Prairiesky Royalty Ltd

TSX:PSK

Earnings Call Transcript

[Operator]

Good day, and thank you for standing by. Welcome to the PrairieSky Royalty Limited Third Quarter 2022 Financial Results Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded.

I would now like to hand the conference over to your speaker today, Andrew Phillips, President and Chief Executive Officer. Please go ahead, sir.

[Andrew Phillips, executive]

Thank you very much, and good morning, everyone, and welcome to the PrairieSky Royalty Q3 2022 Earnings Call. On the call from PrairieSky are Cam Proctor, COO; Pam Kazeil, CFO; and myself, Andrew Phillips. There's certain forward-looking information in my commentary today, so I'd ask investors to review the forward-looking statements qualifier in our press release and MD&A.

Before passing the call over to Pam to walk through the financials, I will provide an operational update. Strong third quarter activity of 286 spuds at an average royalty of 8.9% should result in a strong finish to an already excellent year and a tailwind for 2023. Activity was spread across the basin. The numerous wells were exploratory, testing new concepts and play ideas.

Third quarter leasing was very strong as we entered into 58 leasing arrangements with 46 different companies resulting in lease issuance bonus of $5.9 million throughout the quarter. The compliance group also had a productive quarter and brought in $3.3 million in compliance revenue.

Given the confidence in our organic growth profile, our low payout ratio and the pace at which the debt incurred for the acquisitions in 2021 has been retired. The Board of Directors has made the decision to double the current $0.12 per quarter dividend to $0.24 or $0.96 per share per year. This will be effective for the Q4 2022 dividend for holders on record on December 30, 2022.

Given our continued low payout ratio and organic growth opportunities, investors can expect ratable annual dividend increases in future years. This low payout ratio will allow us to retire the current debt and have significant liquidity available for opportunistic acquisitions or share repurchases, whichever provides the best long-term return for shareholders.

The significant investment that we have made in the large heavy oil-in-place accumulations across the Western Canadian Sedimentary Basin at the inflection point of a new technology used to significantly increase recovery factors will provide our owners with per share reserve growth over the next 5, 10 and 15 years.

Our once every 2-year Investor Day is scheduled for the morning of May 17, 2023, at the Royalty York Hotel in Toronto, where we look forward to publishing our asset handbook and providing shareholders with a range of outcomes over the medium and longer term for the business. Thank you to our owners and staff for patiently allowing us to improve our business over the last 5 years.

I will now turn the call over to Pam to walk through the financials.

[Pamela Kazeil, executive]

Thank you, Andrew. Good morning, everyone. As Andrew mentioned, there are certain forward-looking information in our commentary today. So I'd remind investors to review the forward-looking statements qualified in our press release and MD&A for Q3 2022.

Royalty production averaged 24,986 BOE per day in Q3 and generated another strong quarter of funds from operations, which totaled $123.5 million or $0.52 per share. PrairieSky's oil royalty production averaged 11,376 barrels per day in Q3. Excluding all acquisitions, oil royalty volumes increased 20% over Q3 2021 due to strong third-party drilling activity across our land base. Oil royalty revenues totaled $107.6 million in the quarter as we realized $102.80 per barrel which is up approximately $30 per barrel over Q3 2021.

As expected, oil royalty volumes were lower than Q2 2022 following seasonal breakup when third-party field activity slows down and fewer new wells are drilled and brought on stream. Oil royalty revenue lagged Q2 primarily as a result of lower WTI benchmark pricing and wider light and heavy oil differentials, partially offset by a stronger U.S. dollar. We anticipate higher oil royalty volumes into Q4 and 2023 due to the level of activity on our lands in the quarter when 268 oil wells were spud, including 107 Viking wells, 48 Clearwater wells and 49 light and heavy Mannville oil wells.

