Vermilion Energy Inc. Common (Canada)

Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Q3 conference call. Please note that all lines have been placed on mute to prevent any background noise. Mr. Dion Hatcher, you may begin your conference.

Well, thank you, Sylvie. Good morning, ladies and gentlemen. Thank you for joining us. I'm Dion Hatcher, President and CEO of Vermilion Energy. With me today are Lars Glemster, Vice President and CFO of Darcy Kerwin, Vice President International and HSE. Bryce Kremnicka, Vice President North America. Jensen Tan, Vice President Business Development. Kyle Preston, Vice President of Investor Relations. We'll be referencing a PowerPoint presentation to discuss our Q3 23 results. Presentation can be found on our website under invest with us and events and presentations. Please refer to our advisory on forward-looking statements at the end of the presentation. It describes the forward-looking information non-GAAP measures and oil and gas terms used today and outlines the risk factors and assumptions relevant to this discussion. Production during the third quarter averaged 82,727 views per day, which was at the top end of our Q3 guidance range of 80 to 83,000. This is mainly due to the successful restart of the WANDU facility in Australia in early September and an efficient turnaround at the core facility in Ireland, which was completed five days ahead of schedule. In addition, we continue to see strong operational performance across the majority of our assets. We generated $270 million of fund flow, which represents a 9% increase over the prior quarter. We invested $126 million of E&D capital, resulting in $144 million of free cash flow, which represents an 80% increase over the prior quarter. This level of free cash flow was more than sufficient to fund current asset retirement obligations, lease payments, and the base dividend. with the excess free cash flow allocated to debt reduction and share repurchases. During the quarter, we returned $20 million to shareholders through the base dividend and share repurchases, and we have returned $115 million to shareholders year-to-date, representing about 35% of our free cash flow. Given the improving free cash flow profile, we are now targeting 30% return of capital in 2023, compared to the prior range of 25% to 30%, until we achieve our net debt target of $1 billion. Continue to make progress on debt reduction, with net debt decreasing approximately $80 million from the prior quarter to $1.2 billion at the end of the third quarter, representing a trailing net debt to fund flow ratio of 1.2 times. Based on the forward strip pricing, we expect to achieve our $1 billion debt target in Q1 of 24, at which time we plan to increase the amount of capital returned to our shareholders by the base dividend and share repurchases. Moving on to the operational updates for the quarter. Production from our North American operations averaged 56,758 BUEs per day in Q3, an increase of 5% or 2,700 BUEs per day. From the prior quarter, mainly due to strong recovery following fire-related downtime at our deep basin assets and new production from our recently drilled wells in the U.S., In the Deep Basin, we drilled two and completed one man-built liquids-rich gas well. At MICA, we brought on production four Alberta Montanay liquids-rich gas wells, which are producing into constrained Montanay infrastructure capacity of approximately 8,000 meters per day. In Saskatchewan, we drilled 10, completed nine, and brought on production eight oil wells. In the U.S., we brought on production five oil wells in Wyoming, where production increased 21% from the prior quarter. We continue to progress our BC Montanay development. During the third quarter, we completed the site preparation and awarded all major contracts for our 16,000 BOPD battery in BC. We're excited to break ground on the battery in August, and we'll continue to progress this project over the next several months. Shown here is a clear battery site awaiting delivery of the facility modules that are currently in fabrication. The key piece of infrastructure will underpin the future development and growth of our BC Mike and Montney asset. The majority of construction is scheduled to occur in the first half of 2024, but the battery is expected to be operational by mid-2024. With the additional capacity provided by this battery, we are able to move forward with our growth phase of our mica asset. Our upcoming winter program includes 11 wells on our BC lands, offsetting our recent 16-28 BC pad. which is produced at an average per well rate of 1,150 BUs per day over the first six months with an average 36% liquid yields, which is mainly oil. Given these strong rates, we are piloting a dam spacing program to evaluate the potential for drilling more wells in BC.

