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Good morning. My name is Chris and I will be your conference call facilitator today. Welcome to the Frontera Energy Co Second Quarter 2018 Results Conference Call. [Operator Instructions] I would like to remind you that this conference call is being recorded today and is also being webcast on the company's website. [Operator Instructions]This call contains forward-looking statements, which reflect the current expectations or beliefs of the company, based on information currently available. Forward-looking statements are subject to a number of risks and uncertainties that may cause the actual results of the company to differ materially from those discussed in the forward-looking statements. Factors that could cause actual results or events to differ materially from current expectations are disclosed under the heading Risk Factors and elsewhere in the company's annual information form dated March 27, 2018. Any forward-looking statement speaks only as of the date on which it is made and the company disclaims any intent or obligation to update any forward-looking statement.I would now like to turn the call over to Mr. Gabriel de Alba, Chairman of the Board of Frontera Energy.
Thank you, Chris. And good morning, everyone. Thank you for attending today's conference call to review Frontera's second quarter 2018 financial results, discuss operational performance and provide an update on our value-creating initiatives.I'm joined this morning by Richard Herbert, our CEO and David Dyck, our CFO.Driven by strong operational performance, Frontera announced this morning an increase in the 2018 operating EBITDA guidance to a $400 million to $450 million range from the prior to $375 million to $425 million guidance. The Board is encouraged by the continuing performance improvements driven by better execution and efficiencies. Recent developments with respect to transportation costs have reduced Frontera's future commitments by over $1.5 billion and will enable the company to improve cash generation on this area by approximately $125 million per year.On top of strong financial performance, our current high impact exploration initiatives in the Colombia [indiscernible] and Peru are moving ahead of schedule [Technical Difficulty] while the Alligator-4 well is producing already 1,370 barrels per day.On the capital markets front, the company refinanced its senior secured exceed notes with [Technical Difficulty] launch a normal course issuer bid for the repurchase of up to 3.5% of the company's shares outstanding. The increase in guidance, strong financial results and the steady progress in value-creating initiatives demonstrated the high quality skill and expertise of our people and teams.I would like to pass the call now to Richard Herbert, our CEO.
Gabriel, thank you very much and good morning to everyone and thank you for joining our call this morning. It has been a very strong quarter for Frontera and we continue to deliver our operational plan to position Frontera for growth in reserves and in production.My 4 priorities since taking over as the CEO in April of this year have been the following. First, to ensure that Frontera is on a sound financial footing with a strong balance sheet and the flexibility to manage our cash and take advantage of exploration success and other opportunities, which become available. The refinancing of our exit notes in June was an important step for the company because it releases us from some very restrictive covenants, which were imposed at the time the debt was arranged during the restructuring of Frontera in late 2016.Second priority is to improve the quality of our existing upstream business through higher production, improving efficiency and reducing costs. On production despite losing access to the lower Peruvian export pipeline in Peru for up to 3 months, we are not changing our production guidance range for 2018. We have made significant steps to reduce our transportation costs in Colombia. With the settlement in our favor in the Ocensa pipeline tariff arbitration and through our decision based on our contractual rights to terminate our ship or pay contracts in the Bicentenario and Cano Limon Covenas pipelines. And we have made significant progress in identifying cost savings to apply across our operations and in our offices, which will be a focus of our attention in the second part of this year.My third priority is to create a portfolio of assets which provide Frontera with the capability to grow in the future. To this end, we are working on 2 important exploration projects at the moment, Acorazado in Colombia and Delfin Sur offshore Peru. I would talk about progress with these wells in a minute. And we are also evaluating new projects in our portfolio, such as the next phase of development of CPE-6 in Llanos of Colombia and possible participation in license runs in the region. We see a lot of opportunities for growth, but we'll be very disciplined and we'll only select projects which align to our strategy, have a lose fit to our capabilities and which deliver superior returns.And the fourth