Canacol Energy Ltd

Carolina Orozco - Director of Investor Relations Charle Gamba - President and Chief Executive Officer Jason Bednar - Chief Financial Officer

Nathan Piper - RBC Capital Markets María Yarce - Bancolombia Robert DeJong - Scotia Bank Daniel Gardiola - BTG Pactual

Good morning. And welcome to Canacol’s Second Quarter 2018 Conference Call.

This is Carolina Orozco, Director of Investor Relations. I’m with Mr.

Charle Gamba, President and Chief Executive Officer and Mr. Jason Bednar, Chief Financial Officer.

Mr. Gamba joins the call from Bogotá, Colombia and Mr.

Bednar, joins the conference call from Calgary, Canada. Before we begin, it is important to mention that the comments in this call by Canacol senior management can include projections of the Corporation’s future performance.

These projections neither constitute any commitment as to future results nor take into account risks and uncertainties that could materialize. As a result, Canacol assumes no responsibility in the event that future results are different from the projections shared on this conference call.

Please note that all financial figures on this call are denominated in U.S. dollars.

We will begin the presentation with our President and CEO, Mr. Charle Gamba, on the line from Bagota, who will cover the operational highlights for the second quarter 2018.

Mr. Jason Bednar, our CFO, who listen the line from Calgary, will then discuss financial highlights.

Mr. Gamba will close with the discussion of Corporation’s outlook for the remainder of the year.

A Q&A session will follow Mr. Gamba’s closing segment.

I will now turn the call to Mr. Charle Gamba, President and CEO of Canacol Energy.

Thanks, Carolina. And welcome to Canacol second quarter 2018 conference call.

Since our first quarter call, we have made steady progress towards executing and delivering on our 2018 gas sales, reserves and gas resources, all the while maintaining our focus on growing our gas business to 230 million standard cubic feet per day in 2019. First of all, I’m pleased to report that on August of 3rd of this year, Promigas S.A.

received the final environmental permit required for the expansion of their gas pipeline to Cartagena and Barranquilla. We are currently transporting approximately 100 million standard center cubic feet per day along this pipeline to Cartagena, and Promigas is investing approximately $180 million in this project, which will add 100 million cubic feet per day of new transportation capacity to the existing pipeline with all of the additional capacity assigned to Canacol.

Promigas anticipates that all of the additional 100 million standard cubic feet per day of capacity will be available to Canacol in March of 2019 with the first 20 million standard cubic feet available on December 1, 2018. This will leave Canacol’s gas sales by approximately 20 million standard cubic feet per day on December 1, 2018 and will lift Canacol’s gas sales another 80 million standard cubic feet per day in March 2019, when the entire pipeline expansion project is scheduled to be completed.

For the second quarter of 2018, gas and oil sales averaged 21,540 barrels of oil equivalent per day, a 25% increase compared to the same period in 2017. The second quarter of 2018 marked the fourth consecutive quarter of natural gas sales growth, which increased 43% from 78 million cubic standard per day for Q2, 2017 to 112 million standard cubic feet per day for Q2, 2018.

During the second quarter of 2018, the Corporation’s average oil production was 1,903 barrels per day. As previously announced, forecast realized contractual gas and oil sales, which include contractual gas downtime for 2018, are anticipated to average between 22,000 to 24,000 of barrels of oil equivalent per day, which includes 114 million to 129 million standard cubic feet of gas respectively and approximately 1,700 barrels of oil per day of annualized oil production.

Subsequent to the Corporation’s second quarter report, in July 2018, we provided a midyear conventional natural gas reserve report for Canacol’s recent discoveries at Pandereta-3, Chirimia-1 and Breva-1 located on the VIM-5 and VIM-21 blocks in the lower Magdalena Valley basin of Colombia. The reserve estimates are based on an independent resource audit prepared by Boury Global Energy Consultants effective July 2018.

As for the reports, we added 89 billion cubic feet in new 3P reserves from this very successful exploration drilling program, which more than covers our anticipated 2018 gas production. Also in July 2018, we cased the Canahuate 3 appraisal well as a gas producer and anticipate completing the well with the work over rate shortly.

Since our move into gas in December of 2012, our exploration drillings programs have resulted in over 465 billion cubic feet new 2P reserves from 12 successful exploration wells, which represents an industry leading commercial exploration success rate of 80%, the highest of any oil and gas operator in Colombia. In a separate press release in July 2018, we provided an update of our perspective gas resources, which quantifies the significant gas potential of our five operated exploration blocks located in the lower Magdalena Basin.