Production from our international operations average 25,969 BUs per day,

a decrease of 11% from the prior quarter, mainly due to planned turnaround in the core facility in Ireland, and natural declines partially offset by the resumption of production in Australia following the restart of the Wando facility. In Australia, we successfully completed the remaining inspection and repair work on our Wando facility and restarted production in early September. The wells continue to produce at strong rates with Australia expected to contribute approximately 4,000 barrels per day into Q4 and through Q24, This is resulting in 150 million positive swing in free cash flow relative to 23. In Ireland, we successfully completed the major turnaround at Corb five days ahead of schedule in August. Corb is forecast to produce approximately 10,000 bees per day, net to 4 million, a premium price European gas in Q4. We're excited about the future European gas growth potential in both Germany and Croatia, and we'll speak more about those projects on the following slides. On the left of this slide, we have a picture of the drilling rig on our first of two exploration targets in Germany. On the picture on the right is a map of our German and Netherlands land to illustrate the proximity. We see our development plans in Germany as a natural extension of the successful drilling campaigns we've executed over the past two decades in neighboring Netherlands. We have approximately 700,000 net acres of undeveloped land in Germany, located approximately 300 kilometers east of our producing fields in northern Netherlands. or similar distances between Calgary and Edmonton. Our gas exploration targets are on trend to the Netherlands place where we have drilled 29 gas wells over the past two decades with an average success rate of over 70%. The Germany exploration targets are deeper and higher risk, but have a much larger resource potential than the Netherlands. In addition, we have access to existing infrastructure network, regulatory support for permits, and a track record of execution in Germany. With the success of our Germany exploration drilling program, we believe our land base can support a multi-year drilling campaign, providing Vermilion with years of organic production growth of high-value European gas. In Croatia, we started site preparation for the gas plant, which is scheduled for start-up in mid-2024, and will facilitate production from the SA-10 block, where we have previous gas discoveries. This gas is currently behind pipe, awaiting startup of the gas plant, and we see additional prospects in our acres for future development. At current strip pricing in a mid-year startup, we would expect approximately $40 million of fund flows in 2024. I will now pass it over to Lars to discuss our guidance and financial outlook.

Thank you, Dion. Our 2023 production guidance remains unchanged, with Australia back online and the planned turnaround at the core facility in Ireland complete. We remain positioned to deliver annual production of 82 to 86,000 BOE per day and Q4 production of 86 to 89,000 BOE per day. Our operations teams have done a great job offsetting the forest fires in Alberta and extended downtime in Australia, resulting in strong performance across our asset base. We increased our 2023 capital expenditure guidance by $20 million to $590 million to accommodate accelerated BC multi-drilling into Q4. This ensures we secure a high-performing rig and drill some of the wells before winter, which helps reduce costs. In addition, it also gives us production behind pipe to be ready for a potential early startup of the new BC battery should construction go better than planned. We plan to release our 2024 budget and guidance in the upcoming week. which will also include an update to our return to capital framework. 2024 capital expenditures are expected to increase by about 5% over 2023 levels due to infrastructure spending required to advance our BC mica monte development, and we anticipate corporate production will be consistent with 2023 annual levels. Given the expected increase in FFO and free cash flow generated by the business, Driven by the full-year impact of the core acquisition and Australia, we are able to advance long-term organic growth projects that will support profitability and shareholder returns over the long term. That increasing 2024 cash flow just referenced is the key takeaway of this slide, as well as the significant improvement in our financial position over the past several years. By the end of 2023, we will have nearly cut our debt in half, as shown in the red bars, while also funding over $1 billion of strategic acquisitions. We have also significantly increased our FFO from pre-COVID levels, as shown in the blue bars. This progress is reinforced with an estimated 2024 debt to FFO leverage of 0.6 times. Although we have not finalized our 2024 budget, we are currently forecasting FFO to increase to $1.4 billion. assuming a flat production profile at current strip pricing. With this, we expect to achieve our net debt target of $1 billion during the first quarter of 2024, which will be the trigger for increasing our return of capital to shareholders from the current target of 30%. On this slide, we show free cash flow based on recent pricing and the breakdown of how free cash flow was allocated. the majority of FCF was allocated to debt reduction and acquisitions for the period of 2021 to 2023. We expect to generate significantly higher year-over-year FCF in 2024 due to the full-year impact of the core of acquisition, heading Australia back online for a full year, and first gas from our SCA 10 project in Croatia. These three items alone contribute an expected $270 million year-over-year increase to FCF. which is further underpinned with robust and well-hedged European gas prices. This will position us well to invest in our assets and increase our percentage and absolute level of free cash flow return to shareholders in 2024. With that, I will pass it back to Dion.

