Quarterly / Earnings Reports | Second Quarter (2Q) Update

Perpetual Energy Talks Q2 Results; Cuts 2019 Spending Plans

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   |    Wednesday,July 31,2019

Perpetual Energy Inc. reported its second quarter 2019 financial and operating results.

Outlook

Perpetual has reduced its 2019 capital expenditure and adjusted funds flow guidance from a range of $21 to $25 million and $22 to $27 million respectively. Approximately 80% of Perpetual's natural gas volumes are priced in NYMEX based markets outside of Alberta. The Company continues to anticipate spending 50% of the 2019 capital program in Eastern Alberta targeting heavy oil development. The remaining capital expenditures are planned for East Edson in the fourth quarter, developing liquids-rich natural gas reserves in the Wilrich formation if AECO natural gas prices support investment, or alternatively, will be directed to an expanded heavy oil drilling program. Annual abandonment and reclamation spending of $1.5 to $2.0 million to address decommissioning obligations associated with non-producing wells is expected to provide future surface lease rental and property tax expense reductions, while maintaining regulatory compliance.

Forecast capital activity in Eastern Alberta for the second half of 2019 includes the drilling and completion of two exploratory (2.0 net) multi-lateral heavy oil wells in July. As a result of the drilling program, heavy oil production is forecast to increase by 20% to 30% in the second half of 2019 over first half levels.

At East Edson, the Company has budgeted a two (2.0 net) well drilling program in the fourth quarter of 2019. The two wells will be monobore, extended reach horizontal ("ERH") wells with approximately 2,500 meters of lateral length to optimize the drilling and completion design. The planned drilling will not have a material impact on production in 2019, as new wells are forecast to come on-stream late in the year when AECO natural gas prices are expected to be stronger due to winter heating demand. Natural declines and capital spending deferrals to late 2019 result in lower forecast 2019 production in East Edson with an average of 7,000 to 7,200 boe/d (10% oil and NGL). Despite reduced production in East Edson and a substantially fixed operating cost base, operating costs are forecast to remain low in 2019 at less than $3.25/boe.

Highlights include:

• The Company took advantage of dry early spring conditions to accelerate capital activity plans. Exploration and development spending for the second quarter of 2019 was $5.2 million, of which 75% was directed towards the drilling, completion and tie-in of three (3.0 net) heavy oil wells and a re-entry to add two additional laterals to an existing oil well at Mannville. The four wells were brought on-stream late in the second quarter and have ramped up to approximately 300 boe/d at the end of July. Two additional six-leg multi-laterals targeting heavy oil in Eastern Alberta will complete the summer drilling program in mid-August.
  
  
• Heavy oil production in Eastern Alberta grew 27% relative to the prior year second quarter and 7% from first quarter 2019 levels, driven by positive results from heavy oil focused drilling and waterflood investment during the second half of 2018 and first half of 2019. 
  
  
• Perpetual's market diversification contract provided an 82% uplift ($0.84/Mcf) over average AECO Daily Index prices, adding $3.4 million of incremental revenue and contributing to a realized natural gas price in the second quarter of $2.25/Mcf. Perpetual has extended the term of its market diversification contract by two years. From November 1, 2022 to October 31, 2024, Perpetual will deliver 40,000 MMBtu/d at AECO and receive Malin, Dawn and Emerson daily index prices less US$0.0775/MMBtu and transportation costs from AECO to the market price point. 
  
  
• Cash flow from operating activities in the second quarter of 2019 was $4.3 million ($0.07/share) and adjusted funds flow was $3.6 million($0.06/share). 
  
  
• On June 11, 2019, Perpetual completed the early redemption of the $14.6 million 2019 Senior Notes due July 23, 2019. The redemption was funded by the issuance of $15.7 million 2022 Senior Notes. 
  
  
• Perpetual's Application for Summary Dismissal of the Sequoia litigation relating to the Company's disposition of shallow gas assets in October 2016 to an unrelated third party was heard during the fourth quarter of 2018. The Court's decision is scheduled to be received on August 15, 2019.

Capital Spending, Production and Operations

• Perpetual's exploration and development spending in the second quarter of 2019 was $5.2 million, above Previous Guidance as dry conditions in Mannville allowed for an accelerated start to the summer drilling program.
  
  
• Capital spending in Eastern Alberta was $4.7 million, $3.3 million higher than the comparative period in 2018. Capital activity included the drilling and completion of three (3.0 net) single leg horizontal heavy oil wells, and one re-entry to add two additional lateral legs to an existing heavy oil well at Mannville. Spending also included the installation of automated leak detection monitoring equipment at several water transfer and water injection pipelines in the Mannville area. 
  
