Vermilion Energy Inc
TSX:VET
Earnings Call Analysis
Q3-2023 Analysis
Vermilion Energy Inc
Vermilion Energy showcased solid performance with Q3 production averaging 82,727 barrels of oil equivalent per day (BOEs/d), hitting the high end of their guidance. This was significantly bolstered by the Wandoo facility's restart in Australia and the efficient turnaround of the Corpus facility in Ireland. The positive operational momentum translated into $270 million in funds flow, marking a 9% increase from the last quarter. Capital investment stood at $126 million, creating a substantial $144 million in free cash flow—an impressive 80% jump from the prior period. The company tactically deployed this excess liquidity to pare down debt and buy back shares, in addition to meeting existing financial commitments.
Elevating their financial ambitions, Vermilion Energy is targeting a 30% return on capital in 2023, up from their prior goal of 25-30%. Concurrently, they made headway in reducing their net debt by about $80 million to $1.2 billion. This strategic focus is aligned with their aim to hit a net debt milestone of $1 billion by Q1 of 2024. Reaching this pivotal threshold will trigger increased capital returns to shareholders, signaling strong confidence in the company's financial health and operational efficiency.
North American operations surged 5%, attributed to recovery from wildfires and promising new wells in the U.S., with output climbing to 56,758 BOEs/d. Vermilion is pushing ahead with its Montney development in British Columbia, anticipating a new facility operational by mid-2024 to drive further growth. Internationally, production faced an 11% dip due to routine maintenance and natural declines. However, the revival of the Wandoo facility heralds potential with approximately 4,000 barrels per day expected to feed into Q4 and the next year. Germany and Croatia are earmarked as future growth regions, with new exploration projects and gas plant development auguring well for the European gas market presence.
The company is well-placed to meet its annual production target, projecting 82,000 to 86,000 BOEs/d, and estimating a ramp-up to 86,000 to 89,000 BOEs/d for Q4. Capital expenditures are revised upward by $20 million to $590 million for the year to expedite drilling operations in BC Montney, aligning with operational efficiency and cost-reduction strategies. Looking into 2024, Vermilion plans a moderate increase in capital expenditures by roughly 5% to support its BC Montney development, with expectations of maintaining similar production levels to 2023. This incremental budget will pave the path for executing long-term growth initiatives that promise to reinforce profitability and consistently reward shareholders.
Anticipating boosts in funds flow and free cash flow due to strategic acquisitions like Corrib and the full-year inclusion of Australian operations, Vermilion is positioned to fund growth endeavors. These investments are expected to underpin long-term profitability and enhance shareholder returns. The company stands as an exemplar of improved financial standing and prudent capital allocation over recent years, instilling confidence in its prospective trajectory.
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Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Q3 Conference Call. [Operator Instructions].
Mr. Dion Hatcher, you may begin your conference.
Well, thank you, Sylvie. Good morning, ladies and gentlemen. Thank you for joining us. I'm Dion Hatcher, President and CEO of Vermilion Energy. With me today are Lars Glemser, Vice President and CFO. Darcy Kerwin, Vice President, International and HSE; Bryce Kremnica, Vice President, North America; Jenson Tan, Vice President, Business Development; Kyle Preston, Vice President of Investor Relations. We'll be referencing a PowerPoint presentation to discuss our Q3 '23 results. Presentation can be found on our website under Invest with Us and Events and Presentations. Please refer to our advisory on forward-looking statements at the end of the presentation. It describes the forward-looking information, non-GAAP measures and oil and gas terms used today and outlines the risk factors and assumptions relevant to this discussion.
Production during the third quarter averaged 82,727 BOEs per day, which was at the top end of our Q3 guidance range of 80,000 to 83,000. This is mainly due to the successful restart of the Wandoo facility in Australia in early September and an efficient turnaround at the Corpus facility in Ireland, which was completed 5 days ahead of scheduling. In addition, we continued to see strong operational performance across the majority of our assets. We generated $270 million of fund flow, which represents a 9% increase over the prior quarter. We invested $126 million of E&D capital resulting in $144 million of free cash flow, which represents an 80% increase over the prior quarter. This level of free cash flow was more than sufficient to fund current asset retirement obligations, lease payments and the base dividend with the excess free cash flow allocated to debt reduction and share repurchases.
