Enerplus Resources Fund (ERF) Q3 2021 Earnings Call Transcript

Enerplus Resources Fund (ERF 0.50%)
Q3 2021 Earnings Call
Nov 05, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning, ladies and gentlemen, and welcome to the Enerplus Q3 2021 results conference call. At this time, all lines are in a listen-only mode. And following the presentation, we will conduct a question-and-answer session. [Operator instructions] As a reminder, this call is being recorded on Friday, November 5, 2021.

And I would now like to turn the conference over to Mr. Drew Mair, manager of investor relations. Please go ahead.

Drew Mair -- Manager of Investor Relations

Thank you, operator, and good morning, everyone. Thank you for joining the call. Before we get started, please take note of the advisories located at the end of our third quarter news release. Our financials have been prepared in accordance with U.S.

GAAP. All discussion of production volumes today are on a gross company working interest basis, and all financial figures are in Canadian dollars unless otherwise specified. I'm here this morning with Ian Dundas, our president and chief executive officer; Wade Hutchings, senior VP and chief operating officer; Jodi Jenson Labrie, senior VP and chief financial officer; Shaina Morihira, VP, finance; and Garth Doll, VP, marketing. Following our discussion, we will open up the call for questions.

And with that, I will turn it over to Ian.

Ian Dundas -- President and Chief Executive Officer

Good morning, all. We achieved another company production record in the third quarter with volumes of over 123,000 BOE per day, 7% higher than the prior quarter and 36% higher than the prior-year period. This momentum is expected to continue in the fourth quarter with production set to increase to between 124,500 to 128,500 BOE per day. We've moved the midpoint of our annual 2021 production guidance higher by 750 BOE per day due to outperformance in North Dakota and the Marcellus.

This is despite having sold volumes in connection with our noncore Williston Basin divestment that closed on November 2 and further underscores the operational momentum we are seeing. Our spending plans remain on track, and we have tightened up our 2021 capital guidance to $380 million, the midpoint of our prior range. Our free cash flow profile continues to grow, driven by increasing commodity prices, our higher production outlook, and our disciplined capital allocation. We now expect to generate approximately $540 million in free cash flow in 2021 based on forward strip commodity prices.

This increased free cash flow generation, combined with the $115 million U.S. proceeds related to our noncore sale has accelerated the timetable to achieving our $400 million net debt reduction target. We now expect to achieve this target here in the fourth quarter. As a result, we are accelerating our plans to increase our cash returns to shareholders sooner than anticipated by way of an expanded share repurchase program and a dividend increase.

We are immediately commencing a $200 million share buyback program. Our target today is to fully execute this program by the end of the first quarter of 2022, if not sooner. This represents approximately 50% of forecasted free cash flow over this period based on the forward strip. We continue to see a disconnect between our current market valuation and the intrinsic value of our business based on our view of mid-cycle commodity prices.

As a result, we believe share repurchases offer an attractive capital allocation opportunity. We also announced an 8% dividend increase, our third dividend increase year to date. In aggregate, this represents a 37% increase on an annualized basis from our dividend level at the start of the year. Turning to 2022.

Our preliminary outlook is consistent with the five-year plan we announced earlier this year. Approximately $500 million in capital spending, which is expected to generate strong economic returns and meaningful free cash flow while delivering 3% to 5% liquids production growth. Inclusive of our 2021 acquisitions and recent divestments, the absolute year-over-year liquids production growth is closer to 7%. But normalized for the timing impact of the acquisitions, the organic growth associated with the 2022 budget is in line with our stated 3% to 5%.

Based on strip prices, we see our free cash flow growing by close to 20% year over year in 2022. Factoring in our planned share buyback program, that number moves higher on a per share basis. Now before I turn the call to Wade to discuss operations, I want to reiterate one final point. We are committed to returning a significant portion of free cash flow to shareholders.

The $200 million buyback and dividend increase are just the most recent examples of our commitment to return meaningful amounts of our free cash flow to our shareholders. Although the strategy is becoming more common in the industry, it has been a hallmark of our capital market strategy since the inception of the company. Since 2018, we have returned over $370 million to shareholders through a combination of dividends and buybacks during a time of far less attractive commodity prices. Combining those returns with the buyback we announced today will bring us close to 20% of the value of our market cap, which will be returned to shareholders.

