Canacol Energy Ltd

Good morning, and welcome to Canacol's fourth quarter and year-end 2020 financial results conference call. This is Carolina Orozco, Director of Investor Relations.

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

Jason Bednar, Chief Financial Officer. Before we begin, it's important to mention that the comments on this call by Canacol's senior management team 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 finance figures on this call are denominated in U.S. dollars.

We will begin the presentation with our President and CEO, Mr. Charle Gamba, who will cover the operational highlights for 2020.

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

Mr. Gamba will close with a discussion of the corporation's outlook for 2021.

Mr. Gamba is joining us on the line from Bogotá and Mr.

Bednar is joining us on the line from Calgary. I will now turn the call over to Mr.

Charle Gamba, President and CEO of Canacol Energy.

Great. Thank you, Carolina.

Good morning or good afternoon and welcome to Canacol's fourth quarter 2020 conference call. 2020 the corporation achieved several important goals with respect to growing its gas base in Colombia, including a 20% increase in realized natural gas sales year-over-year, a 16% return on capital employed, strong and stable operating margins at an average of 79%, a 2% increase in 2P reserves year-over-year related to continued exploration and development success, representing a 122% 2P reserve replacement ratio.

We were also awarded two new conventional gas exploration blocks in the 2020 exploration bid round. All of this was achieved despite the global COVID-19 pandemic impacting demand for gas in Colombia, and our ability to operate in the field when country-wide or local pandemic related restrictions were in place.

Our success was possible, thanks to the hard work of our teams that have strong processes in place to deal with the pandemic and the strong long-term fundamentals of the Colombian gas market, which had allowed us to contract the majority of our production capacity under fixed price take-or-pay gas sales contracts. Realized natural gas sales during Q4 were 170 million standard cubic feet per day, a 6% decrease from the same period in 2019, but a 4% increase from the third quarter of 2020.

Realized gas sales have continued to recover from a low point of 136 million standard cubic feet per day in April of 2020 to 182 million standard cubic feet per day on average in January and February of 2021, with an average of 172 million cubic feet per day for the year 2020, which is 20% higher than average gas sales for 2019. Drilling operations were halted in late March by COVID, which was the main reason why despite restarting drilling operations with 2 weeks in July, only six wells were drilled and completed compared to the 12 we had originally planned.

All six wells drilled in 2020, of which two were exploration wells and one was an appraisal well successfully encountered gas contributing to the continued growth in these areas we're able to report at year-end. We achieved 122% 2P reserve replacement ratio and a 2% increase in our 2P gas reserve base to 637 billion cubic feet, approximately 10-year reserve life index under current production.

Our gas exploration drilling results over the past 7 years have yielded an industry leading 83% hit rate for commercial discoveries. The net present value of future net revenue from reserve, discounted at 10% is now estimated at 1.3 billion on an after tax basis, and 1.7 billion on a pre-tax basis, respectively, which equates to a CAD$11.97 per share of reserve value and a CAD$9.55 per share of 2P net asset value as of the end of December 2020, respectively.

2P finding on development costs, aiming at our industry leading $1.33 per Mcf and $0.84 per Mcf for the 1 and 3-year periods ending December 31, 2020, respectively. And we achieved a 2.7x and a 4.4x 2P recycle ratio for the 1 and 3-year periods ending in December 31, 2020, respectively.

We also continue to deliver on a return of capital to shareholders in 2020 via our quarterly dividend program with no cut into the impact of COVID-19, and by buying back shares under our previously announced normal course issuer bid. I'll now turn the presentation over to Jason Bednar, our CFO, who will discuss our fourth quarter financials in more detail.

When he is done, I will provide detail on the outlook for 2021.

Thanks, Charle. Although the global pandemic made it a uniquely challenging year, 2020 was nonetheless a great year financially for Canacol and its stakeholders as we continue to execute our plan to develop our growing natural gas business.

Largely driven by having a full year with higher gas transportation capacity, following the completion of the pipeline expansion in August of 2019, we reported approximately $145 million in funds from operations for the full year of 2020, a 16% increase from 2019 despite sales volumes being negatively impacted by temporary COVID related reduction in demand. It impacted funds from operations for the second quarter of 2020, in particular.

Cash, capital expenditures decreased 6% as we were forced by COVID related restrictions to defer some of our planned spending, and as we focused on the most value enhancing activities within our core gas operations. Increased funds from operations combined with lower CapEx allowed us to achieve four positive results.

First off, we generated approximately $60 million in free cash flow before interest. Secondly, we maintained our quarterly dividend declaring approximately $28 million to shareholders.

