Canacol Energy Ltd

Good morning and welcome to Canacol’s first quarter 2019 earnings conference call. This is Carolina Orozco, Director of Investor Relations.

I am with Mr. Charle Gamba, President and Chief Executive Officer, Mr.

Jason Bednar, Chief Financial Officer and Mr. Ravi Sharma, Chief Operating Officer.

Before we begin, it is important to mention that the comments in this call by Canacol’s senior management team can include projections of the corporations future performance. These projections neither constitute any commitments at your future results nor take into account risk or 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 finance figures on this call are denominated in U.S.

dollars. We will the begin the presentation with our President and CEO Mr.

Charle Gamba who will cover the operational highlights for the first quarter 2019. Mr.

Jason Bednar, our CFO will then discuss financial highlights. Mr.

Gamba, and Mr. Bednar are joining us on the line from Bogota.

Mr. Gamba will close with a discussion of the Corporation's outlook for fiscal year 2019.

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

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

Thanks Carolina and welcome to our first quarter 2019 conference call. Q1 marked our sixth consecutive quarter of natural gas sales growth at industry-leading finding and development costs.

We increased our realized contractual gas sales by 15% to 122 million standard cubic feet per day, up from 106 million standard cubic feet per day during the same period in 2018. This is achieved via delivery of the first 20 million standard cubic feet of the 100 million standard cubic feet of new transportation capacity to Cartagena via the Promigas expansion in December of 2018.

We also increased our average natural gas operating netback by 9% to US$4.03 per thousand cubic feet up from US$3.71 per thousand cubic feet in the same period for 2018 and achieved a 42% increase in funds from operations per share to $0.17 per share compared to the first quarter of 2018. The first quarter also saw a strong start to our 2019 drilling program as we hit on the first two of our eight well program with Palmer-2 encountering 81 feet of net gas pay and testing 29 million standard cubic feet per day.

And Nelson-7 encountering 221 feet of net gas pay. The Nelson-7 has been cased and will be completed by a workover rig prior to being placed on permanent production within the next three weeks.

The drilling rig is currently being mobilized to the Acordeon 1 exploration well location on our VIM 5 contract and is anticipated to spud on May 11, 2019. Located approximately three kilometers to the southeast of the 200 billion cubic foot Clarinete field, which we discovered in 2014, Acordeon-1 has the potential for a significant reserves at the Cienega de Oro and Porquero sandstone reservoirs.

The well will take place approximately five weeks to drill, complete and test. In Q1, we also completed the construction of the Jobo 3 gas processing plant, lifting our total gas processing capacity to 330 million standard cubic feet per day.

The wells that are currently tied into Jobo have the potential to produce up to 330 million standard cubic feet per day, giving us more than sufficient capacity to achieve 215 million standard cubic feet of gas per day with the completion of the Promigas expansion between Jobo and Cartagena in June of 2019. I'd now like to turn the call over to Mr.

Jason Bednar, our Chief Financial Officer for Canacol, to discuss some of the financial highlights associated with our first quarter 2019 results. When he is done, I will provide the outlook for the remainder of 2019.

Thank you, Charle. Success continued in Q1 2019 for Canacol both operationally and financially as we continued to execute our plan to drive our growing natural gas business forward.

For the quarter ended March 31, 2019, total realized contractual sales were 21,848 BOE per day, including 122 million cubic feet of gas a day and 440 barrels of oil a day on average throughout the quarter. As you can see, Canacol generated 122 million cubic feet of gas sales per day in Q1 2019, which is a 15% increase over 106.3 million cubic feet that we averaged in Q1 2018.

As a result of the Promigas pipeline completion expected in June 2019, we expect to see another dramatic increase in 2019 gas sales. Largely driven by this increase in gas sales, we reported $29.9 million in funds from operations during the first quarter of 2019, a 39% increase from the same period a year ago.

Total corporate sales of both natural gas and oil increased 6% to 21,848 boe per day in Q1 of 2019, compared to 20,551 boe for the date for the same period in 2018. Despite the fact that the Corporation divested the Bellatrix's oil properties in September of 2018.