The report was prepared by our independent auditors Gaffney Klein & Associates with an effective date of December 2017. Gaffney Klein independent perspective resources audit estimated conventional natural gas perspective resources for 115 individual prospects and leads, which Canacol has aggregated to an unrisk mean of 2.6 trillion standard cubic feet or a risk mean of 948 billion standard cubic feet net to Canacol’s working interest in those blocks.

In May of 2018, the Corporation completed a private offering of senior notes in the aggregate principle amount of $320 million. The net proceeds of this were used to fully repay the outstanding amounts forward under its existing credit facility with Credit Suisse in the amount of $305 million plus accrued interest and transaction costs.

The senior notes pay interest semiannually at a rate of 7.25% per annum and will mature in May 2025. Key benefits include deferring $23.5 million of quarterly amortization payments that were set to commence in March 2019, and we reduced our annual interest rate by 75 basis points.

I would now like to turn the call over to Mr. Jason Bednar, Chief Financial Officer for Canacol who joins us from Calgary, to discuss some of the financial highlights associated with our second quarter 2018 results.

When he’s done, I’ll provide the outlook for the remainder of 2018.

Thanks, Charle and thank you everyone for joining the call today. Financial highlights for the three months ended June 30, 2018 include realized contractual sales volumes increasing 25% to 21,540 boe per day compared to 17,195 boe per day for the same period in 2017.

The increase is primarily due to a 43% increase in realized contractual gas sales, largely resulting from the completion of the Sabanas pipeline. The overall decrease in crude production volumes during the three months ended June 30 compared to the same period in 2017 is primarily due to the Corporation selling its interest in the Ecuador IPC investments, which closed in February 2018.

Total petroleum and natural gas revenues for the three months ended June 30, 2018 increased 33% to approximately $57 million compared to $43 million for the same period in 2017. Adjusted funds from operations increased 19% to $28.8 million for the three months ended June 30, 2018 compared to $24.2 million for the same period in 2017.

Adjusted funds from operations are inclusive of results from the Ecuador IPC. In total, the Corporation registered $22.90 per boe corporate netback for both gas and oil for the three months ended June 30, 2018.

The second quarter of 2018 marked the third consecutive quarter of natural gas production growth. Gas sales increased by 43% from 78 million cubic feet per day in Q2 of 2017, to 212 million cubic feet per day for Q2 in 2018.

Focusing specifically on our core natural gas business netback components, I am pleased to report that our average gas sales price, net of transportation, was $4.85 per Mcf, which is above our 2018 guidance of $4.75 per Mcf and indeed 3% higher than the $4.72 per Mcf that we recorded in Q1 of 2018. Total natural gas production expenses for the quarter were $0.42 per Mcf, which is also lower than the mid $0.40 level that I provided guidance for on previous calls.

Capital expenditures for the three months ended June 30, 2018 was $31 million. These included midstream pipeline and gas plant costs, the drilling completion and testing of Breva-1, the drilling completion and testing of Borojo-1, pre-drilling expenses at Canahuate-2 and Canahuate-3, facilities cost at Esperanza and VIM-5 and other capitalized costs rather, the largest one being a future non-cash decommissioning cost of $5.6 million.

The second quarter 2018 also had several non-cash and onetime events or charges. First of these was the sale of PPGs, our PPG investments for $12.4 million.

This is payable in 12 equal quarterly installments of approximately $1 million each that the Corporation will be receiving beginning in July of 2018. We also had $9.9 million exploration impairment charge on the planned relinquishment of an oil block that will not be part of the euro sale transaction.

This block was relinquished in 2018 as part of internal tax restructuring, that’s generating corresponding tax shelters. There was $14.4 million loss of settlement of credit facility.

This relates to the termination of the prior Credit Suisse led syndicated term loan and is split into two components. A, approximately $5 million is interest in prepayment penalties, and we also rolled off to remaining $9.4 million of unamortized financing keys, which were scheduled to be amortized over the remaining life of the four years of the term loan.

Given the rather large interest rate savings, the term and the certainty of the May 2018 bond that replace this term loan, the above charges we merited. We also recorded a settlement liability of $20.3 million related to the transpiration cost on our Rancho Hermoso property.

