Exploration & Production

Zargon's Little Bow ASP to Come Online

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Zargon Oil & Gas Ltd. has provided a Little Bow Alkaline Surfactant Polymer (ASP) tertiary oil recovery project update, an operational update, 2014 production and capital guidance and 2013 year end reserves.

Zargon intends to release its 2013 audited financial results on March 11, 2014, after market close.

Little Bow ASP Project Update:

Zargon has commenced commissioning the Little Bow ASP tertiary oil recovery project and continues to forecast that first chemical injections will occur in March 2014. This ASP project entails the injection of large volumes of a dilute chemical solution into a partially depleted oil reservoir to recover incremental oil reserves.

The ASP project construction, which is more than 97 percent complete, entails the construction of a water softening plant, chemical handling/mixing facilities and a water injection plant. In addition, the project has included oil battery upgrades, pipeline replacements/upgrades, water injector conversions, well reactivations and the drilling of two injection wells.

Including the $35.3 million (unaudited) and $6.5 million of ASP costs spent in 2013 and 2012, respectively, the total capital cost of the wholly owned phases 1 and 2 of the Little Bow ASP project will be approximately $61 million (excluding the cost of capitalized ASP chemicals). This estimate is essentially unchanged from the forecast cost provided in February 2013 ($59 million) when the project was sanctioned. The additional costs were spent on a project scope change to drill two additional injection wells. The remaining expenditures for this project are $7 million to be spent in the first half of 2014, and then $12 million in 2015 relating to phase 2 implementation.

Zargon's independent reserves evaluator McDaniel & Associates Consultants Ltd. (McDaniel) in their 2013 year end report has assigned 4.48 million barrels of proved and probable oil and liquids reserves and an incremental discounted cash flow (PVBT 10%) of $66.3 million to phase 1 and phase 2 of this project. Zargon's internal economics are based on a 5.24 million barrel estimate (12 percent incremental tertiary recovery) which has been scaled back from reservoir models that predict 6.50 million barrels of incremental oil can be achieved through optimized chemical injections. The undiscounted cost of the optimized phase 1 and 2 chemicals is forecast to be $78 million ($53 million PVBT 10%) and compares to the McDaniel proved and probable undiscounted chemical cost estimate of $66 million. The phase 1 and 2 chemicals will be injected over the seven year chemical injection period from 2014 to 2021.

Phase 1 of the Little Bow ASP project is expected to provide 100 barrels of oil per day of incremental production in 2014, which will be comprised of an initial production response in the 2014 third quarter and a 2014 year end rate of 350 barrels of oil per day. Incremental production is expected to exceed 900 barrels of oil per day in 2015 and then increase to 1,550 barrels of oil per day in 2016, once phase 2 production begins.

Using forecast rates with an estimated field oil price of $67 per barrel (assuming an Edmonton par price of $85 per barrel), a 12 percent incremental tertiary royalty rate and operating costs of $10 per barrel of incremental oil, the project is forecast to provide a field netback of more than $48 per barrel of incremental oil production and deliver a property capital recycle ratio (including sunk costs) of over 1.8 times. Potential upsides to the project could come from follow-on phases, higher oil prices, improved reservoir recoveries or Alberta Crown tertiary royalty reform.
Follow-on capital expenditures of $77 million (including chemical costs) for phases 3 and 4 of the Little Bow ASP project are expected to yield an additional 3.6 million barrels of incremental oil, and Zargon's combined Little Bow project's (phases 1 though 4) total production is expected to stabilize at 2,200 barrels of oil per day in the 2021 through 2023 period. The long-life stable production profile of the ASP project is well suited for Zargon's dividend paying business model.

Conventional Operations Update:

Zargon's conventional oil exploitation business is characterized by low decline production volumes coming primarily from the measured exploitation of five conventional long-life pressure-supported core oil properties (Williston Basin, Taber, Little Bow non-ASP, Hamilton Lake and Bellshill Lake). Fourth quarter 2013 oil and liquids production volumes averaged 4,625 barrels per day, a four percent decrease from 4,816 barrels per day in the prior quarter and two percent above production guidance levels of 4,550 barrels per day. The quarter over quarter reduction in oil production volumes was due in part to the effect of 360 barrels per day of fourth quarter property sales that reduced fourth quarter production volumes by 200 barrel of oil per day.

