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

Surge Reports Second Quarter 2019 Results

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   |    Monday,August 12,2019

Surge Energy is pleased to announce its financial and operating results for the quarter ended June 30, 2019.

Q2/19 was an excellent quarter for Surge. Production and adjusted funds flow¹ came in higher than analyst estimates²; and the Company’s bank debt, net debt¹, operating expenses, transportation expenses, and general and administrative costs all came in lower than budgeted expectations³.

Production of 21,544 boepd in Q2/19 averaged more than Surge’s 2019 exit rate guidance of 21,500 boepd, which represents an increase of 26 percent over Q2/18 at 17,072 boepd.

Surge was originally guiding to exit 2019 with production of 22,000 boepd; however, the Company sold a 490 boepd non-core asset in Q1/19 for net cash proceeds of $28.1 million, resulting in new 2019 production exit rate guidance of 21,500 boepd.

Drilling results from Surge’s Q2/19 program exceeded management’s expectations. Successful drilling in Q2/19 at the Company’s Sparky, Shaunavon and Valhalla core areas has resulted in current estimated production additions of 1,625 bopd, for total exploration and development expenditures of $25.2 million, providing capital efficiencies⁴ of approximately $15,877 per bopd.

HIGHLIGHTS

• Surge’s Q2/19 quarterly production of 21,544 boepd increased by 26 percent over Q2/18 production of 17,072 boepd.
• Adjusted funds flow in Q2/19 was $50.7 million, an increase of 31 percent as compared to Q2/18 at $38.6 million.
• Cash flow from operating activities in Q2/19 was $45.8 million, an increase of 36 percent as compared to Q2/18 at $33.7 million.
• The Company’s operating netback¹ increased by six percent, to $31.24 per boe in Q2/19, from $29.46 per boe in Q2/18.
• The Company’s operating expenses for Q2/19 were $14.43 per boe and net operating expenses¹ were $14.03 per boe, compared to 2019 guidance of $14.95 – $15.45 per boe.
• The Company generated $17.7 million of adjusted funds flow¹ in the quarter in excess of exploration and development expenditures and dividends paid.
• Surge paid dividends of $7.9 million in Q2/19, representing 15 percent of Q2/19 adjusted funds flow.
• The Company maintained a net debt to annualized Q2/19 adjusted funds flow ratio¹ of under two times (1.9x).
• Surge closed a small, miscellaneous gross overriding royalty (“GORR”) disposition of 214 boepd on June 28, 2019, for net cash proceeds of $29.1 million – providing sale metrics of greater than $135,000 per flowing boepd.
• Subsequent to June 30, 2019, pursuant to a Crown sale on July 31, 2019, Surge successfully acquired an additional 8.5 sections of highly prospective Sparky acreage at Betty Lake – extending the Company’s large new Sparky discovery to the north.
• Subsequent to June 30, 2019, pursuant to a Crown sale on July 31, 2019, Surge successfully acquired an additional 9.5 sections of highly prospective acreage at Nipisi South in the Company’s Greater Sawn core area. This new land is immediately offsetting existing Surge light oil production, and is prospective for both Slave Point and Clearwater oil reserves and production.

FINANCIAL AND OPERATING SUMMARY

OPERATIONAL HIGHLIGHTS 

In Q2/19, Surge successfully drilled 9 gross (9 net) producing wells, currently producing an estimated 1,625 bopd, for total exploration and development expenditures of $25.2 million ($15,877 per bopd).

These excellent results are a continuation of the operational momentum, and track record Surge has generated over the last 12 financial quarters – growing production by 77 percent from 12,182 boepd (78 percent liquids) in Q2/16, to 21,544 boepd (84 percent liquids) in Q2/19.

Sparky Core Area

Cost Reductions From First Four Well Pad

In Q2/19, Surge drilled and completed 4 gross (4.0 net) wells in its Sparky core area.

