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Good morning. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Topaz Energy Corp. Fourth Quarter 2022 Results Conference Call. [Operator Instructions]
Thank you. Mr. Kirker, you may begin your conference.
Thank you, Michelle, and welcome, everyone, to our discussion of Topaz Energy Corp.’s results for the 3 months and year’s ended December 31, 2022, and 2021. My name is Scott Kirker, and I’m a General Counsel for Topaz.
Before we get started, I refer you to the advisories on forward-looking statements contained in the news release as well as the advisories contained in the Topaz annual information form and its MD&A available on SEDAR and on the Topaz website. I also draw your attention to the material factors and assumptions in those advisories.
I’m here with Marty Staples, Topaz’ President and Chief Executive Officer; and Cheree Stephenson, Vice President of Finance and Chief Financial Officer. They will start by speaking some of the highlights of the last quarter and the year so far. And after the remarks, then we will open for questions. Marty, Cheree, go ahead.
Good day. Thanks, Scott. Appreciate that, and thanks for everyone for attending. 2022 is an exceptional year for Topaz. We achieved record production of 18.3000 BOE per day in the fourth quarter, and average production for the year was just under 17,000 BOE per day.
Our average royalty production grew 20%, which includes the impact of the contractual Tourmaline gross overriding royalty changes, which came into effect January 1, 2022. Without the GORR changes, our production growth was 26%. Fourth quarter production demonstrates the full impact of our acquisition and diversification strategy as the Deltastream acquisition was effective for the entire fourth quarter.
Most of our acquisitions have been liquids-focused in order to diversify and complement our premium natural gas royalty portfolio. Q4 total liquids volume weighting was 29%, which has changed significantly from 7% total liquids volume and inception of the company. For the fourth quarter, 56% of our royalty revenue was from total liquids and 44% of royalty revenue was natural gas. Our 2022 reserve report demonstrates the strong organic development activity for our strategic operators.
Year-over-year, our total proved plus probable developed reserve volume increased 13% to 47.5 million BOE. Drilling additions combined with positive technical revisions added 9.1 million BOE of reserves, which represents 1.5x the replacement of 2022 royalty production of 6.2 million BOE. In addition, our acquisitions added 2.6 million BOE of reserves. Please note that as a royalty entity not responsible for the capital, we do not book probable locations or future development capital. The probable and developed reserves attributed to our royalty acreage can be seen through our strategic operator reserve reports, which are available or will be available on SEDAR.
Our infrastructure business continues to provide stable, inflation protected income, which enables strong dividend support. Through 2022, we realized 99% utilization of our natural gas processing capacity and generated total processing revenue and other income of $65.8 million. Our exposure to operating cost is limited to approximately 50% of our infrastructure assets as per the 10- to 15-year contract we have in place. This, in addition to certain contractual inflation adjustment mechanisms provide strong inflation projections for Topaz. We incurred $6.4 million in operating expenses in 2022, resulting in infrastructure operating income of $59.4 million, which represents 38% of our total 2022 dividend.
In the fourth quarter, Topaz generated cash flow of $86.3 million, 11% higher than the prior quarter. For 2022, Topaz generated cash flow of $370 million, which represents 75% growth over 2021. In 2022, we distributed 47% of our cash flow to shareholders through dividends, and we allocated $173 million of excess free cash flow and used just over 1x leverage to -- a combination of royalty and infrastructure acquisitions. In total, we completed $436 million in our acquisitions during 2022. The royalty acquisitions are 80% liquids-weighted and increased our royalty acreage 15%, which are estimated to provide 2,000 BOE per day of 2023 royalty production.
The infrastructure acquisition increased our 2023 fixed revenue by 7%. Our hedging strategy is designed to protect acquisition economics and dividend sustainability, which generated a $1.6 million gain in Q4 and the mark-to-market gain of all outstanding contracts as of February 28 forward pricing is approximately $11 million. Our 2023 natural gas fixed price hedging contracts represented approximately 16% of our 2023 estimated natural gas production and provide an average of [indiscernible] per Mcf above current strip to Topaz’ 2023 guidance.
