprint focused on both oil and gas with a big position in Europe as well as Canada and a small position as well in the U.S. They were one of the first large-scale E&Ps to really have a balanced program of returning a lot of cash to shareholders, and they had one of the industry's most unique dividend stories. But today, they're working on improving the balance sheet. And Curtis, we're looking forward to hearing about some of the interesting things out on the pricing front, including your exposure to the European gas markets. Thrilled to have Curtis Hicks, who is the President of Vermillion. Curtis, perhaps you can give a quick synopsis of the story, and we'll begin our fireside chat right after that. But thanks again for joining us for 2021 conference.

Yes. Well, Arun, thanks for inviting us to participate in the conference. We're pleased to be able to present the Vermilion story to the -- to your clients. Let me start with a few comments. I mean we're -- our production guidance for the year is 83,000 to 85,000 BOEs a day. And just for reference in terms of size, we have assets in North America, Europe and Australia, as Arun alluded to. Our asset base delivers real strong free cash flow. And we did have a unique dividend strategy until early in 2020, when we were hit with a couple of black swan event, which everybody is familiar with, the pandemic combined with the OPEC+ price war. As a result, our dividend was unsustainable at that point, and we suspended it. So our focus for 2021 is reducing the leverage on our balance sheet and getting it back to where we think it makes sense for the long term. And we do want to get back to a dividend capital markets model at some point. But for now, our focus is on leverage reduction. And as Arun said, we -- given our -- the spread of our asset base, we are exposed to multiple different commodity price environments. We think that exposure is an asset to Vermilion as it mitigates commodity price risk as the commodity price environments that we operate in are exposed to -- do not march in step with each other. So at times, oil prices have been good or Brent prices have been good and European gas prices have -- maybe a little softer. And at other times, the European gas prices have been extremely good in offsetting some weakness in the oil price. And then there's times when all commodities have been good. So we like the commodity mix that we've got and the asset mix, frankly, the exposure that we've got to multiple jurisdictions, and we plan to continue with that exposure as we go forward. And maybe with that, Arun, we get into your Q&A. So I think you get some interesting stuff laid out that will help lay out the Vermilion story.

Okay. Curtis, you talked about the priority for the company is kind of deleveraging the balance sheet just like most of your E&P peers. This year, you outlined the $300 million E&D kind of program, but walk us through some of the corporate objectives this year, largely kind of a sustaining program. I think it's going to be a little bit more level loaded. But walk us through where your activity is today and how you're thinking about next year when we get a little bit -- I think we could have a balanced oil market based on -- fingers crossed, on the COVID infection rates, et cetera, but we are moving from a period of where oil prices were in severe -- severely low levels to one of a better kind of outlook as we fast-forward to outlooks around next year and mobility getting better.

Yes, yes. A real good question. Let me start by introducing the fact that oil was around $60 at the beginning of 2020. And by the end of March, it was in negative territory, right? So things can change pretty quickly. That's not to say we don't plan. We don't -- we do have long-term plans, but we haven't got a hard strategy for 2022 at this point. It's very soft. It's been worked on, and we'll come back to you with some more definitive answer. But I can tell you where we're at for '21 for sure. And our focus, as Arun noted, our -- we have a capital program with $300 million this year. And at the time we announced our budget in January, [ TI ] was trading in the low 50s, and we suggested that we were going to generate some $200 million of free cash flow with that $300 million spend. We're going to be disciplined. We're not going to exceed the $300 million and focus on debt reduction to improve our leverage on the balance sheet. Well, here we sit 6 months later, oil prices have rebounded fairly positively. Obviously, as everybody knows, European gas prices similarly are trading fairly strongly. And as a result, based on the first 6 months actuals and looking forward using strip pricing, we'll now generate some $400 million in free cash flow. So we've more than doubled our free cash flow with the improvement in commodity prices. Now when we did come out with the $300 million budget, we did say that we were prepared to allocate an incremental up to $50 million over the -- particularly over the fourth quarter if, in fact, commodity prices held. Now we haven't made that call yet today, and we're still working on where we would invest the incremental $50 million. And to the extent that we do or any portion of that $50 million, it'll typically -- it won't add any production volumes for this year. We typically -- it'll do 2 things for us. One, it'll kick-start our '22 production adds as well as it will probably include some element of what we would call strategic capital. We've got some exploration opportunities in the portfolio that need some seismic in order to help further define them. And so we'll kick some of that off. We expect in the second half to -- really to set us up for the future, if you will, '22 through whenever, '25, '26. So -- and that's kind of how we're thinking about it. But beyond that, there will be no incremental spend. And we were quite happy with the impact, the change in the commodity price environment has had on Vermilion and the way our balance sheet is -- started to look towards the end of the year.