At Provost, Surge drilled four excellent Sparky wells on the Company’s first ever four well drilling pad. Due to pad drilling efficiencies, the average “all-in” cost at Provost was $1.04 million per well, compared to budget of $1.25 million per well.  The four wells combined are currently producing over 675 bopd. Surge has more than 35 net drilling locations⁵ remaining at the Company’s large, internally estimated 90 million net OOIP⁶, Sparky pool at Provost. As a result of Surge’s drilling results at Provost, operating expenses in this area are now $6.75 per boe.

Approximately 18 months ago, Surge announced a large, new Sparky oil discovery at Betty Lake (near Wainwright, Alberta).  The OOIP at Betty Lake is estimated to be over 80 million net barrels. Surge has now largely “de-risked” the Company’s Betty Lake Sparky oil pool, drilling eight consecutive horizontal wells, with 100 percent success. Surge estimates that there are more than 50 net locations⁵ remaining to drill at Betty Lake, with full waterflood upside⁷. Based on Surge’s excellent drilling results at Betty Lake, operating costs in this field are now $7.00 per boe.

In addition, at a recent Crown sale on July 31, 2019, Surge successfully acquired an additional 8.5 sections of land at Betty Lake – extending this large Sparky pool to the north. The Company believes that this acreage comprises a large Sparky oil pool extension, adding up to an estimated 40 million barrels of net OOIP, and up to 38 additional net drilling locations⁵.

The Company is also experiencing consistently strong results at its Sparky MM pool at Sounding Lake, with Surge’s three most recent wells producing above the Sparky type curve (which has an IP 30 of 100 bopd). Surge estimates more than 30 locations⁵ remaining to be drilled at this large, 25 million OOIP, 31 degree API Sparky asset.

Surge anticipates drilling up to 14 locations in the Sparky core area in 2H/19.

Rapidly Expanding Core Area

In less than five years, in Surge’s Sparky core area the Company has amassed more than 900,000,000 barrels of estimated net OOIP, production of over 7,750 boepd (90 percent oil), and over 450 drilling locations – providing a 13 year drilling inventory (at the Company’s current pace of 35 Sparky drills per year).

Surge’s high quality Sparky reservoirs are characterized as conventional, large OOIP per section (>6mm barrels per section), low risk, shallow, sandstone reservoirs, at 700-800 meters depth. The wells are highly economic, delivering over 135,000 boe (90 percent oil) internally estimated ultimate recovery (“EUR”), for primary production only, at an “all-in” cost of less than $1.2 million per well – drilled, completed and onstream.

Surge’s Sparky type curve wells pay out in less than a year, and deliver profit to investment ratios[8] of over 2.0 at current strip oil pricing of US $54 WTI per barrel, for primary drilling. In addition, Surge has successfully proven waterflood upside for the Company’s Sparky/Lloyd plays at: Wainwright, Eyehill, Sounding Lake MM, Provost, Macklin, Lakeview, and Silver.

Surge is now utilizing the following technological improvements and efficiencies that the Company’s experienced and proven Sparky technical team have integrated over the last 4-5 years:

1. Longer horizontal wells;
2. Monobore drilling;
3. Increased number of frac stages;
4. Less frac intensity per stage;
5. Floating in the casing;
6. Cemented liner;
7. Multi cycle frac sleeves vs “ball-drop” system;
8. Modified mud system; and
9. Pad drilling.

Given these exciting improvements in the Company’s drilling and completion processes, Surge has now driven the cost of a Sparky well down from a high of $2.3 million in 2014, to approximately $1.0 million for the Company’s two most recent pad wells at Provost. In addition, Surge has also increased the Company’s internally generated Sparky type curve production estimates significantly over this period (i.e. by as much as 25-30 percent).

By drilling 105 (out of 106) successful, highly economic, horizontal wells in Surge’s Sparky core area over the last five years, the Company has now proven that its proprietary drilling/completion systems deliver excellent results, with remarkable consistency. Management believes this bodes very well for the continued growth and development of Surge’s rapidly expanding Sparky play.