These amounts are currently contractually doing approximately 300k per month until the debt has been distinguished. Lastly, the same Rancho Hermoso property attracted a write up this quarter of a nearly equal and offset amount of $90.1 million, the carrying value of Rancho had previously been zero, it’s write up was triggered by the increase in oil prices, thus increase in the economics of oil production at that property, as well as other oil companies expressing an interest to buyback particular assets.

Just going back to the PPG sale for the $12.4 million, I misspoke earlier. We get 12 equal monthly installments of a million each, not equal quarterly installments.

So at the end of the 12 month period, we will have collected all the $12.4 million, my apologies on that. At June 30, 2018, the Corporation also had $55.2 million in cash and $5.5 million in restricted cash.

Corporation ended the quarter with a very healthy working capital surplus of $83.9 million. On May 31, 2018, the Company entered a share purchase agreement with Aero Exploration Limited.

Aero will acquire from the Corporation the majority of its Colombian conventional oil assets for total consideration of $40 million. The $40 million is comprised of $10 million in cash on day one, if you will, $25 million in common shares of Aero and $5 million in a promissory note with an annual interest rate of 15%, which matures approximately 120 days after the closing of the transaction at which point in time we expect to collect that $5 million.

Just to remind everyone that it was also in the second quarter on May 3, 2018 where the Corporation completed an offering of senior unsecured notes for the principal amount of $320 million, Canacol used the net proceeds to repay the outstanding amounts borrowed under its existing credit facility in the amount of $305 million plus the accrued interest at that point in time, replacing that current credit facility the old term loan at $305 million, the Corporation obtained many benefits. One, replacing the current term loan that bears interest at an interest rate fluctuating, which was the three month LIBOR plus 5.5%, which currently would've totaled approximately 8% as the three month LIBOR has been increasing materially during last 14 months, down to a fixed coupon bond rate of 7.25%.

This of course provided both reduction and certainty of debt expenses in an extremely volatile interest rate environment. Secondly, we deferred the quarterly $23.5 million amortization of that credit facility, which was scheduled to begin in March of 2019.

We obviously exchange that for bullet maturity, which comes due in May 20, 2025, seven years from now. Thirdly and administratively less burdensome notes indenture that will not require collateral or quarterly certification of maintenance covenants as the bond has in current space covenants.

And fourthly, no cash is required to be held any debt service reserve accounts, as was originally required under the prior credit facility. These amounts were scheduled to total approximately $25 million later in 2018 under the prior facility.

At this point I’ll hand back to Charle to close with strategy and outlook for the remainder of 2018. And thank you everyone.

Thanks, Jason. For the remainder of 2018, the Corporation is focused on achieving 230 million standard cubic feet per day of productive capacity, executing its remaining gas exploration drilling program and divesting of its remaining conventional oil assets.

With respect to the work necessary to achieve 230 million standard cubic feet per day of productive capacity, we’ve commenced the civil works associated with the addition of 130 million standard cubic feet per day of additional gas treatment capacity at Jobo, and expect this work to be completed by December of 2018. In addition, we’ve started the process of building 8-inch flow line, connecting our Pandereta gas discovery to Jobo, which will also be completed by December of 2018.

Finally, we have also started debottlenecking at the Betania-to-Jobo flow line, which will allow us to reduce the Nelson and Palmer fields at higher rate than present. This bottlenecking will also be completed prior to December of this year.

We anticipate growing the next gas exploration well Acordeon-1 located on the VIM-5 E&P contract in November of 2018, which will hopefully be followed up by a couple of appraisal wells. For 2019, the corporation is targeting realized contractual sales volumes of 230 million standard cubic feet per day of natural gas.

These volumes represent 90% year-over-year growth in sales versus 122 million standard cubic feet per day of natural gas per day for the Corporation’s planned 2018 average natural gas sales. As previously reported, we are currently in the process of disposing of our remaining conventional oil assets in Columbia, which we anticipate to complete by the end of August 2018.

This transaction will complete the transformation for Canacol into a Colombia-focused gas exploration and commercialization company. We’re now ready to answer any questions that you might have.

On the pipeline, the Promigas pipeline, it seems that there was a slightly which is saving up to be complete through March. I guess the key thing is are all bits of paper in place?

And I know you mentioned the environmental approvals and all the equipment in place to ensure that pipeline doesn't slip any further in the current timetable, which is pretty much what you said in the first place? First question on that one, please.