Just to -- wanted to unpack one thing. So you're saying that if we include, call it, first half of '21 actuals in the strip for the balance of the year, the free cash flow kind of using your guidance that it would be like $400 million, is that what you're saying?

That's correct. Yes.

Okay. Okay.

You're using our guidance production volumes, yes.

Okay. Great. Great. That's great to hear. Let's talk a little bit about the European gas market. We've seen a very, very strong move in European gas prices. It's been a much different market. I think that the storage ended up being quite low. And so maybe talk to us about some of the dynamics that you're seeing and some of -- talking about your country leverage to European gas and how you guys are thinking about this as -- in terms of future capital allocation because it looks quite attractive just looking at price.

Oh, yes. Arun, we've been in that market since 2004 when we entered the Netherlands, and it's always been a much more robust gas and price environment relative to North America. And what we saw in 2019 and into 2020 were some macro issues that worked against the gas price. I mean there was a couple of warm weather, winters, you combine that with LNG gets stranded and Europe became a dumping ground for LNG, which pushed prices down, and then we had the impact of the pandemic, which you had the same impact that -- well, that we had on the demand for oil, the demand for gas went down. And so we saw some fairly weak gas prices latter part of '19 and through 2020. Now the macro events are starting to work in our favor. I'm sure everyone is aware of the LNG market, very robust and huge demand in Asia for LNG. So there's no more stranded LNG, if you will. It's not getting put on a tanker unless it's got a home. And so we're not seeing that. We saw the polar vortex blew through Europe this year, which created some incremental demand, now coming out of the pandemic is helping the demand side of things. And so what we're seeing is storage levels at 5-year lows with ongoing strong demand for gas. And so I think there's a fear that they're going to be unable to get storage levels to where they want them to be prior to the upcoming winter weather season. So there are some issues with supply in Europe and pushing prices upward to our benefit, to be honest. And so -- but that's kind of the macro environment. If you look at our portfolio, I mean, we've got gas production and drilling opportunities in the Netherlands. And those drilling locations have always had economics that are at or near the top of our portfolio in terms of what they'll deliver. The risk -- the challenge for us is how many wells that we can drill in a given year. And the regulatory process is somewhat onerous, and it takes time. And we drilled 2 wells this year. I think our -- what we are planning right now for next year is drill 2 to 4 wells. And it's just -- it's not a program that you can ramp up like you see in North America where you say, well, given the economics and the metrics that you see, let's go drill 15 or 20. I mean just physically that we won't -- we can't make that happen with the regulatory environment. And so we're quite content because what it also does is it eliminates our need to invest a lot of capital and infrastructure. We've got existing infrastructure. We can keep it full and keep the gas flowing. Now if you take that European gas story a little bit further, we look at our Central and Eastern Europe business unit, CEE as we referred to it. And we've got a couple of really nice gas wells that we drilled in Croatia in 2019. They're yet to come on production, again, lack of infrastructure. We're in the process of putting that infrastructure in place. It takes some time, and it takes some process from a regulatory standpoint, and we expect those wells to be on late 2022 and maybe the first part of 2023. But what it's done for us is it really firmed up the fact that there are some -- and maybe what I didn't tell you is that those gas wells tested at 15 million and 17 million a day each, right? So really good-looking wells, and we see some additional anomalies offsetting the locations that we drill. But what we want to do is we want to shoot some seismic to get a better delineation of the opportunity base on that particular land block in Croatia. We've got 2 other land blocks in Croatia that are highly prospective, and they need some seismic as well to delineate the opportunity base there. But we really see our CEE as a midterm growth asset for Vermilion, and we're quite excited about it. And on top of the gas opportunity, we've got a really good-looking oil opportunity in Hungary. We drilled a well earlier this year, which unfortunately didn't work, but there's a couple of different aspects of that play. The other aspect to the play in Hungary still very much perspective, and it's actually something that we're going to see if we can't accelerate drilling on and see if we can't get a well in the fourth quarter. I don't know if we can do it from a regulatory standpoint or a practical standpoint in terms of the equipment. But certainly, that's something that ranks very highly in the portfolio, and we'd like to get after it. So we're really excited about the opportunity base that we've got for us in the CEE and just, in general, our European gas production and incremental drilling locations.

In the CEE, you talked about Croatia. Can you talk about the marketing of that kind of gas -- as investors think about what kind of netbacks or pricing you get from that market? As -- are you selling to the utilities in Croatia? Or what does the market look like there?

