An anonymous director reports
SURGE ENERGY INC. ANNOUNCES $28.4 MILLION SPARKY CORE AREA ACQUISITION; UPWARD REVISION TO 2018 EXIT GUIDANCE; INCREASE TO DIVIDEND
Surge Energy Inc. has executed a formal purchase and sale agreement for the acquisition of high netback, waterflooded, crude oil producing assets in the company's core Sparky area of central Alberta for a purchase price of $28.4-million, which is expected to close on or about May 31, 2018.
Current production from the assets is more than 620 barrels of oil equivalent per day (83 per cent oil), with over 75 per cent of the production focused in Surge's large original-oil-in-place (OOIP), high-netback, core Sparky crude oil properties at Eyehill and Macklin. The assets have an annual decline of less than 27 per cent, and a netback of more than $30 per barrel at $65 (U.S.) West Texas Intermediate per barrel oil prices. The acquisition is accretive to Surge on all key debt-adjusted-per-share metrics. Surge has identified more than 35 net low-risk Sparky development drilling locations on the assets. The assets have a large internally estimated OOIP of over 85 million barrels, and an average gravity of 27 degrees American Petroleum Institute.
In conjunction with the acquisition, Surge is also revising upward the company's 2018 exit production guidance from 16,650 barrels of oil equivalent per day to 17,175 boe/d (82 per cent oil).
In addition, as a result of better-than-anticipated Q1 2018 drilling and waterflood results (press release on May 8, 2018), the Sparky core area acquisition, significantly higher strip crude oil prices than estimated and the narrowing of WCS differentials to near historical levels, Surge is generating substantial free adjusted funds flow (resulting in an estimated dividend simple payout ratio of less than 15 per cent) at current strip crude oil prices. Accordingly, Surge's board of directors has approved an increase to the company's annual dividend from 9.5 cents per share per year (0.79 cent per share per month) to 10 cents per share per year (0.83 cent per share per month).
Original oil in place is the equivalent to discovered petroleum initially in place for the purposes of this press release.
Two thousand eighteen guidance and acquisition metrics are based off of $65 (U.S.) per barrel WTI, $47 (U.S.)/bbl WCS, 0.78 Canadian/U.S. FX, $1.40/GJ AECO.
The Sparky acquisition
The acquisition is consistent with Surge's business strategy of acquiring high-quality, operated, large OOIP, conventional crude oil, sandstone reservoirs with low recovery factors.
The assets are located in the company's Sparky core area trend in which Surge currently has over 700 million barrels of internally estimated net OOIP. The Eyehill and Macklin properties included in the acquisition represent over 75 per cent of the current production from the assets, and directly offset Surge's current production and drilling operations. Surge has identified over 35 net low-risk drilling locations, with additional waterflood upside on these two key properties. The assets are characterized by the following attributes:
More than 85 million barrels of internally estimated OOIP with current recovery factors of less than 2 per cent at Eyehill and Macklin (and an internally estimated recovery factor of 10 per cent on primary, and up to 30 per cent with waterflood);
620 boe/d (83 per cent oil) of 100-per-cent operated, high working interest, low decline, oil-weighted production;
Long life reserves -- over 2.9 million boe of internally estimated proved plus probable reserves (in example, 13-year reserve life index (RLI));
A portion of the production is under successful, active waterflood (with additional waterflood upside at both Eyehill and Macklin);
More than 35 net low-risk, development drilling locations, of which 11 are included in Surge's internal reserve estimates above;
Operating netbacks of more than $30 per boe at $65 (U.S.) WTI;
Sustaining capital of $3.25-million, with anticipated second half 2018 annualized adjusted funds flow of more than $6-million; and
Implied free cash flow yield of approximately 45 per cent.
Attractive deal metrics
The $28.4-million acquisition has the transaction metrics as shown in the attached table.
Current production multiple 620 boe/d (83 per cent oil);
$46,000 per flowing boe/d
2H 2018 annualized adjusted funds flow multiple (3) 4.7 times
Total proved plus probable reserves multiple (internally estimated) (4) $9.79/boe
Recycle ratio 3.1 times
Reserve life index (RLI) 13 years
(3) 2018 guidance and acquisition metrics are based off of $65 (U.S.)/bbl WTI, $47 (U.S.)/bbl WCS,
0.78 Canadian/U.S. FX, $1.40/gigajoules AECO.
(4) RLI defined in reserves data/oil and gas metric.