  
• Spending at the East Edson property in West Central Alberta was $0.4 million and was directed towards compressor optimization work and non-operated facility turnaround costs at the Rosevear plant. 
  
  
• Perpetual also spent $0.4 million (Q2 2018 – $0.4 million) on abandonment and reclamation projects. As part of Perpetual's focus on well and pipeline abandonment and reclamation, four reclamation certificates were received from the AER during the second quarter of 2019 (Q2 2018 – five reclamation certificates) which will result in the cessation of associated property tax and surface lease expenses. The Company's combined ratio of deemed assets to deemed liabilities as per the AER's Licensee Liability Rating was 4.5 at June 30, 2019. 
  
  
• Production averaged 9,370 boe/d in the second quarter of 2019, down 12% from the comparable period in 2018. The decrease was driven by natural declines resulting from limited capital investment on the Company's natural gas assets during 2018 and the first half of 2019 to preserve value during this period of depressed natural gas pricing in Alberta. In addition, Perpetual voluntarily shut-in an average 175 boe/d of East Edson production (2% of total production) during the quarter to take advantage of short-term situations when natural gas could be purchased at minimal cost to satisfy pre-sold volume commitments at attractive margins, resulting in an increase in realized revenue of $0.03/Mcf while retaining reserves for future production.
  
  
• Production at East Edson is expected to decline throughout 2019. Two new wells are planned for the fourth quarter to come on-stream in November when gas prices are expected to be higher, driven by seasonal heating demand. 
  
  
• Crude oil production in Eastern Alberta was 27% higher than the second quarter of 2018, reflecting increased production from the 2018 drilling program and lower base declines at Mannville due to waterflood operations. Compared to the first quarter of 2019, Eastern Albertacrude oil production was 7% higher, reflecting decreased maintenance and downtime from winter freeze-ups, combined with the impact of larger downhole pumps installed late in the first quarter. Crude oil production in Eastern Alberta is expected to increase in the second half of 2019 as new production from the 2019 heavy oil drilling program comes on-stream. 
  
  
• Production and operating expenses were up by $0.6 million (14%) relative to the same period in 2018, as Eastern Alberta heavy oil production increased by 27% over the prior year period, comprising 13% of total production in the second quarter (Q2 2018 – 9% of total production). West Central production and operating expenses were essentially flat relative to the first quarter of 2019 at $2.0 million, reflecting the largely fixed cost nature of the East Edson property.

Financial Highlights

• Realized revenue was $21.26/boe in the second quarter of 2019, 6% lower than the comparative period of 2018 ($22.58/boe). The decrease was due to lower realized pricing across all products, despite the higher proportion of oil and NGL in the production mix (Q2 2019 – 21%; Q2 2018 – 17%).
  
  
• Natural gas revenue of $9.0 million in the second quarter of 2019 comprised 47% (Q2 2018 – 54%) of total P&NG revenue while natural gas production was 79% (Q2 2018 – 83%) of total production. Natural gas revenue decreased 20% from $11.3 million in the second quarter of 2018, reflecting lower natural gas prices and the impact of the 16% decrease in natural gas production volumes. Perpetual's market diversification contract contributed $3.4 million of incremental revenue ($0.84/Mcf) over the AECO Daily Index price in the quarter (Q2 2018 - $5.1 million and $1.06/Mcf). 
  
  
• Oil revenue of $6.7 million represented 35% (Q2 2018 – 24%) of total P&NG revenue while oil production was 13% (Q2 2018 – 9%) of total production. Oil revenue was 33% higher than the same period in 2018, due to the 24% increase in crude oil production combined with the 5% increase in the Western Canadian Select ("WCS") average price. The 5% increase in the WCS price was mainly due to the tightening of the WCS differential by US$8.59/bbl to US$10.68/bbl in response to the Government of Alberta's introduction of production quotas effective January 1, 2019. Perpetual did not fully participate in the improved WCS differential, as hedges were in place protecting a WCS differential of US$25.22/bbl on 750 bbl/d for 2019. 
  
  
• NGL revenue was $3.5 million, representing 18% (Q2 2018 – 22%) of total P&NG revenue while NGL production was just 8% (Q2 2018 – 8%) of total Company production. NGL revenue decreased by 21% from the prior year period while NGL production decreased only 6%, reflecting the 16% decrease in Perpetual's realized NGL price compared to the prior year period. Compared to the first quarter of 2019, realized NGL prices increased by 60% as prices for condensate recovered in the second quarter, close to parity with Cdn$ WTI prices. Condensate production comprised 66% of NGL production in the second quarter (Q1 2019 – 58%). Propane, butane and ethane prices remain disconnected from WTI light oil prices, reflecting excess NGL supply produced from Western Canada and the United States. This oversupply condition is expected to continue. 
  
