Topaz Energy Corp.

Good morning, my name is Michelle and I will be your conference operator today. At this time, I would like to welcome everyone to the Topaz Energy Corp fourth quarter 2022 results conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press the star followed by the two. Thank you. Mr. Kirker, you may begin your conference.

Thank you, Michelle, and welcome everyone to our discussion of Topaz Energy Corps' results for the three months and years ended December 31, 2022, and 2021. My name is Scott Kirker, and I'm the General Counsel for Topaz. Before we get started, I refer you to the advisories on forward-looking statements contained in the news release, as well as the advisories contained in the Topaz Annual Information Forum and its MD&A available on CDAR and on the Topaz website. I also draw your attention to the material factors and assumptions in those advisories. I'm here with Marty Staples, Topaz President and Chief Executive Officer, and Cherie Stevenson, Vice President of Finance and Chief Financial Officer. They will start by speaking to some of the highlights of the last quarter and the year so far, and after the remarks, they will be open for questions. Marty, Cherie, go ahead.

Good day. Thanks, Scott. Appreciate that. Thanks for everyone for attending. 2022 was an exceptional year for Topaz. We achieved record production of 18.3,000 BOE per day in the fourth quarter, and average production for the year was just under 17,000 BOE per day. Our average royalty production grew 20%, which includes the impact of the contractual terminating gross overriding royalty changes, which came into effect January 1, 2022. Without the Gore changes, our production growth was 26%. Fourth quarter production demonstrates the full impact of our acquisition and diversification strategy as the Delta Stream acquisition was effective for the entire fourth quarter. Most of our acquisitions have been liquids focused in order to diversify and complement our premium natural gas royalty portfolio. Q4 total liquids volume weighting was 29%, which has changed significantly from 7% total liquids volume at inception of the company. For the fourth quarter, 56% of our royalty revenue was from total liquids and 44% of royalty revenue was natural gas. Our 2022 reserve report demonstrates the strong organic development activity by our strategic operators. Year over year, our total approved plus probable developed reserve volume increased 13% to 47.5 million BOE. Drilling additions combined with positive technical revisions out of 9.1 million BOE of reserves which represents 1.5 times the replacement of 2022 royalty production of 6.2 million BOE. In addition, our acquisitions added 2.6 million BOE of reserves. Please note that as a royalty entity not responsible for the capital, we do not book probable locations or future development capital. The probable and developed reserves attributed to our royalty acreage can be seen through our strategic operator reserve reports, which are available or will be available on CDAR. Our infrastructure business continues to provide stable, inflation-protected income, which enables strong dividend support. Through 2022, we realized 99% utilization of our natural gas processing capacity and generated total processing revenue and other income of $65.8 million. Our exposure to operating costs is limited to approximately 50% of our infrastructure assets, as per the 10 to 15-year contracts we have in place. in addition to certain contractual inflation adjustment mechanisms, provide strong inflation protection for Topaz. We incurred $6.4 million in operating expenses in 2022, resulting in infrastructure operating income of $59.4 million, which represents 38% of our total 2022 dividend. In the fourth quarter, Topaz generated cash flow of $86.3 million, 11% higher than the prior quarter. For 2022, Topaz generated cash flow of $370 million, which represents 75% growth over 2021. In 2022, we distributed 47% of our cash flow to shareholders through dividends, and we allocated $173 million of excess free cash flow and used just over one-time leverage to complete a combination of royalty and infrastructure acquisitions. In total, we completed $436 million in our acquisitions during 2022. The royalty acquisitions are 80% liquids weighted and increased our royalty acreage 15%, which are estimated to provide 2,000 BOE per day of 2023 royalty production. The infrastructure acquisition increased our 2023 fixed revenue by 7%. Our hedging strategy is designed to protect acquisition economics and dividend sustainability, which generated a $1.6 million gain in Q4 2020. and the mark-to-market gain of all outstanding contracts as of February 28th forward pricing is approximately $11 million. Our 2023 natural gas fixed price heading contracts represent approximately 16% of our 2023 estimated natural gas production and provide an average of $0.38 per MCF above current stripped to Topaz's 2023 guidance. Recently, we financially diversified approximately 9% of our 2023 natural gas pricing exposure using ACO basis of $0.78 per MBTU, which is equivalent to the actual transport cost to deliver to U.S. markets. During the fourth quarter, we expanded and extended our four-year covenant-based credit facility to $700 million, which has an accordion feature providing $300 million of incremental credit capacity for which we do not pay standby fees. During the quarter, Topaz reduced net debt by $34 million, and subsequent to year end, we have repaid an additional $55 million on our credit facility. We have provided a 2023 guidance range of $308 to $316 million, which is based on estimated average annual production range between 18.3 and 18.8 thousand BOE per day, the midpoint of which represents 10% growth over 2022. Our guidance is based on expected operator development plans, commodity prices of $2.86 an MCF for natural gas, eco-based, and U.S. $75.55 barrels WTI for crude oil, and incorporates outstanding financial derivative contracts. After payment of 2023 estimated dividends of $173 million, Topaz expects to generate between $114 and $121 million of excess free cash flow. exiting 2023 with estimated net debt below $290 million before giving effect to any incremental acquisitions. We're pleased to share achievements that continue to expand our trading liquidity despite Topaz's young history as a public company. In addition to being added to the S&P TSX Composite Index in December 2021, Topaz was added to the FTSE Renaissance Global IPO Index in December of 2022 and will be added to the FTSE Small Cap Index of effective March 2023. We have continued to improve our ESG profile and recently achieved low risk ratings from Morningstar Sustainalytics and Institutional Shareholder Services, which demonstrates Topaz's unique energy investment structure. I look forward to discussing Q1 with you on the next call and we're pleased to answer any questions at this time.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. Should you wish to decline from the polling process, please press the star followed by the two. If you are using a speakerphone, please lift the hands up before pressing any keys. One moment, please, for your first question. First question comes from Aaron Bilkowski of TD Securities. Please go ahead.