priority is to remain focused on the key relationships in the ways of working which make us a natural partner for the governments, the communities and the contractors where we operate. We seek to operate at the highest levels of HSE performance and ethical compliance to bring technological solutions and to be seen as a positive force in our interactions with communities where our assets are located.Turning to exploration, the Acorazado-1 well on the Llanos 25 Block in Colombia reached total depth of 15,470 feet on July 23, which was a week ahead of schedule and under budget. This was a significant operational achievement in Frontera's first deep foothills drilling project. We are currently in the process of locking and evaluating the well. And we expect to be able to provide results from the well in the coming weeks once the evaluation and any potential testing operations are complete.Offshore Peru on Blocks Z1, the Delfin Sur-1 exploration well began drilling on July 15 with a planned total debt of 9,750 feet. We are currently at 6,000 feet and the well should be complete by the middle of August with evaluation and testing operations set for the end of August.The recent arbitration settlement agreement on the P-135 project on the Ocensa pipeline, combined with the termination of our ship-or-pay contracts on the Bicentenario and Cano Limon pipelines results in a reduction in fees paid on suspended pipeline capacity, which was $122.5 million in 2017. Our transportation commitments have been reduced by more than $1.5 billion between now and 2028. The savings the company generates as a result of these initiatives will be used to invest in upstream capital projects with the intention to deliver production and reserves growth and increased activity and employment in the areas where we operate.Our strong financial results so far this year combined with continuing high oil prices and the positive results from the arbitration relating to P-135 have led to the company increasing its operating EBITDA guidance to $400 million to $450 million from $375 million to $425 million. We are also narrowing our transportation cost expectations to a range of $12.50 to $13.50 per barrel of oil equivalent from $12.50 to $14.50 per barrel of oil equivalent. The recent termination of the ship-or-pay agreements on the Cano Limon and Bicentenario pipelines will help normalize the margins for Frontera to be in line with those of our peers and eliminate the fees paid on suspended pipeline capacity, which have been a significant cash burden for the company over the past several years.Average daily net production after royalties decreased 3% quarter-over-quarter to 64,120 barrels of oil equivalent of which 56% was light and medium oil. Downtime in Peru related to a force majeure event on the NorPeruano pipeline impacted production on Block 192, reducing company production by almost 1,900 barrels of oil per day in the quarter. We are encouraged the Petroperu has indicated that they expect the pipeline to be repaired and operating as normal by the end of August. Higher oil prices, which result in lower volumes relating to PAP at Quifa Southwest across the cost company of further 700 barrels of oil per day and has impacted total company volumes by 1,700 barrels of oil per day so far in 2018.Despite these third-party issues, we have kept our production guidance for 2018 unchanged. This reflects our confidence in our ability to deliver strong production during the second half of 2018 and position the company for 2019. The exploration success we've had at Guatiquia so far this year have been integrated into the existing water handling and production facilities that already exist on the block. These discoveries delivered 5% quarter-over-quarter production growth in our light and medium oil business unit. In our heavy oil business unit, we await the start up of additional water handling capacity in the Quifa area by the end of the year.In the second quarter, we delivered a 10% increase in Operating Netback to $26.76 per boe. As we progress through 2018, we will continue to identify and evaluate areas for continued efficiency gains in our operations and improve our cost structure. During the second quarter of 2018, we spent $87 million on capital expenditures, including the drilling of 24 development wells and one exploration well. A number of development wells at Quifa Southwest, originally planned for the first half of 2018 have been deferred to the second half of the year to match the startup of the increased water handling capacity project in the fourth quarter.The company currently has 9 drilling rigs operating, 5 in our Quifa Southwest heavy oil area, 2 at our Guatiquia light oil block, 1 on the Llanos 25 Block and 1 on Block C-1 offshore Peru. During the third quarter of 2018, the company plans to drill 39 development wells and 1 exploration well. Of the 32 of the development wells and 2 water injector wells are targeted to be drilled in the Quifa Southwest area.I'm now going to turn the call over to David Dyck, our Chief Financial Officer, who will go over the financial highlights of the second quarter.