A 15% increase in natural gas sales volumes during the three months ended March 31, 2019 compared to the same period in 2018, was primarily as a result of the Corporation’s partially-owned Sabanas pipeline operating at full capacity in February 2018. Q1 total natural gas and oil revenues, net of royalty and transportation expenses were approximately $49.4 million, up 4% from approximately $47.6 million reported in the first quarter of 2018.

The decrease in oil sales during this quarter related solely to the company's sale of the majority of it's Colombian oil assets to ARROW Exploration in September of 2018, as previously mentioned. The Corporation’s average realized natural gas price, net of transportation was US$4.97 per Mcf in the first quarter of 2019.

This price is 5% higher than the $4.72 per Mcf, which was realized in the first quarter of 2018. Additionally, our average gas sales price, net of transportation expense for the first quarter of 2019 was slightly higher than the $4.95 we realized in the fourth quarter of 2018 and higher than the $4.75 price that we had released as a guidance for 2019.

This high average price as a result of strong spot market sales prices during the quarter. To refresh everyone's memory, Canacol leaves 10% of its natural gas production uncontracted, which allows us to capitalize on such occurrences in the spot market.

This $4.97 gas price in Q1 drove a very strong natural gas netback of $4.03 per Mcf in the first quarter of 2019 or margin in excess of 81% and the fifth consecutive quarter of increasing natural gas netbacks. Focusing on the other components of the very strong $4.03 netback, natural gas operating expenses per Mcf decreased 25% to $0.30 per Mcf for the three months ended March 31, 2019, compared to $0.40 for the same period in 2018.

This decrease is attributable to several things. Firstly being the fact that the majority of our natural gas operating expenses are fixed and hence are reduced on a per Mcf basis as production continues to decline.

Additionally, as I referred to on our last call, Canacol purchased Jobo 2 gas plant, which previously we'd been leased, which then allowed us to operate that plant to realize operating efficiencies of approximately $2 million per annum. You may recall during that same call in March, I told you that the Corporation expects its natural gas operating expenses per Mcf to decrease to approximately $0.30 per Mcf, which I'm pleased with our Q1 results now reflects.

We do anticipate further reductions in operating costs on a per Mcf basis upon the commencement of operations of the new Promigas pipeline in June. G&A expenses per boe decreased 12% during the three months ended March 31, 2019, compared to the same period in 2018, largely driven by the increase in natural gas realized contractual sales.

G&A per boe is expected to continue to decrease as a Corporation's production base grows for the remainder of 2019 and indeed into 2020. Capital expenditures for Q1 of 2019 totaled $34.7 million.

The largest segment of CapEx in the quarter included the completion of the construction of the Jobo 3 gas plant. The Jobo 3 natural gas plant’s expansion will facilitate up to 330 million cubic feet of production, which will allow for spare capacity above the Corporation’s 215 million cubic feet of production expected when the Promigas pipeline expansion is completed.

Other items in the first quarter included the completion and tie-in of Nelson-13, the drilling of the Palmer-2 well and the pre-drilling of the Nelson-7 well. Additionally, since the Corporation obtained necessary approval to conduct its normal course issuer bid in November of 2018, the Corporation has purchased 785,000 common shares for US$2.4 million, including roughly 342,000 shares during this first quarter of 2019.

At March 31, 2019, the Corporation had $39 million in cash and $4.3 million in restricted cash and a working capital surplus of $51.2 million. Canacol remains well capitalized while also generating cash flow in excess of its planned 2019 capital budgets.

In summary, the first quarter of 2019 was a very strong quarter driven by the sixth consecutive quarter of growth in realized contractual natural gas sales with Q1 averaging 122 million cubic feet per day. At this point, I'll hand it back to Charle to close the strategy and outlook for the remainder of 2019.

Thank you everyone.

Thanks, Jason. Looking forward to the remainder of 2019, the Promigas expansion between Jobo and Cartagena is on target to deliver an additional 80 million standard cubic feet per day of new transportation capacity in June of 2019, which will lift gas sales to approximately 215 million standard cubic feet per day for the remainder of the year.