Third, we applied approximately $6 million to the repurchase of shares; and lastly, we increased our holdings of cash and cash equivalents by approximately $27 million. Our dividend currently represents an annual yield of approximately 5.7% with the last quarterly dividend paid in January, and the next one due to be paid on April 15, 2021.

Our year end net debt position of approximately $342 million was effectively unchanged from a year-ago. As we announced in August, we were able to reprofile our credit facilities during 2020 to substantially lower our cost of debt -- our cost of debt capital.

Thanks to lower interest rates. While increasing the financial flexibility, we have to invest in strategic growth projects including the Medellin pipeline and El Tesorito power plant projects.

Our net debt to EBITDAX ratio is reduced from 2.1x at December 31, 2019 to 1.85x at December 31, 2020, well inside covenant limits. We continue to plan to pay down our debt in due course rather than building up large cash balances, but we'll do so strategically to minimize our finance expenses while we maintain our financial flexibility and our ability to continue investing in our business and buying back shares when it makes sense to do so.

Focusing on the fourth quarter of 2020. Financial highlights include, revenues net of transportation royalties decreased 6% to $62 million compared to $66 million for the same period in 2019, mainly due to a 6% decline in sales volumes, which was due to reduce gas demand resulting from the gas market still not being fully recovered from COVID related weakness in Q4.

Adjusted funds flow from operations increased 7% to $35 million from $33 million in 2019 as lower revenues were more than offset by lower G&A expenses and cash taxes. EBITDAX increased 6% to $46 million from $43 million.

Our cash position increased 66% to $68 million from $41 million, and net income decreased 96% to $1 million from $25 million. That year-over-year decline in net income is largely attributable to a deferred tax expense of $12 million in Q4 2020, compared to a deferred tax gain of $16 million in the comparable quarter in 2019.

Focusing solely on 2020, we see a simple trend we view as more important when we look at revenues, funds from operations and EBITDAX, all steadily recovering from the lows seen in Q2 2020 at the height of the COVID first wave in Colombia. As Charle already highlighted in his opening statement, we have reported that monthly sales volumes continued to recover in January and February, so we're optimistic that this trend will continue throughout 2021.

Our operating netback was unchanged at $3.58 per Mcf in the 3 months ended December 31, 2020, compared to the same period in 2019, while our operating margin declined only very slightly from 78% to 77%. These results again highlight the stability and high margin nature of our gas business.

What wasn't shown in the preceding operating netback and margin slide is the success we've achieved in lowering our corporate costs including G&A, finance and other expenses, particularly when measured in proportion to our sales volumes in revenue. G&A for the first 12 -- for the 12 months ended December 31, 2020 average just $0.42 per Mcf, 23% lower than the $0.55 per Mcf for the prior year.

To further highlight the strength and stability as well as growth that we see in our business and financial results, we want to highlight the return on capital employed -- implied by our financial statements over the last eight quarters. The COVID pandemic curtailed the positive trajectory, our return on capital employed was showing a year ago, but our return on capital employed remains very high by E&P standards at 16% on average for the full year 2020, up from 15% in 2019.

And quarterly results are now demonstrating a clearly positive trend that we are optimistic will continue as we move forward. In closing, our Q4 financial results were strong and relatively stable, despite the challenges that the coronavirus pandemic presented.

And we are now in an increasingly enviable position of financial strength with an ability to easily maintain a steady return to shareholders and increased flexibility to ramp up investment levels when we think it makes sense to do so. And if operational restrictions don't prevent us from doing so.

At this point, I'll hand it back to Charle. Thank you, everyone.

Thanks, Jason. Our results for the fourth quarter of 2020 showed positive impact to our investments in growth and return to a slightly more normal operating environment in gas market.

Our results for the full year demonstrate the long-term stability provided by our business model, including our fixed take-or-pay gas sales contracts. For 2021, despite the impact of COVID-19 lingering in the short-term, we are optimistic we will continue to see demand and related sales volumes and pricing gradually strengthened, allowing us to report continued growth in sales volumes revenues and funds from operations.

We therefore expect to remain well-positioned to continue returning capital to shareholders, while reducing our leverage ratios and investing for growth. Although the pandemic is not over, we are progressing our drilling program with two rigs currently drilling at the Milano 1 exploration well in the Cañahuate 4 development well.

And a total of 12 wells planned for the year, with 9 of those wells being exploration wells are drilling and seismic programs for this year has a significant focus on exploration to support long-term production growth. In addition to investing in drilling and seismic to allow us to grow production reserves over the long-term, we are working diligently to progress important strategic process -- projects that will support increased transportation capacity and demand for our gas, such as Medellin pipeline, and the El Tesorito power plant project.

