Gran Tierra Energy Inc. (GTE) Q1 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen and welcome to Gran Tierra Energy’s Results Conference Call for the First Quarter 2018. My name is Amanda and I will be your coordinator for today. [Operator Instructions] I would like to remind everyone that this conference call is being webcasted and recorded today, Wednesday, May 2, 2018 at 11 a.m. Eastern Time. Today’s discussion may include certain forward-looking information, oil and gas information, including information about Gran Tierra’s perspective resources as well as certain non-GAAP financial measures. Please refer to the earnings and operational update press release we issued yesterday for important disclaimers with regard to this information and reconciliation on any non-GAAP measures discussed on today’s call. Please also see at Gran Tierra’s 51-101F1 available on SEDAR. Finally, this earnings call is the property of Gran Tierra Energy Incorporated. Any copying or rebroadcasting of this call is expressly forbidden without the written consent of Gran Tierra Energy. I would now like to turn the call over to Gary Guidry, President and Chief Executive Officer of Gran Tierra. Mr. Guidry, please proceed.

Thank you, Amanda. Good morning and welcome to Gran Tierra’s first quarter 2018 results conference call. My name is Gary Guidry I am Gran Tierra’s President and Chief Executive Officer. Today with me is Ryan Ellson, our Chief Financial Officer and Rodger Trimble, our Vice President of Investor Relations. We issued a press release yesterday that included detailed financial and operational information about our first quarter 2018 results, which are available on our website at www.grantierra.com. Ryan and Rodger will make a few brief comments and then we will open the line for questions. Ryan, please go ahead.

Good morning, everyone. Our strategy of focusing on capital efficiency and returns on invested capital is delivering great results on many fronts in Columbia. During Q1 2018, our Columbia only average production was up 23% from a year ago and 33% on a per share basis. This growth was mostly achieved organically through the drill bit. In Q1, 2018, we reached an all-time high of approximately 35,100 BOE per day, 55% higher than Q2 2015 when we refocused the company’s strategy on profitably growing in Columbia. We are well on track to meeting our 2018 guidance of 36,500 to 38,500 BOE per day. We also remain very confident that our high-quality set of assets can deliver forecasted production of approximately 50,000 BOE per day by 2020 based on the 2P forecast from our 2017 year end reserve report. Gran Tierra’s return to profitability generated net income of $18 million in the first quarter. In Q1 2018, our funds flow from operations was up 8% in Q4 2017 to $75 million or $300 million on an annualized basis. Our quarterly adjusted EBITDA was up 14% from last quarter to $89 million or $355 million on an annualized basis. Gran Tierra had a very active Q1 with capital investment of approximately $73 million, which is more than covered by our Q1 funds flow. Approximately, 42% of our capital expenditures were directed to exploration facilities construction. Whilst these activities do not contribute to production growth in the quarter, there are two key components to our strategy. We want to ensure that we continue the development of the water injection facilities and process facilities in the Accordionero field and to capture and prove up resources through the exploration program. We continue to have top quartile operating netback performance in Q1 2018, which increased by 45% compared to a year ago and by 20% in last quarter to approximately $34 per BOE. This trusted growth in funds flow from operations greatly exceeded 23% increase in the Brent oil price in Q1 2018 and the strong indicator of our sharp focus on control on our cost structure and optimizing oil marketing strategy is working. With our large un-risked mean prospective resource base of 1.5 billion BOEs, we plan to drill 30 to 35 exploration wells over the next 3 years throughout Columbia which are all expected to be funded by cash flow. A big part of our current success at Gran Tierra was our strategic acquisitions of PetroLatina in mid-2016 whose major asset in the Middle Magdalena Valley in Acordionero field. In the 21 months Gran Tierra is only an operator of these assets, the results have been stellar and represents one of our most significant operational highlights. During this time, we have almost quadrupled Acordionero’s production to roughly 17,300 BOE per day by drilling and bringing on 13 oil wells, 2 water injectors and 1 water source well. Acordionero and the other Middle Mag assets have been a cash flow engine as well generating oil and gas sales of $241 million and operating netback of $184 million since acquisition more than covering our $140 million in capital investment in the Middle Mag during this time and the fact our Middle Meg assets have self-funded the active Acordionero development program as well as paid for our Middle Mag appraisal and exploration drilling. To recap, we have more than tripled production from the PetroLatina assets while generating positive free cash flow and as reported last quarter, the 2P NPV is 3x more than what we paid for the assets. We are only halfway through our full 2P development plan. We are also in the midst of expanding the central processing facilities to potential capacity of 30,000 barrels of oil per day with $5 million incremental capital investment added in scope to support the better than expected production results to-date. This new higher facilities capacity could handle our 3P production forecast of over 27,000 BOE per day from Acordionero which maybe possible if our water flood is accessible as our reservoir models per day. An additional $17 million is facilities capital has been added for the construction of the Gran Tierra owned 22 megawatt gas-fired facility in Acordionero, which is expected to lead to significant operating cost savings of $8 million to $10 million per year and equally important improve production and water injection reliability. In combination with incremental capital for remote power generation capacity in the Putumayo basin this year, we have updated our forecasted 2018 capital by $25 million to a new guidance range of $275 million to $295 million. We expect forecasted cash flow from operations to fully fund our revised 2018 capital program. During Q1, we also believe the markets delivered a strong vote of confidence in our Columbia focused long-term strategy as evidenced by our successful offering of $300 million and 6.25% senior unsecured notes with a 7-year term. After paying down our revolving credit facility and placing the excess cash on the balance sheet, we now have about $160 million of cash on our balance sheet and net debt of $255 million at March 31, 2018, which represents low leverage of roughly 0.9x debt to annualized Q1 funds flow. In addition, our $300 million credit facility is un-drawn and available which provides us with a substantial additional liquidity. We believe our bond issue improved our financial flexibility and left us in a strong liquidity position such that Gran Tierra is well-positioned substantially to accelerate current development projects such as Acordionero or future exploration discoveries in the Putumayo and Middle Magdalena Valley basins. We produced essentially 100% oil and all our sales contracts are linked to Brent pricing. We have hedged 10,000 barrels of oil per day of which 5,000 barrels per day of upside commodity price exposures through participating swaps. Our participating swaps have loss discounts of less than $4 per barrel. Over 80% of our forecasted net production has exposure to oil price upside in 2018. Currently, we do not have any hedges in place for 2019. Finally, during the quarter, we repurchased $1.2 million worth of shares under our NCIB. I will now turn the call over to Rodger Trimble, Vice President of Investor Relations to discuss some of the highlights of our Q1 2018 operations and potential upcoming catalysts in 2018.

