Topaz Energy Corp.

Good morning. My name is Joelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Topaz Energy Corp. Second Quarter 2023 Resolve 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 star, followed by the two. Thank you, Mr. Staples. You may begin your conference.

Good day. Thank you, Joelle. And good morning, everyone. Welcome to our discussion of Topaz Energy Corp's results as of June 30th, 2023, and for the three and six month ended June 30th, 2023 and 2022. My name is Marty Staples and I am president and CEO of Topaz. With me today is Sri Stevenson, CFO and VP Finance. Before we get started, I'll refer you to the advisories on forward-looking statements contained in the news release. as well as the advisories contained in the TOPEZ annual information form and our MD&A available on CDAR and our website. I also draw your attention to the material factors and assumptions in those advisories. We will start this morning by speaking to some of the highlights of the last quarter and our year so far. After these opening remarks, we'll be open for questions. TOPEZ second quarter average royalty production of 18.4 thousand BOE per day includes a new record in total liquids royalty production 5.5,000 barrels per day. Second quarter production was approximately 2.5% lower than the prior quarter due to planned facility maintenance, spring breakup conditions, and unplanned impacts related to BC and Alberta wildfire situation. However, no significant asset damage or injuries have been reported. From Q2 of last year, production grew 10% driven by acquisition activity and operated funded drilling development across our acreage. Year over year, Topaz's second quarter total liquids royalty grew, production grew by 41%. During the second quarter, 106 gross wells were drilled on our acreage, a 4% increase from prior year. Of the new wells drilled, 38 were brought on production, leaving 68 gross wells that will be brought on production in subsequent periods. Second quarter drilling activity was diversified across Topaz's portfolio as follows. 51 Clearwater, 31 Northeast BC Montney, 11 Peace River, 1 West Central Alberta, and 12 Southeast Saskatchewan slash Manitoba. Year-to-date in 2023, 270 gross wells were spread across our royalty acreage, a 13% increase from the first half of 2022. Year-over-year, our acquisition activity increased our gross royalty acreage 3%. Of the 270 gross wells drilled, 167 gross wells, or 62%, were drilled in the Clearwater and Northeast BC Montane our high-growth areas. Average royalty production from these areas combined has increased 21%. There are currently 26 to 28 rigs active across our royalty acreage, and based on planned operator drilling activity, we expect this activity to continue through the third quarter. Our Q2 royalty production revenue of $57.7 million was 29% weighted towards natural gas royalty revenue and 71% to total liquids royalty revenue. Topaz's realized pricing before hedging was $2.38 per mcf for natural gas and $90.61 Canadian for light oil. Relative to benchmark pricing, ACO 5A and Canadian dollar Edmonton PAR, Topaz's differential for quality and transport were 7 cents per mcf for natural gas and $4.91 per barrel for light oil. In Q2, Topaz realized a $4.9 million hedging gain, which increased Topaz's total realized price on a per BOE basis by $2.95, or 9%. Our infrastructure business continues to deliver inflation-protected income, which further supports our dividend. Through Q2, we realized 98% utilization of our natural gas processing capacity, despite intermittent impacts related to the BC and Alberta wildfires. Topaz generated $13.4 million in processing revenue and $3.6 million in other income from third-party fees at non-owned infrastructure assets. Topaz incurred $3 million in operating expenses, which is higher than previous quarters due to planned facility turnaround maintenance and includes costs that were forecasted as capital maintenance expenditures. Overall, our infrastructure assets generated 82% operating margin in the second quarter. Topaz generated cash flow of $67.5 million or $0.47 per basic share and diluted share and we distributed 64% of cash flow to shareholders through a $0.30 per share quarterly dividend. On July 31st, our board approved a $0.01 per share increase to our quarterly dividend which translates to $1.24 per share on an annual basis and represents a 5.8% yield to our current share price. The dividend increase is consistent with our strategy to continue to provide dividend increases alongside revenue growth. Our dividend is sustainable to low commodity prices, and our estimated 2023 payout ratio remains at the lower end of our long-term range of 60 to 90% payout, which maintains flexibility for growth, strategic growth opportunities, or further dividend increases. In Q2, our access-free cash flow was allocated to debt repayment, and to date in 2023, we've reduced our net debt $53.5 million, or 13% from year-end 2022. We exited Q2 with $352.4 million of net debt and approximately $600 million of available credit capacity. Subsequent to the second quarter, TOPA has announced the tuck-in acquisition of royalty and infrastructure assets from an existing partner in the Charlie Lake and Clearwater operating areas, which closed on July 31st. Total consideration of $39.5 million was funded through our existing credit capacity, and the acquisition is estimated to provide $6 million of annual stable revenue before consideration of royalty acreage development attributed to the 17,000 gross acres of new royalty acreage added to the portfolio. From a guidance perspective, we've confirmed our previously announced 2023 royalty production estimate between 18.3 and 18.8 thousand VOE per day. We've increased our estimate of processing revenue and other income attributed to the infrastructure assets from $65 million previously to $69 million. The increase is attributed to higher year end to date financial results, certain inflationary processing fee increases, higher estimated third party fees and the recent infrastructure acquisition. No significant changes are expected to our overall cost estimates for 2023. And we estimate we'll exit 2023 with net debt of approximately $340 million, which represents a 16% reduction from year end 2022. We look forward to discussing the third quarter on our next call, and we're pleased to answer any questions at this time.