Recently, we financially diversified approximately 9% of our 2023 natural gas pricing exposure using AECO basis of $0.78 MMBtu, which is equivalent to the actual [indiscernible] costs to deliver to U.S. markets. During the fourth quarter, we expanded and extended our 4-year covenant-based credit facility to $700 million, which has an accordion feature providing $300 million of incremental credit capacity for which we do not pay standby fees.
During the quarter, Topaz reduced net debt by $34 million; and subsequent to year-end, we have repaid an additional $55 million on our credit facility. We have provided a 2023 guidance range of $308 million to $316 million, which is based on estimated average annual production range between 18.3000 and 18.8000 BOE per day, the midpoint of which represents 10% growth over 2022.
Our guidance is based on expected operator development plans, commodity prices of $2.86 an Mcf for natural gas AECO based and USD 75.55 barrels WTI for crude oil and incorporates outstanding financial derivative contracts. After payment of 2023 estimated dividends of $173 million, Topaz expects to generate between $114 million and $121 million of excess free cash flow, exiting 2023 with estimated net debt below $290 million before giving effect to any incremental acquisitions. We’re pleased to share achievements -- continue to expand our trading liquidity despite Topaz’ young history as a public company. In addition to being added to the S&P TSX Composite Index in December 2021, Topaz was added to the FTSE Renaissance Global IPO Index in December of 2022 and will be added to the FTSE small-cap index effective March 2023.
We have continued to improve our ESG profile and recently achieved low-risk ratings from Morningstar sustainalytics, an institutional shareholder services, which demonstrates Topaz’ unique energy investment structure. I look forward to discussing Q1 with you on the next call, and we’re pleased to answer any questions at this time.
[Operator Instructions] First question comes from Aaron Bilkoski of TD Securities.
I guess my first question is, how are you thinking about the proportion of revenue coming from the infrastructure business? Maybe said another way, what’s the ideal weighting in your mind?
Yes. So we’ve always kind of talked about it and thought about being 50-50. Right now, we sit at 20% of our revenue is infrastructure weighted, covers 38% of our dividend. We had a lot of opportunity over the last 2.5 years to get involved in the royalty business and really expand that part of our business. We did -- we have grown our infrastructure business quite significantly. I just -- I think we’ve just grown the royalty business that much more. We have been active looking at different infrastructure opportunities, have closed some smaller opportunities as well. But yes, I think over time, we do expect to step up the infrastructure business.
So maybe a related question, how much leverage would you be comfortable with putting on the balance sheet to acquire infrastructure assets, maybe relative to upstream assets?
Yes, I think max is probably 2x, and that would definitely be infrastructure focused, but I think we’d be most comfortable overall corporate leverage between 1 and 1.5x. But yes, definitely willing to push a bit further from an infrastructure perspective.
If I can ask maybe 1 or 2 more questions. In your release, you talked about the number of wells drilled on your royalty acreage in 2022. If you apply a capital cost to each one of those wells, how much gross third-party capital do you think was spent on your land last year?
Well, we haven’t done the exact math, but I would say there is over $2 billion of capital deployed across our acreage. And we would expect somewhere in the neighborhood of $2 billion to $2.3 billion in 2023.
Yes. I think we [indiscernible] last year at 32 rigs on our royalty acreage. Right now, we’re sitting around 29. So even with reduced activity in the basin, I think we still see a lot of activity just based on the quality of our acreage that we own.
All right. One more sort of detailed drilling question for you. What does that 564 gross wells drilled in 2022 equate to on a net basis?
It is -- I don’t have that right in front of me, but I do have that number, so I can circle that back to you after the call.
The next question comes from Luke Davis of RBC.
Just wondering if you guys can frame out some of the activity assumptions that are implicit in the low and high end of your guidance. Just trying to get a sense for where the biggest swing factors are.
Yes, for sure. So the guidance, the midpoint, essentially follows the midpoint of our most strategic operators’ capital plan. So we kind of ebb and flow within our guidance range to where their guidance ranges are. And the midpoint would assume our other properties, call it our fee title mineral acreage, things like the Weyburn asset, some of our really lower decline and resilient assets stay flat. So recently, we’ve seen a lot of activity pick up across the reserve and Keystone acreage.