Thank you, Richard and good morning, everyone.Frontera delivered strong financial results in the second quarter of 2018 and our increased guidance expectations demonstrate that we expect these results to continue through the remainder of 2018 and into 2019.During the second quarter, the company refinanced its $250 million senior secured 10% coupon exit notes that were due in 2021 with a new bond offering of $350 million senior unsecured 9.7% coupon notes due 2023. This refinancing provides the company with a significant amount of flexibility both financially and operationally going forward. For example, the company has recently implemented a normal course issuer bid, where the company has been granted approval to repurchase up to 3.5% of its outstanding stock, an initiative that would not have been possible under the terms of the former bonds.We generated cash flow from operations of $108 million in the second quarter, $21 million higher than our capital expenditures of $87 million and that is despite having 60% of our production hedged with a ceiling of $55 Brent. For the third quarter, 60% of our production is hedged at $60 Brent and then in the fourth quarter, we're only hedged in October and will enjoy a significant increase in Netbacks and cash flow for the fourth quarter should oil prices hold around current levels.For the second quarter of 2018, total sales after realized risk management contracts increased 40% to $350 million compared to about $250 million in the first quarter of 2018 and increased 17% from $300 million in the second quarter of 2017. Sales volumes were 6% higher than the net production volumes as a result of the 500,000 barrel benefit, approximately 5,500 barrels per day from the oil cargo that was sold with crude oil inventory that had been built up from prior periods.Oil sales in Peru continued despite the interrupted production on Block 192 as a result of a force majeure event that Richard referred to earlier.During the second quarter of 2018, net loss attributable to equity holders of the company was $184.4 million or $1.84 per share compared with a net loss of $3.1 million or $0.03 per share in the first quarter of 2018. The majority of the loss was attributable to an impairment of $107.7 million that the company recorded on its investment in Bicentenario. In addition, other non-recurring losses included increased losses on realized risk management contracts of $26 million, a loss from the extinguishment of debt of $25.6 million and the reclassification of currency translation adjustment related to the sale of Petroelectrica de los Llanos of $51 million.Our balance sheet remains very strong with combined cash balances of $730 million and positive working capital of $317 million. Our net debt to operating EBITDA based on trailing 12-months is 0.1x and our debt-to-book capitalization is just over 23%.During the second quarter of 2018, the company executed on $87 million of capital expenditures and generated $108 million in cash provided by operating activities. This strong financial position will enable Frontera to deliver on its key growth initiatives in 2018 including exploration capital expenditures of between $100 million and $120 million and infrastructure expansion spending of between $125 million and $140 million out of a total capital expenditure program of $450 million to $500 million for the year.We continue to have approximately 60% of our daily production hedged between now and the end of October with ceilings ranging from $59.22 and $61.63 per barrel, both of which are below the current forward Brent strip. Assuming the forward strip, Frontera has exposure to significantly higher realized prices during the second half of 2018, as we're currently unhedged in November and December and into 2019.I'll now turn the call back over to Richard for some closing comments.
Good. David, thank you very much. This concludes summary of the highlights from the second quarter, a quarter in which I believe Frontera has made significant progress.I'd now like to turn the call back to Chris, our operator, who will then coordinate a question-and-answer session.
(Operator Instructions) Cameron Ross, Mangrove Partners.
This is Nathaniel August. I have 2 questions. The first is, I did not hear an update on the port. So if you could just give us a brief update on the port, I'd appreciate that. And the second is, I understand that you're ramping up your investment, especially on the exploration side, but I haven't yet heard a discussion about how you think about the returns that you target when you're investing capital in either exploration or development and to the extent you could help us better understand that, I'd appreciate it.