And of course, in order to build a sustainable business, we will seek further continuous improvement in our strategy and execution as it relates to all ESG matters. Given currently prevailing optimism around COVID-19 incident rates, hospitalizations and vaccines as well as the positive dynamics we see taking place in Colombia's gas market is probably worth reminding you that we could yet look at investing beyond our base budget program as indicated in our guidance press release in December.

Conversely, if gas demand were again impacted by a third or fourth wave of COVID related restrictions, we maintain flexibility in our capital program to adjust accordingly. I'd like to thank the entire Canacol team as well as our contractors, partners and clients for their support and hard work during this challenging year that 2020 was, and with somewhat uncertain times that continue as we seek to return to more normal operating conditions.

It was our team partners and clients that allowed us to continue operating safely, sustainably, reliably and profitably while investing for future growth. We're now ready to answer any questions that you might have.

Thank you. We have a first question from Alejandro Demichelis from Nau Securities.

Alejandro is asking, could you please comment how you see the situation with the fracking pilot?

Yes. As you know, Ecopetrol is preparing to execute a fracking pilot, a non-conventional pilot for oil in the middle of Magdalena Valley.

And ExxonMobil recently announced that they're applying for a permit to execute a similar pilot also in the middle Magdalena Valley. So the regulatory environment at the moment is favorable for these fracking pilots.

By no means does that ensure that, they will be able to execute them without difficulty, especially from the communities who remain heavily opposed to fracking from an environmental perspective. These pilots are non-commercial pilots, or they are not intended to establish commercial production.

As a matter of fact, these pilots do not have any commercial terms associated with them. They're simply designed to apply typical massive hydraulic fracturing techniques here in Colombia, and monitor the impact of those operations on the environment, specifically, groundwater, micro tremors, etcetera.

So really these pilots are designed not for commercial test basis, but really to prove or to collect information with respect to the potential environmental impacts of [indiscernible] technology in the study areas.

Thank you, Charle. Operator, I believe we have someone in the queue who wants to ask some question.

And thanks for taking the call. Two modeling questions.

El Tesorito, you mentioned in your early remarks that volumes are picking up in January, February. Can you talk about the COVID issue and how El Tesorito is moving forward?

And should we be modeling in anything for volumes in Q1 of '22? Or should we drag out a little bit further like when do you expect the potential 30 million a day to come on, given the current status of construction with COVID rules?

Hey, Josef. Yes, El Tesorito is on schedule basically.

I mean, it's the civil works has started there and the licenses are all in order. The motors have all been commissioned, and in the process of fabrication in Europe.

The start date is estimated between December and February. December of this year and February of next year.

So that seems to be moving ahead smoothly. With respect to potential sales volumes, there remains a deficit still in the electrical market related to the delay of Ituango hydroelectric project.

So there's a 2,500 megawatt deficit in the hydro space. So the forecast is that our cash repo will be generated between 50% and 75% capacity would translate between 20 million to 30 million cubic feet per day of sales when it starts up.

The model 20 million to 30 million in -- from Q2 of '21 would be …

Correct. Yes.

So -- correct.

Second, you still have the oil production on with high 60s for Brent. I would have thought somebody would have wanted to come by and buy them by now.

Is there a sales process still underway? And do you see that potentially coming off the books in '21?

Yes, the Rancho Hermoso asset that you refer to, we're netting 200 or 300 barrels a day. The net backs are actually very good.

I think their net backs are almost $40 a barrel, given that the OpEx is reasonable there. But that's a very complicated contract.

It's an Ecopetrol contract. And as usual, not an easy contract to manage, particularly with respect to sign the contract.

So it's the very first contract we ever picked up in Colombia in 2008. And it seems like it's going to be with us for quite a while, Josef.

Yes. Do you see given the netbacks, as you said, are pretty lucrative.

Do you see potentially looking at opportunities on the lighter barrel side of oil and building a business over there as well?

No. No, we're 100% focused on gas, so we will not invest.

We will simply invest a minimum work program type of investment in the Rancho Hermoso field which is related more to maintenance and occasional workovers. But we do not foresee drilling of any new wells, for example, regardless of what the price environment for oil is, which is of absolutely no interest whatsoever to us.

Okay, super. Thanks so much.

Much appreciated.

Thank you, Josef.

We have a question from Mark VanderBeek [ph]. Mark is asking what are your plans for the announced share buyback program?

Can you provide any color on your plans to buy back shares in 2021?

Yes. I mean, as you know, we bought back 2 million shares in 2020 for approximately US$6 million.

Under our bond covenant limits we can buy back $15 million a year, but we are allowed to carry forward from prior years if we don't spend all that. I can't -- at this point in time, I can't give you any clear goals or targets.