Well, I got to be honest with you, Arun, I can't tell you exactly who the end buyer is, but I do know that the market is very much based off of TTF, which is the Title Transfer price in Europe, in the Greater Europe, which is what we saw our Netherlands gas at. We sell our gas in Ireland. The Corrib field is sold at -- oh, gosh, I've just gone blank here, NBP, which is a different price, but very same. It tracks with TTF. I mean they're in lockstep. So we're going to get the same price in Croatia. From a cost perspective, I don't think our cost structure will be any different than the Netherlands. That's something that at this stage would suggest probably as good a proxy as any. And so the netbacks in the current price environment will be very strong.

Okay. So Netherlands, I think you're doing a well tie-in this year. Maybe 2 this year in the Netherlands and then you talked about maybe 2 more next year?

Yes. Well, we drilled 2 wells in the Netherlands this year. We'll get those wells tied in, in the second half and on production. We're working on that as we speak. Next year's program hasn't been totally firmed up, but we've been talking 2 to 4 wells, again, depends on the permits that we get in country. But if we can get 4 permits, then I expect that we'll drill 4 wells in the Netherlands next year.

What about at Corrib? What are you doing at Corrib to kind of manage the decline there?

Corrib is a PDP asset. You're right, it's on decline. There's not a lot that we can do. There's no incremental drilling that we can do. We're looking at some potential workovers to maybe enhance some production, but it's kind of modest at best. There's nothing -- there's no magic bullets there, Arun. It's a really strong free cash flow generating asset, and we'll continue to take the free cash flow that we generate there and redirect it to other parts of the business, including the balance sheet.

Okay. And then just last question on kind of European gas. As you know, we'll see what happens with Biden and Nord Stream 2, but there is the potential for a linkage from Russia on the Nord Stream 2 pipe down in Germany. So any thoughts -- or how do you think about the implications to that to your -- to European gas business?

Yes. The information that we've got on Nord Stream 2 is that, first off, it -- Russia used to and it still is, to a degree, flowing gas through Poland to get it into Germany. The Nord Stream 2 is going to replace that gas, and the Russian commitment to the existing line, if you will, has been pulled back. And so they don't have access to it to the same degree they did. And I think the timing hasn't quite worked in terms of switching over from the existing line to the Nord Stream 2 line. So I think near term, there could be some supply issues and that they're not getting enough gas into mainstream Europe. I think longer term, Nord Stream 2, I think, adds an incremental 2 BCF a day to Europe over and above the existing capacity, which we think is not that significant, will be absorbed by declines from existing fields. The fact that Groningen field in the Netherlands is going to be shut in entirely by the end of '22 as a result of the seismicity issues that it creates. So at the end of the day, we think there's going to be some short-term angst in the markets and it could make the markets a little volatile, but maybe to the upside. Long term, we don't think there's a significant impact on our market.

Okay. Actually, I lied. I wanted to ask you just about your -- call it, some of your exploration activities in Germany. I know you've had some drill bit success there, and just thoughts on bringing that discovery on to production.

We participated in a while. We had success on an existing field in Germany, [indiscernible] assets. That was our initial acquisition into Germany. We had visions of expanding our exploration activities in-country. I think the reality is the regulatory restrictions and the environmental restrictions there are going to preclude us from pursuing a lot of inventory or exploration inventory in-country. And then when -- the reality is when we get into the details, some of those wells were $15 million to $20 million wells. And that's not the type of activity that Vermilion does, right? We're a little more bread and butter. And so we're focused on the exploitation of the asset base that we've got in-country, and particularly on the oil side, the operated oil side, we continue to work that. And we're seeing some positive results. Again, it's not high-impact stuff, but it's value add, and we'll build up that business unit to -- a bit larger. And certainly, in this price environment, we'll throw off some pretty good free cash flow.

Okay. Let's talk a little bit about Australia. What are your plans there? You have a high margin -- a small but a very high-margin oil business in Australia.

Yes. That's been a great business to be in, Arun. We got in, in 2006. We bought 60% in operatorship with the Wandoo platform off the Northwest shelf. We bought out our partner in 2008. So we own it 100% today. And our goal is to sort of mitigate declines by drilling a couple of wells every other year, right? And again, it's a situation where you're not going to drill every year. You require a jackup rig to drill. And so they're not cheap wells. They're upwards of $30 million a well. So we got 2 wells planned for next year. They come on. They're very prolific oil wells. That's an oil market that we love to be in. It's -- current pricing for that oil is Brent plus USD 10, USD 11. So trades at a substantial premium to [ TI ] and generates an incredible amount of free cash flow. So it's an asset that has really served Vermilion well over time. We've looked, over the years, to try and add to our portfolio in Australia, but we just haven't been able to come up with anything that fits the portfolio. And so we continue to look, but if nothing else, we've got a tremendous oil asset in hand today that's producing about 4,000, 4,500 BOEs a day, and just really high netback crude.