As I said earlier, we are commencing the buyback immediately and expect it to be completed relatively early next year. But once this plan is executed, we will continue to look for opportunities to further increase returns to shareholders as we move into next year [Inaudible] further visibility to the commodity price environment, inflation expectations, and overall market conditions. The portion of free cash flow that we do not allocate to shareholder returns will be used to fortify the balance sheet. We continue to believe that having a top-quartile balance sheet strength is a strategic asset.

Volatility will continue. We want to maintain our resilience through the cycle and through price shocks. With that, I will leave it there. I'll turn the call to Wade.

Wade Hutchings -- Senior Vice President and Chief Operating Officer

Thanks, Ian, and good morning, everyone. Our operational performance this year continues to be solid and is reflected by our increased production guidance and disciplined capital execution. We brought 16 operated wells on production in the Bakken in the third quarter and have maintained our strong completions efficiency, continuing to average approximately 13 stages per day over 30% faster than our 2020 performance. In terms of Bakken well costs, we continue to track to an average expected 2021 total cost of $5.7 million, despite some inflationary pressures that are starting to emerge in the supply chain specific to steel and diesel costs.

With respect to remaining 2021 completions activity, we're bringing on an eight-well pad on production in the fourth quarter in North Dakota, which along with strong volumes in the Marcellus is expected to drive Q4 production to over 126,000 BOE per day based on our guidance midpoint. Third quarter operating expenses were higher than forecast, which was a function of two factors. The biggest of which was a temporary increase in well service activity resulting from our decision to accelerate the restoration of downed wells. This activity became increasingly economic as oil prices moved substantially higher through the summer.

The other factor was an increase in water handling costs, largely due to contracts with price escalators linked to WTI. While the higher water handling charges will persist in the current WTI price environment, we are back down to a more normalized pace of well workover activity and workover rigs. And as a result, we expect operating costs to come down in the fourth quarter to approximately $8.80 per BOE. Moving on to 2022, our preliminary capital budget of approximately $500 million will be largely focused on North Dakota where we plan to add a second rig for about half the year.

During the past six months, we have secured pricing for approximately 75% of our 2022 North Dakota development program, providing protection against inflationary pressures. Key items we have secured include drilling rigs, pressure pumping, sand and the majority of casing. Notwithstanding this, we do expect to see some impacts from inflation and have budgeted for a 5% to 7% increase in total North Dakota well costs in 2022, assuming the current strength that WTI continues. In terms of our 2022 development focus, we plan to be active on the acreage we acquired in our transactions earlier this year.

So in addition to Fort Berthold Indian Reservation, operations will also be focused on the lightly drilled acreage to the south at Little Knife and Murphy Creek. Today, we see over a decade of Tier 1 drilling inventory ahead of us in North Dakota. However, we think there is an opportunity to extend this further by bringing modern stimulation and well design to other parts of our acreage footprint, specifically in Southern Little Knife, Murphy Creek, and Central Williams. The Southern acreage in Dunn County was not a focus for the previous operator.

So there are very few wells in these units, and they are generally of an older vintage. Several recent wells from offset operators have strong production results, and we see the potential to extend the core of the play to these areas. I'll now pass the call to Jodi.

Jodi Jenson Labrie -- Senior Vice President and Chief Financial Officer

Thanks, Wade. Our third quarter adjusted funds flow was $256 million with capital spending of $80 million resulting in free cash flow for the quarter of $176 million. Our realized Bakken oil price differential improved to $2.9 per barrel below WTI in the third quarter. Refining demand was strong, and there continues to be significant available pipeline capacity in the basin supporting pricing.

Following Dakota Access Pipeline expansion in August to 750,000 barrels per day, we see approximately 400,000 barrels per day of spare capacity in the basin, and we believe it will remain overpiped for a number of years. Given the improved pricing year to date and ongoing market strength, we have narrowed our 2021 differential guidance in the Bakken to $2 per barrel below WTI. Spot differentials have continued to strengthen in the fourth quarter, and we expect this pricing dynamic to continue into 2022 with potential for sub-$2 Bakken differentials to WTI. Our Marcellus natural gas pricing also improved quarter over quarter with a realized differential of $0.45 per Mcf below NYMEX due to increased natural gas demand and lower storage levels.