Good morning. I will briefly mention some other key operational highlights during Q1 2018. Our Middle Mag drilling program in the North of Columbia delivered exciting results at the Ayombero-1 well with un-stimulated production test rates from the LaLuna carbonate conventional oil reservoir about 600 barrels of oil per day our natural flow with no water that Ayombero well may have opened up an exciting new front for appraisal and development in the Middle Mag for Gran Tierra. As production testing of this well continues through the second quarter 2018 we are already assessing the potential for future LaLuna appraisal and development well locations on the IM barrel to era structure later this year. Our independent qualified reserve evaluator, McDaniel has updated its prospective resource assessment of the IM barrel prospect in light of these positive well results. McDaniel has assigned mean prospective resources to IM barrel of 66 million barrels of oil on an un-risk basis and 31 million barrels on a risk basis. So, we are very excited about the IM barrel 1 results. Down south in the Putumayo Basin, the Vonu-1 exploration well on the PUT-1 Block, where we have an operated 55% working interest, continues to be our star performer in the A-Limestone. On a 100% gross basis, it has produced at an average rate of 1,849 barrels oil per day during Q1 with only modest natural decline observed so far. Since starting production in July of last year, Vonu-1 has produced a total of just over 500,000 barrels of oil with essentially no water. With the success of the A-Limestone in the Vonu well, in the PUT-1 Block, we are now working to permit a new well to appraise this discovery during 2019. As Vonu-1 also discovered oil in the U Sand and net oil pay in the N Sand, our evaluation is designed to identify the best drilling locations to test the stacked multi-zone potential of the PUT-1 block. Also in the Putumayo and Costayaco, we have drilled or are drilling three infill development wells to tack into our legacy reservoirs, the Costayaco 31, 32 and 33 wells. We have already had some interesting and encouraging results with the Costayaco 32 in which we have had our first successful oil test from the new M2 Limestone, which produced from 147 to 230 barrels oil per day of 29 degree API oil with virtually no water. We are assessing the potentially positive implication of the M2 Limestone at Costayaco and the Putumayo Basin overall. The Costayaco 33 well, which is currently drilling has our legacy reservoirs as primary targets, but has the potentially interesting secondary objective of evaluating the A-Limestone’s prospectivity on the other side of the main fault system that found the Costayaco field to the Southeast. At this point in time, our new A-Limestone and other carbonate conventional oil resource plays are still in their infancy and are just over 1.5 years old. As with other resource plays around the world, it will continue to take time to optimize drilling and completion techniques to maximize recoveries and achieve the best economics. We remain very encouraged about the massive prospectivity of these plays. As indicated by the more than 800 million BOE of mean unrisked prospective resources assigned by McDaniel at 2017 year end to the A-Limestone alone. We look forward to many more years of drilling in this exciting new – in these exciting new carbonate plays in the Putamayo Basin. Some upcoming catalysts in 2018 are as follows. First, we plan to drill three exploration wells in the PUT-7 block in the Putamayo Basin in second half 2018, the Pecari Pomorroso and Northwest wells are all designed to test the N Sand, the A-Limestone and the U Sand as well as other prospective targeting formations. Second, we plan to drill two development oil wells in PUT-7 in the Cumplidor Confianza field with the Cumplidor-2 well currently drilling. Third, we are also excited of the prospect of drilling several other A-Limestone and N Sand exploration wells in the Putamayo over the next several months. For example, the Colibri well on the PUT-4 block, the Chilanguita well on Alea 1848-A and the Comadreja well on PUT-2. Our A-Limestone conventional resource play represents 56% of our total mean unrisked prospective resources of 1.5 BOE. So our 2018 exploration drilling is very much focused on assessing this massive resource base. I will now turn the call back to the operator and Gary, Ryan and I will be happy to take your questions. Operator, please go ahead.