Okay. To kind of round out the portfolio, talking -- let's talk a little bit about North America and Canada. How do you think -- how does Canada fit within kind of the portfolio? And what's -- what is the key kind of draw -- how do you create value from your position in Canada?

Well, Canada today represents probably 60% of the portfolio. So it's the biggest chunk, if you will. We've got 2 separate pieces in Alberta. We've got a liquids-rich gas play in sort of the deep basin. It's a play that's been part of Vermilion since well before I originally started here in 2003 and continues to deliver as we -- technology improves, as the information and our knowledge base improves. We continue to find opportunities. And so we continue to drill on that play. And today -- in today's gas market, that play is even more lucrative today. Like we were drilling up the Ellerslie in Alberta to get the liquids, right, the condensate and being the primary economic driver of that play in gas. It was just a by-product, but you need to get a gas market today, and we can sell that gas for $3 an Mcf. I mean it -- all of a sudden, the gas is a very lucrative product to drill. So we continue to drill that. Good success. We drill it horizontally. We frac it. It's an unconventional play but very, very strong economics to say the least. And then offsetting that, we've got oil in southeast Saskatchewan. We've got a good base in southeast Saskatchewan, 20-some-thousand BOEs a day. It's very -- it's mature, but it's got lots of, as I would call it, bread-and-butter opportunities, workovers, recompletions, drilling. We're just starting a 20 to 25 well program. It's just getting underway. We'll drill the summer. And again, the economics that we're in looking at in today's environment is somewhere in 70% return range. So again, very, very strong results and something that is low risk, and it's closer to market. So you get pretty good pricing for it. And it's something we know, we know well and we can continue to exploit over time.

Great. And final part of the portfolio, you have a position in the Powder River Basin. And are you active there now? And what are your thoughts on some of your delineation work in that emerging U.S. shale play?

Yes. No, it's -- we're drilling the Turner Sand. It's been good. We like it. We like the economics and the returns. We like the location. We had a 4-well program that we just recently completed. 2 wells came on earlier in the month at rates slightly above our type curve, so they look good. The other 2 wells were drilled but will get completed sometime in July and brought on towards the end of July, early August. We're -- again, we're mindful of the profitability. So we're combining the frac of those wells with a competitor where we participated in a well due to our ownership in the land base. And so we'll utilize the same equipment, right? We're all about keeping our cost structure down and maximizing the benefit of economies of scale and whatnot. And so for the sake of waiting for a few weeks, we can use the same equipment and reduce the cost to complete that location so -- those locations. So we'll get those wells drilled, and we've got a good inventory of opportunity there. We've got some other horizons that we see that are untested today. But again, there are things that we've identified, some strategic capital that we want to implement here over the next year or 2 to try and delineate some additional horizons. And so that land base could certainly deliver a lot more than what we see today subject to how things turn out there. So...

Okay. I want to maybe shift gears and talk a little bit about the balance sheet. And you can talk about some of the steps you guys have taken to kind of get the leverage down. I think net debt at the end of 1Q is just under $2 billion, which is down about 5% sequentially. And talk about some of the targets you have in terms of reducing leverage.

Yes, yes, yes. No, for sure. I mean we've got a long-term range that we want to operate the business in, where the balance sheet is somewhere between 0.8 and 1.5x debt to cash flow. It was a range that we used for a number of years. That was very successful for us because it provides you with the flexibility to operate through the down cycles. And we're in a commodities business. And so we know that commodities are going to cycle, right? And you have to be prepared for that. Unfortunately, we got away from that and let our debt climb to levels that just were untenable over the last 18 months, right, when you see what happened in 2020, right? So we want to get back to the way we used to operate the business. We're well on our way. Now as I said, we started the year with $2.1 billion in debt. If we generate $400 million of free cash flow, that gets us down to $1.7 billion and gets us somewhere in the sort of 2 to 2.5x debt to cash flow. So we're not at our target at this point, but we knew we weren't going to get there in a year. And frankly, with what's going on this year, that's accelerated our time line because it's been that much more positive from a pricing perspective than we expected. So -- but we're going to be patient, and we're going to be disciplined, and we're going to make sure we get our balance sheet in line. And we're well on track to seeing that happen here in the near term as opposed to the medium to long term. So...