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 and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the hands up before pressing any keys. Your first question comes from Jeremy McRae with Raymond James. Please go ahead.

Hi, guys. A couple quick questions here. First, I just wondered if you can comment more on the M&A market. Good little acquisition that you guys picked up here right now, but... are things getting easier with commodity prices lower? What do you see? What are you targeting? How many deals are you looking at here in the last quarter? And how does that compare to maybe last year? Anything along those lines?

Yeah, good question, Jeremy. Good morning. We've definitely been busy and active on the M&A front throughout the year. We did kind of pause, I think, from January until we announced this deal in July. And what I would say is the... quality that we've put into our asset portfolio just didn't live up to what we were looking to add to it. And so we have been quieter on the M&A front, wanted to wait for the right quality, the right opportunity, the right metric. And I think we did that here. But, you know, we're still looking at quite a bit of opportunity in front of us. We do think that going into the fall, that'll continue to be a very active space for us. But The big question is, is there a bid-ask price disconnect? And we did see that through the first part of this year. We did see it tighten kind of into July. And I think, as you've seen this week, there is some activity happening inside the basin to major transactions announced last night and this morning. So, you know, we do kind of monitor that and see where we can be useful.

Okay. And then maybe just on your guidance that you have, I'm trying to get a sense of maybe what's not included in your guidance when you put that out. Some of the water flooding that's happening in the Clearwater looks a lot stronger than I think maybe initial projections were. I'm just trying to get a sense of what could surprise guidance to the upside here that you're seeing some early signs of a lot better success than what you guys are modeling.

Yeah, I think the range kind of accounts for, you know, some intermittent disruption with additional wildfire activity through the summer or near-term surprises. I think, yeah, we've definitely been pleased with a lot of results in the Charlie Lake and the water flood. But at the end of the day, we just don't control the capital. So that's why we have to have a range and kind of allow for some give and take as, you know, near-term, longer-term. So...

And remember, Jeremy, water flood's still pretty early stages. Obviously, Headwater announced last quarter a pretty material event for us, 2,800 barrels of sustainable oil production on their water flood project. I think we're at project number six inside the Clearwater with 17 pilots in behind it. So, you know, we do see upside there, but we haven't modeled it in yet. We're really going to wait for the results before we get aggressive and guess at what they might be. In addition to that, the $100 million of exploration that Tourmaline has talked about That adds 750 locations inside our portfolio alone, and so we're getting the added benefit of buying these royalties at the right time, and as producers step out and delineate and test the outer regions of this land, not just tourmaline, but our clearwater operators too, it's just added upside for a royalty business.

Okay. Thanks, guys. That's all for me. Okay. Thanks, Jeremy.

Your next question comes from Joseph Sachter with Sachter Energy Research. Please go ahead.

Good morning, Marty and Sherry. I want to follow up a little more on that M&A side. Is the deal flow both medium and large companies as well as the smaller deal like you just did? And then you mentioned that there's a price disconnect, so that's the economic side. Are there also substantive issues related to reservoir quality decline rates, abandonment liabilities, environmental issues. Are any of those stumbling blocks in getting over to the deciding phase of saying, yeah, it meets all of our specs and requirements so we can take it to our board for approval? I'm just trying to get an idea if it's more than economic. Is it also quality of assets?

Yeah. So I'll maybe start with your first question. It is a balance between new startups to mid-sized to larger companies, although I would say the larger companies we're probably, other than Tourmaline, not transacting a lot with right now. I think they've got enough capital and cash flow in their system right now where they probably don't require Topaz. And you look at how these companies are performing, it's mainly just organic growth inside their company through development and then returning capital. And so unless they're doing some type of major transaction Topaz probably does not fit for them at this time. So I would say probably more opportunity on the mid to junior space than the large cap. As kind of your last part of your question there, we have pretty strict criteria mandated by our board when we're evaluating not only reservoir, geological formation, absolute output to see if there's any technological advancements that producers are doing to kind of enhance those types of plays. But we also do look at from an ESG scorecard as well. And so that has been a big requirement for us since inception where, you know, if there is a lot of reclamation work, liability work attached to it, we're not putting an offer out there with some type of plan in place. That's been kind of front and center for us is we want to maintain the high quality of ESG performance we have alongside the high quality of assets we have. Anything to add to that, Sheree?

Yeah, I would say it applies to the infrastructure assets as well, and we're really, you know, focused on new infrastructure with really strong underlying reserves. So it goes to both sides, royalty and infrastructure, and also extends to management teams. It would be, you know, credit quality, credit capacity. We don't want to be the only financier. So, yeah, willing to look at lots of different deals to wait for the right one.