During the quarter, we returned $20 million to shareholders through the base dividend and share repurchases, and we have returned $115 million to shareholders year-to-date, representing about 35% of our free cash flow. Given the improving free cash flow profile, we are now targeting 30% return on capital in '23 compared to the prior range of 25% to 30% until we achieve our net debt target of $1 billion. We continue to make progress on debt reduction with net debt decreasing approximately $80 million from the prior quarter to $1.2 billion at the end of the third quarter, representing a trailing net debt to fund flow ratio of 1.2x. Based on the forward strip pricing, we expect to achieve our $1 billion debt target in Q1 of '24, at which time we plan to increase the amount of capital returned to our shareholders via the base dividend and share repurchases.
Moving on to the operational updates for the quarter. Production from our North American operations averaged 56, 758 BOEs per day in Q3, an increase of 5% or 2,700 BOEs per day. From the prior quarter, mainly due to strong recovery following fire related downtime at our Deep Basin assets and new production from our recently drilled wells in the U.S. In the Deep Basin, we drilled 2 and completed 1 Manville liquid trace gas well. Mica, we brought up production for Alberta Montney liquids-rich gas wells, which are producing into constrained Montney infrastructure capacity of approximately 8,000 BOEs per day. In Saskatchewan, we drilled 10 completed 9 and brought on production 8 oil wells. In the U.S., we brought up production 5 oil wells in Wyoming where production increased 21% from the prior quarter.
We continue to progress our BC Montney development. During the third quarter, we completed the site preparation and awarded all major contracts for our 16,000 BOPD battery in BC. We're excited to break ground on the battery in August, and we will continue to progress this project over the next several months. Shown here is a cleared battery site awaiting delivery of the facility modules that are currently in fabrication. The key piece of infrastructure will underpin the future development and growth of our BC Mica and Montney asset. The majority of construction is scheduled to occur in the first half of '24, but the battery expected to be operational by mid-'24. The additional capacity provided by this battery, we were able to move forward with our growth phase of our Mica asset. Our upcoming winter program includes 11 wells and our BC lands offsetting our recent 16 to 28 BC pad, which has produced at an average per well rate of 1,150 BOEs per day over the first 6 months with an average 36% liquid yields, which is mainly oil.
Given these strong rates, we are piloting a downspacing program to evaluate the potential for drilling more wells in BC. Production from our international operations averaged 25,969 BOEs per day, a decrease of 11% from the prior quarter, mainly due to planned turnaround in the Corpus facility in Ireland and natural declines, partially offset by the resumption of production in Australia following the restart of the Wandoo facility. In Australia, we successfully completed the remaining inspection and repair work on our Wandoo facility and restarted production in early September. The wells continue to produce at strong rates with expected to contribute approximately 4,000 barrels per day into Q4 and through '24. This is resulting in a $150 million positive swing in free cash flow relative to $23 million.
In Ireland, we successfully completed the major turnaround at Corrib 5 days ahead of schedule in August. Corrib is forecast to produce approximately 10,000 BOEs per day net to Vermilion, of premium priced European gas in Q4. We're excited about the future European gas growth potential in both Germany and Croatia will speak more about those projects on the following slides.
On the left of this slide, we have a picture of the drilling rig on our first of 2 exploration targets in Germany. While the picture on the right is the map of our German and Netherlands land illustrate the proximity. We see our development plans in Germany as a natural extension of the successful drilling campaigns we've executed over the past 2 decades in neighboring Netherlands. We have approximately 700,000 net acres of undeveloped land in Germany, located approximately 300 kilometers east of our producing fields in Northern Netherlands or similar distances to Calgary and Edmonton. Our gas exploration targets are on trend to the Netherlands plays where we have drilled 29 gas wells over the past 2 decades with an average success rate of over 70%. The Germany exploration targets are deeper and higher risk but have a much larger resource potential than the Netherlands. In addition, we have access to existing infrastructure network regulatory support for permits and a track record of execution in Germany.
With the success of our Germany exploration drilling program, we believe our land base can support and multiyear drilling campaign, providing Vermilion of years of organic production growth of high-value European gas. In Croatia, we started to site preparation for the gas plant, which is scheduled for start-up in mid-'24 and we'll facilitate production from the SA-10 block, where we have previous gas discoveries. This gas is currently behind pipe waiting start-up of the gas plant, and we see additional prospects in our acreage for future development. At current strip pricing in a midyear startup, we would expect approximately $40 million of fund flows in '24.