And then how do you think about -- in my preamble, I talked about how Vermilion had returned a lot of cash to shareholders. And so how do we think about the handover from the sole focus on the balance sheet, which I think is the right objective today to perhaps one where you're taking some of that free cash flow for your like shareholders?

Yes. Well, Arun, thanks for your view that it's the right thing to do because we've had a lot of good feedback from shareholders that they agree with that. We're certainly convinced it's the right thing to do. Having said that, we've said right from day 1 that we think the dividend capital markets model is the right model, and it's a model that we want to get back to. The question is when. We don't need to get our debt to that 1.5x or less in order to reimplement the dividend, but we want to -- we have said right from day 1 that we'll need to have seen some substantial progress in deleveraging the balance sheet, and we'll need to feel comfortable with the commodity price environment as we look forward and we look out sort of 2 to 5 years. And again, nobody can predict, but you get a sense, right? And then we'll bring the dividend back. It will be a much more modest dividend. Again, our dividend strategy historically was 20% to -- 25% to 30% of cash flow being allocated to dividends. Unfortunately, we let that creep up to about 50% the last year or 2, and it just was unsustainable, particularly in the downturns. Now you didn't even need a downturn like we saw in 2020 to identify an issue with the level of dividends that we're paying. So we're going to come back, and we'll be sort of -- again, we haven't come up with a firm policy, but the discussion we've been having internally is in the 5% to 10% range of cash flow being allocated to dividend and recognizing that shareholders are looking for returns, and we want to return capital to shareholders. When we've got excess free cash flow because the commodity prices being much better than we think or our operations delivering not much more than we think, then we'll combine a modest dividend with another return to shareholders, be it through share buyback, a variable dividend is something that's come into play here in the last year. We'll consider that. I'm not sure where we end up, but we will, again, have a -- combine a modest dividend with some incremental return to shareholders when the ability to pay that is there.

Last question is we've seen quite a bit of A&D activity in North America. We've seen a lot of M&A, I think, in the depths of the pandemic, prevaccine. In the U.S., we've seen more public for private partnerships. But maybe talk to us about how you're -- how Vermilion is thinking about A&D and if you see an opportunity to get -- are you seeing some opportunities -- some -- for some value-added inorganic -- to pursue some inorganic growth opportunities.

Yes, yes. No, let me state -- start by saying that A&D has always been a piece of the portfolio that we think is valuable if it's utilized correctly. And so we haven't gone away from that. And when we say A&D, it's primarily the acquisition side. We're not really looking to divest of anything. Somebody wants to write us a big check, any of this is for sale. And we aren't actively searching to divest, but we are actively looking for opportunities. And what we've been saying for the last year, in an ideal world, we find a deleveraging transaction whereby the vendor is prepared to take back some Vermillion paper, and we accelerate the deleveraging of our balance sheet. Now those types of transactions are much harder to come by because vendors typically want cash. They don't want somebody else's paper. So we've got a -- we've looked at a couple of things. Obviously, haven't got them to fruition. We've got some other ideas that we'll continue to pursue. And in the meantime, we are looking at other opportunities that would be accretive on many, many metrics to Vermilion. And again, we've been bidding on some stuff, haven't been successful, but we're going to maintain our discipline in that market. We're not going to get caught up in a bidding frenzy. We're going to look for assets to add to the portfolio and -- that we see have got a future opportunity to provide growth. And so don't be surprised if we do something. Now given where our balance sheet is, we're probably restricted in size. If it's not a deleveraging transaction, probably $100 million, $150 million would be sort of the range that we're probably looking at. But as we get leverage back to where we want, then that expands our ability to do deals as well. So we'll be active in that market.

And with -- the last question, would it be in your existing core areas, any part that you're seeing some interesting opportunities in North America, Europe?

Well, we'd be looking to add to the existing core areas. No, no, we're not looking to add a new area, a new country, if you will. And typically, most of the M&A activity in our world is in North America. The European A&D market is very illiquid. There's not much going on. There's the odd opportunity. And again, we'll look at everything that comes to us. And to the extent that there's something that makes sense, then we'll try and transact more typically just because of the volume of transactions is a North American opportunity. But it's not to say we're not...

Curtis, we're out of time.

Okay.

I'm sorry. Sorry to speak over you, but we're out of time. Thanks for your continued support of JPMorgan and participating in our conference. Hope to see you next year live.

Yes. Well, thanks for having us. I really appreciate it, Arun. Have a great day.

Great.