According to the company’s website news release on November 9, 2022, Vermilion Energy Inc. ("Vermilion", "We", "Our", "Us" or the "Company") (TSX: VET) (NYSE: VET) is pleased to report operating and condensed financial results for the three and nine months ended September 30, 2022.
The unaudited interim financial statements and management discussion and analysis for the three and nine months ended September 30, 2022 will be available on the System for Electronic Document Analysis and Retrieval ("SEDAR") at www.sedar.com, on EDGAR at www.sec.gov/edgar.shtml, and on Vermilion's website at www.vermilionenergy.com.
Highlights
- Q3 2022 fund flows from operations ("FFO")(1) was $508 million ($3.10/basic share)(2), an increase of 12% from the prior quarter, driven by higher European natural gas prices.
- Free cash flow ("FCF")(3) was $324 million ($1.98/basic share)(4), a decrease of 5%, due to higher capital expenditures primarily related to the offshore drilling campaign in Australia. Cash flow from operating activities was $448 million in Q3 2022, including the impact from asset retirement obligations settled and changes in non-cash operating working capital.
- Pro forma Q3 2022 FFO and FCF incorporating the incremental 36.5% ownership in Corrib was $611 million ($3.73/basic share) and $426 million ($2.60/basic share), respectively. As a reminder, all FCF from the Corrib acquisition accrues to Vermilion as at January 1, 2022 and will be netted off the final purchase price at the time of closing, which we now expect to occur in Q1 2023 due to administrative delays.
- Net earnings were $271 million ($1.65/basic share) for the quarter ended September 30, 2022.
- Long-term debt and net debt(5) were $1.4 billion at September 30, 2022, resulting in a net debt to trailing FFO ratio(6) of 0.8 times, which is at the lowest level in over ten years.
- Cash flow used in investing activities totaled $168 million in the third quarter of 2022, including exploration and development ("E&D") capital expenditures(7) of $184 million.
- In early July 2022, we announced the approval of a normal course issuer bid ("NCIB") for the purchase of up to 16 million common shares, representing approximately 10% of Vermilion's public float as at June 22, 2022. To date, we have repurchased 2.3 million common shares for $72 million.
- In conjunction with our Q3 2022 release, we announced a quarterly cash dividend of $0.08 CDN per share, payable on January 16, 2023 to shareholders of record on December 30, 2022. Including dividends and share buybacks, we returned $85 million to shareholders in Q3 2022, representing 26% of Q3 2022 FCF.
- Production in Q3 2022 averaged 84,237 boe/d(8) a decrease of 1% from the previous quarter, primarily due to fire-related downtime in France and third-party downtime in Canada.
- Production from our International operations averaged 27,095 boe/d(8) in Q3 2022, an increase of 1% from the prior quarter, primarily due to higher production in Australia and Germany, which more than offset fire-related downtime in France and natural decline in the other jurisdictions.
- In Australia, we successfully drilled the B17 and B18 wells into oil-bearing formations in the Wandoo field. The wells have produced over 300,000 barrels cumulative to date and generated approximately $30 million of operating cash flow, recovering 40% of the invested capital in the first two months on production.
- Production from our North American operations averaged 57,142 boe/d(8) in Q3 2022, a decrease of 2% from the prior quarter, primarily due to third-party downtime in Canada and delayed start-up of our Turner wells in the United States.
- During the quarter, we completed the 6-well Montney pad that was drilled in Q2 2022 and are in the process of finishing construction of the initial build-out of the facility and bringing these wells on production.
- Late in the third quarter, the European Union ("EU") announced the approval of a temporary windfall tax measure aimed at EU companies with activities in the hydrocarbon sector. Based on preliminary information currently available, we estimate Vermilion's exposure to the EU windfall tax could be in the range of $250 to $350 million for 2022.
Message to Shareholders
Energy security and inflation have become focal points for many countries and citizens around the world, especially in Europe, where the energy security situation is a result of policy decisions over multiple years and has been exacerbated by the ongoing and unfortunate conflict in Ukraine. During the third quarter, European natural gas prices reached an all-time high in excess of $120/mmbtu (TTF) in late August following various supply disruptions and growing concerns regarding Europe's ability to meet winter energy demand. Prior to 2022, Europe relied on Russia for approximately 40% of its gas supply, but Russian imports have significantly decreased in recent months as key infrastructure was taken off-line. Damage to the Nord Stream 1 gas pipeline in the Baltic Sea in late September removed approximately 6 Bcf/d of capacity, in addition to other supply losses throughout the year.
