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

Vermilion Talks Q2 2019 Ops and Results

Share Print Bookmark    |    Monday,July 29,2019

Vermilion Energy Inc. reported its Q2 2019 results.

Highlights

• Q2 2019 production averaged 103,003 boe/d, down slightly from the prior quarter, as increases in the US and Australia were more than offset by lower production in France due to a refinery outage in the Paris Basin.
  
  
• Fund flows from operations ("FFO") for Q2 2019 was $223 million ($1.44/basic share⁽¹⁾), a decrease of 12% from the previous quarter due to the refinery outage, timing of crude lifting in Australia, and lower natural gas prices. Despite lower year-over-year commodity prices, FFO for Q2 2019 was up 14% from the same quarter last year due to increased production.
  
  
• In Germany, we finished drilling and completing our first exploratory well, which was tested subsequent to the end of the quarter. The well (46% working interest) encountered 125 feet of net pay and tested at a rate of 8.8mmcf/d⁽²⁾, with the test rate limited by weather conditions.
  
  
• In CEE, we drilled three (2.3 net) exploration wells in Hungary and one (1.0 net) exploration well in Croatia during Q2 2019. Subsequent to the end of the quarter, we drilled and completed a fourth (1.0 net) exploration well in Hungary. Three of the Hungarian wells and the Croatian well resulted in gas discoveries. The Hungarian wells tested at rates of 1.7 mmcfe/d⁽³⁾ (81% gas), 2.0 mmcf/d⁽⁴⁾ and 3.4 mmcf/d⁽⁵⁾ respectively. The Croatian well tested at a rate of 15.0 mmcf/d⁽⁶⁾.
  
  
• Subsequent to the end of the second quarter, we were awarded two exploration licenses in Ukraine, subject to finalization of production sharing agreements, in partnership with Ukrgazvydobuvannya ("UGV", a Ukrainian state owned gas producer). The licenses cover approximately 585,000 gross acres in the Dnieper-Donets Basin, one of the most prolific natural gas regions in Europe.
  
  
• In the United States, Q2 2019 production averaged 4,414 boe/d, an increase of 21% from the prior quarter, primarily driven by contributions from our first half 2019 Hilight drilling program. Production performance from the drilling program is above our type curves.
  
  
• In Australia, production averaged 6,689 bbl/d in Q2 2019, an increase of 14% from the previous quarter, primarily due to contributions from the two (2.0 net) well drilling program completed at the end of January 2019.
  
  
• In France, Q2 2019 production averaged 9,800 boe/d, a 15% decrease from the prior quarter. The decrease resulted from curtailment of our production in the Paris Basin as a result of an unplanned outage at the Grandpuits refinery, where all of our Paris Basin production is processed. The refinery was returned to service in late July and has now resumed accepting our oil deliveries. During the refinery outage, we utilized trucks and barges to ship a portion of our oil production to alternate delivery points in France and Germany.
  
  
• On June 12, 2019, Vermilion entered into a series of cross currency interest rate swaps with a syndicate of banks, financially swapping the remaining term of our 5.625% US$300 million senior unsecured notes due March 15, 2025 into a €265 million obligation bearing interest at 3.275%. At current foreign exchange rates, this swap is expected to reduce our annual cash interest costs by approximately $9 million.
  
  
• Our Board of Directors has authorized an application to the TSX to implement a normal course issuer bid ("NCIB") for a maximum amount of 5% of the issued and outstanding shares of Vermilion, which we plan to use as an additional means of returning capital to shareholders under appropriate market conditions. The NCIB is intended to augment our dividend, with excess free cash flow allocated to a combination of debt reduction and share buybacks.
  
  
• Vermilion was recently rated "AA" in MSCI's annual ESG rankings for 2019, placing us in the top 19% of oil and gas companies worldwide. This rating is an improvement from "A" in the previous two years, and is driven by our determination to be the leader in ESG in the energy industry

Summary

During the second quarter, we conducted our most active exploration drilling program in Europe in the history of the company.  Over the past four months, we have drilled one exploration well in Germany and five exploration wells in our Central and Eastern European ("CEE") business unit, with successes on all but one well in Hungary.  This drilling campaign was preceded by several years of careful implementation of our new country entry strategy.  We entered Germany in 2014 and initially focused on expanding our land position through various acquisitions, farm-ins and government concessions, and we now have approximately 1.2 million net acres of land, comprising about one-quarter of the prolific North German Basin.  The first few years were focused on building our team and executing on low risk development opportunities on the existing producing assets while evaluating future exploration and development prospects.  Following the successful completion of our first operated drilling in Germany this summer, we now plan to drill at least one exploration well in Germany each year over the next several years, targeting other sizable gas prospects in the basin.