Strong pricing is expected through the winter season, and we have tightened our 2021 full year Marcellus differential at $0.55 per Mcf below NYMEX. Further to Wade's comments on operating expenses, although we increased 2021 operating expense guidance, our total cash costs remain approximately the same. The reduction in cash G&A guidance, combined with the improved Bakken and Marcellus differential guidance has effectively offset the impact to our annual cash flow from the higher operating expenses. Now turning to the balance sheet.

We remain in a strong financial position and expect the delevering to continue with meaningful free cash flow forecast in the fourth quarter of 2021. Our net debt to adjusted funds flow ratio is expected to be under one times by year-end. Lastly, we recently added 12,500 barrels per day of incremental oil hedges for the first half of 2022, using three-way collars with average U.S. dollar WTI strike prices of approximately 58 by 75 by 88.

These structures provide protection at $75 WTI while allowing participation up to $88 WTI, helping to protect the free cash flow generation associated with our return of capital plans as outlined by Ian at the beginning of the call. I'll leave it there, and we'll turn it over to the operator to have the question period.

Questions & Answers:

Operator

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. [Operator instructions] Your first question comes from Jeoffrey Lambujon of Tudor, Pickering, Holt. Please go ahead.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Good morning. Thanks for taking my questions.

Ian Dundas -- President and Chief Executive Officer

Hey, Jeff.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

My first one is just on free cash flow allocation once you achieve your balance sheet objectives, which as you all pointed out earlier, should happen here in the fourth quarter. we certainly appreciate the buyback over the next few quarters and what that means relative to free cash flow across that same time frame. But is there any additional color you can give us on how you like the balance sheet to look longer term maybe toward giving us a sense of how the free cash flow allocation framework in terms of debt versus capital returns mix could evolve over time, especially as we think about you all exiting the year under one times on leverage?

Ian Dundas -- President and Chief Executive Officer

Yeah. Thanks for that, Jeff. So I guess I'll start by saying it's strategically important to us, and it's all the cool kids are doing it now, but we've been doing this for a long time. And so, it really is an important part of our framework.

As it stands today, I guess we've given very explicit visibility to what happens over the next couple of quarters, which is a continuation to pay down debt, about 50% free cash flow with the majority [Inaudible] shareholders with the majority of that going to the buybacks. As we move forward and assuming the outlook remains supportive, which certainly has that feel now, I think you're going to continue to see very similar themes. You know, we are -- when we think about delivery mechanism to shareholders, a stable growing base dividend, that's highly resilient. That makes a lot of sense to us.

So I think there's room to continue to go there. I think the thing that we've maybe stayed away from a little bit is exactly what percentage of free cash flow gets allocated, and we will evaluate that as we move forward. You know, as we think about value in the stock today, we really do think the share buyback has a very strong role to play, highly accretive, and strong capital allocation choice. I guess we are open-minded to specials and variables and those sorts of things that are starting to get a little bit of traction in the market, and we'll evaluate that as we go through looking for what we think is the best way to continue to deliver returns to shareholders and maintain a sustainable business.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Great. I appreciate that. And then just as a follow-up, I wanted to ask one on portfolio management. I think this was not highlighted as a potential use of free cash flow over the near term.

But just given that there's been some bolt-on activity to the Bakken in the recent past. Just wondering if additional activity like that is maybe further down the road at this point. And then conversely, I'd be curious to see your thoughts on if the commodity price environment has maybe opened up some doors to keep selling down some of the noncore positions.

Ian Dundas -- President and Chief Executive Officer

Yeah, thank you. So relative to bolt-ons or acquisitions, I think folks who've been following us over the last year will appreciate we really made significant changes to the portfolio through the Bakken acquisition that we were able to execute somewhere in the trough if they have effectively doubled our inventory plus additional optionality that sits there that Wade alluded to in his comments. So the bar to bring additional inventory, the bar for acquisitions, those are things is higher than it once was. We really don't have any holes in the portfolio now.

we'll obviously remain opportunistic, and the balance sheet strength is exceptional. And I think that is sort of a core business for people thinking about whether you can accretively add value in those areas, but the bar is higher than it once was. To your question about, I guess, the market and the ability to sell noncore, I guess I would highlight this divestment we just executed is a good example of that. So if you look at the acquisitions we executed in the front half of the year.

I just want to put them on a cash flow metric. We effectively bought it three times based on a 60 deck. The deck wasn't 60 at the time, but just to normalize it. And we just sold assets that are more mature with higher cost structures at five times based on a 60.