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Eyehill – A Case Study

An illustration of Surge’s track record for adding value in its Sparky core area is at the Company’s high quality, 170 million net OOIP, 29  degree API oil asset at Eyehill. Over the last four years at Eyehill, Surge has: 1) aggressively grown the asset – adding significant value; and 2) strategically transitioned the property into a sustainable, long life, waterflooded asset, as set forth within the Eyehill Production Growth section:

Eyehill – Production Growth > 380 Percent in 3 Years

• Increased production 380 percent in three years.
  
  
• Of the 63 operated horizontal wells at Eyehill, Surge drilled 51 and acquired 12.
  
  
• Peak production of 2,950 boepd was reached in May 2017.
  
  
• Surge had only 15 horizontal wells producing 500 boepd (80 percent liquids) at year end 2015.
  
  
• Surge has drilled an average of 14 wells per year (12 per year excluding acquisitions), increasing production significantly – inclusive of lost production associated with water injector conversions.

To date seven of the 63 wells drilled have now been converted to water injection at Eyehill, providing pressure support and lowering the production decline for this large, conventional Sparky oil pool (i.e. lower annual declines fit very well with Surge’s growth and dividend paying business model).

Eyehill – Production Profile (Low Decline Waterflood)

Based on Surge’s strong drilling and waterflood results at Eyehill, operating expenses are now $7.50 per boe.

Eyehill – Value Creation

In the last three years Surge has increased the Company’s Sproule NPV10 Total Proved plus Probable reserve value at Eyehill by 395 percent; from $49 million to $242 million.

Surge will continue to follow this proven, disciplined operating strategy of delivering higher initial drilling growth and value creation, followed by strategically transitioning the Company’s high quality, large OOIP, Sparky sandstone reservoirs into waterfloods (to deliver long term adjusted funds flow in excess of exploration and development expenditures, and excellent profit to investment ratios) at: Eyehill, Betty Lake, Provost, Sounding MM, Sounding East, Lakeview, Macklin, Cadogan and Eyehill South.

This conservative operating strategy is a key component of Surge’s growth plus dividend paying business model.

Valhalla Core Area

At Valhalla, in Q2/19 Surge drilled a successful, 100 percent working interest, Doig horizontal light oil well. This is Surge’s third 200 meter horizontal in-fill well drilled into the Doig reservoir, and further validates the continued downspacing of this large, 150 million OOIP net, light oil pool. This well is currently producing more than 750 boepd (70 percent light oil).

Surge estimates an inventory of more than 50 net light oil locations⁵ at Valhalla in the Doig, Charlie Lake and Montney formations, providing a drilling inventory of more than 10 years.

The Company anticipates drilling up to two locations at Valhalla in 2H/19.

Shaunavon Core Area

In Q2/19 Surge drilled 4 gross (4.0 net) successful new wells at Shaunavon. Two of the wells were drilled in the Upper Shaunavon formation, and two were drilled in the Lower Shaunavon formation. The Company also continued its successful pump jack conversion program, with another 30 wells converted to pumpjacks in 1H/19.

Surge estimates over 125 net drilling locations5 remaining in the Upper and Lower Shaunavon formations, and over 400 million barrels of estimated (combined) net OOIP. The Shaunavon field has a high operating netback, is waterflooded, and delivers annual adjusted funds flow in excess of exploration and development expenditures – which fits very well with Surge’s lower risk, lower decline, growth and dividend paying business model.

Surge plans for the drilling of up to four additional locations at Shaunavon in 2H/19.

Greater Sawn Core Area

At Greater Sawn, Surge continues to enjoy the significant free adjusted funds flow from this 5,000 bopd light oil asset. The Company drilled its first four wells at Sawn late last year, and early this year, with 100 percent success.

Surge continues to optimize the successful waterflood at Sawn, with plans to expand waterflood operations later this year, and into 2020. Surge estimates a drilling inventory of over 10 years in the Greater Sawn area, with more than 100 net locations⁵ at this high quality, 600 million barrel net OOIP, light oil asset.