This acquisition is accretive on all key debt-adjusted-per-share metrics.
Strategic fit with Surge's core Sparky assets
Production in Surge's Sparky core area has increased 145 per cent over the last two years, from 2,850 boe/d to over 7,000 boe/d (85 per cent oil) today. Each of Surge's core assets depicted below can be characterized as a high-quality, low-risk, operated, large OOIP, conventional sandstone reservoirs.
Sparky area -- continued growth momentum
Over the last two years, Surge has successfully grown production in the company's Sparky core area by more than 145 per cent -- turning its key producing Sparky asset base into a low-cost, high-netback, conventional sandstone resource play.
Over the past 12 months, Surge has successfully completed three separate accretive Sparky core area acquisitions, purchasing over 2,200 boe/d (90 per cent oil) combined, for an average of less than five times forward adjusted funds flow from the acquired assets. The combination of these transactions, together with Surge's highly successful development drilling program, has allowed the company to amass an exciting core growth area with the following characteristics:
Since year-end 2016, Surge has increased the company's internally estimated net OOIP in the Sparky core area to over 700 million net barrels, and added more than 125 internally estimated drilling locations.
Surge's proved plus probable oil reserves in the Sparky core area have grown by more than 75 per cent from 18 million boe (independently evaluated year-end 2015 Sparky area reserves), to an internal estimate of more than 32 million boe today.
Production from Surge's Sparky core area has increased by over 145 per cent in the last two years from approximately 2,850 boe/d to over 7,000 boe/d today (85 per cent oil).
Today, Surge has more than 340 internally estimated low-risk, Sparky area development drilling locations -- providing shareholders with a 12-year inventory of high rate of return (and excellent profit to investment ratio) locations at strip oil prices.
In addition, Surge is now experiencing significant economies of scale based upon regional dominance in this key growth area in terms of services, land, infrastructure and existing production.
Management sees further opportunity to both expand and consolidate Surge's position in the Sparky core area, utilizing the following strategies: 1) organically grow through land acquisitions and follow-up development drilling; and 2) actively pursue, evaluate and transact on accretive acquisitions of large OOIP, long life, low decline, conventional sandstone reservoirs.
Surge has now identified and delineated several distinct assets in its Sparky core area that will underpin growth in the area for the foreseeable future. The company's key operated, large OOIP, sandstone reservoirs at Eyehill, Lakeview, Sounding Lake, Sounding Lake East, Betty Lake, Provost and Macklin all possess multiyear development drilling inventories, exciting growth prospects and waterflood upside.
Over all, the company anticipates its Sparky core area to grow from 7,000 boe/d currently, to over 10,000 boe/d over the next three to four years.
Upward revision to 2018 exit guidance
Based on better-than-anticipated drilling and waterflood results (press release on May 8, 2018), Surge's Q1 2018 production of 16,027 boe/d again exceeded managements budgeted expectations.
In accordance with the acquisition, Surge is now revising upward the company's 2018 production exit rate from 16,650 boe/d to more than 17,175 boe/d. Surge has now revised upward the company's production estimates five times in the last two years (in example, two times organically and three times pursuant to core area acquisitions).
Surge's upwardly revised guidance for 2018 is set forth in the attached table.
