PrairieSky Royalty Ltd.

Good day, and thank you for standing by. Welcome to the Prairie Sky Royalty Limited third quarter 2022 financial results conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there'll be a question and answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Andrew Phillips, President and Chief Executive Officer. Please go ahead, sir.

Thank you very much, and good morning, everyone, and welcome to the Prairie Sky World TQ3 2022 earnings call. On the call from Prairie Sky are Cam Proctor, COO, Pam Gazelle, CFO, and myself, Andrew Phillips. There's certain forward-looking information in my commentary today, so I'd ask investors to review the forward-looking statements qualified in our press release in MDMA. Before passing the call over to Pam to walk through the financials, I will provide an operational update. Strong third quarter activity of 286 FUDs and an average royalty of 8.9% should result in a strong finish to an already excellent year and a tailwind for 2023. Activity was spread across the base and the numerous walls were exploratory, testing new concepts and play ideas. Third quarter leasing was very strong as we entered into 58 leasing arrangements with 46 different companies, resulting in lease issuance bonus of $5.9 million throughout the quarter. The compliance group also had a productive quarter and brought in $3.3 million in compliance revenue. Given the confidence in our organic growth profile, our low payout ratio and the pace at which the debt incurred for the acquisitions in 2021 has been retired. The Board of Directors has made the decision to double the current $0.12 per quarter dividend to $0.24 or $0.96 per share per year. This will be effective for the Given our continued low payout ratio and organic growth opportunities, investors can expect rateable annual dividend increases in future years. This low payout ratio will allow us to retire the current debt and have significant liquidity available for opportunistic acquisitions or shareholder purchases, whichever provides the best long-term return for shareholders. The significant investment that we have made in the large heavy oil and place accumulations across the Western Canadian sedimentary basin at the inflection point of a new technology used to significantly increase recovery factors will provide our owners with per share reserve growth over the next 5, 10, and 15 years. Our once every two-year investor day is scheduled for the morning of May 17, 2023. with a range of outcomes over the medium and longer term for the business. Thank you to our owners and staff for patiently allowing us to improve our business over the last five years. I will now turn the call over to Pam to walk through the financials.

Thank you, Andrew. Good morning, everyone. As Andrew mentioned, there's certain forward-looking information in our commentary today, so I'd remind investors to review the forward-looking statements qualifier in our press release in MD&A for Q3 2022. Royalty production averaged 24,986 BOE per day in Q3 and generated another strong quarter of funds from operations, which totaled $123.5 million, or 52 cents per share. Prairie Sky's oil royalty production averaged 11,376 barrels per day in Q3. Excluding all acquisitions, oil royalty volumes increased 20% over Q3 2021 due to strong third-party drilling activity across our land base. Oil royalty revenues totaled $107.6 million in the quarter, as we realized $102.80 per barrel, which is up approximately $30 per barrel over Q3 2021. As expected, oil royalty volumes were lower than Q2 2022 following seasonal breakouts when third-party field activity slowed down and fewer new wells are drilled and brought on stream. Oil royalty revenue lagged Q2 primarily as a result of lower WPI benchmark pricing and wider light and heavy oil differentials, partially offset by a stronger U.S. dollar. We anticipate higher oil royalty volumes into Q4 in 2023 due to the level of activity on our lands in the quarter, when 268 oil wells were spud, including 107 Viking wells, 48 Clearwater wells, and 49 light and heavy Madville oil wells. Natural gas royalty revenues totaled $24.2 million in the quarter, which was up 55% over Q3 2021, as royalty production volumes averaged $65.7 million a day and benchmark pricing improved. Volumes increased due to acquisition volumes as well as 5% organic growth. Natural gas royalty production volumes remained flat with Q2, but natural gas revenue declined 34% due to lower ACO and Station 2 benchmark pricing. During the quarter, there were 18 natural gas wells split on our royalty lines, including five Spirit River wells and four Manville wells. NGL royalty revenue totaled 14.2 million, which was up 41% from Q3 2021 due to strong benchmark pricing and flat average NGL production volumes of 2,660 barrels per day. NGL royalty revenue decreased 20% from Q2, primarily due to lower benchmark pricing. Prior period adjustments totaled 1,257 VOE per day in the quarter, with 798 VOE per day related to new welcome streams and 459 VOE per day related to compliance activities. Overall, PPAs were 40% liquid. The compliance group recovered MIPS and incorrect royalties through forensic accounting, collecting $3.3 million in the quarter. During Q3, other revenues totaled $8.7 million and included $1.6 million of lease households, $1.2 million of other income, and $5.7 million of bonus consideration. Year-to-date, we have entered into 164 new leases as compared to 91 leases in the first nine months of 2021. New leasing is a leading indicator of field activity, and we anticipate near-term drilling on many of these new leases. Cash administrative expenses total $4.9 million, or $2.13 per BOE in quarter. We anticipate cash administrative expenses will be well below $3 per BOE for the full year. Current tax expense total $20.4 million in Q3. Entering the year for FSI has $1.75 billion of tax goals to offset future taxable income. So in 2022, the first $175 million of cash flow is tax-free, and the remainder will be taxed at a statutory tax rate of approximately 23.5%. During the quarter, Prairie Sky declared dividends of $28.7 million, or 12 cents per share, with a payout ratio of 23%. Excess funds from operations above the dividend and our $2.5 million of acquisitions was used to repay bank debt. Net debt at September 30th was $364.2 million, Prairie Skies has reduced net debt by 43% of $270.8 million since December 31, 2021. We are pleased to announce a 100% increase in our quarterly dividend to $0.24 per share, or $0.96 per share annualized, effective for the December 30, 2022 record date. Since IPO, Prairie Skies generated approximately $2 billion in funds from operations and returned $1.5 billion to shareholders through dividends and buybacks. We will now turn it over to the moderator to proceed with the Q&A.