  
• Perpetual's operating netback of $9.1 million ($10.69/boe) in the second quarter of 2019 decreased 32% from $13.4 million ($13.85/boe) in the comparative period of 2018. This decrease was due to a 6% reduction in realized revenue per boe, due to lower realized pricing across all products combined with higher costs per boe due to the 12% production decline against a largely fixed cost base. The higher percentage of oil and NGL in the production mix was less impactful during the second quarter of 2019, as realized oil prices were 6% lower than the prior year period due to realized hedging losses on crude oil derivatives of $1.2 million ($11.30/boe). 
  
  
• Net loss for the second quarter of 2019 was $36.3 million ($0.60/share), compared to a net loss of $1.3 million ($0.02/share) in the comparative period of 2018. The increase in net loss from the prior year period was largely driven by an impairment charge of $22.6 milliontriggered by lower forecast natural gas prices, combined with the $6.6 million decrease in the fair value of the TOU share investment compared to an increase of $2.8 million in the comparative period of 2018, and lower operating netback performance. 
  
  
• Cash flow from operating activities in the second quarter of 2019 was $4.3 million ($0.07/share), down $4.1 million from the prior year period of $8.4 million ($0.14/share) due to the impact of the 12% decrease in production, as the impairment loss and changes in fair value of the TOU share investment that impacted net loss did not impact cash flow from operating activities. Adjusted funds flow in the second quarter of 2019 was $3.6 million ($0.06/share), down $4.2 million (53%) from the prior year period of $7.8 million ($0.13/share). On a unit-of-production basis, adjusted funds flow was $4.28/boe in the second quarter of 2019, down 47% from the prior year period of $8.12/boe due to the combined impact of lower commodity prices and the effect of a largely fixed cost base against lower total production, partially offset by the increase in higher netback heavy oil. 
  
  
• On June 11, 2019, the Company successfully completed the early redemption of all of the $14.6 million 8.75% senior unsecured notes due July 23, 2019 (the "2019 Senior Notes"). Pursuant to the early redemption, Perpetual issued $15.7 million of 8.75% senior unsecured notes due January 23, 2022 (the "2022 Senior Notes") to fully redeem the 2019 Senior Notes. After giving effect to the senior note refinancing, there are $33.6 million 2022 Senior Notes outstanding. 
  
  
• At June 30, 2019, Perpetual had total net debt of $112.5 million, unchanged from December 31, 2018 and $10.2 million higher than March 31, 2019. The increase in net debt from the first quarter of 2019 was mainly attributable to the $6.6 million decrease in the fair value of the Tourmaline Oil Corp. ("TOU") share investment during the second quarter of 2019, combined with capital expenditures which exceeded net cash flow from operating activities during the period. 
  
  
• As at June 30, 2019, 70% of net debt outstanding was repayable in 2021 or later. Perpetual's net debt to trailing twelve-months adjusted funds flow at the end of the second quarter increased to 4.8 times (December 31, 2018 – 3.7 times; March 31, 2019 – 3.7 times), due primarily to the impact of lower adjusted funds flow. 
  
  
• Perpetual had available liquidity at June 30, 2019 of $27.6 million, comprised of an unutilized revolving bank debt Borrowing Limit of $13.5 million and the market value of its TOU share investment, net of the principal amount of the associated TOU share margin demand loan, of $14.1 million.

The table below summarizes actual and anticipated capital spending and drilling activities for the first and second half of 2019.

2019 Exploration and Development Forecast Capital Expenditures

Perpetual is managing the 2019 capital program to be funded by adjusted funds flow. Average production of 9,200 to 9,500 boe/d in 2019 is close to Previous Guidance, with oil and NGL production growing to represent approximately 20% to 24% of the production mix. Natural declines and heavy oil focused investment is anticipated to result in an 11% year-over-year reduction in average daily production relative to 2018, but includes a 27% increase in heavy oil production. The Company expects to exit the year at approximately 10,500 boe/d as natural gas and NGL production ramps up again driven by fourth quarter capital spending targeting seasonal natural gas price optimization. The Company may continue to voluntarily shut-in natural gas production in response to weak AECO daily price conditions that may arise during the second half of 2019 to preserve reserves and purchase natural gas to satisfy existing sales obligations at attractive cash margins.

Cash costs of $17.00 to $18.00/boe continue to be forecast for 2019, up approximately 13% to 16% from 2018 due to the impact of lower forecast 2019 production on a substantially fixed operating cost base. Increased heavy oil production in the second half of 2019, which is higher cost compared to the West Central deep basin liquids-rich gas operation, is expected to contribute to increased cash costs per boe in the second half of 2019.