Thank you. Ladies and gentlemen, we will now conduct the question-and-answer session for securities analysts. [Operator Instructions] And our first question comes from the line of Nathan Piper of RBC. Your line is open.

Thank you. Good morning guys. And a couple of quick questions please, first of all on the additional CapEx, you are bringing forward, well I guess the question is are you bringing forward activity you would have done in 2019 or are you doing supplementary activity because results have been better than you expected. Second on Ayombero, it looks like a decent initial result given as an exploration well, would you expect further drilling to generate better production numbers than you got so far and also maybe it’s a definition thing, but why have McDaniel has called it prospective resources given you actually drilled and tested the reservoir? And then I guess lastly more of a wider point as we go through May we have got elections in Columbia, I wonder if you can give us your perspectives on how that Presidential campaign is unfolding? Thanks.

Okay. On the capital, the answer is both of the above. The results have been better than expected and it is capital that we are pulling forward, so we are just accelerating. Ryan mentioned the 30,000 barrels of oil per day capacity. We are just moving things forward from 2019. The exception is the power generation, our commitment on the installation of gas to power equipment is a purchase, it’s new and we are shifting from a rental situation where we supply fuel and rent the equipment. And so that’s really just about reliability. In terms of Ayombero the reason that the McDaniel’s classify that as prospective resource, they are looking at the entire structure. If you look at the Chuira field that’s been on production, it’s produced several hundred thousand barrels already. This structural closure, we just drilled on the far eastern flank of the structure and our view is it’s really a closure that we are appraising, but it will take some wells to move that into a reserve category. Your question on could we get higher rates, we are quite enthusiastic that we can. It’s a structurally complex reservoir that’s fractured. And our real objective on this well, the exploratory part of this well was the Salada, it’s the deepest, it’s the first test of Salada in this area. And so we geared our drilling program to get to that depth and tested it. It was wet with some traces of heavy oil. And the secondary objective was the Galembo, which is turned out to be great in terms of productivity, it’s confirmed that the closure exist all the way through the Ayombero field. In subsequent appraisal wells which we are planning now and hope to be kicking those off to appraisal/development wells, we can gear the completions to rates and recoveries and our team will do just that. And turning to politics, that’s a loaded question Nathan, we observe the primary that seemed to consolidate a lot of the vote moved Ivan Duque into the lead position and we just continued to observe. All of our programs will continue whoever is the next President of the country and the next Senate. All of our social programs and our development programs are all geared to long-term. Hopefully, that answers…?