Thank you. Good morning. I guess my first question is, how are you thinking about the proportion of revenue coming from the infrastructure business? Maybe said another way, what's the ideal weighting in your mind?

Yeah, good morning, Aaron. So we've always kind of talked about it and thought about being 50-50. Right now we sit at 20% of our revenue is infrastructure weighted, covers 38% of our dividend. We had a lot of opportunity over the last two and a half years to get involved in the business and really expand that part of our business. We have grown our infrastructure business quite significantly. I think we've just grown the royalty business that much more. We have been active looking at different infrastructure opportunities. I've closed some smaller opportunities as well. But yeah, I think over time, we do expect to step up the infrastructure business.

So maybe a related question. How much leverage would you be comfortable with putting on the balance sheet to acquire infrastructure assets, maybe relative to upstream assets?

Yeah, you know, I think max probably two times, and that would definitely be infrastructure-focused, but I think we'd be most comfortable overall corporate leverage between one and one-and-a-half times. But, yeah, definitely willing to push a bit further from an infrastructure perspective.

Thanks, Sheree. If I can ask maybe one or two more questions. In your release, you talked about the number of wells drilled on your royalty acreage in 2022. If you apply a capital cost to each one of those wells, how much gross third party capital do you think was spent on your land last year?

Well, we haven't done the exact math, but I would say there is over $2 billion of capital deployed across our acreage. And we would expect somewhere in the neighborhood of $2 to $2.3 billion in 2023.

Yeah, I think we maxed out last year at 32 rigs on our royalty acreage. Right now we're sitting around 29, so even with reduced activity in the basin, I think we still see a lot of activity just based on the quality of our acreage that we own.

Alright, one more sort of detailed drilling question for you. What does that 564 gross wells drilled in 2022 equate to on a net basis?

It is. I don't have that right in front of me, but I do have that number, so I can circle that back to you after the call. Perfect.

Thank you, guys. I appreciate it. Thanks, Eric.

Thank you. The next question comes from Luke Davis of RBC. Please go ahead.

Hey, good morning. Just wondering if you guys can frame out some of the activity assumptions that are implicit in the low and high end of your guidance. Just trying to get a sense for where the biggest swing collectors are.

Yeah, for sure. So, you know, the guidance, the midpoint essentially follows the midpoint of our most strategic operators capital plan. So we kind of ebb and flow within our guidance range to where their guidance ranges are. And the midpoint would assume our other properties, call it our fee title mineral acreage, things like the way burn assets, some of our really lower decline assets. resilient assets stay flat. So recently we've seen a lot of activity pick up across the reserve and Keystone acreage. So I'd say the midpoint is maybe a bit conservative to where we've seen recent activity. But those are the kind of properties we wouldn't bank on growth because we can't see the transparency of the capital deployment. So there's some modest swings there, but it's less material to the portfolio. And then the overall guidance range would kind of ebb and flow between the kind of key operators' public guidance ranges.