Thank you. As a reminder, to ask a question, you'll need to press star 11 on your telephone. Please wait for your name to be announced. Please stand by while we compile the Q&A roster. One moment for our first question. Our first question comes from Patrick O'Rourke with ATV Financial. Your line is now open.

Hey guys, good morning. Nice pleasant surprise on doubling up the dividends here. Just curious, in terms of timing and sort of cadence in terms of review of the dividend policy going forward here, we had sort of been thinking about it as being an annual event that happened with the Q4 reporting in the February timeframe. Is this, you know, still the right way to be thinking about it? And sort of what was the sort of milestone for or motivation for this move here? Yeah, thanks for the question, Patrick. It will be an annual event in the future, typically in the February timeframe. We were just well ahead of our estimates when we made the acquisitions in terms of debt repayment and growth profile, so we were comfortable rewarding shareholders just one quarter earlier. Okay, great. And then one of the key milestones, I think, for the business is extinguishing the debt that was taken on with the heritage acquisition. Taking this into account in current strip prices, when do you forecast today that milestone happening? Yeah, it'd be in late 2024, early 2025, depending on the pricing we achieve over that period of time. But it'll be at very low levels in a pretty short period of time, just given the pair ratio still remains quite low. Okay. And then final question, more on the operational prime. Obviously, leasing has been very strong as well as FUD. How much of that is sort of being driven by that heritage acquisition and And then wondering, you know, what you're seeing in terms of the new technology deployment, multilateral wells on that land. Yeah, I know. Operationally, actually the leasing has been across the entire basin, right from some original prairie sky lands we had in southwest Manitoba all the way to the deep basin. So it's been pretty wisely distributed across the Western Canadian Basin. And then from an operational standpoint, we've seen numerous kind of stacked heavy oil opportunities where you have really good grain size drilled multilaterally and some pretty significant discoveries made across some of those heritage lands. So there's been some bite spots there. And we've even seen a light oil opportunity where the multilateral technology was tried in a formation where typically they fracture simulated almost every well in the pool. So Pretty interesting dispersion of this technology across the basin, and we look forward to the next year. It's going to be a record number of wells. We should have net capital spent on our lands. It's greater than the last two years combined this year, so we're seeing a lot of new wells filled and not just development wells and exploration wells, so it should be a fun year to watch the technological advancements on this, primarily the heavy oil, but

Thank you. One moment for our next question, please. Our next question comes from Matthew Weeks with IA Capital. Your line is now open.

Good morning. Thanks for taking my question. I'm just interested in the opportunity on the carbon capture royalty side. I know it's something that's been discussed before. I'm wondering if you've kind of looked internally and estimated you know, what the opportunity could be for carbon capture royalties on your lines in terms of a tonnage amount sort of annually over the long term.

Yeah, it's an important part of our business that we're working towards expanding. We've been approved for another project in kind of southern Alberta. I think it's a huge opportunity, particularly between kind of Edmonton and Calgary, just where a lot of the pollution corridor is, but that's where a lot of or all the big reservoirs are as well. So I think, and there you can really quantify exactly the volumes of CO2 that can be sequestered into those reservoirs. So we need a little more clarity from the government on incentives to try and align them more with what the U.S. has. But there's definitely a huge opportunity. We don't quantify the amount of carbon dioxide that can be sequestered, but it's a pretty significant amount across the basin, obviously. And I think there's a lot of people pursuing it, which is great. And I think it'll be good for the Canadian Energy Sector to show the developments on this front. Matthew. Okay, thank you. And yeah, I agree with that last point. And just a second question on the clear water.

