Mr. Paul Colborne reports
SURGE ENERGY INC. ANNOUNCES SECOND QUARTER RESULTS; APPOINTMENT OF CFO
Surge Energy Inc. has provided its financial and operating results for the quarter ended June 30, 2019.
Message to the shareholders
Q2 2019 was an excellent quarter for Surge. Production and adjusted funds flow came in higher than analyst estimates and the company's bank debt, net debt, operating expenses, transportation expenses, and general and administrative costs all came in lower than budgeted expectations.
Production of 21,544 barrels of oil equivalent per day (boepd) in Q2 2019 averaged more than Surge's 2019 exit rate guidance of 21,500 boepd, which represents an increase of 26 per cent over Q2 2018 at 17,072 boepd.
Surge was originally guiding to exit 2019 with production of 22,000 boepd; however, the company sold a 490 boepd non-core asset in Q1 2019 for net cash proceeds of $28.1-million, resulting in new 2019 production exit rate guidance of 21,500 boepd.
Drilling results from Surge's Q2 2019 program exceeded management's expectations. Successful drilling in Q2 2019 at the company's Sparky, Shaunavon and Valhalla core areas has resulted in current estimated production additions of 1,625 barrels of oil per day, for total exploration and development expenditures of $25.2-million, providing capital efficiencies4 of approximately $15,877 per bopd.
Surge's Q2 2019 quarterly production of 21,544 boepd increased by 26 per cent over Q2 2018 production of 17,072 boepd.
Adjusted funds flow in Q2 2019 was $50.7-million, an increase of 31 per cent as compared with Q2 2018 at $38.6-million.
Cash flow from operating activities in Q2 2019 was $45.8-million, an increase of 36 per cent as compared with Q2 2018 at $33.7-million.
The company's operating netback increased by 6 per cent, to $31.24 per boe in Q2 2019, from $29.46 per boe in Q2 2018.
The company's operating expenses for Q2 2019 were $14.43 per boe and net operating expenses were $14.03 per boe, compared with 2019 guidance of $14.95 to $15.45 per boe.
The company generated $17.7-million of adjusted funds flow in the quarter in excess of exploration and development expenditures and dividends paid.
Surge paid dividends of $7.9-million in Q2 2019, representing 15 per cent of Q2 2019 adjusted funds flow.
The company maintained a net debt to annualized Q2 2019 adjusted funds flow ratio of under two times (1.9 times).
Surge closed a small, miscellaneous gross overriding royalty (GORR) disposition of 214 boepd on June 28, 2019, for net cash proceeds of $29.1-million -- providing sale metrics of greater than $135,000 per flowing boepd.
Subsequent to June 30, 2019, pursuant to a Crown sale on July 31, 2019, Surge successfully acquired an additional 8.5 sections of highly prospective Sparky acreage at Betty Lake -- extending the company's large new Sparky discovery to the north.
Subsequent to June 30, 2019, pursuant to a Crown sale on July 31, 2019, Surge successfully acquired an additional 9.5 sections of highly prospective acreage at Nipisi South in the company's Greater Sawn core area. This new land is immediately offsetting existing Surge light oil production, and is prospective for both Slave Point and Clearwater oil reserves and production.
FINANCIAL AND OPERATING SUMMARY
(in thousands of dollars except per share amounts)
Three months Six months
ended June 30, ended June 30,
2019 2018 2019 2018
Oil sales $104,387 $83,516 $195,515 $148,008
NGL sales 1,649 2,486 4,074 4,947
Natural gas sales 1,629 1,092 5,944 2,429
Total oil, natural gas and NGL revenue 107,665 87,094 205,533 155,384
Cash flow from operating activities 45,807 33,725 74,715 57,940
Per share -- basic ($) 0.15 0.15 0.24 0.25
Adjusted funds flow 50,742 38,596 92,593 66,765
Per share -- basic ($) 0.16 0.17 0.30 0.29
Total exploration and development expenditures 25,197 23,344 66,458 58,253
Total acquisition and dispositions (29,166) 28,939 (56,973) 22,454
Total capital expenditures (3,969) 52,283 9,485 80,707
Net debt, end of period 391,020 276,140 391,020 276,140
Oil (bbl per day) 17,366 13,343 17,454 12,897
NGLs (bbl per day) 727 556 685 558
Natural gas (mcf per day) 20,706 19,038 20,685 18,585
Total (boe per day) (6:1) 21,544 17,072 21,587 16,553
Average realized price (excluding hedges)
Oil ($ per bbl) 66.05 68.78 61.89 63.40
NGL ($ per bbl) 24.93 49.15 32.84 48.99
Natural gas ($ per mcf) 0.86 0.63 1.59 0.72
Netback ($ per boe)
Petroleum and natural gas revenue 54.92 56.06 52.60 51.86
Realized gain (loss) on financial contracts (1.29) (2.46) (0.83) (1.81)
Royalties (7.03) (8.36) (6.36) (7.32)
Net operating expenses (14.03) (14.16) (14.58) (14.37)
Transportation expenses (1.33) (1.62) (1.66) (1.45)
Operating netback 31.24 29.46 29.17 26.91
G&A expense (1.86) (2.06) (1.82) (2.14)
Interest expense (3.48) (2.56) (3.66) (2.50)
Adjusted funds flow 25.90 24.84 23.69 22.27
In Q2 2019, Surge successfully drilled nine gross (nine net) producing wells, currently producing an estimated 1,625 bopd, for total exploration and development expenditures of $25.2-million ($15,877 per bopd).