Natural gas royalty revenue totaled $24.2 million in the quarter, which was up 55% over Q3 2021, as royalty production volumes averaged 65.7 million a day and benchmark pricing improved. Volumes increased due to acquisition volumes as well as 5% organic growth. Natural gas royalty production volumes remained flat with Q2, but natural gas revenue declined 34% due to lower AECO and Station 2 benchmark pricing. During the quarter, there were 18 natural gas wells spud on our royalty lands, including 5 Spirit River wells and 4 Mannville wells.

NGL royalty revenue totaled $14.2 million, which was up 41% from Q3 2021 due to strong benchmark pricing and flat average NGL production volumes of 2,660 barrels per day. NGL royalty revenue decreased 20% from Q2, primarily due to lower benchmark pricing. Prior period adjustments totaled 1,257 BOE per day in the quarter with 798 BOE per day related to new wells on stream and 459 BOE per day related to compliance activities. Overall, PPAs were 40% liquids. The compliance group recovered missed and incorrect royalties through forensic accounting, collecting $3.3 million in the quarter.

During Q3, other revenue totaled $8.7 million and included $1.6 million in lease rentals, $1.2 million of other income and $5.7 million of bonus consideration. Year-to-date, we have entered into 164 new leases as compared to 91 leases in the first 9 months of 2021. New leasing is a leading indicator of field activity, and we anticipate near-term drilling on many of these new leases.

Cash administrative expenses totaled $4.9 million or $2.13 per BOE in the quarter. We anticipate cash administrative expenses will be well below $3 per BOE for the full year. Current tax expense totaled $20.4 million in Q3. Entering the year, PrairieSky has $1.75 billion of tax pools to offset future taxable income. So in 2022, the first $175 million of cash flow is tax-free and the remainder will be taxed at our statutory tax rate of approximately 23.5%.

During the quarter, PrairieSky declared dividends of $28.7 million or $0.12 per share with a payout ratio of 23%. Excess funds from operations above the dividend in our $2.5 million of acquisitions was used to repay bank debt. Net debt at September 30 was $364.2 million. PrairieSky has reduced net debt by 43% or $270.8 million since December 31, 2021. We are pleased to announce the 100% increase in our quarterly dividend to $0.24 per share or $0.96 per share annualized effective for the December 30, 2022, record date. Since IPO, PrairieSky has generated approximately $2 billion in funds from operations and returned $1.5 billion to shareholders through dividends and buybacks.

We will now turn it over to the moderator to proceed with the Q&A.

[Operator]

[Operator Instructions] Our first question comes from Patrick O'Rourke with ATB Financial.

[Patrick O'Rourke, analyst]

Pleasant strides on doubling of the dividend here. Just curious, in terms of timing and sort of cadence in terms of review of the dividend policy going forward here, we had sort of been thinking about it as being an annual event that happened with the Q4 reporting in the February time frame. Is this still the right way to be thinking about it? And sort of what was the sort of milestone or motivation for this move here?

[Andrew Phillips, executive]

Yes. Thanks for the question, Patrick. It will be an annual event in the future, typically in the February time frame. We're just well ahead of our estimates when we made the acquisitions in terms of debt repayment and growth profile. So we were comfortable rewarding shareholders just 1 quarter earlier.

[Patrick O'Rourke, analyst]

Okay. Great. And then one of the key milestones, I think, for the business is extinguishing the debt that was taken on with the Heritage acquisition. Taking this into account and current strip prices, when do you forecast today that milestone happening?

[Andrew Phillips, executive]

Yes, I'd be in late 2024, early 2025, depending on the pricing we achieved over that period of time, but it will be at very low levels in a pretty short period of time, just given the payout ratio still remains quite low.

[Patrick O'Rourke, analyst]

Okay. And then final question, more on the operational front. Obviously, leasing has been very strong as well as spuds. How much of that is sort of being driven by that Heritage acquisition? And then wondering what you're seeing in terms of the new technology deployment, multilateral wells on that land?