We followed a similar approach when we entered Central and Eastern Europe later in 2014.  We acquired land in the Pannonian Basin in Hungary, Croatia and Slovakia through various government concessions and deals with industry partners. Our initial focus was on building our knowledge of the basin and operating environment, while acquiring and evaluating seismic to identify future drilling prospects. This summer's drilling program has yielded four conventional discoveries in Hungary and Croatia in five exploratory attempts.  We look forward to executing the remainder of our Croatian program and to initiating our Slovakian program later this year.

Subsequent to the second quarter, we further expanded our CEE presence as we were awarded two exploration licenses in Ukraine in partnership with Ukrgazvydobuvannya ("UGV", a Ukrainian state owned gas producer) in the prolific Dnieper-Donets Basin.  These two licenses are in close proximity to several multi-TCF gas fields with most of the basin (and awarded license areas) still not covered by 3D seismic.  Entering Ukraine aligns with our strategy to capitalize on opportunities in under-exploited basins by using modern technologies to improve success rates and recovery.

In addition to our Germany and CEE exploration drilling programs, we are also currently preparing to drill the first well (0.5 net) of our two (1.0 net) well 2019 program in the Netherlands after having received permits for these wells in the second quarter.  Netherlandscontinues to be a strong free cash flow generating business and we look forward to resuming drilling there after a two-year hiatus.

Our second quarter results were negatively impacted by a third-party refinery outage in France which reduced production and forced us to find alternate transportation methods and delivery points for our oil in the Paris Basin, which is the larger of our two producing regions in the country.  Our French team did an exceptional job of contracting for alternate delivery points for most of our production, and conducting the required long-haul trucking and barging in a safe manner.  Despite the refinery outage, which impacted quarterly production volumes by approximately 1,300 boe/d and FFO by approximately $11 million, we recorded corporate production of approximately 103,000 boe/d, little changed from the previous quarter.

We recorded FFO of $223 million in Q2 2019, down 12% from the prior quarter.  In addition to the France refinery impact, the primary drivers for this lower FFO were the timing of crude lifting in Australia, which resulted in an inventory build and lower sales volumes ($8 millionimpact), and weaker natural gas prices in Europe and North America ($33 million impact).

We were able to mitigate a portion of this pricing variance through our hedging program, particularly in European gas, realizing a $14 million pre-tax gain during the quarter.  European gas prices weakened this summer due to increased LNG deliveries.  However, we have locked in pricing on approximately 70% of our summer European gas at significantly higher prices than the spot price.  The forward price for European gas remains in strong contango compared to the front month price, with the calendar 2020 strip for NBP at approximately $8.50/mmbtu, and calendar year strips for the next three years are currently trading within approximately 1% of where they were one year ago.  While our fundamental view on European gas is that the forward market realistically reflects supply and demand drivers, we are willing to lock in this curve and attendant strong levels of free cash flow and expected project economics.  Accordingly, we have already hedged 65% of our expected 2020 European gas production, with hedges continuing at lower percentages on into 2022.

Since 2003, Vermilion has had a track record of returning capital to shareholders through our monthly dividend (previously a cash distribution during the trust era).  This distribution and dividend stream has been increased four times and has never been reduced.  We also recognize that other forms of returning capital to shareholders, such as share buybacks, may be appropriate to complement our dividend in certain market conditions.  With this in mind, our Board of Directors has authorized an application to the TSX to implement a normal course issuer bid ("NCIB") for a maximum amount of 5% of the issued and outstanding shares of Vermilion.  We intend to use the NCIB to return capital to our shareholders, augmenting our current return of cash through dividends.  We will also continue to allocate a portion of excess free cash flow to debt reduction.