Nathaniel, good morning, it's Richard here. Let me just say some words about the port, about Port of Bahia and then I'll hand over to David just to answer the second question on our returns expectations. I think the short answer on Port of Bahia is that there hasn't -- there is no update to really report to investors at this stage. We continue to look for solutions to increase the value of the port, which primarily involves looking at infrastructure connections to the refinery next door. Obviously, we've been in a period over the last few months in Colombia where this large political change and so there's not a lot of -- not been a lot of progress in those negotiations, but they do continue. So at this stage, nothing to update you on the port, but obviously, as we get information, we'll be sharing that. And now David, if you can just talk a little bit about how we think about returns from our exploration and development projects.
Thank you. So first, all of our exploration projects are [indiscernible] as you know, but based on our evaluation, we're looking at returns that are in excess of our cost of capital for exploration projects and we'd be in a range of 15% to 20%.
(Operator Instructions) Jason Wangler, Imperial Capital.
I appreciate the conversation about the hedges rolling off in October, and obviously with the financial flexibility you guys have now, could you maybe talk about what your thoughts are once we get outside of October and maybe even in 2019, how you look at that part of the business?
Yes, Jason, it's David here. Thanks for that question. Yes, you're right, we're looking forward to a significant increase in cash flow when our hedges rolled off. We're in the process of evaluating our program for 2019. And so we've been having discussions internally and with our Board on that. So we don't have anything specific, but obviously we have a key amount of capital that we spend every year, which we consider our maintenance capital, and so one approach would be to put a hedging -- put hedges in place to protect that level of spending, about $250 million to $300 million per year, which will allow us to keep our production flat and stable over the next 5 years. So that's the way we're thinking about it right now.
And then obviously, you still have a big cash position and the balance sheet in really good shape too, and with the increase in EBITDA you guys are guiding to for this year, it looks like it will pretty close on a cash flow to CapEx function. As you think about that 2019, should we kind of think about that as being kind of the plan as well depending on opportunities, but kind of [indiscernible] aligned with EBITDA and CapEx?
Yes, you're right, Jason. That's the way we see ourselves on a go-forward basis, kind of a sustainability index of 1, so roughly spending our cash flow. However, the additional cash balances that we have certainly provide us with ample flexibility, should we have success on our exploration projects, we can immediately go to a larger development program and be able to fund those programs with existing cash resources.
Jenny Xenos, Canaccord.
I have 4 questions, please, 3 to Richard I guess and 1 to David. The first question is regarding your success on the Guatiquia block. You've successfully drilled a number of wells now, some of them have been tied in. Could you please walk us through the process of approval for tying in these wells and the timeline how long it typically takes? And what are your plans for this bock, drilling plans for the rest of the year? The second question is on Quifa, could you give us please, some color on your planned horizontal development well program for 2019 and what kind of impact do you expect it to have on reserves and on production? And the third question is on Peru. Should we expect sales to ramp up to the full amount of roughly 8,600 barrels a day? And once the pipeline repairs are completed since you have oil in storage there and how much barrels do you actually have in inventory on the block? And the final question is to David, if I may, at the end of Q1 your carrying value for Bicentenario investment was $208 million and you're all down about half of that. Why only half?
Jenny, good morning and thank you, I don't know if you are allowed 4 questions, but it's very nice to get your questions. So we'll have a go at answering them. And on your questions on Guatiquia and Quifa, I'm going to hand over in a second to Duncan Nightingale, our Chief of Operations, who can tell you how we think about approval of new -- tying in new wells on Guatiquia and what our plans going forward are and he can also update you on the drilling program in Quifa. And then I would make the -- I'd just like to make a point on Quifa, which is that Quifa has a lot of opportunity. As you know, we are investing quite significantly this year in additional water handling facilities, which will allow us to then bring on another suites of new wells. Our goal in Quifa at this stage is to maintain flat production. I think when you look at the reserves to production life, the reserves to production ratio, the reserves-life index that the company has which is a relatively modest 4.5 years at 1P or 6.5 years at 2P. It doesn't to my mind make sense to try and grow our production of our base. We should be looking to grow production of new projects, which bring a longer at R to P ratio to the company. So our goal in Quifa is to stabilize the production and keep it flat and continue to improve the efficiency by bringing on wells with higher oil percentage in them because obviously these are wells that have very high -- high water cuts. Just to answer your question on Peru, before I hand it off to Duncan, the short answer is yes, we will -- as soon as the pipeline is put back into operation by Petroperu, we will be ramping up our production back to the -- to at least the levels that we had before the pipeline was shut down. We're actually using this opportunity while the pipeline is down to do some well workovers and actually position ourselves to have slightly increased production for when the pipeline is back on. And in terms of the inventory numbers you asked about, we -- in total, that's about 1.4 million barrels, but a large part of that of course is the [indiscernible]. And I don't actually have with me the actual amount that we've got in tank storage in the field. With that, let me just hand over to Duncan to talk about Guatiquia and Quifa, please.