I will now pass it over to Lars to discuss our guidance and financial outlook.
Thank you, Dion. Our 2023 production guidance remains unchanged with Australia back online and the planned turnaround at the Corrib facility in Ireland is complete. We remain positioned to deliver annual production of 82,000 to 86,000 BOE per day and Q4 production of 86,000 to 89,000 BOE per day. Our operations teams have done a great job offsetting the forest fires in Alberta and extended downtime in Australia, resulting in strong performance across our asset base. We increased our 2023 capital expenditure guidance by $20 million to $590 million to accommodate accelerated BC Montney drilling into Q4. This ensures we secure a high-performing break and drill some of the wells before winter, which helps reduce costs.
In addition, it also gives us production behind pipe to be ready for a potential early start-up of the new BC battery should construction go better than planned. We plan to release our 2024 budget and guidance in the upcoming weeks, which will also include an update to our return of capital framework. 2024 capital expenditures are expected to increase by about 5% over 2023 levels due to infrastructure spending required to advance our BC Mica, Montney development, and we anticipate corporate production will be consistent with 2023 annual levels.
Given the expected increase in FFO and free cash flow generated by the business, driven by the full year impact of the Corrib acquisition and Australia, we are able to advance long-term organic growth projects that will support profitability and shareholder returns over the long term. That increasing 2024 cash flow just referenced is the key takeaway of this slide as well as a significant improvement in our financial position over the past several years. By the end of 2023, we will have nearly cut our debt in half, as shown in the red bars while also funding over $1 billion of strategic acquisitions. We have also significantly increased our FFO from pre-COVID levels as shown in the blue bars. This progress is reinforced with an estimated 2024 debt to FFO leverage of 0.6x. Although we have not finalized our 2024 budget, we are currently forecasting FFO to increase to $1.4 billion, assuming a flat production profile at current strip pricing. With this, we expect to achieve our net debt target of $1 billion during the first quarter of 2024, which will be the trigger for increasing our return of capital to shareholders from the current target of 30%.
On this slide, we show free cash flow based on recent pricing and the breakdown of how free cash flow was allocated. The majority of FCF was allocated to debt reduction and acquisitions for the period of 2021 to 2023. We expect to generate significantly higher year-over-year FCF in 2024 due to the full year impact of the Corrib acquisition having Australia back online for a full year and first gas from our SA-10 project in Croatia. These 3 items alone contributed an expected $270 million year-over-year increase to FCF, which is further underpinned with robust and well hedged European gas prices. This will position us well to invest in our assets and increase our percentage and absolute level of free cash flow returned to shareholders in 2024.
With that, I'll pass it back to Dion.
Thanks, Lars. I'd like to take this opportunity to provide some background on European gas as we head into the winter heating season for European consumption typically increases 30 to 40 Bcf per day compared to the summer. Last year, Europe lost approximately 12 Bcf a day of Russia supply, which has resulted in even greater dependence on LNG imports. Last winter, Europe demand was down about 10 Bcf per day compared to the prior winters due to it being the second warmest winter on record and government policy focused on gas conservation. Even with this, gas averaged over CAD 30 during the winter. A combination of a very warm winter and government policy to mandate full storage during the summer has resulted in European stories being effectively full today. Reality is that Europe will continue to depend heavily on LNG imports to meet winter demand. It may be more challenging this year due to higher Chinese demand post-COVID 0 policy and potentially a return to a more normal winter. Any potential supply disruptions or increased demand from Asia will put upward pressure on euro gas prices. You can see the impact from this tight supply in the forward curve on this slide as European gas prices continue to hold at or above CAD 20 per MMBtu. We sell directly into the European gas markets, not via LNG. So we realize these high prices. For the upcoming periods in European gas, in Canadian dollar terms, we have 45% hedged for Q4 '23 at an average floor of $34, 38% hedged for '24 at an average floor of $3, 20% hedge for '25 hedged at an average floor of $22. These hedge prices are 13, 11 and 6x higher than equivalent periods of Canadian AECO gas prices. We will continue to be opportunistic during periods of volatility to increase our hedge position. Including all of our products, we have approximately 30% of our corporate production hedged for 24, which provides greater certainty on achieving our debt targets and supports our return of capital to shareholders.