These excellent results are a continuation of the operational momentum and record Surge has generated over the last 12 financial quarters -- growing production by 77 per cent from 12,182 boepd (78 per cent liquids) in Q2 2016 to 21,544 boepd (84 per cent liquids) in Q2 2019.
Sparky core area
Cost reductions from first four-well pad
In Q2 2019, Surge drilled and completed four gross (4.0 net) wells in its Sparky core area.
At Provost, Surge drilled four excellent Sparky wells on the company's first ever four-well drilling pad. Due to pad drilling efficiencies, the average all-in cost at Provost was $1.04-million per well, compared with a budget of $1.25-million per well. The four wells combined are currently producing over 675 bopd. Surge has more than 35 net drilling locations remaining at the company's large, internally estimated 90 million net OOIP6, Sparky pool at Provost. As a result of Surge's drilling results at Provost, operating expenses in this area are now $6.75 per boe.
Approximately 18 months ago, Surge announced a large, new Sparky oil discovery at Betty Lake (near Wainwright, Alta). The OOIP at Betty Lake is estimated to be over 80 million net barrels. Surge has now largely derisked the company's Betty Lake Sparky oil pool, drilling eight consecutive horizontal wells, with 100-per-cent success. Surge estimates that there are more than 50 net locations remaining to drill at Betty Lake, with full waterflood upside. Based on Surge's excellent drilling results at Betty Lake, operating costs in this field are now $7 per boe.
In addition, at a recent Crown sale on July 31, 2019, Surge successfully acquired an additional 8.5 sections of land at Betty Lake -- extending this large Sparky pool to the north. The company believes that this acreage comprises a large Sparky oil pool extension, adding up to an estimated 40 million barrels of net OOIP, and up to 38 additional net drilling locations.
The company is also experiencing consistently strong results at its Sparky MM pool at Sounding Lake, with Surge's three most recent wells producing above the Sparky type curve (which has an IP 30 of 100 bopd). Surge estimates more than 30 locations remaining to be drilled at this large, 25 million OOIP, 31-degree American Petroleum Institute Sparky asset.
Surge anticipates drilling up to 14 locations in the Sparky core area in the second half of 2019.
Rapidly expanding core area
In less than five years, in Surge's Sparky core area the company has amassed more than 900 million barrels of estimated net OOIP, production of over 7,750 boepd (90 per cent oil) and over 450 drilling locations -- providing a 13-year drilling inventory (at the company's current pace of 35 Sparky drills per year).
Surge's high-quality Sparky reservoirs are characterized as conventional, large OOIP per section (over six million barrels per section), low-risk, shallow, sandstone reservoirs, at 700- to 800-metre depth. The wells are highly economic, delivering over 135,000 barrels of oil equivalent (90 per cent oil) internally estimated ultimate recovery (EUR), for primary production only, at an all-in cost of less than $1.2-million per well -- drilled, completed and on stream.
Surge's Sparky type curve wells pay out in less than a year, and deliver profit to investment ratios of over 2.0 at current strip oil pricing of $54 (U.S.) WTI per barrel, for primary drilling. In addition, Surge has successfully proven waterflood upside for the company's Sparky/Lloyd plays at: Wainwright, Eyehill, Sounding Lake MM, Provost, Macklin, Lakeview and Silver.
Surge is now utilizing the following technological improvements and efficiencies that the company's experienced and proven Sparky technical team have integrated over the last four to five years:
Longer horizontal wells;
Increased number of frac stages;
Less frac intensity per stage;
Floating in the casing;
Multicycle frac sleeves versus ball drop system;
Modified mud system;
Given these exciting improvements in the company's drilling and completion processes, Surge has now driven the cost of a Sparky well down from a high of $2.3-million in 2014, to approximately $1.0-million for the company's two most recent pad wells at Provost. In addition, Surge has also increased the company's internally generated Sparky type curve production estimates significantly over this period (such as by as much as 25 to 30 per cent).