Further to the above, at a recent Crown sale on July 31, 2019, Surge successfully acquired an additional 9.5 sections of acreage at Nipisi South in the Company’s Greater Sawn core area. Surge believes Nipisi South contains up to 30 million barrels of net OOIP (light oil) in the Slave Point formation, with over 20 additional net Slave Point drilling locations⁵. The new acreage is also prospective for Clearwater oil reserves and production.

The Company anticipates drilling up to four locations at Greater Sawn in 2H/19.

BANK LINE UPDATE

Surge’s new borrowing base has been confirmed by its lenders at $500 million, comprised of a $450 million revolving line of credit, and a $50 million operating line of credit (with unanimous lender consent required for the Company to draw in excess of $425 million). On this basis, Surge has over $105 million⁹ of unrestricted liquidity available to the Company, and committed access to over $180 million¹⁰ of total liquidity.

ENVIRONMENTAL, SOCIAL AND GOVERNANCE

During the first half of 2019 the Company elected to participate in the Alberta Energy Regulators (“AER”) Area Based Closure program (“ABC program”). Building on the Company’s work in Q1/19, Surge has continued to efficiently direct capital towards abandoning and reclaiming its non-core Cherry natural gas property.

The Company has seen abandonment and reclamation costs continue to be approximately 55 percent of AER estimates, confirming Surge’s belief in the economies of scale that are found within the ABC program. Given the Company’s success in Q1/19 at Cherry, Surge has now initiated ABC programs in a number of the Company’s non-core areas.

Surge has committed $6 million in 2019 to a proactive, well-funded, annual abandonment and reclamation program. This exceeds AER mandated contributions by over $1.8 million, and builds on the $17 million the Company has spent since 2014.

During 1H/19 the Company abandoned 76 wells. The Company has now increased its target abandonment commitment for 2019 from 125 to 150 wells, which is approximately three times the number of wells the Company plans to drill this year.

The Company also continued to advance its Social and Governance leadership by further demonstrating its commitment to diversity in the workplace and on the Board of Directors.  Following the Annual General Meeting, the percentage of female Directors on Surge’s Board of Directors increased to 33 percent from 22 percent in Q3/18.  The Company is pleased to not only have increased gender diversity on the Board, but to have added three highly qualified directors with diverse backgrounds, and proven track records, in the past year.

As further evidence of Surge’s commitment to Board diversity and renewal, Surge’s Board independence has increased to 78 percent in Q2/19 from 71 percent in Q2/18; and the average age of Surge Board members is currently 58 years, down from 62 years in Q2/18.

Surge is a supporter of community engagement and recognizes the importance of supporting charitable organizations and the communities in which the Company operates. Details on the Company’s recent community engagement initiatives can be found on Surge’s website at www.surgeenergy.ca.

OUTLOOK – CONSISTENT GROWTH; SUSTAINABLE DIVIDEND

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

Surge focuses on sustainability, balance sheet management, and cost controls to deliver returns to Surge shareholders. The Company continues to grow its production base, and 14 year drilling location inventory, in its core areas of Sparky, Valhalla, Greater Sawn, and Shaunavon through low risk development drilling, and waterfloods – in accordance with management’s detailed business plan. Surge also strategically applies growth capital to high quality, large OOIP, core area acquisitions.

The Company has an excellent hedging program in place to protect Surge’s adjusted funds flow. For 2H/19, Surge has hedged 7,000 bbl/d of WTI crude oil with an average floor price of CAD $78/bbl. This represents approximately 50 percent of Surge’s forecasted after royalty crude oil production for 2H/19. Surge has also retained upside to further WTI price increases on 55 percent of the hedged volumes, with an average ceiling of CAD $103/bbl.

On this basis, Surge continues to pay the Company’s monthly cash dividend (currently 8 percent yield¹¹). Surge targets dividend payments that range from 20 to 30 percent of adjusted funds flow. Surge paid dividends of $7.9 million in Q2/19, which equates to 15 percent of Q2/19 adjusted funds flow