It probably was a very loaded question, but if I can go back to the prospective resources on Ayombero and in terms of sort of $60 million number, how much of that is associated with this formation that you had success with and how much is associated with the one with the Salada which was less perspective at this location?

Yes. They – virtually, I would say not all, but most, very small amount they still believe that there could be some up-dip accumulation in Salada. They also gave us a little bit of credit. I think it was about 4 million to 5 million barrels in the Pujamana which was actually the best looking formation of oil. It looks as good or better than the Galembo, we just did not tested it yet. And likely we will not test it on this well due to the complex completion, but the Pujamana between the Salada and Galembo very fractured, we had great shows when we drilled through it. And so we are still encouraged and we will likely test that on a subsequent well.

Sure, the majority of that number is associated with the success you have had?

What was that Nathan?

So I was just being clear that the numbers really associated with it bit of success, but you successfully tested it?

That’s correct.

Perfect. Thank you for that.

Thank you. Our next question comes from the line of Luiz Carvalho of UBS. Your line is open.

Hi, everyone. Thanks for taking the questions. Basically, I have two questions here, first of all, you are able to improve netbacks quite significantly recently and your plan to improving it, so I would like to see we get a bit more color on how do you see your oil breakeven currently off the [indiscernible], all these improvements on the netback front? And second from a capital allocation perspective, I mean the CapEx increase that you announced was mainly allocated by – to the facilities improving, right, so what do you expect to see that in production and cost will be on a cash flow from different customers? Thank you very much.

Thanks. On the first question, the netbacks, the netbacks continued to improve. Part of that is Acordionero makes up a larger percentage of our production base and Acordionero has the highest netbacks in the company. Our operating costs are sub-$3 in Acordionero field. So if you look at our corporate breakevens, they would be sub-$30 per share.

So $30, you didn’t mean just to oil, right?

Correct.

Okay. And regarding the capital allocation in terms of impact?

Yes. So there really is no impact on the production, there are two components. The big component is the power generation, the 22 megawatt power generation that we are going to build. And really that is not what would be reflected in productions, but reflected in operating cost savings going forward. If you look at it we will save $8 million to $10 million per year for $20 million investment and it is what a 2-year payback on that investment. So no impact on production, but it does impact our bottom line.

Okay, pretty clear, yes. Thank you.

Thanks.

Thank you. Our next question is from the line of Matias Vammalle of Argo Capital Markets. Your line is open.

Hi, thank you very much. Thanks for the call. Two quick questions. The first one is starting from our low leverage point what can you guide us in terms of where do you think the sustainable leverage for the company is? And then secondly and I think you were just touching upon that, but how sustainable do you think your cost improvements have been especially on the operating costs that those are big achievement this quarter. And then if you can give us a bit of guidance in terms of transportation expenses which have paced marginally, but a bit higher this quarter? Thank you.

Okay. On the first one, what we target internally is debt to cash flow of one to one. And so not debt to EBITDA, but more of a debt to cash flow number is what we target, so that’s what the debt to EBITDA of around 0.75 or so. But debt to cash flow one to one is what we target. The second question was sustainability of the operating costs, again, like I said on the last question is a big chunk of our operating costs decreases just the higher percentage of the Acordionero production. We are quite comfortable that if you look at the operating costs and transportation costs in Q1, that’s a good proxy for the transportation costs and operating costs going forward for the remainder of 2018.

Great, thank you. And if I can sorry, I couldn’t catch you did you say what – is it net debt or gross debt both on either debt to cash flow or debt to EBITDA sorry?

The way we define net debt is really just the face value of our debt, which is $300 million on the bonds and $115 on our convertible left cash on hand.

Great. Thank you, guys. Thanks.

Thanks.

Thank you. Our next question is from the line of Josef Schachter of Schachter Energy. Your line is open.