Yes, Promigas all of the tubular have been delivered in Cartagena and are currently mobilized into the field. All of the heavy construction equipment likewise is currently being mobilized in the field.

Promigas is going to initiate the construction on five separate work fronts essentially to accelerate the pace of construction. So the physical lane of the pipe and digging into lane of the pipe will be occurring on five different fronts along the length of the expansion.

In the mean time, all of the compression expansion equipment for Philadelphia has also arrived and derived from several months ago in Cartagena. So that is being mobilized to Philadelphia to begin the expansion of that compression station, which should actually be completed in October and November.

So with that schedule that accelerated compression schedule, Promigas is anticipating completing the entire project by March of 2019.

And should we assume that the ramp up, relatively rapid ramp up to the 100 million cubic feet a day of additional capacity than through to the course of Q2 or shorter than that?

As per the last time they did the expansion back in 2016, we’ll see 20 million coming on stream December 1st of this year. And then in March the production will very rapidly ramp up to the full 100 million with the completion of their works.

So first on the gas 2019 production guidance is basically a 100 from -- or a 100 further production from March and then that will ramp up in between those things?

So basically of the 100 million of new capacity that is being given to us by this expansion, 20 million will come on in December and the remaining 80 million will come in on in March for the full 100 million…

So more of a step change, that’s clear. The other question I had was on your divestment of your oil assets.

And I know you’re looking for completing that transaction through August, which is that month is passing. Is there any risk there on RO completing their side of deal?

I mean, clearly you wanted to sell the assets. But do you see risks around completing that transaction with this particular party?

At this point in time, the only risk associated with the transaction is then closing on their financing.

Which should be done by the end of the month?

That’s correct.

And then last one for me, if I may. On the upcoming well, the Acordeon well, I assume that’s a CDO well.

Is it on VIM-5?

That is correct, the CDO well on VIM-5, it’s immediately to the east of Clarinete.

I think I remember it from the Investor Day, you held a well back. What prospect size are you or size of opportunity is that prospect?

It’s a Clarinete SA type opportunity, so I’d say 100 plus bcf is what we’re looking at in that particular prospect. It’s a nice sized one on the VIM-5 block.

I also have a couple of questions, the first one would be also regarding the deal for the sale of the conventional oil assets in Colombia, and is that -- you had previously mentioned that you would maybe redistributing the shares of this new company to existing shareholders. And I was wondering is this still the plan?

And if so, would Canacol have any remaining participation in this new company? And if so, would you have any control over this new company or how would it be consolidated in your results?

We were expecting to now receive 25 million shares, the original expected are $25 million worth of stock U.S. dollars.

The original expectation was for 20 million. So at our AGM on July 3, 2018, i.

e. a month ago, we got shareholder approval to distribute 20 million of that stock.

So if you follow me on that, Canacol will intend to distribute 20 million of that stock shortly after closing, and we will keep the remaining 5 million and deal with that at a future date, which was only 5 million shares of -- that’ll be less than 10%. It will not show up in our consolidated numbers, it will simply be a line investment in the financial statements.

But would you still receive a small share of the result of this new company, of the profits, I mean…

I mean we just like we would on any portfolio investment, so you won’t see there been alongside, our barrels included in our consolidation. You will simply see the investment grow on the balance sheet where applicable.

And that will be how much percentage of the new company you said?

It obviously depends on -- so that's $5 million that will be left for us after we distribute the 20 million to our shareholders, we’ll be somewhere less than 10%. Arrow hasn’t closed their book, so I don't know exactly how many shares are going to be outstanding at this point in time, but it’ll be less than 10%, that’s a certainty.

And my second question is that is there -- are there any advances on the sale of Rancho Hermoso? I noticed you had like results of the deterioration of these added here in Columbia.

I imagine it’s still for sale. Do you have any advantage on the sale of Rancho Hermoso?

We’re currently in the process -- we’re currently in negotiation with a Colombian operator to sell our interests in the contract to them. And if successful, if the negotiations conclude successfully this month, we will expect to announce the sale of that field in sometime in September or October.

And I have two questions left, and this one would be -- I have the understanding that selling these conventional oil assets in Colombia would pre-amp some obligations with ANH, some liabilities that you had associated with these assets. Do you know how much would be the impact on the liabilities on the balance sheet, how much would that be on liabilities on your balance sheet?

So the liabilities on the balance sheet are actually zero. If you look to our notes, you‘ll see a schedule of commitment rates which are ANH commitments.

