Obsidian Energy Ltd (OBE) 2003 Q4 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by.

Welcome to the Penn West Petroleum, Ltd. announces fourth quarter and year end results, and a review of strategic and alternative conference call. At this time all participants are in a listen-only mode.

Following the presentation we will conduct a question and answer session. Instructions will be provided at that time for you to give your questions. If anyone has difficulties during the conference, please press star 0 for operator assistance at any time. I would like to remind everyone that this conference call is being recorded on Tuesday, March 2, 2004 at 11:00 a.m. Eastern Time.

I would now turn the conference over to Mr. William Andrew, President. Please go ahead, sir.

Thank you very much and welcome to everybody, from snowy Calgary. A special hello to, I'm sure there's some of the people that we met while we were on the road last week to New York and the East Coast of the United States and Canada. We had some good meetings, good discussions down there, so we appreciate the time for those of you that may be on the phone with us.

By now most of you will have read our news release, including the information regarding the Board of Directors decision to investigate strategic alternatives for the company. Many of you have followed the story of Penn West over the past 11 years. Our long-term shareholders have seen the share price move from about $3 per share early in 1993 to over $62 per share yesterday. As the management of Penn West, and our staff as well, we've always tried to deliver value for our shareholders, and we've always been responsible corporate citizens.

We generated record financial results at Penn West during 2003, but we're not satisfied with our operational performance in terms of reserve and production adds through the drill bit. I'll review both of these areas in more detail, and then we'll -- I'll answer some questions if you have them at the end.

Before I get into the financials too far, I should note that we will use Canadian dollars unless otherwise stated, that our production numbers will reflect the Canadian standard and include the Crown Royalty Share, and that we're using a standard ratio of six to one for a conversion of natural gas and barrels of oil equivalent.

In 2003, Penn West generated record cash flows and record average annual production rate. We also achieved a significant reduction in bank debt, from $598 million at the end of 2002, to $442 million at the end of 2003. This represents a year end debt to cash flow ratio of 0.5 to 1. These results were underpinned by strong commodity prices in 2003.

Reflecting our strong financial position, we declared our first ever dividend during 2003, and that was a special dividend of $1.50 per share. As well we initiated a quarterly dividend of 12.5 cents per share, payable at the beginning of the first quarter of 2004. Additionally, in 2003 we initiated a normal course issuer bid to take dilution out of the stock. During the year, the company purchased a 1,249,000 shares at an average price of $42.25 per share. That's for a total cost of about $52.7-or-8 million.

Revenues for the year increased by 39% from $987 million in 2002, to almost $1.4 billion in 2003. Fourth quarter revenues for 2003 decreased by 4% to 304 million, from 318 million in the fourth quarter of 2002. That was mainly due to the relative weakness of the U.S. dollar in comparison to the Canadian dollar.

Cash flow from operations in the fourth quarter of 2003 reached $194 million, that's a 27% increase over the fourth quarter of 2002. For the year, cash flow increased by 75% to a new record of $813 million, from $464 million the year before. Cash flow was in excess of our exploration and development expenditures during the year, by a total of $205 million. These expenses, the exploration and development expenses, totaled just over $608 million, and I think as you can see on your release and we talked about our on slides, we had minimal net property acquisitions during the year, basically less than a half a million dollars.

For the year, adjusted income from operations was $298 million. That's a 92% increase, compared to $155 million in 2002. In this calculation, adjusted income from operations was before foreign exchange gain, changes in future tax liabilities, and stock based compensation charges. Fourth quarter adjusted income from operations was down by 44%, to $34.5 million. That reflects higher depletion charges during the quarter, due to our reserve revisions.

Cash taxes, and this is certainly an item that has been forefront with Penn West, and our cash taxes decreased significantly from the $82 million paid in 2002, $10 million in 2003. 2004, we're estimating cash taxes will be in the range of 20 to $40 million.

We generated an after tax return on equity from operations in excess of 20% during 2003, and that reflected an ongoing focus on value creation in the company. Over the past 11 years, our average return on equity has been over 16%.

On average, we have 23 million cubic feet of natural gas hedged for the first quarter of 2004, and we have another 29 million cubic feet of natural gas hedged under a collar with a basement or a floor of 519 and a ceiling of 748 for the period April through October, 2004. So basically through the second and third quarter.