Obviously, we're cognizant of share price fluctuations, when it may be more opportune as to less. I will say that some of you probably on the line probably received questionnaires that Canacol sent out.

We're actively soliciting shareholders thoughts with respect to what they viewed as more valuable, increased dividends or increased share buybacks or increased debt repayments. So, we just got those back and we're starting to have a look at those, and there'll be some more discussions on that topic.

But at this stage, I can't give you any defined limits.

Thanks, Jason. Now we have a question from Till Moss [ph] from Schroders.

Till [ph] is asking, can you elaborate on your debt pay down strategy, please?

Sure. So just to refresh everyone's memory, we of course have the bond that was issued in May of 2018, which is $320 million.

That's a -- that is typical, no call options and we'd be paying penalty -- penalties. We paid that down earlier for another year or two on that.

But just in the normal course of business, some of our other loans, we will be paying down $7 million in 2021, $17 million of structured debt repayment in 2022 and $8.6 million in 2023.

Thanks, Jason. We have a question now from Sofia Rojas from BD Capital.

She's asking has it been decided who will be the EPC contractor for the Mediline pipeline project? Is there any update regarding this project?

With respect to the project in Mediline, we continue to wait for the execution of the main sales after contract with the public utility company there. We have received all of the final offers from the EPC contractors, of which there are three.

And we have essentially completed the financial structuring of the project with respect to debt and equity. But again, we wait.

The main component that we're waiting for would be the execution of the off the main off take contract to the main consumer Mediline.

Thanks, Charle. The next question is from Rodrigo Torres from [indiscernible].

He is asking if you can remind him about our investment plan for 2021, and its comparison with 2020 plan.

I think Jason can take that.

Yes. By investment plan, I assume we're talking about capital expenditures.

So we put out a press release in January, which has all the details but the high case I believe was $140 million and included 12 wells with 9 of those being exploration wells, I believe. And this last year, we -- in 2020, the CapEx number was $85 million.

So we're certainly planning on increased investment and increased well count in 2021.

Thanks, Jason. The next one is we have another question from [indiscernible] from Schroders.

He is asking should we expect any impact of the tax bill on yourself directly or impacting Colombian purchasing power?

Yes, that's a very good question. This relates directly to a deferred tax write-down we did in Q4.

So in late 2020, a Council of State Court ruling essentially disallowed the use of losses on merge companies. So the particular case that was in front of the court at that point in time was not an oil and gas case.

And it had different facts, circumstances than the Canacol case. It's probably important to note that the DN [ph] has yet to change the tax laws to reflect that particular court's ruling.

So as you can imagine that has affected many companies, and many challenges to that ruling are expected in the near future, with Canacol being one of those challenges. So many experts believe the ruling is unconstitutional.

And it was due to the ambiguity surrounding that ruling that we do recognize the deferred tax assets on our balance sheets. Having said that, if -- should Canacol or any other company proved successful in any challenge, which we believe some will be heard within the first 12 months, we would be able to use those $29 million of losses in the year where we are successful or someone else is successful.

I should note that it was that particular court only disallowed certain tax losses in that particular case. So, we're hopeful that we will get that back and obviously we're working with local experts via constitution or tax wise on that particular topic.

But we ended with 60 -- at the end of the year with $68 million in cash. We've got a $46 million revolving line of credit that is untouched, and our budgets would not be looking to touch that.

So, it was unfortunate, but it has no impact on our plans at this stage.

We have one last question from James Branch [ph]. James is asking your production by field show some interesting shapes.

Nelson and Palmer are declining and being replaced by Clarinete and Pandereta. Are there exploration targets in 2021 of a size of Clarinete?

Yes, thank you, James. Yes, as we continue to add more fields to our production mix, we tend to back off production and some of the other fields to lower the production in order to capture as much reserves as we can, as we sort of lower the production from the big producing fields and as we bring on new fields.

But in general, we've been shifting our exploration away from Esperanza, which are where Nelson and Palmer are located and where we did our first exploration, 5, 6 years ago. We've been shifting more and more exploration activity into VIM-5, which is where Clarinete and Pandereta are located.

So yes, the new discoveries were making -- the big new discoveries we're making tend to be located in Clarinete and the VIM-5 area. This year with 12 wells, 9 exploration wells being drilled are those 12, this is our biggest exploration year ever for gas.

The 9 exploration wells are targeting over 300 Bcf of unrisked prospective gas resource that we have identified. And yes, we do see some targets that are in the range of -- in between Clarinete and Pandereta size, 100 plus Bcf targets.

Thank you, Charle. We don't have any more questions.

So thanks to all for participating in Canacol's quarter year end conference call. Have a great day and you may now disconnect.