We're also focused on executing the remainder of our drilling programs throughout the remainder of this year. Finally, good progress is being made towards signing new gas sales and shipping agreements for a new pipeline that will transport 100 million standard cubic feet per day of new gas sales to Medellin in 2020.

Are there any questions from the audience?

Hey, good morning. Thank you for taking my question.

First is towards your plan and to reward shareholder through share buyback and the potential dividend, is that still on track for the second half of the year?

Well, as I mentioned, we have bought shares. We bought approximately what was the number, just slightly less than 800,000 shares to-date, including 342,000 in the first quarter.

And we do expect to keep that up, obviously we can buy up to 15 million shares were approved for such – it's quite a large number, not structured by all of those obviously but we do expect to keep repurchasing shares. And with respect to potential dividends, I think we've been saying for quite some time, it's something you’ll examine, once we get all of the Promigas pipeline on production.

Okay. So I guess, just talking about preferences of long-term shareholders, probably preferred to continue to more – if not more share buyback.

I feel quite a few days, you do 31,000 a day, I mean, at this top price and your cash flow is very undervalued. Hopefully you can takeoff of the weekend and get a share a little bit higher.

So the preference would be to share buyback versus potential dividend or – based on your whole cost of powering is a one-time distribution, actually that's very tax effective because for the United States, when we get dividend, we've had to pay 10% tax, even though we can get it back from tax filing is pretty complicated. So the tax rate distribution actually hit just the money just into our pocket has done that was very good.

So just a comment on the preference.

Please proceed.

Okay. Yes.

My next question is, so for maintaining the current production with the new pipeline, there's over 200 Mcf. So what will – how many wells do you need to drill each year?

So what kind of a CapEx do you need to maintain, the production starting – with a new pipeline starting in June?

So as I mentioned, we are well over 300 million standard cubic feet per day of productivity from the existing wells that are tied into the Jobo gas field processing facility. But if you consider to maintain 215 million or 220 million standard cubic feet per day, we're looking at the annual decrease of approximately 10%.

So we'd be looking to replace 20 or so million cubic feet per day of decline on an annual basis. As you know, the wells we drill test up to between 20 million and 30 million standard cubic feet per day.

Now we did not produce any individual well at that kind of rates. We tend to produce our wells between 8 million and 10 million cubic feet per day to manage the reserves capture from the field.

So to replace 20 million or 22 million, we've probably drilled three development wells per year simply to as maintenance capital to maintain that at a cost of approximately $4.5 million per well so about $13 million or $14 million worth of maintenance capital on the drilling. As I mentioned earlier, Chen in my presentation, the processing capacity of the facility is 330 million standard cubic feet per day.

So we really need no more – we do not require any additional investment on the processing facilities. So really maintenance capital is to simply maintain 215 million or 220 million would be that number associated with the drilling capital.

But of course, every year we have – we drill exploration wells and we intend to continue that activity. So we drill on average 8 to 10 wells per year.

So if three of those are maintenance development wells, seven will be other wells, seven or – six or seven will be other wells, plus we continue to acquire 3D seismic over our exploration acreage to firm up our portfolio with future drilling. So I think we can realistically say that in terms of CapEx going forward, we're probably in the range of up to $100 million of CapEx per year for all of those activities.

Okay, great. Thank you.

Finally as a spinoff, Arrow Exploration I think you still own quite substantial portion of the stock. So now what's your plan?

I just had a meeting with our old friend, Bruce McDonald. He mentioned that your Colombian shareholder will not able to get the distribution and have to sell on the open market.

Is that correct? Can you confirm that?

Thank you.

I can't – yes, I can't comment on that, Chen. I have no idea who was selling Arrow shares on the open market.

Bruce McDonald, the CEO would obviously have a much better idea than I, and I really have no comment on that.

All right. What's your plan for the rest of the Arrow share?

Do you plan to distribute that at certain point?

I know we evaluate our options we hold, I believe 5 million shares…

It was US$5 million worth of stock, which of course that particular, that financing was done at the multiples of the current price. So it's probably $1.5 million worth of stock right now.