And that happened over -- not much more than one and a half quarters. It was really quite astounding how fast the market has moved. Since then, though, with the increased strength in oil and maybe a bit of volatility, there actually hasn't been a lot of deals. So I think the market is actually struggling a little bit with the volatility and good [Inaudible] spread doesn't usually close in those periods of volatility, maybe the takeaway though, to your question, do I think there might be better opportunity to realize proceeds from noncore? I would think so.

We've come from what has been felt like a generational buying opportunity, which we're able to take advantage of and now it feels like there will be opportunity to monetize noncore, but I guess we'll have to see where the market goes. Two weeks of stability might just help with a little bit of stability.

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

All right. Appreciate it. Thank you very much.

Ian Dundas -- President and Chief Executive Officer

Thanks, Jeff.

Operator

Your next question comes from Aaron Bilkoski of TD Securities. Please go ahead.

Aaron Bilkoski -- TD Securities -- Analyst

Thanks. Good morning.

Ian Dundas -- President and Chief Executive Officer

Hey, Aaron.

Aaron Bilkoski -- TD Securities -- Analyst

I was hoping you could talk a little bit about the parameters you look at when making a decision to buy your shares. I understand you've gone down that route. I'd be curious sort of what framework you think about when you when you think about them being undervalued. Are you looking at them on a NAV-type basis? Is that like a 2P NAV? Is there upside in that 2P NAV -- what sort of pricing assumptions? I don't want you to tell me when you're going to stop buying your shares.

I'm just kind of curious what goes [Inaudible] decision-making process?

Ian Dundas -- President and Chief Executive Officer

Yeah. No, I think that's fair. And I would expect that will come under increasing focus as the quantum of buybacks across sales increases. I guess for us, it's relatively straightforward.

It's based on a view of intrinsic value, the stock relative to trade. And we -- as you know, that is a multistep process. You have to think about commodity prices and cost structures and those sort of things and we build it up PDP and we build it by wedge and all of those things apply discount rates. So I guess, I won't give you exactly the math on it.

But we've given some insights into it. It's based on a price view on our midpoint price view. You can look at the stock now versus the strip compelling value. We don't think we actually have to lean into the strip to feel comfortable with returns, and we're thinking about our mid-cycle pricing in that $55 to $65 range.

So let's call it $60 for kicks. And we see returns strongly supported in that -- with that framework, independent of the capital markets drivers, which we think are supportive and all those sorts of things. This on a pure capital allocation basis, we think, is a great idea. And I guess you didn't ask this question, but I'll use the opportunity.

You know, so the reasons we don't have a listed formula in the market right now is, you know, Enerplus was $25 a share instantaneously. I'm not sure it would be $200 million of a share buyback. I'm not sure about that. And so, you know, things evolve, and things change.

But right now, it feels like a very clear decision that we should execute an aggressive buyback, you know, representing about 7% of our stock based on valuation.

Aaron Bilkoski -- TD Securities -- Analyst

Perfect. Thanks, Ian.

Ian Dundas -- President and Chief Executive Officer

Thanks, Aaron.

Operator

Your next question comes from Travis Wood of National Bank. Please go ahead.

Travis Wood -- National Bank -- Analyst

Yeah, thanks. Good morning. Question is a bit of a follow-on around the free cash, but more so, I wanted to get a sense of how you think about debt levels and not obviously in this market as respect to kind of a max number. But could you see debt? I mean, we see it pretty easily in this type of commodity price environment and the free cash generation having significantly lower.

Do you think it's optimal to drive that to zero? Do you think there's a cap stack that you can leverage on, and maybe that ties into the sustainability-linked lending as well? But just kind of want your thoughts on debt or gross debt or net debt on types of levels at this kind of free cash generation point?

Ian Dundas -- President and Chief Executive Officer

Yeah. Thanks, Travis. So, you know, those -- we'll probably remember, we had set a, I guess, a target -- a gated target on debt that we would hit and then accelerate returns. And, you know, that was one-time debt to cash flow based on a 50 deck.

And as we announced, you know, we see getting there this month -- next month. And so, we now -- and we have now highlighted the excess cash beyond the share buyback and the dividend increase that will go to the balance sheet right now. So, you know, implicitly, we are, I guess, moving past that debt target. We have not set an explicit debt target.