Despite various supply challenges, Europe managed to source enough gas over the summer months to essentially fill storage ahead of the winter heating season, albeit at very high prices and with less global competition due to lower LNG demand from Asia as a result of COVID lockdown policies in China. With storage essentially full, Europe is expected to have enough gas to meet demand this winter, assuming average weather conditions; however, refilling storage next year will be more difficult with Nord Stream 1 offline and Chinese demand potentially returning to pre-COVID levels. Looking further out, we expect Europe to become increasingly dependent on LNG to meet its natural gas needs, which will require direct competition with Asia, where LNG demand is expected to increase substantially over the coming decade. There is very limited new LNG supply coming online over the next few years, and new projects require significant capital underpinned by long-term contracts. Given this global LNG backdrop and the underlying supply and demand fundamentals in Europe, we expect LNG and European natural gas prices to remain elevated for the foreseeable future.
The prospect for higher energy costs and the resulting impact on European households and the economy has become a front and centre concern for all stakeholders in Europe. Over the past several months there have been various policy ideas debated on how to contain energy prices in Europe, ranging from voluntary demand reduction to price caps to windfall taxes. Vermilion has been actively engaged with government officials in the countries where we operate to identify opportunities where we can contribute to domestic gas needs. Vermilion has been operating in Europe for over 25 years and we are a reliable and responsible producer of indigenous natural gas in the region. We believe natural gas is an important energy source that should be produced locally where possible to ensure security of supply. Producing countries that provide predictable and reliable fiscal and regulatory frameworks can benefit from the direct and indirect employment, tax and royalty revenues, lower full-cycle emissions, and added energy security that comes with domestic production. With approximately 3.8 million net acres of undeveloped land in prospective basins across Europe, and the ability to accelerate drilling, we believe there is an opportunity to increase gas production with government support and the appropriate regulatory frameworks in place.
Late in the third quarter, the European Union ("EU") announced several proposals in an attempt to address high energy costs. One of the proposals, which was subsequently approved, is a temporary windfall tax measure aimed at EU companies with activities in the hydrocarbon sector. This windfall tax, which is referred to as a solidarity contribution in the EU regulation, is calculated as a percentage of earnings above a baseline level of 120% of the average of taxable earnings of a subject company between 2018 and 2021. Certain implementation details are the responsibility of EU Member States (countries), including the applicable tax rate (the EU regulation specifies a minimum rate of 33%) and whether this windfall tax will apply retroactively to 2022, prospectively to 2023, or to both 2022 and 2023. We do not believe a windfall tax is an appropriate solution as it will not incentivize new domestic supply nor reduce consumption, and it may ultimately result in higher natural gas prices in Europe. We are working with government officials in the countries where we operate to express our concerns and work collaboratively to achieve an equitable implementation under the relevant circumstances. Based on preliminary information currently available, we estimate Vermilion's exposure to the EU windfall tax could be in the range of $250 to $350 million for 2022. As the windfall tax legislation was not substantively enacted by September 30, 2022 and there is significant uncertainty on associated implementation details, no provisions for this measure are included in our Q3 2022 results.
Despite political headwinds during the quarter, we delivered another quarter with strong financial results. Q3 2022 production of 84,237 boe/d was in line with the prior quarter. Oil prices weakened in the third quarter, however European gas prices nearly doubled in Q3 2022 compared to the prior quarter which contributed to record quarterly FFO of $508 million, a 12% increase over the prior quarter. Capital spending increased to $184 million in the third quarter primarily related to the offshore Australia drilling campaign which was delayed from the previous quarter, resulting in FCF of $324 million. Pro forma Q3 2022 FFO and FCF incorporating the incremental 36.5% ownership in Corrib was $611 million and $426 million, respectively.
The majority of Q3 2022 free cash was allocated to debt reduction, with net debt decreasing by approximately 11% to $1.4 billion, representing a debt to trailing 12-month FFO ratio of 0.8x – the lowest level in over ten years. We have made significant debt reduction progress in 2022, which allowed us to increase the amount of capital returned to shareholders in the third quarter. Vermilion declared a quarterly cash dividend of $0.08 CDN per share in Q3 2022 which was paid on October 17, 2022. This represented a 33% increase over the Q2 2022 dividend and aligns with our dividend policy of providing ratable increases while ensuring the annual dividend amount is sustainable at mid-cycle pricing. In addition, we repurchased 2.3 million shares under our NCIB for $72 million in Q3 2022, representing 14% of the 16 million shares approved for purchase under our current NCIB. Including dividends and share buybacks, we returned $85 million to shareholders in Q3 2022, representing 26% of Q3 2022 FCF.
Outlook
With the potential funding of a windfall tax in Q4 2022 and a weaker Canadian dollar relative to the US dollar, we expect our year-end 2022 debt will exceed our previous target of $1.2 billion, however we anticipate we will remain below our leverage target. Following the EU approval of the windfall tax, we elected to suspend share repurchases under our NCIB for Q4 2022 as we continue to prioritize financial discipline and assess the impact of the windfall tax on our debt targets. We will evaluate the reinstatement of share repurchases under our NCIB once we have more clarity on the amount of windfall tax to be incurred in 2022 and the potential impact on 2023.