[Andrew Phillips, executive]

Yes. No. Operationally, actually, the leasing has been across the entire basin right from some original PrairieSky lands we had in Southwest Manitoba all the way to the Deep Basin. So it's been pretty widely distributed across the Western Canadian basin. And then from an operational standpoint, we've seen numerous kind of stack heavy oil opportunities where you have really good grain size drilled multilaterally and some pretty significant discoveries made across some of those heritage lands. So there's been some bright spots there.

And we've even seen a light oil opportunity where the multilateral technology was tried in a formation where typically they've fracture stimulated almost every well in the pool. So a pretty interesting dispersion of this technology across the basin, and we look forward to the next year. It's going to be a record number of wells. We should have net capital spend on our lands that's greater than the last 2 years combined this year. So it's -- we're seeing a lot of new wells drilled and not just development wells, some exploration wells. So it should be a fun year to watch the technological advancements on this primarily the heavy oil play.

[Operator]

Our next question comes from Matthew Weekes with iA Capital.

[Matthew Weekes, analyst]

I'm just interested in the opportunity on the carbon capture royalty side. I know it's something that has been discussed before. I'm wondering if you kind of looked internally and estimated what the opportunity could be for carbon capture royalties on your lands in terms of a tonnage amount sort of annually over the long term.

[Andrew Phillips, executive]

Yes. It's an important part of our business that we're working towards expanding. We've been approved for another project in kind of Southern Alberta. I think it's -- there's a huge opportunity, particularly between kind of Edmonton and Calgary, just where a lot of the pollution corridor is, but that's where a lot of our old, depleted reservoirs are as well. So I think -- and there, you can really quantify exactly the volumes of CO2 that can be sequestered into those reservoirs. So we need a little more clarity from the government on incentives to try and align them more with what the U.S. has. But there's definitely a huge opportunity.

We don't quantify the amount of carbon dioxide that can be sequestered, but it's a pretty significant amount across the basin obviously, and I think there's a lot of people pursuing it, which is great. I think it will be good for the Canadian energy sector to show the developments on this front, Matthew.

[Matthew Weekes, analyst]

Okay. And yes, I agree with that last point. And just a second question on the Clearwater. It looks like activity is pretty strong. I'm just wondering if you can comment on generally the trend on the Clearwater royalties and how that might be performing versus initial expectations.

[Andrew Phillips, executive]

Yes. No, thanks for the question. I think it's interesting because Nipisi and Marten Hills are kind of the majority of our 1,500, 1,600 barrels per day of net royalty production. There's been significant new discoveries made of size across the land base. That's one of the benefits of having that big early land base we put together in 2016, 2017. And those discoveries are going to start to see some development this year. So we should see -- we should see some pretty significant growth probably in the 50% range growth year-over-year over the next 12 months.

And then in terms of performance expectations, two things that have positively surprised the 90-day IPs have been a positive surprise across all the plays. And then the second surprise has been the success of some of the water and polymer opportunities across the land base. So I think the recovery factors will probably be a little higher than we initially anticipated.

[Operator]

And our next question comes from Jeremy McCrea with Raymond James.

[Jeremy McCrea, analyst]

Just a couple of questions here. In terms of you guys bumping the dividend here, is this a bit of -- I'm curious what you think of the M&A market here going forward? Just do you feel confident that you can come to dividend? But do you feel like there's enough cash if you want to make an acquisition out there? And what does the M&A market look like here going forward into 2023?

[Andrew Phillips, executive]

Yes. And I guess -- thanks for the question, Jeremy. I think when you think about the M&A market, we did a review of all of the M&A we've conducted since 2014 when we IPO-ed, and it's all been between $40 and $60 oil. So we're quite disciplined on that front and typically try and buy at those parts of the cycle.