Operational $65 (U.S.) WTI 2018 $75 (U.S.) WTI 2018
guidance (5) guidance (6)
2018 average production (boe/d) 16,585 16,585
2018 exit production (boe/d) (82 per cent oil) 17,175 17,175
Total 2018 capital spending $105 million $105 million
Operating expenses -- 2H 2018 ($/boe) $13.95/boe $13.95/boe
Transportation expenses -- 2H 2018 ($/boe) $1.50/boe $1.50/boe
Royalties as a % of revenue -- 2H 2018 14-15% 15-16%
Estimated 2H 2018 annualized adjusted funds flow $149 million $190 million
Estimated 2H 2018 annualized adjusted funds flow per share $0.65 $0.82
Estimated Q4 2018 net debt to adjusted funds flow 1.66x 1.2x
Annualized dividend $23.1 million $23.1 million
Sustainability ratio -- 2H 2018 annualized 86% 67%
Simple payout ratio -- 2H 2018 annualized 16% 12%
* Note: In 2017, Surge budgeted WCS differentials at $12.75 (U.S.) per bbl. Surge has now increased its
WCS differential assumption by 41 per cent in 2018, to $18 (U.S.) per bbl in its $65 (U.S.) WTI budget on a
(5) Two thousand eighteen guidance and acquisition metrics are based off of $65 (U.S.)/bbl WTI, $47 (U.S.)/bbl
WCS, 0.78 Canadian/U.S. FX, $1.40/GJ AECO.
(6) Two thousand eighteen guidance and acquisition metrics are based off of $75 (U.S.)/bbl WTI, $56 (U.S.)/bbl
WCS, 0.79 Canadian/U.S. FX, $1.40/GJ AECO.
Based on better drilling results than anticipated at the company's core Valhalla light oil property, Surge has added one net Valhalla well in the fall of 2018 to its capital expenditure budget, plus $1-million of incremental facilities capital to handle the associated light oil volumes.
5.3-per-cent increase to dividend
As a result of the Sparky core area acquisition, along with better than anticipated operational results in Q1 2018, significantly higher strip WTI oil prices than the company was budgeting, as well as WCS crude oil differentials narrowing close to long-term average levels, Surge has much larger free adjusted funds flow in 2018 than management was projecting.
Accordingly, with the continuing protection from Surge's strategic commodity hedging program, the board and management of Surge intend to increase the company's dividend by 5.3 per cent, from $21.9-million annually to approximately $23.1-million annually, effective June 15, 2018.
This equates to a simple payout ratio of less than 16 per cent of forecasted second half of 2018 annualized adjusted funds flow at WTI crude oil prices of $65 (U.S.) WTI per barrel, including a WCS differential assumption of $18 (U.S.) per barrel.
Outlook -- sustainable growth, long-term value and income
Management's stated goal is to be the best positioned light/medium gravity crude oil growth and dividend paying public company in the company's peer group in Canada.
Over the last seven financial quarters, Surge has now increased production per share by 25 per cent, increased its dividend by 31 per cent, and upwardly revised production estimates five times -- twice times organically, and three times pursuant to accretive Sparky core area acquisitions.
Management attributes the company's continued quarterly operational outperformance to be a direct result of applying growth capital to Surge's high-quality, large OOIP, light and medium gravity crude oil, conventional sandstone reservoirs, and successful waterflood implementation.
Management believes that Surge offers its shareholders a unique return based model with multifaceted, low-risk, light and medium gravity crude oil investment opportunity as follows:
Sustainable annual-production-per-share growth of 5 to 7 per cent per year, pursuant to the company's strategic five-year business plan;
Very high internal rate of return drilling locations -- with very quick payouts (11-year drilling inventory; with a weighted-average internal rate of return greater than 90 per cent at $65 (U.S.) WTI flat pricing);
Significant incremental long-term value from Surge's large OOIP conventional reservoirs that have very high profit to investment ratio waterfloods (low-risk drilling and waterfloods provide low harmonic declines, and deliver annuity-type annual reserve bookings);
Current yield of approximately 4 per cent through a sustainable, increasing, compounding dividend;
Free adjusted funds flow yield (above $57.50 (U.S.) WTI flat pricing);
Significant financial leverage to higher oil prices;
Significant upside for share price appreciation as Surge common shares trade up to (and through) the company's new net asset value of $6.06 per share (calculated based on the company's Dec. 31, 2017, independently estimated (Sproule) reserve report total proved plus probable value, discounted at 10 per cent).
Surge will continue to grow its production base and location inventory in the company's three core areas -- at Sparky, Shaunavon and Valhalla -- through, organic, low-risk, development drilling, combined with strategic, high-quality, core area acquisitions.
We seek Safe Harbor.
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