By drilling 105 (out of 106) successful, highly economic, horizontal wells in Surge's Sparky core area over the last five years, the company has now proven that its proprietary drilling/completion systems deliver excellent results, with remarkable consistency. Management believes this bodes very well for the continued growth and development of Surge's rapidly expanding Sparky play.
Eyehill -- a case study
An illustration of Surge's record for adding value in its Sparky core area is at the company's high-quality, 170 million net OOIP, 29-degree API oil asset at Eyehill. Over the last four years at Eyehill, Surge has: 1) aggressively grown the asset -- adding significant value; and 2) strategically transitioned the property into a sustainable, long life, waterflooded asset, as set forth within the Eyehill production growth section.
Eyehill -- production growth over 380 per cent in three years
Increased production 380 per cent in three years;
Of the 63 operated horizontal wells at Eyehill, Surge drilled 51 and acquired 12;
Peak production of 2,950 boepd was reached in May, 2017;
Surge had only 15 horizontal wells producing 500 boepd (80 per cent liquids) at year-end 2015;
Surge has drilled an average of 14 wells per year (12 per year excluding acquisitions), increasing production significantly -- inclusive of lost production associated with water injector conversions.
To date seven of the 63 wells drilled have now been converted to water injection at Eyehill, providing pressure support and lowering the production decline for this large, conventional Sparky oil pool (lower annual declines fit very well with Surge's growth and dividend paying business model).
Eyehill -- production profile (low decline waterflood)
Based on Surge's strong drilling and waterflood results at Eyehill, operating expenses are now $7.50 per boe.
EYEHILL -- VALUE CREATION
No. of No. of TPP TPP
Net OOIP producing hz wtr Production reserves NPV 10
(mmbbl) hz injectors (boepd) % oil (Mboe) ($-millions)
YE 2015 70 15 1 500 80% 4,089 $49
YE 2018 170 56 7 2,400 81% 13,305 $242
Three yr change 100 41 6 1,900 1% 9,216 $193
143% 273% 380% 225% 395%
In the last three years Surge has increased the company's Sproule NPV10 total proved plus probable reserve value at Eyehill by 395 per cent, from $49-million to $242-million.
Surge will continue to follow this proven, disciplined operating strategy of delivering higher initial drilling growth and value creation, followed by strategically transitioning the company's high-quality, large OOIP, Sparky sandstone reservoirs into waterfloods (to deliver long-term adjusted funds flow in excess of exploration and development expenditures, and excellent profit to investment ratios) at: Eyehill, Betty Lake, Provost, Sounding MM, Sounding East, Lakeview, Macklin, Cadogan and Eyehill South.
This conservative operating strategy is a key component of Surge's growth plus dividend paying business model.
Valhalla core area
At Valhalla, in Q2 2019 Surge drilled a successful, 100-per-cent working interest, Doig horizontal light oil well. This is Surge's third 200-metre horizontal infill well drilled into the Doig reservoir, and further validates the continued downspacing of this large, 150 million OOIP net, light oil pool. This well is currently producing more than 750 boepd (70 per cent light oil).
Surge estimates an inventory of more than 50 net light oil locations at Valhalla in the Doig, Charlie Lake and Montney formations, providing a drilling inventory of more than 10 years.
The company anticipates drilling up to two locations at Valhalla in the second half of 2019.
Shaunavon core area
In Q2 2019 Surge drilled four gross (4.0 net) successful new wells at Shaunavon. Two of the wells were drilled in the Upper Shaunavon formation, and two were drilled in the Lower Shaunavon formation. The company also continued its successful pumpjack conversion program, with another 30 wells converted to pumpjacks in the first half of 2019.
Surge estimates over 125 net drilling locations remaining in the Upper and Lower Shaunavon formations, and over 400 million barrels of estimated (combined) net OOIP. The Shaunavon field has a high operating netback, is waterflooded and delivers annual adjusted funds flow in excess of exploration and development expenditures -- which fits very well with Surge's lower risk, lower decline, growth and dividend paying business model.
Surge plans for the drilling of up to four additional locations at Shaunavon in the second half of 2019.
Greater Sawn core area
At Greater Sawn, Surge continues to enjoy the significant free adjusted funds flow from this 5,000 bopd light oil asset. The company drilled its first four wells at Sawn late last year, and early this year, with 100-per-cent success.