And one of the interesting things that we bought last year, discounting $65 crude was something that was for sale 6 years prior to that. So if you're patient and disciplined, all the best assets will end up in the hands of the low-cost royalty operators. So we're we just maintain discipline on that front. The extent to which royalty opportunities are available, we have significant liquidity and still a continued low payout ratio to enable us to execute on those opportunities as they come.

I think the one comment on the Canadian energy sector is it's a plus of cash, and a lot of the companies are going to debt 0 in a shorter period of time. So that's great news for us because of healthy operators, the health of PrairieSky. And that's one of the reasons we're seeing a lot of new exploration plays developed and a lot of new leasing on new opportunities. But I think probably, there is a more -- it will be a little more muted on M&A, and we certainly would have trouble discounting $100 oil in an acquisition opportunity.

[Jeremy McCrea, analyst]

Okay. And then just lastly, of the new leases that you guys signed here, how -- breakdown would you say is because the way the Crown royalty is now just quite a bit higher than where it's ever been where guys are just saying, I'm not interested in paying 35% Crown. I'm more interested in paying 18% of PrairieSky. So like how much of this new leasing activity is because of you guys have a more favorable royalty right now versus the Crown?

[Andrew Phillips, executive]

Yes. And I think -- well, I guess 2 answers to that. One would be that the majority of the really strong leasing is just from strong oil, gas and NGL pricing across the basin. I think it's strong it's been in a long time, all 3 commodities. So that would probably be the major driver. Number 2 would be the financial health.

But I think for sure, there's the recognition in a lot of plays where they're getting pretty quick payout that the NPV on a PrairieSky section for an operator is actually quite a bit higher than it is on the Crown right now just because the wells post C-Star are jumping to a higher royalty. So that definitely is a benefit. It's hard to know because the operators -- we have 330 different operators on our lands, and they don't tell us specifically why they're leasing, but I think that would be a driver in certain plays for sure, Jeremy.

[Jeremy McCrea, analyst]

And just with the higher royalty rate that you guys were seeing from the new wells here, is that something we can expect going forward? Or does that drop back down to more of a long-term normalized rate closer to that 6%?

[Andrew Phillips, executive]

Yes. It's interesting. So our average royalty on our 42,500 wellbore portfolio is 6%. We obviously saw a very strong number in terms of average royalties for the wells that were spud on our land this quarter. A couple of drivers of that. One is the seasonal Viking activity. And typically, the Viking wells get drilled in Q3 and early in Q4 that they don't have to run a boiler on the single rigs. They're not competing with any oil sands, core-hole drilling. And in addition, when they're fracking the well, they don't have to keep the water up as significantly from a lower ambient temperature. So a lot of the Viking activity happened, and those are typically 1-mile laterals. So those would be on 17.5% PrairieSky leases. So that kind of drives the average royalty higher.

But there is one structural change that should affect that over the next 3, 5 and 10 years is the heritage acquisition, all the heavy oil opportunities that exist on those lands from the Waseca, Sparky, GP, Rex all the way down to the Cummings. Those are typically 17.5% leases. And so the Clearwater-type potential results were significantly higher royalties. So that could help bring the average royalty up and bring the net capital up as well.

[Operator]

And our next question comes from Jamie Kubik with CIBC.

[James Kubik, analyst]

Just a quick question on capital allocation. How should we think about the NCIB for PrairieSky and when that could be utilized? Can you just outline a little bit capital allocation framework that you're thinking about here?

[Andrew Phillips, executive]

For sure. And Jamie, I think on the NCIB, if you look historically at what we've done, we bought back $0.25 billion worth of stock. I think an average price of just over $14 per share, we've issued at an average of around [ 25 ]. So we've done it okay in the past. We have an NCIB that's out there right now. I think we will use it opportunistically.

Obviously, the #1 priority right now is paying the debt down to a low level, which gives you optionality on any opportunity that might come available, whether it's buying back the stock or maybe there's a better per share return to be achieved with an acquisition if natural gas prices get weak or something like that. So we just want that optionality, which is why we're not active with it right now, but the debt repayment is #1 priority today.