Thanks, Lars. I'd like to take this opportunity to provide some background on European gas as we head into the winter heating season where European consumption typically increases 30 to 40 BCF per day compared to the summer. Last year, Europe lost approximately 12 BCF a day of Russia's supply, which has resulted in an even greater dependence on LNG imports. Last winter, Europe's demand was down about 10 BCF per day compared to the prior winters, due to it being the second warmest winter on record and government policy focused on gas conservation. Even with this, gas averaged over $30 Canadian during the winter. Combination of a very warm winter and government policy to mandate full storage during the summer has resulted in European storage being effectively full today. Reality is that Europe will continue to depend heavily on LNG imports to meet winter demand. It may be more challenging this year due to higher Chinese demand, post-COVID-0 policy, and potentially a return to a more normal winter. Any potential supply disruptions or increased demand from Asia will put upward pressure on Euro gas prices. You can see the impact from this tight supply in the forward curve on this slide as European gas prices continue to hold at or above $20 Canadian for MMBTU. We sell directly into the European gas markets, not by analogy, so we realize these high prices. For the upcoming periods in European gas, in Canadian dollar terms, we have 45% hedge for Q4-23 at an average floor of $34.00. 38% hedged for 24 at an average floor of $33. 20% hedged for 25 hedged at an average floor of $22. These hedge prices are 13, 11, and 6 times higher than equivalent periods of Canadian equal gas prices. We will continue to be opportunistic during periods of volatility to increase our hedge position. Including all of our products, we have approximately 30% of our corporate production hedged for 24. provides greater certainty on achieving our debt targets and supports our return of capital to shareholders. In closing, it's an exciting time for Vermillion and its shareholders. We're gaining operational momentum with Australia now back online, the Micah BC Battery and Croatia Gas Plant construction underway, and the first well of our German gas exploration program being drilled. Second, we have direct exposure to premium price European gas, which remains an extremely tight supply. and we are progressing projects to increase our European gas production. We are pleased with our current hedge levels and will continue to be opportunistic during periods of volatility to add more hedges. Third, we are seeing the benefits of the strategic asset high-grade and focus on debt reduction with a significant increase in 24 free cash flow. With that, we are on track to achieve our debt target in Q1 2024 and intend to increase our return on capital to shareholders. That concludes my prepared remarks, and with that, I'd like to open it up for questions.

Thank you, sir. Ladies and gentlemen, if you would like to ask a question, please press star followed by one on your touch-tone phone. You will then hear a three-tone prompt acknowledging your request. And if you would like to withdraw from the question queue, please press star followed by two. And if you are using a speakerphone, we do ask that you please lift the handset before pressing any keys. Please go ahead and press star one now. If you do have any questions, the first question will be from Travis Wood at NetBank Financial. Please go ahead.

Yeah, good morning. Thanks for taking my question. I wanted to get a sense of 2024 in terms of volumes and a bit of cadence. I know you've provided some indicative commentary in terms of the average rates, but with a strong Q4 this year and then some interesting projects and facilities and kind of a drill-to-fill program in Canada for the Montney, how should we be thinking about volumes through the beginning of next year and into later next year as you kind of start to fill those facilities? And then if you could maybe some kind of year-over-year comparison on CapEx would be helpful as well. Thank you.