Closing of the Corrib acquisition is nearing the final stages, and we now anticipate the acquisition to close in Q1 2023 due to administrative delays. As previously noted, all free cash flow generated by the acquired interest in Corrib from January 1, 2022 until close will accrue to Vermilion and be netted off the final purchase price. Our 2022 capital budget of $550 million and annual production guidance of 86,000 to 88,000 boe/d remain unchanged, however, we expect annual production to be at the lower end of this range as a result of fire-related downtime in France and delayed onstream timing of the Australia and United States wells.
The company plans to announce our 2023 budget in early January as we take additional time to assess the impact of the windfall tax, work with regulators in Europe to facilitate additional drilling, and confirm timing of the Corrib acquisition close. We will remain disciplined in 2023 as we continue to focus on debt reduction. At this time, we anticipate a capital budget similar to 2022 investment levels, with potentially a greater proportion allocated to European gas. We have the ability and desire to drill more wells in Europe, and, if ongoing discussions with regulators are productive, we will look to allocate additional capital to the region in 2023.
Q3 2022 Operations Review
North America
Production from our North American operations averaged 57,142 boe/d(1) in Q3 2022, a decrease of 2% from the prior quarter primarily due to third-party downtime in Canada and delayed start-up of our Turner wells in the United States. During the third quarter, we drilled 20 (15.0 net) wells, completed 18 (14.6 net) wells, and brought on production 14 (13.5 net) wells in south-east Saskatchewan. In Alberta, we drilled two (1.1 net) Mannville liquids rich gas wells and completed the six (6.0 net) wells on our first Montney pad at Mica which were drilled in Q2 2022. We successfully completed the Montney wells with over 1,000 fracs placed over six wells with no material downtime. Natural gas powered frac equipment was used during the completions, replacing 1 million litres of diesel and saving approximately $1.4 million. Construction of the initial build-out of the facility is nearing completion and these wells will be brought on production shortly. The performance of this pad will provide information on the reservoir deliverability and assist us with planning for future development as we await resolution on the Blueberry River First Nations permitting for our British Columbia lands.
In the United States, we drilled the remaining one (1.0 net) well of our planned six (5.8 net) well operated Turner program, and completed and brought on production the remaining five (4.8 net) wells of the six (5.8 net) well Turner program during the third quarter. As part of our ongoing efforts to optimize the development of the Turner play, three of the wells were drilled with extended reach (two-mile) laterals and we executed smaller fracs across all the wells, which resulted in approximately $2.7 million of total cost savings. While the initial production from these wells is lower than higher intensity completions, we are monitoring performance to determine the impact on the longer-term decline profile, well recovery, and overall capital efficiency. During the quarter, two (0.4 net) non-operated commitment Parkman wells were completed and brought on production as part of a farmout agreement. The performance of both wells has exceeded our internal type curves, which we will continue to monitor while assessing the potential of this play on our lands.
International
Production from our International operations averaged 27,095 boe/d(1) in Q3 2022, an increase of 1% from the prior quarter. Production increased in Australia and Germany, which more than offset fire-related downtime in France and natural decline in the other jurisdictions. In Australia, we successfully drilled the B17 and B18 wells into oil bearing formations in the Wandoo field, with a total of 6,500 metres of horizontal well length drilled between the two wells. The wells have produced over 300,000 barrels cumulative to date. Our Wandoo crude oil currently sells at an approximate US$14/bbl premium to Brent, resulting in a Q3 2022 Australian operating netback of $96/boe. At current pricing, these two new wells have generated approximately $30 million of operating cash flow, recovering 40% of the invested capital in the first two months on production.
Production increased in Germany due to the successful results from our 1H 2022 drilling program and various workovers completed during the third quarter. In France, we have made progress in restoring production impacted by recent forest fires, including repairing and rebuilding damaged electrical infrastructure and facilities, and pressure testing the gathering system in affected areas. We expect most of the remaining shut-in production to be restored by the end of the year. During the quarter, three wells were drilled in Hungary, but none of the wells encountered commercial hydrocarbons. The capital spend on this program was minimal, while the findings will further enhance our knowledge and understanding of the geology in this region. Elsewhere in Europe, we continued with support work for our Q4 2022 drilling campaign which will include one (0.5 net) well in Netherlands, one (1.0 net) well in Germany, and two (2.0 net) wells in Croatia.
Commodity Hedging
Vermilion hedges to manage commodity price exposures and increase the stability of our cash flows. In aggregate, as of November 9, 2022, we have 26% of our expected net-of-royalty production hedged for the remainder of 2022. With respect to individual commodity products, we have hedged 57% of our European natural gas production, 17% of our oil production, and 37% of our North American natural gas volumes for the remainder of 2022, respectively. Please refer to the Hedging section of our website under Invest With Us for further details using the following link: https://www.vermilionenergy.com/invest-with-us/hedging.cfm.
