Quarterly / Earnings Reports | First Quarter (1Q) Update

Surge Energy Talks Q1 Results, Operations

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Surge Energy Inc. reported its Q1 2019 results.

Q1 2019 Highlights

• Surge's Q1/19 quarterly average production of 21,630 boepd (84% liquids) increased by 35 percent over Q1/18 average production of 16,027 boepd (81% liquids).
• Cash flow from operating activities in Q1/19 was $28.9 million, an increase of 19 percent as compared to Q1/18 at $24.2 million.
• Adjusted funds flow in Q1/19 was $41.9 million, an increase of 49 percent as compared to Q1/18 at $28.2 million.
• Crude oil and liquids production increased by 40 percent - from 13,006 barrels per day in Q1/18 to 18,186 barrels per day in Q1/19.
• The Company's operating netback⁵ increased by 12 percent, to $27.12 per boe in Q1/19, from $24.18per boe in Q1/18.
• The Company's December 31, 2018 net asset value ("NAV")⁶ is $5.58 per common share for Proven plus Probable ("P+P") reserves ($3.20 per share for Total Proved ("TP") reserves), based on the Company's independently evaluated Sproule reserve report (based on NPV10 before tax).
• On March 28, 2019 Surge closed the disposition of certain non-core assets for cash proceeds of $28.1 million

Message to Shareholders

Q1/19 was a solid "recovery" quarter for Surge, as the extremely weak Q4/18 Canadian crude oil pricing fundamentals quickly turned positive during the period. With crude oil prices averaging US $54.90 per bbl, Surge's cash flow from operating activities increased eight percent as compared to Q4/18, and adjusted funds flow¹ in Q1/19 increased by 570 percent to $41.9 million, as compared to Q4/18 at $6.2 million.

In Q1/19 Surge delivered record quarterly average production of 21,630 boepd (84% liquids), an increase of 35 percent over Q1/18 production of 16,027 boepd (81% liquids).

Operationally, Surge had a successful capital program in Q1/19, drilling and completing wells in all four core areas, namely Sparky, Valhalla, Greater Sawn, and Shaunavon. Surge added over 2,800 boepd (>90% liquids) in the quarter on total exploration and development expenditures of $41.3 million, resulting in excellent capital efficiencies² of $14,750 per flowing boepd on an IP60³ basis.  

Over the last 11 financial quarters Surge has now grown its quarterly production 78 percent, from 12,182 boepd (78% liquids) in Q2/16 to 21,630 boepd (84% liquids) in Q1/19. This consistent quarterly production growth has been achieved by adding predominantly high netback, light oil.

During Q1/19 Surge announced that the Company had increased its proven plus probable ("P+P") reserves by 29 percent, from 95.2 MMboe at year-end 2017, to 122.6 MMboe at year-end 2018. Surge also announced during the first quarter that the Company organically replaced 133 percent of 2018 production.

Furthermore, as compared to Q1/19, today Surge has additional upward leverage in its adjusted funds flow, with Q2/19 crude oil prices now trading over US$61 WTI per barrel, and Canadian WCS differentials narrowing below long term averages, at US$12 per barrel. At present crude pricing levels, the Company is generating meaningful free adjusted funds flow¹.

The Company continues to focus on sustainability, balance sheet management, and cost controls to deliver returns to Surge shareholders. The Company also continues to grow its production base and 14 year drilling inventory in its four core areas at Sparky, Valhalla, Greater Sawn and Shaunavon – through low risk development drilling, waterfloods, and strategic, high quality, large OOIP⁴, core area acquisitions.

Financials

Ops Highlights

In Q1/19, Surge successfully drilled 12 gross (11.6 net) wells and completed a total of 18 gross (17.6 net) wells, adding over 2,800 boepd (>90% liquids) for a cost of $41.3 million ($14,750 per flowing boepd on an IP60 basis).

These results are a continuation of the operational momentum Surge has generated over the last 11 financial quarters - growing production by 78 percent from 12,182 boepd (78% liquids) in Q2/16, to 21,630 boepd (84% liquids) in Q1/19.

Throughout Q1/19 Surge operated three drilling rigs, drilling and completing wells in the Sparky, Valhalla, and Greater Sawn core areas, as well as, completing four previously drilled wells at the Company's Shaunavon core area. Each of the Company's four core areas are comprised of high quality, conventional, large OOIP per section, light and medium gravity crude oil reservoirs with large, consistent, scalable drilling inventories.

Sparky Core Area

In Q1/19, Surge drilled and completed 8 gross (7.6 net) wells in its Sparky core area at Sounding Lake, Eyehill, and Betty Lake.

At Sounding Lake, Surge drilled 2 gross (2.0 net) horizontal wells into its 25 million barrel net estimated OOIP Sparky MM pool, following up on the success of the first horizontal infill well drilled into the pool in Q4/18.  These two new wells were producing at rates of 180 bopd and 130 bopd respectively, during the last week of March. With 3 horizontal wells now placed into this previously vertically-developed pool, Surge estimates there are over 15 net additional horizontal drilling locations⁷ within the pool, at 400 meter spacing.