Thank you, Richard. Good morning, Jenny. Good to hear from you. Let me deal with Guatiquia first, if I may, regarding the time to tying in wells and then the required approvals. As you know, we have the development component on Guatiquia as well as the exploration. So let me deal with development first. Typically once we've TDed a well and we've locked it and confirmed the pay sections requiring completion and perforation, we obviously move ahead with that and then enter into a short test period and that test period can be a matter of -- literally a matter of days, while we are making the necessary arrangements to get the well on production. So typically post completion, we will have a well on production in Guatiquia in less than a week, maybe a week maximum and the reason we can do that is because we have a well-developed infrastructure. And secondly, if an additional flow line is required to tie the well into the main flow lines, we can obviously truck for a few days the total fluid for separation at [indiscernible] processing facility. So development well are very quick. With respect to exploration wells on the block, the process is obviously a little bit longer. Normally, upon completion of the well, we enter into a 7-day test period, which is the period permissible by the ANH for exploration wells. Upon successful conclusion of the initial 7-day test period, we then make an application normally to the ANH for a long-term test. Now, the long-term test typically has to be at least 1 month but it can be anywhere from 1 month to 6 months. And then upon successful conclusion of the long-term test period, we then make a declaration of commerciality to the ANH and to move ahead with a development. And again, with respect to the exploration wells, depending on the distance from existing infrastructure, the tie-in can be quite quick or it can be a couple of months while we're actually laying flow-lines to connect with the main processing facilities. So I don't know if that answers your question adequately.
It does, Duncan.
And with respect to Quifa, what we can say at the moment is obviously we are entering into the 2019 budget planning process this month. So our exact number of wells for Quifa has not yet been determined, obviously that has to be discussed with our partners, Ecopetrol. But all I can say is at the moment we would certainly, with respect to Quifa, expect the same level of activity as 2018. However, with respect to the recent discovery earlier this year, Jaspe, we would expect to be drilling some appraisal wells on Jaspe this year with the intention of getting close to or at declaration of commerciality at the end of this year or the early part of 2019.
Very good. Duncan, thank you for that. Let me just hand over to David to address Jenny's final question on the impairment.
Hi, Jenny good morning. So you're right. We've written down or we've impaired our investment in Bicentenario by about 50% down to 108% and the reason that the impairment wasn't more is that there's still a fair bit of value associated with that investment. So what we've done is just in our modeling, the impairment modeling, we've just taken out our 47,000 barrels a day out of approximately 1,10,000 barrels a day that are going through that pipeline. So there is still considerable value in that with other volumes, not our volumes, but other volumes that are going through that pipeline. So that's why the investment was only written down that much.
So you're still assuming going forward that that pipeline will be operational?
Sorry, could you repeat that, you kind of broke up?
You are assuming then going forward that that pipeline will continue to be operational?
Yes, it is operational today, yes.
[Operator Instructions] Rene Burgos, CarVal.