Okay. If I can add to that. In terms of deal flow, are you expanding that to look at deals that could be royalty deals that relate to the renewable world, be it solar or wind or any of the other things, carbon capture? And maybe a second part, would you expand if the deal flow doesn't seem to happen in 2023-2024? I know you've got the big upside from... Conroy in Q1 26 and then 28 with Tourmaline. Do you think you may need to expand your horizon to look at deals like in the U.S., like some of your royalty competitors have done?

So as far as the renewable space goes, I mean, we do look at that space. I think our attitude about that has always been walk, not run. I think we're looking for true return. in these projects. It just doesn't require non-stop capital going into it and, you know, very concerned about how funding is going to work for those types of transactions. Not to say we're against it and, you know, keep in mind we are partners with Advantage and our glacier facility where they have a carbon capture project by entropy right beside it and we're monitoring that very closely and seeing if we can be useful down the road then. I think that's going to be some time for us before we invest. We just think that there's enough to invest in on traditional forms of oil and gas, both on the royalty side and the infrastructure side. We have no plans to look in the U.S. at this time.

Okay. Well, thanks for answering my questions, and thanks for the dividend increase. You're welcome.

Hopefully we do more of those. Take care, Joseph.

Yeah. Thank you.

Ladies and gentlemen, as a reminder, should you have a question, please press star followed by the one. Your next question comes from Jamie Kubik with CIBC. Please go ahead.

Good morning, and thank you for taking my questions here. I wanted to just ask on the production side, without the impact of outages in the quarter of, I think you quoted, 300 to 350 buies a day, of impact. The QT volumes would have almost been as strong as Q1. Can you talk a little bit about what areas of the portfolio you're seeing the strength in and how we should think about the second half of 2023 unfolding?

For sure, Jamie. So we definitely saw consistent development activity from our, you know, what we refer to as our strategic operators, which would be the likes of Headwater, Tamarack, Tourmaline, Whitecap to some degree. So saw that capital being deployed approximate about $1.2 billion of capital deployed in the first half. And second half, we see that stepping up slightly. So do see lots of capital. We estimate about $1.3 to $1.4 billion for the second half. Definitely saw surprise strength from the Keystone and Reserve fee mineral title packages through the first half and even through 2022 for that matter. Those are volumes that we never... will count on because we don't have as much clarity and line of sight to that capital deployment. So that's where there could be some surprise to the upside. And from our other operators, just with wildfire activity, you know, we definitely saw the completions reduced and mainly from term line, to be honest, in the deep basin and northeast BC just with wildfire activity. So just, you know, we see the capital coming for the second half, but It could be a little bit more delayed just on accessibility to crews and timing and wildfire impact.

Yeah, one thing that we're watching really close is the access to completion crews. And we're really fortunate, I think, based on our relationship with Termaline. They have long-term contracts in place with their completion providers. And we do think that they're going to have a pretty steady completion program. And then the second part of our growth profile, as we talked about in the conference call, is the Clearwater program. which doesn't require completion. So we do think that that's going to be a bonus for us, but we're willing to step out and increase guidance at this point in time, just based on how we want to see Q3 play out.

Okay. Good answer. And then maybe other question that I had here was just, can you talk a little bit about how you're thinking about balancing debt levels versus dividend levels and maybe down to what commodity price? you feel the dividend is defensible to?

One moment, please. This is the operator. It'll just be a moment. Mr. Jamie Kubik, can you repeat your question, please?

Yeah, you bet. So just a question in regards to the dividend level versus debt levels in the business. Can management just comment on how they're thinking about balancing debt levels versus increasing the dividend? And then in regards to that, down to what commodity price is the dividend defensible to in either 2023 or 2024?

Yeah, sorry, we didn't hang up on you, Jamie, because we didn't like the question.

All good.

So, yeah, so from the dividend perspective, we definitely want to strike a balance. We want to always have a sustainable dividend, but do want to continue to grow the dividend alongside sustainable revenue growth. And we feel that was, you know, sort of due. And then the infrastructure royalty acquisition that we just announced sort of solidified that. So wanted to provide that dividend increase The 23 dividend is sustainable to $0 ACO and about $45 WTI, just with the hedge book we have in place. On 2024, it would be about $1.50 ACO, $55 WTI. So feel we have very good resilience to commodity, and that's partly due to the hedges we have in place, as well as the infrastructure revenue, which is very stable and provides a very high operating margin So do look to continue to replenish debt. You know, if the right opportunity presents itself, that fits all of our criteria. Happy to use some leverage, but unless all criteria are met, we are happy to replenish debt and just wait for the right opportunity set.

Okay. Thank you. That's it for me.

Thanks, Jamie. Thanks, Jamie. Ladies and gentlemen, as a reminder, should you have a question, please press star followed by the one. There are no further questions at this time. Please proceed.

Okay. Thanks very much, everyone. We'll see you next quarter. Enjoy the rest of your summer.

Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.