So I’d say the midpoint is maybe a bit conservative to where we’ve seen recent activity. But those are the kind of properties we wouldn’t bank on growth because we can’t see the transparency of the capital deployment. So there’s some modest swings there, but it’s less material to the portfolio. And then the overall guidance range would kind of ebb and flow between the kind of key operators, public guidance ranges.
That’s helpful. Also wondering where you would see the most potential upside activity wise on your royalty lands if pricing trends above where your deck is currently?
It’s absolutely always going to be driven by Tourmaline just because of the magnitude of the acreage we own and just the size within our portfolio. Obviously, Clearwater has high growth rates, but it’s a smaller wedge relative to the Tourmaline piece. So I think market supply-demand, pricing, availability to services, all those kind of things will kind of dictate the Tourmaline gauge within the guidance ranges.
Yes. And one thing I will say about that as well, Luke, is we do see 13 to 14 rigs on Tourmaline’s acreage, and they have not communicated through their 5-year plan that they would accelerate any type of drilling activity. So I think that’s pretty sound, that 13 to 14 rigs, and that kind of grows Tourmaline at 3% to 5% per year. I think the goal for Tourmaline right now, and I’m not speaking for them, but they’ve said this publicly is they don’t want to disrupt supply-demand imbalance right now, and I think that’s why they’re monitoring their growth. So the bigger wedge, I think, ultimately ends up happening kind of what Cheree mentioned before on some of this fee land that we’ve seen kind of more activity on for the last kind of 8 months, while oil price is higher.
So -- and not just on the oil side, but as well as the gas side through the summer as well on some of the reserve royalty lines that we had. So very nice added surprises to the portfolio.
The next question comes from Josef Schachter of Schachter Energy Research.
Two questions for you. You make a note in there about the Blueberry First Nations with the BC government and potential growth there. Do you see much happening in 2023? Or is this a 2024 potential upside for you as companies start work to get volumes ready for the Coastal Gaslink pipeline?
Yes. Good question, Josef. We’ve already seen permits start to get released. I know there was a bunch in the queue and Tourmaline has been a big benefit of seeing some of those permits -- early permits released in the Blueberry River First Nations agreement. So very positive from that standpoint. So it’s kind of my comment before. I don’t think we’re going to see a massive ramp inside 2023, but I do think it’s going to be a lot more economic to drill some of these pads that they were waiting on permits for what they would have communicated early in January. So a big positive for us. The real ramp is going to come in decade when LNG Canada kind of comes on stream. And I think that’s when a lot of the producers, particularly Tourmaline are building into this. And that’s for us where we see the biggest ramp in our portfolio over the next decade coming.
So would that really start in 2024 because of just the time line?
It’s going to step slowly 2023, 2024, and then a bigger ramp in 2025. So keep in mind, Conroy facility is planned for 2025. It’s a 400 million a day facility, the biggest project plan in Western Canada. We have a royalty on 99% of that acreage out there. So we’re a direct benefit of the Conroy facility being built, but really that’s commissioned kind of 2025 and that’s what we’re timing kind for the massive round for.
Okay. Yes, I remember that now. Last one for me. With the price deck coming down and especially natural gas side, liquids as well, do you see more opportunity for deals? Is the deal flow more active now so that we could see announcement sometime Q2, Q3 of deals? Is it easier to do deals now with the commodity price down and as the traffic flow higher?
I think the traffic flow is relatively the same for kind of the latter part of Q4, started Q1, the tier stepped down a lot. I think that’s why you didn’t see us doing a lot of transactions. It’s just the quality wasn’t there that we were looking for. I wouldn’t say deals are ever easy. At this higher commodity cycle, we’re happy to sit and wait and make -- wait for lower commodities to kind of come around.
Yes, there might be some more gas-weighted opportunities. I think more likely, you see a lot of these gas transactions that were looking like they were going to transact, probably stall a little bit and wait for better gas prices. There isn’t the same urgency for producers, I think, to do a disposition all of a sudden. They’re healthier right now. They’ve got better balance sheets. But I think there’s always opportunity for the Topaz entity, whether it be on the royalty or infrastructure side. And we’re going to continue to monitor, examine, a lot of those opportunities are available.