Q2 2019 Operations Review

Europe

In France, Q2 2019 production averaged 9,800 boe/d, a decrease of 15% from the prior quarter.  Our production in the Paris Basin was temporarily curtailed as a result of a third party refinery outage due to a failure on the refinery's main feedstock line. The Grandpuits refinery, where all of our Paris Basin production is processed, returned to service in late July, and has resumed processing Vermilion deliveries. During the refinery outage, we made arrangements to ship most of our oil to alternate delivery points in France and Germany utilizing trucks and barges. The net impact from the refinery outage reduced our Q2 2019 production volumes by approximately 1,300 boe/d and after-tax FFO by approximately $11 million ($0.07/share) from reduced sales and higher transportation expense.  In addition, approximately $2 million in capital investment was required to put truck and barge loading equipment in place.

In the Netherlands, Q2 2019 production averaged 8,917 boe/d, an increase of 3% from the prior quarter.  The increase is primarily due to the successful completion of our first half 2019 workover and facility maintenance program, which was partially offset by minor downtime.  During the second quarter we received the draft drilling permit for the Waalwijk South well (0.5 net), the second well in our planned 2019 drilling program.  We recently began site construction for the first well of our 2019 program, the Weststellingwerf well (0.5 net), which is expected to commence drilling in August 2019.  Drilling of the Waalwijk South well is expected to begin in Q4 2019.

In Ireland, production averaged 49 mmcf/d (8,201 boe/d) in Q2 2019, a decrease of 4.8% from the prior quarter.  The decrease was due to natural decline and minor unplanned downtime at the Corrib natural gas processing facility.  Since we took over as operator of the Corrib Project late in 2018, operating costs have decreased 14% over the comparative six-month period.  At present, our efforts are focused on evaluating future facility and drilling projects, and optimizing our maintenance activities, including a scheduled plant turnaround in Q3 2019.

In Germany, production in Q2 2019 averaged 3,474 boe/d, a decrease of 8% from the prior quarter.  The decrease is primarily due to unplanned downtime on several operated and non-operated assets, which was partially offset by a full quarter contribution from various well workovers performed on our operated oil assets earlier this year.  During the quarter, we completed drilling our first exploratory well in Germany, the Burgmoor Z5 well (46% working interest).  The well reached a measured depth of 11,480 feet and encountered 125 feet of net pay in the Zechstein carbonate.  The well was tested at the end of July at a final flow rate of 8.8 mmcf/d⁽²⁾ limited by weather conditions.  The Burgmoor Z5 well has been turned over to ExxonMobil as operator during the testing and production phases.  We also completed and brought on production a non-operated coil tubing sidetrack (0.25 net) during the quarter.

In Central and Eastern Europe, we drilled four (3.3 net) exploration wells during Q2 2019, and one (1.0 net) subsequent to the end of the quarter.  Four of these wells resulted in new gas discoveries.  In Hungary, we drilled four (3.3 net) exploration wells, the first (1.0 net) of which was dry.  The second well (1.0 net) of our 2019 Hungary drilling program encountered 15 feet of net gas pay and tested at a rate of 1.4 mmcf/d and 55 bbls/d⁽³⁾ of condensate.  The third well (0.3 net) encountered 26 feet of net gas pay, and tested at a rate of 2.0 mmcf/d⁽⁴⁾ in July.  The fourth Hungarian well (1.0 net) was drilled and tested in July, encountering 17 feet of net gas pay and testing at 3.4 mmcf/d⁽⁵⁾.  In Croatia, we drilled our first natural gas exploration well (1.0 net) in the country which encountered 32 feet of net gas pay in two zones.  Subsequent to the end of the quarter, it tested 15.0 mmcf/d⁽⁶⁾ from the lower zone.

Subsequent to the end of the second quarter, we were awarded two exploration licenses in Ukraine, subject to a final production sharing agreement, in a 50/50 partnership with Ukrgazvydobuvannya ("UGV", a Ukrainian state owned gas producer).  The licenses cover approximately 585,000 gross acres situated in one of Europe's most prolific natural gas regions (Dnieper-Donets Basin).  The new licenses are in close proximity to several multi-TCF gas fields with most of the basin (and awarded license areas) still uncovered by 3D seismic.  The terms of the licenses include a modest capital commitment, back-loaded over a five-year time frame.