I have a couple of questions. One is, it seems like the second half is going to be teed off as a -- probably like a good momentum of growth. So I just wanted to get a sense of how should we be thinking considering your development program, not your exploration program, how should we be thinking about your reserves, what reserves you're going to replace and what's your view on your end balance of reserves this year? My follow-up question then on the EBITDA the answer you gave earlier, you're seeing higher -- now you're seeing higher oil prices, but yet your EBITDA range only looks like $25 million. I found that interesting only because your production is actually supposed to be stronger in the second half based on [indiscernible] development activity and others. So I just wanted to kind of, on that one, get a sense of what your production views are for the second half and the impact of those [indiscernible] initiatives and why only is the EBITDA moving $25 million? And my last question was on the cash balance. You spoke on the cash balance as the optionality that gives you, but if over the next 6 months you can [indiscernible] your plan, oil prices stay where they are, it will be clear that there will be excess cash for you guys to do something and I'm wondering what that something is. We'd like to get a little bit further clarity on the cash. Those will be my 3 questions.
Okay, Rene. Thank you very much for your questions. Let me address the first one and maybe just ask Duncan if he's got any additional comments on that and then I'll hand over to David to talk about EBITDAR and the cash balance. I think the simple answer on sort of how we think about -- well, let me talk first of all about reserves replacement in 2018. I mean, our goal is to replace -- at least to replace reserves each year at a level of 100%. And we have a number of ways we can do that. One is through reserves growth in our fields as we drill additional development wells and where we see improved performance. Secondly is through the addition of what we call certain near field exploration volumes, particularly good example of that is the success we've had at Guatiquia this year. And then thirdly, obviously where we drill sort of a more frontier exploration well, we have the opportunity to add reserves from that if we can see a sort of a near-term route to development. We haven't yet started out our reserve evaluation process for 2018 that actually starts this month. We had good success in the first half of the year in Guatiquia, as I said. Our drilling at Quifa continues to be encouraging. So at the moment I think the way we think about this is that we are -- as we did last year, we're hoping that through the drill pit we can basically replace 100% of our reserves by the end of the year, but we won't know the numbers obviously until we complete the work in December. And then with key wells like Acorazado and Delfin, obviously these discoveries, these have the opportunity add significantly above that and that's really what then provides us with the underlying capability to grow. That's on the first question. David, would you like to address EBITDAR and the cash balances?
Just one follow-up, if you allow me. Then do you have a sense of how many reserves you already replaced this year thus far with the key developments and your Quifa work, you're [indiscernible] I mean, do you have a sense of more or less if you're 50% there or you're 25% there?
I think, I mean we haven't done the detailed work, there's a lot of work that has to go into this, Rene. I would say that we are confident that we're on track for what I described is our goal for the year.
Rene, it's David. Just on your question regarding of EBITDA, one of the main reasons that we didn't increase our EBITDA more was the impact of our hedges that still are going to be in place for the third quarter in October. The other thing is that we've been fairly conservative in looking at our production ramp profile, you're right that we do have a number of activities in the second half that are going to add to production but we've kind of waded that toward the back end, just to be conservative. So I think that that's a conservative viewpoint on our EBITDA guidance.
The other leg of that would have been cost. So I was just hoping that it wasn't cost banks -- you're deferring -- you're being very conservative on your production ramp up for all these deferrals that you've done thus far this year.
That's correct. On the cash balance question you had asked, really the way we're looking at that first of all, we've only got $550 million that's available to us because we've got roughly $200 million that's restricted cash. And so we're really looking at first, opportunities to deploy additional capital with the success on our exploration programs which will lead to further exploration activities and a ramp up on development activities that would be outside of our normal CapEx budget spend and we've got some significant exploration work underway now and so there's, I think, ample provision to be able to fund any development activities going forward. We're always looking at new opportunities and new assets, and so again, we don't have anything specific that we're able to talk about at this point in time, but having those cash resources available for us is, I think, very important.
There are no further questions at this time. Should you have any further questions, please email ir@fronteraenergy.ca. This concludes the call. Thank you all for participating.