It looks like activity is pretty strong. I'm just wondering if you could comment on, you know, generally the trend on the clear water royalties and, you know, how that might be performing versus initial expectations.

Yeah, no, thanks for the question. I think it's interesting because Nipissi and Martin Hills are kind of the majority of our 1,500, 1,600 barrels per day of net royalty production. There's been significant new discoveries made of size across the land base. That's one of the benefits of having that big early land base we put together in 2016, 2017. And those discoveries are going to start to see some development this year. So we should see some pretty significant growth, probably in the 50% range, growth year over year over the next 12 months. And then in terms of performance expectations, two things that have positively surprised the 90-day IPs has been a positive surprise across all the plays. And then the second surprise has been the success of some of the water and polymer opportunities across the land base. So I think the recovery factors will probably be a little higher than we initially anticipated. Okay, that's great commentary. Thank you. I'll turn it back to you.

Thank you. One moment for our next question, please. And our next question comes from Jeremy McRae with Raymond James. Your line is now open.

Just a couple of questions here. In terms of you guys bumping the dividend here, I'm curious what you think of the M&A market here going forward. Do you feel confident that you can bump the dividend, but do you feel like there's enough cash if you want to make an acquisition out there? What does the M&A market look like here going forward into 2023? Yeah, and I guess, you know, thanks for the question, Jeremy. I think when you think about the M&A market, we did a review of all the M&A we've conducted since 2014 when we IPO'd, and it's all been between $40 and $60 oil, so we're quite disciplined on that front and typically try and buy at those parts of the cycle. One of the interesting things that we bought last year, discounting $65 crude, was something that was for sale six years prior to that. So if you're patient and disciplined, all the best assets will end up in the hands of a low-cost realty operator. So we just maintain discipline on that front. The extent to which realty opportunities are available, we have significant liquidity and still a continued low-payer ratio to enable us to on those opportunities as they come. I think the one comment on the Canadian energy sector is that it's flush with cash, and a lot of the companies are going to debt zero in a shorter period of time. So that's great news for us because the healthy operators are helping the prairie side, and that's one of the reasons we're seeing a lot of new exploration plays developed and a lot of new leasing on new opportunities. But I think probably there is a more... It'll be a little more muted on M&A, and we certainly... would have trouble discounting $100 in an acquisition opportunity. Okay. And then just lastly, of the new leases that you guys signed here, what breakdown would you say is because the way the crown royalty is now just quite a bit higher than where it's ever been, where guys are just saying, I'm not interested in paying 35% crown, I'm more interested in paying 18% on price, guys, or I'm like, How much of this new leasing activity is because of you guys have a more favorable role to right now versus the Crown? Yeah, and I think I'll get two answers to that. One would be that the majority of the really strong leasing is just from strong oil gap and NGL pricing across the basin. I think it's strong. It's been in a long time, all three commodities. So that would probably be the major driver. Number two would be the financial health. And I think for sure there's a recognition in a lot of places where they're getting pretty quick payout that the MPB on a prairie sky section for an operator is actually quite a bit higher than it is on the Crown right now just because the walls post seats are jumping to a higher world fee. So that definitely is a benefit. It's hard to know because the operators, you know, we have 330 different operators on our lands and they don't tell us specifically why they're leasing, but I think That would be a driver in a certain place for sure, Jeremy. And just with the higher royalty rate that you guys were seeing from the new wells here, is that something we can expect going forward? Or does that drop back down to more of a long-term normalized rate, close it at 6%? Yeah, it's interesting. So our average royalty on our 42,500 wellbore portfolio is 6%. We obviously saw a very strong number in terms of average royalties for the wells that were spun on the land this quarter. A couple of them drive us out. One is the seasonal viking activity, and typically the viking wells get drilled in Q3 and early in Q4. They don't have to run a boiler on the single rigs. They're not competing with any well sands core hole drilling. And in addition, when they're fracking the wells, they don't have to heat the water up as significantly from a lower ambient temperature. So a lot of the biking activity happened, and those are typically one mile lateral, so those would be on 17.5% price at least. So that kind of drives the average royalty higher. But there is one structural change that should affect that over the next three, five, and ten years. is the heritage acquisition, all the heavy oil opportunities that exist on those lands from the Waseca, Sparky, GP, Rex, all the way down to the Cummings. Those are typically 17.9% leases, and so the Clearwater-type potential results were significantly higher royalties, so that could help bring the average royalty up and bring the net capital out as well. Okay, perfect. Thanks, Chris.