Surge continues to optimize the successful waterflood at Sawn, with plans to expand waterflood operations later this year, and into 2020. Surge estimates a drilling inventory of over 10 years in the Greater Sawn area, with more than 100 net locations at this high-quality, 600-million-barrel net OOIP light oil asset.
Further to the above, at a recent Crown sale on July 31, 2019, Surge successfully acquired an additional 9.5 sections of acreage at Nipisi South in the company's Greater Sawn core area. Surge believes Nipisi South contains up to 30 million barrels of net OOIP (light oil) in the Slave Point formation, with over 20 additional net Slave Point drilling locations5. The new acreage is also prospective for Clearwater oil reserves and production.
The company anticipates drilling up to four locations at Greater Sawn in the second half of 2019.
Bank line update
Surge's new borrowing base has been confirmed by its lenders at $500-million, comprising a $450-million revolving line of credit and a $50-million operating line of credit (with unanimous lender consent required for the company to draw in excess of $425-million). On this basis, Surge has over $105-million
of unrestricted liquidity available to the company, and committed access to over $180-million
of total liquidity.
Environmental, social and governance
During the first half of 2019 the company elected to participate in the Alberta Energy Regulators (AER) area-based closure program (ABC program). Building on the company's work in Q1 2019, Surge has continued to efficiently direct capital toward abandoning and reclaiming its non-core Cherry natural gas property.
The company has seen abandonment and reclamation costs continue to be approximately 55 per cent of AER estimates, confirming Surge's belief in the economies of scale that are found within the ABC program. Given the company's success in Q1 2019 at Cherry, Surge has now initiated ABC programs in a number of the company's non-core areas.
Surge has committed $6-million in 2019 to a pro-active, well-financed, annual abandonment and reclamation program. This exceeds AER mandated contributions by over $1.8-million, and builds on the $17-million the company has spent since 2014.
During the first half of 2019 the company abandoned 76 wells. The company has now increased its target abandonment commitment for 2019 from 125 to 150 wells, which is approximately three times the number of wells the company plans to drill this year.
The company also continued to advance its social and governance leadership by further demonstrating its commitment to diversity in the workplace and on the board of directors. Following the annual general meeting, the percentage of female directors on Surge's board of directors increased to 33 per cent from 22 per cent in Q3 2018. The company is pleased to not only have increased gender diversity on the board, but to have added three highly qualified directors with diverse backgrounds, and proven records, in the past year.
As further evidence of Surge's commitment to board diversity and renewal, Surge's board independence has increased to 78 per cent in Q2 2019 from 71 per cent in Q2 2018, and the average age of Surge board members is currently 58 years, down from 62 years in Q2 2018.
Surge is a supporter of community engagement and recognizes the importance of supporting charitable organizations and the communities in which the company operates. Details on the company's recent community engagement initiatives can be found on Surge's website.
Outlook -- consistent growth; sustainable dividend
Management's stated goal is to be the best positioned, top-performing, light/medium gravity crude oil growth and dividend-paying public company in its peer group in Canada.
Surge focuses on sustainability, balance sheet management and cost controls to deliver returns to Surge shareholders. The company continues to grow its production base and 14-year drilling location inventory in its core areas of Sparky, Valhalla, Greater Sawn and Shaunavon through low-risk development drilling and waterfloods -- in accordance with management's detailed business plan. Surge also strategically applies growth capital to high-quality, large OOIP, core area acquisitions.
The company has an excellent hedging program in place to protect Surge's adjusted funds flow. For the second half of 2019, Surge has hedged 7,000 barrels per day of WTI crude oil with an average floor price of $78 (Canadian)/bbl. This represents approximately 50 per cent of Surge's forecasted after royalty crude oil production for the second half of 2019. Surge has also retained upside to further WTI price increases on 55 per cent of the hedged volumes, with an average ceiling of $103 (Canadian)/bbl.
On this basis, Surge continues to pay the company's monthly cash dividend (currently 8-per-cent yield). Surge targets dividend payments that range from 20 to 30 per cent of adjusted funds flow. Surge paid dividends of $7.9-million in Q2 2019, which equates to 15 per cent of Q2 2019 adjusted funds flow.
Appointment of chief financial officer -- Jared Ducs
Surge is also pleased to announce the promotion of Mr. Ducs to the office of chief financial officer of the company effective Aug. 9, 2019. Mr. Ducs has been the vice-president, finance, of Surge since Aug. 16, 2018, and has been with Surge for over nine years.
"Jared has been a leader at Surge for many years. His extensive financial, operational and strategic experience will continue to be a huge asset for the company," says Surge president and chief executive officer, Paul Colborne.
We seek Safe Harbor.
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