We do see value in continuing to strengthen the balance sheet. And although it's not a goal, I could see taking the balance sheet to zero. You know, if we continue to generate extraordinary cash flow and we don't see a compelling alternative to redeployment. I'm not saying that's a goal.

And I understand that what the textbooks would tell us about efficiency and capital structure there. You know, I don't know how important those are in -- when you put those in the context of the volatility that we've been experiencing. But this will be something we'll be talking to our board over time. You know, I think it's, you know, absent additional divestments, it's not a next quarter-type thing.

And I do see -- you know, as long as we still have debt on the balance sheet, allocating some capital toward that, I think, is a derisking and value-creating event. And you can see that playing out in many, many different ways. We wouldn't have been able to execute on just $800 million of acquisitions where we have now effectively doubled our money if we didn't have exceptional balance sheet strength. But I do see that question and a conversation continuing over time as these -- if these commodities continue to hold and the cash will show up the way that they're looking right now.

Travis Wood -- National Bank -- Analyst

OK. That's a great color. Thanks, Ian. And this might be for Jodi or Wade.

I might have missed it. I think they might have touched on it. But just some color as we -- on opex as we step into 2022. I mean, obviously, I think Q4 guide looks to be significantly better after some transient items in Q3.

But how can we think about that opex into next year? And do you still see some opportunity that there's some inflationary pressure on the 2021 an average number. Thanks.

Ian Dundas -- President and Chief Executive Officer

Thanks, Travis. I think maybe I'll hand it over to Wade. He'll sort of talk us through that.

Wade Hutchings -- Senior Vice President and Chief Operating Officer

Yeah. Happy to. Good morning, Travis. Thanks.

Let me give you a little context for Q3 and then try to address your question on '22. So, as we indicated in the press release and the script, you know, we see a key part of that higher Q3 opex is temporary. Essentially, what we had occur was, you know, as you recall, we inherited a fair number of shutting wells in the Bruin transaction. And as we cleared that backlog in the early summertime, we also experienced more wells needing work over than normal in the middle to late summer.

Given the really robust pricing environment, we chose to add workover rigs to restore those valuable volumes. By late September, we had returned to a more typical pace of workover activity and a more typical rig count. And so that's why you see the lower, you know, opex guide for Q4 based on that trend. Now, the reality is some of that increase in Q3 was a bit inflationary, simply tied to WTI price where some of our water handling contracts have a bit of a link to WTI price.

So, clearly, some of that, if we stay at these levels, we'll continue into 2022. Now we, of course, haven't, as you noted, put out any official opex guidance for '22. And so, you know, that will come, you know, in January when we put out a more robust budget guide. But, you know, clearly, to your question, we're watching lots of inflationary pressures, either emerge or strengthen into next year.

You know, on the capital side of the business, we've been very proactive. Over the last six months, we've actually locked in about three-quarters of our total well cost. And so, we feel like we're protected there. We've done a few things like that on the opex side.

For instance, we have our workover rig day rates locked in. So, you know, we've been proactive on several items in the opex arena. But as you can appreciate, there's a lot of moving pieces on opex. So, you know, we would expect some inflation in that operating cost environment.

You know, the guide we've given for Q4 is probably a reasonable starting point to think about where the future is headed.

Travis Wood -- National Bank -- Analyst

OK. Much appreciate that, Wade. Thanks very much, and that's all for me.

Wade Hutchings -- Senior Vice President and Chief Operating Officer

Sure.

Operator

[Operator instructions] There are no further questions at this time. So I will turn the conference back over to Mr. Mair. Please go ahead, sir.

Drew Mair -- Manager of Investor Relations

Thanks, operator, and thank you to everyone who joined the call today. Have a great rest of your day and weekend. See you. Bye.

Operator

[Operator signoff]

Duration: 31 minutes

Call participants:

Drew Mair -- Manager of Investor Relations

Ian Dundas -- President and Chief Executive Officer

Wade Hutchings -- Senior Vice President and Chief Operating Officer

Jodi Jenson Labrie -- Senior Vice President and Chief Financial Officer

Jeoffrey Lambujon -- Tudor, Pickering, Holt and Company -- Analyst

Aaron Bilkoski -- TD Securities -- Analyst

Travis Wood -- National Bank -- Analyst

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