Thank you. Thank you, Chris. One moment for our next question. And our next question comes from Jamie Kubik with CIBC. Your line is open.

Yeah, good morning. Thanks for taking my question. Just a quick question on capital allocation. How should we think about the NCIB for Prairie Sky and when that could be utilized? Can you just outline a little bit capital allocation framework that you're thinking about here?

For sure. Good morning, Jamie. I think on the NCIB, if you look historically at what we've done, we've bought back a quarter billion dollars worth of stock. I think an average price of just over $14 per share. We've issued at an average of around $25. We've done it okay in the past. We have an NCIB that's out there right now. I think we will use it opportunistically. Obviously, the number one priority right now is paying the debt down to a low level, which gives you optionality on any opportunity that might come available, whether it's buying back the stock or maybe there's a better pressure to return to be achieved with an acquisition if natural gas prices get weak or something like that. So we just want that optionality, which is why we're not active with it right now, but the debt roofing that's an important priority today.

Got it. Okay. And then on the new dividend rate, can you talk a bit about maybe what commodity price you think that that is defensible down to?

Yeah, I'd be defensible down to $40 oil or $50 oil and $0 gas or something like that. But again, we'll have, you know, when you think about the businesses over the next 12 months, the debt levels are going to get very, very low on our $800 million bank line. And so even if it got anywhere near that, it would actually provide great opportunities for our business because we'll be virtually debt-free and one of the few that can sustain it at a $40 oil environment.

Okay, great. And then last question from me, a lot of activity noted in the quarter across a number of different plays. The Duvernay was absent in that commentary, though. Can you talk a bit about maybe the leasing opportunity that you have remaining there and any new activity that we should be looking for in the coming quarters?

For sure, yeah. I think we should see a couple. We have two of our three kind of primary operators in the Duvernay have some pads planned on Prairie Skylands and even some licensing that's already in place. And then we are working on some significant leasing arrangements a little further west with a number of different operators. There's a bit of an increase in activity there in terms of the leasing opportunity. And I do think certainly west of Holmes on Rimby Reef and kind of Wilson Green to the north to Pigeon Lake, there's a great opportunity there. There's been some pretty interesting discoveries made. And a full-scale development of that could be a very significant operating asset for Prairie Sky. It could be in the range of 1,000 to 2,000 net royalty barrels per day from a very low level today, which would be 350 barrels per day.

Okay, that's great. Thank you. That's it for me.

Thank you. As a reminder to ask a question, that's star 11. One moment for our next question. Our next question comes from Mitch Cantor with Mountain Lake Investment. Your line is open.

Good morning, guys. I guess, Andrew, I noted in your opening comments that you talked about optimism in the trend in reserves per share on a 5, 10, and even 15-year basis. Some of the factors contributing that you probably touched on, but I'm wondering, What else you're looking at when you think about that opportunity?

Yeah, no, thanks for the question, Mitch. And what's interesting, and if you reference our realty playbooks or our asset handbook that we've released in the previous three cycles, so over the last six years, typically on a lot of these heavy oil reservoirs, we have a 5% to 7% recovery factor, maybe slightly higher if there's a water, palm, or flood opportunity on it. But what's happened with these multilaterals is you're achieving far higher recovery factors and probably having a far more optimal water or polymer flood in the future. So what it's basically done is the same. This is the neat thing about technology and the great optionality that you have when you own a real PF, that is we've owned a lot of this stuff for almost a decade now, and we've always said, okay, well, the total recovery is going to be 100,000 barrels on this section, and Lo and behold, you could probably get another million barrels out of it with the new technology. So that's kind of the major change in the multilateral technology has kind of advanced this, specifically on the heavy oil reserves that the company owns. So it just gives us confidence that that should continue to grow as more of these different zones within the Mandel stack are developed with horizontal multilaterals.

Interesting. So it's the... existing technology just rolling out, in a sense, through the accounting in the portfolio.

Precisely, yeah. And having said that, there are some new discoveries as well that are completely brand-new discoveries, but a lot of this heavy oil resource has been known accumulations over the last 50 years. There just hasn't been a way to exploit it until this technology evolves in a low-cost manner.

Great. Thank you.

Thank you. And I'm currently showing no further questions at this time. I'd like to hand the conference back over to Mr. Phillips for any closing remarks.

Thank you, everyone, for dialing in to the Prairie Sky Q3 conference call. And at any time, please call either Pam or myself if you have any follow-up questions. Have a good day.

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone have a wonderful day.