In closing, it's an exciting time for Vermilion and its shareholders. We're gaining operational momentum with Australia now back online, the Mica battery and Croatia construction underway and the first well of our German gas exploration program being drilled. Second, we have direct exposure to premium priced European gas, which remains an extremely tight supply, and we are progressing projects to increase our European gas production. We are pleased with our current hedge levels, and we'll continue to be opportunistic during periods of volatility to add more hedges. Third, we are seeing the benefits of the strategic asset high grade and focus on debt reduction with a significant increase in '24 free cash flow. With that, we are on track to achieve our debt target in Q1 '24 and intend to increase our return of capital to shareholders.
That concludes my prepared remarks. And with that, I'd like to open it up for questions.
[Operator Instructions] The first question will be from Travis Wood from National Bank Financial.
Yes. I wanted to get a 2024 in terms of volumes and a bit of cadence. I know you've provided some indicative commentary in terms of the average rates. But with the strong Q4 this year and then some interesting projects and facilities and kind of drill to fill program in Canada for the Montney. How should we be thinking about volumes through the beginning of next year and into later next year as you kind of start to fill those facilities. And then if you could, maybe some kind of year-over-year comparison on CapEx would be helpful as well.
Thanks, Travis. I can take this one. This is Dion. We'll be providing more details when we release our budget in the upcoming weeks as noted on the call. But I think how you should be thinking about it is, as noted, flat volumes and capital 4% to 5% higher really driven by the increased investment in infrastructure in the Montney. From a cadence point of view, again, we'll provide more details later, but the 2 significant drivers of that would be the Montney battery, that 16,000 BBD battery would be midyear. We'll have a pad behind pipe ready for that start-up until then, we're capacity constrained. As well as the SA-10 plant that we talked about, it's about 15 million a day of gas, but again midyear. So again, we'll provide more details, but really, there will be a ramp-up in the second half of the year is how we're thinking about it.
[Operator Instructions] And your next question will be from Dennis Fong at CIBC.
I guess my first 1 here is, obviously, with the upcoming potential completion of the infrastructure there in Croatia, can you outline a little bit more of the opportunity opportunity set that exists there? And what that could mean kind of going forward, especially given its European gas revenue line?
Thanks, Dennis. I'll pass that over to Darcy to provide some detail on Croatia. .
Yes. Thanks, Dennis. Darcy here. Yes. We're currently in the process of building that Croatian gas plants. Dion mentioned earlier, that's kind of -- we've got a nominal sales capacity of about 15 million cubic feet a day. I think in Europe, you need to think of those numbers not necessarily in terms of just -- in terms of volume, but in terms of the much higher netback that we get in Europe versus here in North America. So if we think of Croatia at a CAD 20 in Mcf those 2 wells going through that plant in SA-10 forecast to generate $10 million of revenue per month. And with netbacks that are kind of 7 or 8x what they are in Canada, going forward.
In terms of future potential on that block, we do see some prospects there and the intent there would be to, over time, continue to drill that block to keep that plant full over time. And then outside of the block of SA-10, of course, we have SA-7, which is a pretty prospective block that we're quite excited about with intent to drill 4 wells on that block in early 2024.
Great. I appreciate that color there. My second question just Lars, thank you for providing that update around the financials and the driving down of obviously net debt. Can you talk towards a little bit more around, a, where maybe even next net debt target looks like and how you think about capital structure as well as how the company and the Board will think about free cash flow allocation once you kind of get towards that level?
Great. Thanks for the question, Dennis. Yes. So as we referenced that target will be $1 billion line of sight to hitting that in the first quarter of 2024 and looking forward to providing what that next step is going to look like with the budget release here in the coming weeks. I think the best way to think about it is we do have a clear plan in place in terms of getting to that target I think the big thing that we're trying to emphasize as well is if you look at the free cash flow for 2024, not only is there going to be an increase in the percentage of free cash flow that is allocated to return of capital for shareholders but the absolute amount of free cash flow as well is increasing quite significantly in 2024 to 2023 and kind of that 60% or $300 million year-over-year.
In terms of debt targets beyond that, we're quite comfortable with that $500 million to $1 billion range. The lower end of that target, we represent the amount of debt that we have turned out to 2030. And so we think that that's a good way to think about longer-term debt levels for Vermilion.
And at this time, gentlemen, it appears we have no other questions registered. Please proceed with any additional comments.
Well, with that, I'd like to thank you again for participating in our Q3 conference call.
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for calling. And at this time, we ask that you please disconnect your lines.