[James Kubik, analyst]

Got it. Okay. And then on the new dividend rate, can you talk a bit about maybe what commodity price do you think that, that is defensible down to?

[Andrew Phillips, executive]

Yes, it'd be defensible down to $40 oil -- or $50 oil and $0 gas or something like that. But again, we'll have -- when you think about the business over the next 12 months, the debt levels are going to get very, very low on our $800 million bank line. And -- and so even if it got anywhere near that, it would actually provide great opportunities for our business because we'll be virtually debt-free and one of the few that can sustain it at $40 oil environment.

[James Kubik, analyst]

Okay. Great. And then last question for me. A lot of activity noted in the quarter across number of different plays. The Duvernay was absent in that commentary, though, can you talk a bit about maybe the leasing opportunity that you have remaining there? And any new activity that we should be looking for in the coming quarters?

[Andrew Phillips, executive]

For sure. Yes. I think we should see a couple -- we have 2 of our 3 kind of primary operators in the Duvernay have some pads planned on PrairieSky lands and even some licensing that's already in place. And then we are working on some significant leasing arrangements, a little further west with a number of different operators. So there's a bit of an increase in activity there in terms of the leasing opportunity. And I do think, certainly, West the Homeglen Rimbey reef and kind of Williston Green to the North Pigeon Lake, there's a great opportunity there. There's been some pretty interesting discoveries made and a full-scale development of that could be a very significant operating asset for PrairieSky, could be in the range of 1,000 to 2,000 net royalty barrels per day from a very low level today, which should be 350 barrels pound.

[Pamela Kazeil, executive]

Yes. Exactly.

[Operator]

[Operator Instructions] Our next question comes from Mitch Cantor with Mountain Lake Investment.

[Mitchell Cantor, analyst]

I guess, Andrew, I noted in your opening comments that you talked about optimism in the trend in reserves per share on the 5, 10 and even 15-year basis. Some of the factors contributing that you probably touched on, but I'm wondering what else you're looking at when you think about that opportunity.

[Andrew Phillips, executive]

Yes. No, thanks for the question, Mitch. And what's interesting in -- and if you reference our royalty playbooks or our asset handbook that we've released in the previous 3 cycles, so over the last 6 years, typically on a lot of these heavy oil reservoirs, we have a 5% to 7% recovery factor, maybe slightly higher if there's a water, polymer flood opportunity on it. But what's happened with these multilaterals is you're achieving 5 -- far higher recovery factors and probably having a far more optimal water or polymer flood in the future. So what it's basically done is the same -- this is a neat thing about technology and the great optionality that you have when you own a royalty asset base is -- we've owned a lot of this stuff for almost a decade now, and we've always said, okay, well, the total recovery is going to be 100,000 barrels on the section and won't behold, you could probably get another 1 million barrels out of it with the new technology. So that's kind of the major change in the multilateral technology, has kind of advanced this specifically on the heavy oil reserves that the company owns. So it just gives us confidence that, that should continue to grow as more of these different zones within the Mannville stack are developed with horizontal multilaterals.

[Mitchell Cantor, analyst]

Interesting. So it's the existing technology just rolling out in a sense through the accounting in the portfolio?

[Andrew Phillips, executive]

Precisely, yes. And there -- and having said that, there are some new discoveries as well that are completely brand new discoveries, but a lot of this heavy oil resource has been known accumulations over the last 50 years. There just hasn't been a way to exploit it until this technology evolves in a low-cost manner.

[Operator]

And I'm currently showing the further questions at this time. I'd like to hand the conference back over to Mr. Phillips for any closing remarks.

[Andrew Phillips, executive]

Thank you, everyone, for dialing into the PrairieSky Q3 conference call. And at any time, please call either Pam or myself if you have any follow-up questions. Have a good day.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect. Everyone, have a wonderful day.