Good morning and congratulations on the good quarter and drilling success. Question for you, you talked about the politics in Columbia with the May 27 election, can you talk about how you see things moving with the potential in Mexico of the leftwing candidate who seems to be anti-outsiders coming in, in the oil and gas industry. If he gets elected, would you close down the office in Mexico what’s your thoughts there?

Yes, just looking at the polls, I think the consensus is that is the likely outcome of the election. All of the analysis we have seen and done ourselves that the new petroleum legislation that’s gone through Congress, it would be very difficult to turn back. That’s not to say that it will not. And it’s not to say that things might slow down. We are in fact looking at the joint venture around. We are very enthusiastic about the Pemex joint venture partnerships and there is also another onshore round that we look at. Our interest in Mexico is subsurface. We see lots of opportunities the way the country is setup there, their fiscal system for the petroleum industry is very similar to Columbia. And so when we compare profitability of projects, we think there is potential there, but there is also the risk of things slowing down. And so we will weigh that. The bids are going to occur after the election and we will look it at that time. So, our view is we will continue looking at it and assess as the election results are in.

Okay, thank you very much and good quarter.

Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Jenny Xenos of Canaccord Genuity. Your line is open.

Good morning, gentlemen. I have three questions if I may please. The first one is do you actually have any exploration wells drilling right now?

The answer is yes, we are just about to spud. It’s the frontier Sinu Basin. Then we should be drilling that well here very shortly. Little bit of exploration, Rodger mentioned, we are crossing the bounding fault at Costayaco. We are going to take a look at what the carbonates look like on the east side of the Costayaco bounding fault. And beyond that, we are drilling development wells. The one thing that I will point out that we have not declared a discovery in the carbonates, in the U Sands at Cumplidor in Putamayo-7, we are about 10,000 feet on that well. We will be cutting core and the N Sands to get ready to develop. There is about 14 million barrels of undeveloped 2P reserves there that will waterflood and we will also test the 8 carbonates and the U Sands in that well and declare that discovery. You will recall we did test both of those already in the Confianza well. So that’s the other exploration activity ongoing.

Okay. So, these are essentially the three things that are happening in the second quarter, the Sinu well, then the CYC well and the Cumplidor well. Those are the three that are – we should expect results by the end of the second quarter.

That are going there, yes.

Okay, perfect. And could you give us a little bit color more please on the M2 Limestone I know that you have encountered it before. I seem to remain that pay was thinner than what you have seen in the A-Limestone, but could you give us a bit more color on kind of how it compares to the A-Limestone in terms of raw quality, thickness or pay and potentially area or extent if you could say?

Yes, the exciting part, Jenny is it’s a refill phases on top of the A which is a platform carbonate. So, you can have some as you know – as we get into refill phases, you can have some spectacular results highly reactive to hydrochloric acid we stimulated it and we are excited to get back on it and test it. In terms of regionally, we have got a pretty extensive seismic database. We see lots of potential throughout the lands that we already hold as well.

Okay. So it could be a material addition to the 800 million barrels that have already been attributed in prospective resources to the A-Limestone?

It can. And the exciting part for us was demonstrating that we can produce oil out of it and we got a couple of 100 barrels a day like.

Fantastic. Okay. And maybe the final question, you have significant financial capacity now on your balance sheet with $160 million in cash and $200 million in undrawn credit capacity, what are you planning to do with that other than the obvious share buybacks, your debt is already at a well within your targeted range. So what are you planning to do without extra financial capacity?

Yes, I think Jenny, we have a very active as you know exploration program and we are planning for success. We do think we will have discoveries and then this really just gives us the financial capacity to fast track those discoveries.

Okay. So could we see you then potentially expanding your work program further to develop discoveries or maybe bring forward the drilling of some additional wells?

There is a possibility. I think we just want to make sure that we remain disciplined. You start fast-tracking the program too much, that’s when you run into operational challenges cost overruns etcetera. So, we will do it in a disciplined way.

Fantastic. Thank you, Ryan.

Thanks.

Thank you. And gentlemen, there are no further questions at this time. Please continue.

Okay. Thank you, Amanda. On behalf of the management team at Gran Tierra, I want to thank you for joining us today. We look forward to speaking with all of you during the exciting quarter that we are in now and we will talk to you in 3 months. Thank you.