At Eyehill, 3 gross (2.6 net) Sparky wells were drilled, of which 2 gross (1.6 net) wells were drilled at 200mspacing, and continue to perform as per management's expectations. The third well (1.0 net), was successfully drilled offsetting existing horizontal water injection, which is expected to provide pressure support to the well. Surge has now drilled over 60 wells into its Eyehill Sparky pool and successfully implemented waterflood with the conversion of 7 wells to water injection. The Eyehill property has become a cornerstone of the Company's Sparky core area, with over 170 million barrels of estimated net OOIP, 56 producing horizontal wells, and 7 horizontal water injection wells placed in the pool in the last 5 years. Surge plans to continue to systematically develop and waterflood the pool with more than 65 net locations⁷ remaining to be drilled.

At Betty Lake, Surge continued operations drilling 3 gross (3.0 net) wells from a single pad. These 3 wells continued to produce at a combined rate of over 400 bopd for the last week of March. Surge now has 8 successful horizontal wells on production at its Betty Lake property. The Company plans to continue development, with more than 80 million barrels of estimated net OOIP, and more than 50 net drilling locations⁷ remaining.

For the remainder of 2019, Surge has budgeted 21 additional horizontal wells to be drilled in the Sparky core area, focusing its drilling at Provost, Eyehill and Betty Lake.

Valhalla Core Area

At Valhalla, development drilling entered its 9^th consecutive year. In Q1/19, Surge successfully drilled and completed 2 gross (2.0 net) horizontal wells into the Company's Doig light oil pool which has an estimated 150 million net barrels of OOIP. The two wells had an average 30-day initial production oil rate of over 1,000 bopd each, and were drilled more than 16 km apart, at opposite ends of the large Doig oil fairway. 

Surge has budgeted 3 gross (3.0 net) additional wells in the Valhalla area for the remainder of 2019.

Greater Sawn Core Area

In Q1/19, Surge drilled 2 gross (2.0 net) wells, and completed a total of 4 gross (4.0 net) wells at the Company's newly acquired, large OOIP, light oil assets in the Greater Sawn core area. All four of the wells were drilled using existing well control and 3D seismic, targeting the Slave Point reef facies in the Sawn oil pool with 100 percent success. The four wells were completed with an average of 28 frac stages and had combined production of over 820 bopd in the last week of March.

Surge plans to drill 5 gross (5.0 net) additional wells in 2H/19.

Shaunavon Core Area

In Q1/19, Surge completed 4 gross (4.0 net) wells in its Shaunavon core area, where production receives Fosterton pricing, which has historically traded at a premium to WCS. Three of the four wells targeted the Upper Shaunavon sandstone, with the remaining well placed in the Lower Shaunavon carbonate. The wells were drilled near the end of Q4/18, with completion operations commencing in early Q1/19.

Surge plans to drill 8 gross (8.0 net) additional wells in 2H/19.

Consistent Quarterly Production Growth

Based on continued positive drilling results, operational execution, and key core area acquisitions, Surge has consistently grown its quarterly production over the previous 11 financial quarters. The Company has now delivered six upward revisions to production guidance since Q2/16 - twice organically, and four times through accretive, core area, light and medium gravity crude oil acquisitions.

Ongoing Sustainability Program

During Q1/19 Surge determined that, in addition to its ongoing, proactive, annual abandonment and reclamation program, the Company would elect to participate in the Alberta Energy Regulator's ("AER") Area Based Closure program ("ABC program"). 

Over the past 5 years, Surge has directed $17 million towards the abandonment and reclamation of inactive wells, abandoning over 475 wells in that time.  The Company believes participation in the ABC program will further allow Surge to optimize cost efficiencies as they relate to abandonments and reclamation.

On this basis, Surge will complete its first abandonment project under the ABC program in the first half of 2019, abandoning the Company's inactive Cherry natural gas property for approximately 55 percent of the deemed liability recorded by the AER.  This confirms the Company's belief that there are significant economies of scale to be achieved under the ABC program.

Surge remains committed to a proactive, well-funded annual abandonment and reclamation program.  The Company has budgeted $6 million for decommissioning expenditures in 2019, which is 45 percent more than required by the AER under the ABC program. Surge anticipates abandoning 125 wells in 2019.

Risk Management

The Company has been active with its ongoing crude oil and WCS differential hedging strategy designed to protect the capital program and Surge's annual dividend.

For 2H/19, the Company has hedged 6,250 bbl/d of WTI crude oil with an average floor price of CAD $77/bbl. This represents approximately 40 percent of Surge's forecasted after royalty crude oil production for 2H/19. Surge has also retained upside to further WTI price increases on 60 percent of the hedged volumes, with an average ceiling of CAD $103/bbl.

Furthermore, Surge has hedged 4,800 bbl/d of WCS basis differential for Q2/19 and Q3/19. This represents approximately 60 percent of the Company's forecasted net after royalty WCS corelated crude oil production. Of the 4,800 bbl/d of WCS basis differentials hedged, 55 percent are swapped at a US$16.40/bbl discount to WTI, and the remaining 45 percent are collared at an average discount to WTI of US$15.15 - $20.20/bbl.

Outlook

Management's stated goal is to be the best positioned, top performing, light/medium gravity crude oil growth and dividend paying public oil company in our peer group in Canada.

Today, Surge has the following key operational and financial attributes:

Management believes that the operational and financial corporate fundamentals set forth above will allow Surge to continue to be a top performing, light and medium gravity crude oil growth and dividend paying Company for the foreseeable future. 

Surge's disciplined growth and dividend paying business strategy is set forth in the Company's detailed five-year growth plan⁸ as follows:

• Grow production per share at five to six percent annually;
• Maintain and grow the Company's dividend (current yield ~6.8%⁹); and
• Deliver free adjusted funds flow annually of four to five percent.