And those total approximately $40 million in the current phase that we’ll be passing along to Arrow. But on the physical balance sheet, there is zero of that is in liabilities -- they’re just future commitments.

And my last question is -- are you expecting any additional operational cost from the Promigas pipeline or any investments from your part in compression units, or can anything of the sort?

No, Promigas is responsible for 100% of the investment concerning their expansion, which is approximately 180 million to 190 million. Canacol will not be investing anything whatsoever on the Promigas expansion.

And are you expecting any additional operational costs from the usage of pipelines?

No, we’re not.

I just had two questions here, one relating to the settlement liability and other relating to the flow line between Britannia and Hobo. Just related to liability, you mentioned that we paid down with regular payments or until the mutual agreement has been settled for the debt.

I was wondering if you guys had a target or timing in mind into when you may able to reach an agreement like that. And then relating to the flow line, I was wondering how much additional capacity do you expect to be added from that flow line.

And will that be available this year? In addition to that, will those incremental volumes be sold at spot prices, or they’d be related to fix contracts?

Thanks.

With respect to the settlement agreement on the Rancho Hermoso transportation issue, we are investigating -- the document calls for a period of up to six months to figure alternate payment arrangements, which could include slight discount on the shipping of gas volumes, which the counterparties interested or other as the note say, other non-core oil asset divestments to partially satisfy that. So the simple answer is the document contemplates a six months timeframe to engage in those negotiations.

And then with regards to the flow line, I guess just in guide I guess the capacity that you guys expect to come online with that. And will that be this year and the sales related to spot prices are into fixed contracts?

So this would be a debottlenecking of the existing flow line, which is a 6-inch line that we’re using to produce gas from the Nelson field and the Palmer field up into the Jobo facility so we’re laying an 8-inch line parallel to the existing 6-inch line and we’re also laying another 6-inch line, which is a water disposal line from there as well. And this will essentially allow us to produce Nelson and Palmer at a rate of approximately 50 million to 60 million cubic feet a day higher than current rates.

And really this would just allow us flexibility with respect to selectively producing wells and field. Amongst all of our producing fields, we have to produce 230 million cubic feet next year.

And we can pick and choose which fields we want to producer harder or softer, so this will simply give us more flexibility to increase the production rate from Nelson and Palmer if we choose. And one of the reasons we would choose to do that is probably the royalty rates on the Esperanza contract is lower than the VIM-5 contract.

So it makes sense to accelerate the production from Nelson and Palmer a little faster to benefit from the lower royalty associated with that gas. So it’s really just the debottlenecking to give us more flexibility in terms of the mix of production from the various fields we operate.

And would those sales be -- or those, the volumes there be sold at spot prices, or would they be related to fixed contracts or materially other sales?

Those sales would be related to fixed contracts.

I have a very brief question regarding the execution of the gas contractors are backing out the construction of the Promigas pipeline. And just a question regarding the timing I mean you’ve mistaking contracts are expected to start in December, which is three months before the expected date on which the facilities will come online.

So I wanted to know if I mean do you think the actual date will generate for you a boarding, or otherwise you’re going to have to go market acquire these gas and sell it? Or if actually in the contracts you were contemplating already the delay and you have grace period waiver?

Yes, there’s only one contract that’s problematic with respect to the delay, the other contracts do have a grace period in them, which allows us to start late with no penalty. But the one contract which is 25 million cubic feet per day, we have already arranged a series of swaps between December through to April.

So we’re basically swapping gas that we’re delivering to Cartagena along the existing pipeline for gas coming from Gaiteros to satisfy this contract. And it’s essentially costless swapping.

So the one contract that was problematic we’ve already addressed the issue with respect to the late start and any potential penalties by arranging for a swap, which will cover the period of time where we need to cover that contract.

And Charle just a follow-up, I mean what if the delay the noise and what if the gas pipeline doesn’t come align in March merchandize in June? Are you going to have to not enter into new substructure like this?

We’ll have to extend the existing swap contract to this one particular contract, but the remainder, the grace period is through until the end of June. So we’re pretty good for additional delays.

Although, it’s unlikely given the fact that Promigas is going to be working now on five separate fronts in the construction and it seems that the construction should go on fairly smoothly, but we are covered through to the end of June.

Thank you for participating in Canacol’s second quarter conference call. Please join us again in November for our third quarter conference call.

Have a great day.