We have hedges totaling 50% of our liquids production in the first half of 2004 and another 40% currently hedged for the third quarter of the year. Price call has ranged from a floor of $25.50 per -- U.S. per barrel of WTI to a ceiling of $33.20 U.S. per barrel. And additional details on this -- these hedges are included in our website, www.pennwest.com. And I should add, on the power side, we've an average of 57 megawatts per hour hedged over the next three years at an average price of just under $45 per megawatt.

Now I'll move on to the operational results. For the year average daily natural gas volumes remained even, while average daily light oil, conventional heavy oil, and natural gas liquid volumes increased by 5%. The fourth quarter of 2003, our light oil and natural gas liquids production averaged 36,044 barrels per day, conventional heavy oil production averaged 11,035 barrels per day, and natural gas production averaged 314 million cubic feet per day.

Operating costs for 2003 increased to 663 per barrel of oil equivalent that compares with 581 per barrel of oil equivalent in 2002. The increases is attributable to two things, one of which is a greater proportion of crude oil in the production mix, which has by its nature a higher per unit operating cost than natural gas, and also to a general cost increases which were experienced industry-wide.

The company's production of crude oil increased to 46% of total production in 2003, that compares to 44% in 2002. Looking at reserves and comparing established reserves at the end of 2002 with proven plus probable reserves at the end of 2003, total company reserves were down 8% year over year. And I should mention that independent third party engineers were used to evaluate all of our properties, and that the 2003 reserve estimates meet the National Instrument 51-101 Standards and Guidelines.

During 2003, we experienced negative proved reserve revisions of approximately 13% of the opening balance. Of this amount 1% relates to the elimination of reserves having a remaining life in excess of 50 years. And that is all related to the Pembina field, and we expect that those reserves will be recognized as we move onward with development and growth in the field.

An additional 3% loss was related to the transfer of references from proven to probable, and that reflects stricter guidelines for timing on bringing on undeveloped reserves -- bringing undeveloped reserves on stream; and for those that may not understand the guidelines, they call for a two-year time frame for bringing on gas reserves, and we do have a number of fields that are several -- many miles from tie in, particularly in northern British Columbia and we didn't envision having those tied-in in the two-year time frame, so they were moved to probable.

The balance of the 9% reduction was spread out across a large number of properties, but there were two large ones in particular. Our two largest single revisions occurred at the north Pembina cardium unit number 1, that was 3.2 million barrels oil equivalent; and at Mitsue [ph] for almost 3 million barrels of oil equivalent. I should mention that both of those fields are non operated.

During 2003 we drilled 713 net wells, an increase of 113% over the total of -- over a total of 335 net wells in 2002. For 2004, and recognizing that we are -- just finished an acquisition, we are scaling back our program somewhat and we now expect to drill about 400 wells, of which fully half of them have already been drilled in the first quarter.

Recently we completed a 10,000 barrel BOE per day acquisition of assets from Petro Vera. This acquisition puts us on track for better performance in 2004. The acquisition itself, in my view and in our view, is a tremendous strategic fit because it complements our existing operations in southwestern Saskatchewan, it takes away our primary competitor in the area, and basically creates large blocks of land where we would have a 100% working interest and total control. We expect that the acquisition will present opportunity for both short term value creation through an efficiency and optimization and also long-term value creation with growth in our land in the area.

In 2004, Penn West is targeting capital spending of between 600 and $700 million. This spending will be weighted to lower-risk development activities for the balance of the year.

In the first quarter we focused on natural gas in the Northern area and some highlights on that are primarily in the Wildboy. We have discovered a new pool at Wildboy. Recent production tests that we have on that zone is 13 million cubic feet a day in excess of 1,000 pounds, which is a new and exciting lead that we will be following up. We're also continuing with the development and exploration in the Wildboy area itself.

Another area of focus has been primarily on light oil in the central area, where we continue to work on the Pembina Cardium plate and get it ready ultimately for tertiary recovery. To that end, we are continuing our efforts on cold bed methane development and enhanced recovered through miscible flood and tertiary recovery, and we will keep to our original budget of approximately 40 to $45 million for those two items.

And I should mention on the CO2 front that we have received Alberta government confirmation of Royalty Credit incentives in support of our CO2 pilot project at Pembina, and we are moving forward with the CO2 pilots, and are in the midst of drilling the first two injections wells in that. We also we're very pleased to see the announcement by the government of Canada on the money that will be made available for companies that are sequestering CO2 and using them in association with enhanced recovery projects, and that was especially singled out in the news release yesterday.

For 2004 based on commodity prices of $30 U.S. per barrel of WTI and 580 per million cubic feet -- per MCF of natural gas, we're forecasting cash flow of 640 to $670 million. The proposed capital program for 2004 will be funded primarily through internally generated cash flow.