They are drilling an exploration well. They had just some interesting things going on and when the share price rebounds.

I'm sure we may look at selling these.

Yes. We evaluate our position and we will act at the time we feel would be appropriate.

All right. Thank you.

Thank you for taking my questions.

Thank you, Chen.

Thank you for the presentation and for the opportunity. I have two questions.

The first one is regarding when we will have news regarding the next [indiscernible] expansion of the Company. You mentioned it before that Canacol want to expand its pipeline through Medellin or through Cartagena in Colombia.

We want to know when we have news regarding that. Thank you.

Yes, thank you for the question. As I mentioned in the main part of my presentation, we are looking to expand gas sales in the direction of Medellin with a new pipeline that will connect our production station at Jobo 2 Medellin, which is approximately 300 kilometers to the south of Jobo.

We're in negotiations with a number of potential clients to buy our gas in Medellin. We think that we can design the pipeline to transport up to 100 million cubic feet per day of gas to Medellin.

And based on our analysis of the routes – the routes we're looking, we're analyzing two separate routes to get there. But we're looking at a project that after permitting and sanctioning from the regulator would probably be ready to deliver gas to Medellin in 2022 – late 2022.

So I would say that once we have the off-take contracts, the sales contracts executed, which we anticipate to have this summer, July and August of this summer that we will move ahead and sanction the project and commence the process of permitting, environmental permitting and consult the previous for the project for completion in late 2022.

Thank you. And the other question is regarding the exploration in unconventional, when Canacol team could begin the pilot projects to fracking in Columbia?

There’s been a number of recent developments concerning the regulation around development of nonconventional resources, particularly the application of massive hydraulic fracturing? As you may know, I think as I disclosed in our last meeting, conference call, the permits – the environmental permits that were submitted by the consortium, which would be ourselves and ConocoPhillips to the annual last year were rejected, in November of last year.

So, assuming that those permits are resubmitted and we are analyzing that eventuality with the operating partner, ConocoPhillips, assuming that the consortium resubmits those permits. I think we can expect easily another year or so of a time prior to those permits potentially being granted to execute a pilot.

So I think if we assume that the reapplication for permit can take up to a year. And then mobilizing of all of the equipments which all has to come from the United States in terms of the hydraulic stimulation equipment.

You can probably add another a year to a year and a half onto that. So I would realistically, if we started today, I don't think it's possible that we would see any drilling for at least two to two and a half years realistically, if the permits were approved by the EMA.

Thank you for your answers.

Thank you.

Hey Charle, how are you? I have a couple questions.

First, regarding the CapEx. Now that the year to the processing plant is pretty much completed, how do you see that the CapEx will evolve in terms of the current needs of the future level?

That would be the first one. The second one is about the if you can share any forecast or any views on the potential unrisked volumes for Acordeon that would be helpful as well.

And the third question is that I mean after the results from Palmer-2 and Nelson-7, do you believe that these wells could trigger any type of, I don't know, technical revision from the reserves upwards or downwards? That will be my questions.

Thank you.

Sure. Just dealing with the CapEx so our guidance in December for CapEx for all of 2019, I believe it was $119 million.

Obviously, this quarter we spent $35 million of it. The largest of that being on Jobo, $15 million of the $35 million was on facilities and infrastructure, which leaves the rest over the remainder of the year.

My expectation is considering that we have one drill rig contracted, another six wells to go, I believe. That it will be spread evenly throughout the remainder of the year.

Luiz, going to the forecast for a potential unrisked prospective resources at Acordeon, we're looking at a pre-drill estimate for the entire Acordeon accumulation of up to 100 Bcf of unrisked recoverable gas resource in Acordeon. So it's a material prospect.

It's on trend with Clarinete, which of course is a 200 Bcf discovery that we made in 2014. So, we're very excited and it's a high impact exploration well for us, the first well for us this year.

With respect to Palmer-2 and 7 results, Palmer-2 is an appraisal well of the Palmer discovery that we made in 2015 and Nelson-7 was an infill development well in the Nelson field. So, we expect that there might be some small technical revisions associated with Palmer-2 as it is an appraisal well, but for Nelson-7, we're not expecting any impact, any material impact on existing reserves because that was an infill development well that had already been incorporated in our reserves report.