Fourth quarter 2013 natural gas production volumes averaged 15.90 million cubic feet per day, a three percent decrease from the prior quarter rate of 16.46 million cubic feet per day and six percent above production guidance levels of 15.00 million cubic feet per day, due in part to prior period adjustments. On a combined basis, fourth quarter 2013 total production averaged 7,276 barrels of oil equivalent per day (on a 6:1 equivalency basis), a four percent decrease from the prior quarter's rate of 7,560 barrels of oil equivalent per day.

During the 2013 fourth quarter, Zargon spent $12.6 million (unaudited) on field capital programs in addition to $11.7 million (unaudited) on the Little Bow ASP project. The quarter's drilling activity totalled 8.5 net wells and included 5.5 net conventional oil exploitations wells and 3.0 net wells (2.0 injection wells and 1.0 disposal well) at the Little Bow ASP project. The conventional drilling program was divided between the Bellshill Lake and Williston Basin (Elswick) conventional oil exploitation properties. Fourth quarter capital projects also included pipeline and infrastructure upgrade expenditures at Steelman, Saskatchewan and a pilot waterflood at Bellshill Lake (Killam), Alberta.

During the full year 2013, Zargon spent $40.8 million (unaudited) on field activities and a further $35.3 million (unaudited) on the Little Bow ASP project. The capital expenditures included 16.6 net wells that resulted in 13.6 net oil exploitation wells at Taber, Bellshill Lake, Harmattan and Williston Basin (Steelman, Elswick, Weyburn, Mackobee Coulee) properties and 3.0 net ASP related service wells at Little Bow. These expenditures were partially offset by a net $34.5 million (unaudited) of property dispositions. In aggregate, the disposition properties had been producing 626 barrels of oil equivalent per day (comprised of 506 barrels of oil per day and 0.72 million cubic feet per day of natural gas).

2014 Capital and Production Guidance:

Zargon's 2014 capital budget has been set at $35 million for (non-ASP) conventional projects with the drilling of 18 net oil exploitation wells, plus an additional $7 million to finish the first phase of the Little Bow ASP project and $9 million for ASP chemical expenditures. This $51 million capital program is forecast to be funded by cash flows, the sale of a minimum of $5 million of minor non-strategic primarily natural gas properties and increases in bank debt.

As at the end of the 2013 fourth quarter, Zargon's debt net of working capital is $116.2 million (unaudited), a level that represents 52 percent of the $222.5 million of credit through convertible debentures and syndicated loan facilities. Zargon has sufficient debt capacity to manage a small increase in debt levels until ASP production is realized by the end of 2014.

The 2014 conventional capital program will focus on Williston Basin Midale type horizontal exploitation locations (9), Taber waterflood horizontal development locations (4), Bellshill Lake Mannville vertical stepout and infill locations (5). In all cases, the 2014 drilling program targets the efficient development and/or acceleration of the production from existing low production decline oil pools. For the 2014 first quarter, four horizontal locations are scheduled at the Williston Basin, Saskatchewan properties at Weyburn (2), Elswick (1) and Ralph (1).

Based on this 2014 capital program, Zargon expects oil production to steadily grow from second quarter levels throughout 2014 as stable conventional oil production volumes are augmented by growing Little Bow ASP oil production volumes. Specifically, first and second quarter 2014 oil production is expected to average 4,300 barrels of oil per day and then increase with ASP production gains to a year end rate of 4,650 barrels of oil per day.

Zargon continues to focus on conventional secondary (waterfloods) and tertiary (ASP) oil exploitation while allocating minimal capital to natural gas properties. For the 2014 first quarter, natural gas production is anticipated to average 14.0 million cubic feet per day, and calendar 2014's production forecast to average 13.5 million cubic feet per day although this estimate will depend on the magnitude and timing of the company's 2014 property disposition program.

In 2014, Zargon will continue to actively pursue property dispositions that improve its profitability and operational focus by selling (or trading) primarily natural gas, non-strategic properties. Over time, Zargon anticipates that these dispositions will enable Zargon to realize a lower-cost, higher-netback structure through a disciplined focus on a growing tertiary ASP oil recovery business and the stable production volumes coming from the measured exploitation of five conventional long-life low-decline core oil properties.