That's helpful. Also, wondering where you'd see the most potential upside activity-wise on your royalty land if pricing trends above where your deck is currently?

It's absolutely always going to be driven by term lane just because the magnitude of the acreage we own, and just the size within our portfolio. Obviously, Clearwater has high growth rates, but it's a smaller wedge relative to the tourmaline fees. So, you know, I think market supply-demand, pricing, availability to services, all those kind of things will kind of dictate the tourmaline gauge within the guidance ranges.

Yeah, and one thing I will say about that as well, Luke, is we do see 13 to 14 rigs on tourmaline's acreage, and They have not communicated through their five-year plan that they would accelerate any type of drilling activity. So I think that's pretty sound, that 13 to 14 rigs, and that kind of grows tourmaline at 3% to 5% per year. I think the goal for tourmaline right now, and I'm not speaking for them, but they've said this publicly, is they don't want to disrupt supply-demand imbalance right now, and I think that's why they're monitoring their growth. So the bigger wedge, I think, ultimately ends up happening, kind of what Sri mentioned before on some of this fee land that we've We've seen kind of more activity on for the last kind of eight months while oil price was higher. And not just on the oil side, but as well the gas side through the summer as well on some of the reserve royalty lands that we had. So very nice added surprises to the portfolio.

Really helpful. Thanks. That's it for me.

Thanks. Thank you. The next question comes from Joseph Skatchter of Skatchter Energy Research. Please go ahead.

Good morning, everyone, and thanks for taking my calls. My questions, two questions for you. You make a note in there about the blueberry frustrations with the B.C. government and potential growth there. Do you see much happening in 2023 or is this a 2024 potential upside for you as companies start work to get volumes ready for the coastal gasoline line?

Yeah, good question, Joseph. We've already seen permits start to get released. I know there was a bunch in the queue and termling has been a big benefit of seeing some of those permits, early permits released in the Blueberry River First Nations Agreement. So very positive from that standpoint. So it's kind of my comment before, I don't think we're going to see a massive ramp inside 2023, but I do think it's going to be a lot more economic to drill some of these paths that They were waiting on permits for it, but they would have communicated early in January. So a big positive for us. The real ramp is going to come mid-decade when LNG Canada kind of comes on stream. And I think that's when a lot of the producers, particularly Tourmaline, are building into this. And that's, for us, where we see the biggest ramp in our portfolio over the next decade coming.

So would that really start in 2024 because of just the timeline? Yeah.

It's going to it's going to step slowly 2023 2024 and then a bigger ramp in 2025. So keep in mind Conroy Conroy facility is planned for 2025. It's a 400 million a day facility, the biggest project plan in Western Canada. We have a royalty on 99% of that acreage out there, so we're a direct benefit of the Conroy facility being built, but really that's commissioned kind of 2025 and that's what we're timing kind of the massive round for.

OK. Yeah, I remember that now. Last one for me. With the price stack coming down and especially natural gas side liquids as well, do you see more opportunity for deals as the deal flow more active now so that we could see announcements sometime Q2, Q3 of deals? Is it easier to do deals now with the commodity price down and is the traffic flow higher?

I think the traffic flow is relatively the same. You know, for kind of the latter part of Q4, start of Q1, the tier stepped down a lot, and I think that's why you didn't see us doing a lot of transactions is just the quality wasn't there that we were looking for. I wouldn't say deals are ever easy. At this higher commodity cycle, you know, we're happy to sit and wait and wait for, you know, lower commodities to kind of come around. Yeah, there might be some more gas-weighted opportunities. I think more likely you see a lot of these gas transactions that were looking like they were going to transact, probably stall a little bit and wait for better gas prices. There isn't the same urgency for producers, I think, to do a disposition. All of a sudden, they're healthier right now. They've got better balance sheets. But I think there's always opportunity for the Topaz entity, whether it be on the royalty or infrastructure side. And we're going to continue to monitor, examine. A lot of those opportunities are available.