The next question comes from Jamie Kubik of CIBC.
A little bit already answered perhaps, but can you talk about some of the drivers of increasing the credit facility at the current time? And maybe on the back of Aaron’s earlier question, can you just frame out some of the qualities that a potential acquisition might need to fit Topaz’ criteria?
Yes. I can speak to the credit facility. So we definitely weren’t in a position we needed to increase our credit capacity, but it was available to us. We maintain the same pricing structure, have an opportune structure where we have M&A capital available to us with just agent consent, and we don’t pay standby fees on that. So in a volatile credit type of market and seeing some potential further pressure in the future coming from banks from a cost structure perspective, we thought it was opportune for us to expand that capacity to have the well-costed liquidity available to us, not necessarily a full intention of using that.
As I mentioned, we definitely have a modest leverage strategy. So it’s not to go use that tomorrow as per se, but good structure, good term, good bank support and you just don’t know what the market is going to do. So nice to have that within our toolkit.
Yes. And I think it keeps our liquidity very well protected. The message here is, hey, we’re running out to go do a transaction. The message here is we have the ability to use some debt if need be if something really good comes along. And so we’re ready for that. The criteria hasn’t changed since day 1, Jamie. I think it always starts with the quality of the asset; number two, the quality of the owner; and number three, how accretive it is back to Topaz and Topaz shareholders. So that has not changed. That is always our criteria when we look at any asset on the infrastructure royalty side.
Okay. That’s helpful. And then maybe an additional question here. Topaz maintains a dividend payout target of 60% to 90% and -- on our numbers, and as you indicated in your press release as well, the forecast look like you’re trending below that this year, even with a meaningfully lower natural gas price than what we entered the year at. What would be a driver to potentially increase the dividend this year if you were to do so?
We’ve always looked at the dividend as an output of the business. We’ve tried to time it alongside growth. If M&A is just not available to us, I think that is an opportunity for us to increase the dividend. It’s still out there. We’re still in data rooms, looking to support transactions or kind of put together our own idea of manufacturing GORR or streaming some type of infrastructure components.
So we know some things are coming to market. We wanted to make sure that we didn’t increase the dividend just to increase it. And I mean we’re sitting above a 6% yield right now. So I think it’s quite healthy, the dividend, as it stands today, even at that kind of 60% payout ratio.
The next question comes from Mike Dunn of Stifel First Energy.
I think you’ve mostly answered this question, but I know you’ve been focusing your -- at least your producer GORR acquisitions on oil in 2022. Did you have a -- I guess a target you’d want to get to in terms of the oil versus gas split. And just wanted to hear your thoughts. Are you still sort of actively looking at, I guess, more gas-weighted GORR acquisitions too, just to not close off any opportunities that might come up?
The important part for us over the last 2.5, 3 years was to diversify our business. And I think we’ve done a good job of that, 30% of our revenue now liquid weighted, and that was important through the cycle. Ultimately, we’re big gas [indiscernible]. I would add more gas to the portfolio if it was in the right part of the basin. But keep in mind, being tied to this massive drill program that’s going to happen in Northeast BC with the development of Conroy, it is the largest project planned in the next 10 years in the Western Canadian sedimentary basin.
We’re always going to get bigger on the gas side just by being attached to Tourmaline. So I think we were able to achieve and add very good assets at an opportune time on the oil side being in the Clearwater, Charlie Lake, Southeast Saskatchewan, I mean, the CO2 project that we’re involved in with Whitecap is about the flattest project I’ve ever seen. It only declined to 2% a year. it’s pretty steady business, and they do a great job operating out there. So if the right project comes along, I wouldn’t say we’d say no to an oil acquisition. But at $75, $80 WTI, it better be the highest of quality if we’re going to invest in something like that.
There are no further questions. I will turn the call back over to Mr. Staples for closing remarks.
Okay. Thanks, everyone. Appreciate you tuning in, and look forward to catching up in Q1.
Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.