Okay. Clear.

Thank you very much.

Thank you, Luiz.

We received one question from José Zitelmann from BTG Pactual. Have you decided with the new expansion project for energy.

Can you comment on the cost of the project, the developmental strategy, product consumption with 25% participation versus contracting Promigas or TDI and the rationale of choosing the expansion to Medellin instead of Cartagena/Barranquilla and who would be the main client?

Yes thank you. Thank you, José.

Yes, as I mentioned a little earlier, we have essentially settled on the option to build the pipeline from Jobo to Medellin. Given the length of the route, which is approximately 300 kilometers, we're looking at the potential cost of a 20 inch pipeline with first stage compression in the range of $350 million of gross cost to build the project.

The development strategy in terms of how we're planning to form the consortium, we're evaluating a number of options. One of those options involves working with existing pipeline operators here in Colombia.

However, we would like to have and participate in a 25% participation in the project. Whether that's with existing pipeline operators in Colombia or with a private consortium, our strategy is to participate as a working interest partner at 25% so that we can influence the timing of the project, specifically the delivery dates, given our expertise with respect to managing environmental processes and the community issues.

So, the rationale for our financing strategy is that we will participate 25% interest either with existing pipeline operators in Colombia or with a private consortium. And with respect to the rationale of choosing to expand to Medellin instead of Cartagena and Barranquilla, with the current expansion of the Promigas pipeline up to Cartagena and Barranquilla, with the termination of that expansion – the completion of that expansion, there is an excess of 280 million to 300 million cubic feet per day of gross transportation capacity installed.

So, we see quite sufficient transportation capacity to Cartagena. So really the pipeline into Medellin allows us to sort of expand our footprint in terms of delivering gas to a completely different market, that of course being the interior.

And naturally you can imagine the main clients in Medellin would include, of course PMA who operates several thermal projects in that area as well as many commercial users. So we see a number of clients who are very interested in contracting gas from us in Medellin.

So, thank you for that question, José.

Good morning. I have three brief questions, please.

First, could you please confirm that the two remaining amendments have been approved by ANLA to construct Jobo, Majaguas section of the pipeline? Second, could you comment please on the current conditions in the Caribbean as they relate to the natural gas demand and how that's affecting spot prices?

And finally a question for Jason, what would be the evolution of OpEx during the time when Promigas' pipeline is tied-in last time when the Sabanas line was being tied-in? We saw kind of an uptick in the operating costs and then it came down as the pipeline was online.

Is it the same kind of trend as we're going to see in Q2 and more so in Q3 and then coming down again in Q4? Thank you.

Yes, with respect to the first question that the approval of the two modifications, that is still in progress. Those have not come up.

Promigas, of course, are managing those and they expect those to come out within the next week or so, allowing them to complete the entire project in June. They are working on five separate construction fronts and the pipeline and the installation of compression is almost complete.

With respect to recent trends in the Caribbean coast, we've seen very strong demand, particularly in spots. We were settling into the spots in first quarter at pricing up to $9 in an MMbtu.

And we continue to see very good demand in the coast, particularly considering the continued decline coming from the Porquero fields as well as from thick supply in those markets. And Jason will take care of the third.

Sure. With respect to operating costs, obviously it's gone from $0.40 to $0.42 down to $0.30 this quarter as we had anticipated.

And further once the Promigas pipeline comes on, we anticipate that same OpEx to be closer to $0.25 than it will be to $0.30. So, those are detailed models at this time.

As with respect – and I'm not anticipating any spikes in that for the first quarter or two. Just to comment briefly on that, of course, the last time we had a pipeline come on, the production base was much smaller and as such an incremental couple of hundred grand had the effect of moving the OpEx on a per MCF basis.

So that's just simply not the case now and I'm not anticipating it at least.

Thank you.

Thank you.

Thank you for participating in Canacol's first quarter and fiscal year-end conference call. Please join us again in August for the second quarter 2019 conference call.

Have a great day.