Super. That's it for me. Thank you very much. Thanks, Joseph.

Thank you. The next question comes from Jamie Kubik of CIBC. Please go ahead.

Good morning. Thanks for taking my question here. A little bit already answered perhaps, but can you talk about some of the drivers of increasing the credit facility at the current time? And maybe on the back of Erin's earlier question, can you just frame out some of the qualities that a potential acquisition might need to fit Topaz's criteria? Thanks.

Yeah, I can speak to the credit facility. So we definitely weren't in a position we needed to increase our credit capacity, but it was available to us. You know, we maintain the same pricing structure, have an opportune structure where we have M&A capital available to us with just agent consent, and we don't pay standby fees on that. So, you know, in a volatile credit type of market and seeing some potential further pressure in the future coming from banks from a cost structure perspective. We thought it was opportune for us to expand that capacity to have the well-costed liquidity available to us. Not necessarily a full intention of using that. As I mentioned, we definitely have a modest leverage strategy, so it's not to go use that tomorrow as per se, but good structure, good term, good bank support, and You just never know what the market's going to do, so nice to have that within our toolkit.

Yeah, and I think it keeps our liquidity very well protected. You know, the message here isn't, hey, we're running out to go do a transaction. The message here is we have the ability to use some debt if need be, if something really good comes along. And so we're ready for that. You know, the criteria hasn't changed since day one, Jamie. I think it always starts with the quality of the asset. number two, the quality of the owner, and number three, how accretive it is back to Topaz and Topaz shareholders. So that has not changed. That is always our criteria when we look at any asset on the infrastructure royalty side.

Okay, that's helpful. And then maybe an additional question here. You know, Topaz maintains a dividend payout target of 60% to 90% on our numbers, and as you indicate in your press release as well. Forecasts look like you're trending below that this year, even with a meaningfully lower natural gas price than what we entered the year at. What would be a driver to potentially increase the dividend this year if you were to do so?

We've always looked at the dividend as an output of the business. We've tried to time it alongside growth. If M&A is just not available to us, I think that is an opportunity for us to increase the dividend. It's still out there. We're still in data rooms. looking to support transactions or kind of put together our own idea of manufacturing a gore or streaming some type of infrastructure component. So we know some things are coming to market. We wanted to make sure that we didn't increase the dividend just to increase it. And I mean, we're sitting above a 6% yield right now. So I think it's quite healthy, the dividend as it stands today, even at that kind of 60% payout ratio.

Okay, thanks. That's it for me. Thanks for taking my questions.

Thanks, Jamie.

Thank you, Jamie.

Thank you. The next question comes from Mike Dunn of Stifle First Energy. Please go ahead.

Thanks. Good morning, folks. I think you've mostly answered this question, but I know you've been focusing at least your producer, Gore, acquisitions on oil in 2022. Did you have, I guess, a target you'd want to get to in terms of the oil versus gas split and Just wanted to hear your thoughts. Are you still sort of actively looking at, you know, I guess more gas-weighted gore acquisitions too, just to not close off any opportunities that might come up?

You know, the important part for us over the last two and a half, three years was to diversify our business, and I think we've done a good job of that. 30% of our revenue now liquid-weighted, and that was important through this cycle. Ultimately, we're big gas bulls. I would add more gas to the portfolio if it was in the right part of the basin. But keep in mind, being tied to this massive drill program that's going to happen in northeast BC with the development of Conroy, it is the largest project planned in the next 10 years in the western Canadian sedimentary basin. We're always going to get bigger on the gas side just by being attached to tourmaline. So I think we were able to achieve and add very good assets at an opportune time on the oil side, being in the Clearwater, Charter Lake, Southeast Saskatchewan. I mean, that CO2 project that we're involved in with Whitecap is about the flattest project I've ever seen. It only declines to 2% a year. It's pretty steady business, and they do a great job operating out there. So if the right project comes along, I wouldn't say we'd say no to an oil acquisition, but at $75, $80 WTI, it better be the highest of quality if we're going to invest in something like that.

Right. Okay, thanks, Marty. That's all for me.

Thank you, Mike.

Thank you. There are no further questions. I will turn the call back over to Mr. Staples for closing remarks.

Okay, thanks, everyone. Appreciate you tuning in and look forward to catching up with you in Q1.

Ladies and gentlemen this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.