Thanks, Travis. I can take this one. This is Dion. We'll be providing more details when we release our budget in the upcoming weeks, as noted on the call. But I think how you should be thinking about it is, as noted, flat volumes and capital, you know, 4% to 5% higher, really driven by the increased investment in infrastructure in the Montenegro. From a cadence point of view, again, we'll provide more details later, but the two significant drivers of that would be the Montney battery. That 16,000 BUD battery would be mid-year. We'll have a pad behind pipe ready for that startup. Until then, we're capacity constrained. As well, that SA-10 plant that we talked about, it's about 15 million a day of gas, but again, mid-year. So, Again, we'll provide more details, but really there will be a ramp up in the second half of the year is how we're thinking about it.

Okay, that's perfect. Thank you very much for that. Thanks, Rebs.

Thank you. As a reminder, ladies and gentlemen, please press star 1 if you have a question. And your next question will be from Dennis Fung at CIBC. Please go ahead.

Hi, good morning, and thanks for taking my questions. I guess my first one here is, obviously, with the upcoming potential completion of the infrastructure there in Croatia, can you outline a little bit more of the opportunity set that exists there and what that could mean kind of going forward, especially given its European gas revenue line? Thanks.

Thanks, Dennis. I'll pass that over to Darcy to provide some detail on Croatia.

Yeah, thanks, guys. Darcy here. Yeah, so we're currently in the process of building that Croatian gas plant. Dion mentioned earlier that's kind of got a nominal sales capacity of about 15 million cubic feet a day. I think in Europe you need to think of those numbers, not necessarily in terms of just in terms of volume, but in terms of the much higher net back that we get in Europe versus here in North America. So if we think of Croatia at a $20 Canadian in MCF, Those two wells going through that plant in SA10 forecast to generate $10 million of revenue per month, and with netbacks that are seven or eight times what they are in Canada going forward. In terms of future potential on that block, we do see some prospects there. The intent there would be to, over time, continue to drill that block to keep that plant full over time. Outside of the block of SA-10, of course, we have SA-7, which is a pretty prospective block that we're quite excited about with intent to drill four wells on that block in early 2024. Thanks, Darcy.

Great.

Appreciate that caller there. My second question, just, Lars, thank you for providing that update around the financials and the driving down of, obviously, net debt. Can you talk towards a little bit more around, A, where maybe even next net debt target looks like and how you think about capital structure as well as how the company and the board will think about free cash flow allocation once you kind of get towards that level. Thanks.

Great. Thanks for the question, Dennis. Yeah, so as we referenced, that next debt target will be $1 billion. Linus cited that in the first quarter of 2024. and looking forward to providing what that next step is going to look like with the budget release here in the coming weeks. I think the best way to think about it is we do have a clear plan in place in terms of getting to that debt target. I think the big thing that we're trying to emphasize as well is if you look at the free cash flow for 2024, Not only is there going to be an increase in the percentage of free cash flow that is allocated to return of capital for shareholders, but the absolute amount of free cash flow as well is increasing quite significantly in 2024 to 2023, kind of that 60% or $300 million year over year. In terms of debt targets beyond that, you know, we're quite comfortable with that $500 million to billion dollar range. The lower end of that target will represent the amount of debt that we have turned out to 2030. And so we think that that's a good way to think about longer-term debt levels for Vermilion.

Thanks, Cyrus. Great. I appreciate that. I'll turn it back. Thanks, Dennis.

Thank you. And at this time, gentlemen, it appears we have no other questions registered. Please proceed with any additional comments.

Well, with that, I'd like to thank you again for participating in our Q3 conference call.

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for calling. And at this time, we ask that you please disconnect your lines.