Obviously our plans could change as we move forward and consider strategic alternatives. In the interim, we are moving forward in a way that would let us unlock the untapped potential that still exists in the company.

I would like to also emphasize, before we go to questions, that our current production of approximately 108,000 BOE per day is ahead of our plan. The break down of that is about 320 million cubic feet of natural gas and 55,000 barrels per day of oil and natural gas liquids. And our financial position remains as strong as ever. And that we are presently in a situation with very favorable and very strong commodity prices.

And I also know that there should be some questions this morning, so I would ask the operator now to open up the lines for questions.

Thank you, sir, one moment, please.

Ladies and gentlemen, we will now conduct a question and answer session. If you have a question, please press star followed by the 1 on your touch-tone phone. You will hear a three-toned prompt acknowledging your request. Your questions will be polled in the order they are received. If you would like to decline from the polling process, please press star followed by the 2. Please ensure you lift the handset before pressing any keys. One moment, please, for your first question.

The first question comes from Allan Stepa, Salman Partners. Please go ahead.

Yes. You talk about the Board of Directors obviously redoing these three strategic alternatives: status quo, trust conversion, or merger.

Obviously the rumors have been swirling around for some time now. When do you expect the Board to come back with firm recommendations? Are we talking one month, two months, or six months? What's the timing on that?

We had a meeting yesterday and we didn't know [inaudible] the time frame, but I think we have an annual meeting coming up in May. That may give you some idea. But, we want to, this is a very large company, and we want to take the time necessary to provide the shareholders with proper information. So we have not set a time frame.

Would it be safe to say don't expect anything before the May meeting or . . .

I don't think it would be safe to say anything, but I think the only thing that I can say is that we'll take the care and attention that these items deserve.

Okay.

Second question, on the fourth quarter gas production 314 million cubic feet a day, obviously 7% lower than year ago numbers; yet you had a substantial increase in your drilling and completion budget versus '02. When you look at the company's overall gas weighted portfolio of exploration and development opportunities going forward into 2004, what are your expectations for a year-end exit rate given the reserve revisions in the light that we've seen?

I will talk a little bit about that. I didn't introduce anybody, but Don Rae has been with me since day one in the company, our Senior Vice President of Exploration. He and I were both disappointed with the first quarter of 2003, and I think if we had some of the hits we're getting now in the first quarter of 2004, it'd be a better year.

So basically we came out of the first quarter of 2003 behind probably 25 million cubic feet a day on our gas budget. And at that point, I thinks there's -- there's a couple of alternatives. One would be to push the capital as hard as you can and try and achieve the numbers that you talked about. The other is to just move to a program of more conservative drilling. In this case, there was oil as well as gas. We didn't have the luxury of just pulling that amount of gas prospects in a short time over the half. So we moved to drill a balanced portfolio of gas and oil. We stayed within our original guidance on capital. And we made up some of the volumes by year end. We were at the lower part of our guidance rather than being outside our guidance or totally outside of our guidance.

So looking at 2004, we expect year end production to be around 335 million cubic feet per day. There's nothing we're seeing now that tells us that we've got the same problem in 2004 that we had in 2003.

And once again do you expect a lot of those technical and economic revisions to eventually work their way back on to the proven category again, it's just a matter of timing and being more conservative with the new rules?

That's what we're told. But, yeah, I would expect that, and I think people are aware of how the -- particularly under the NI 51-101 how the reserves are being looked at this year.

So I think there was certainly some expectation that a portion of those reserves would come back, definitely the reserves that are related to the economic life, and certainly reserves that have been moved to probable, and as we get development plans they would be moved back to proven.

The others, there was a pretty -- I think as was referenced in the materials on the National Instrument 51-101, that the evaluators were going to take a conservative approach this year and they did.

Great. Thank you.

You're welcome.

The next question comes from Chris Theal, Tristone Capital. Please go ahead.

Good morning, Bill. Can you give us some perspective in terms of reserves acquired from Petro Vera.

I haven't done that, but -- and I'm reluctant to throw one out there, because their reserves were evaluated before the NI 51-101. They'll have to be reevaluated next year, so. Basically the metrics on the deal on our part we were looking at around $7 a barrel proven.

Seven proven?

Yes.

And did that include any future development costs?

No, not a tremendous amount.

I think the one thing -- and I haven't had a chance to certainly talk to many people about the acquisition and even on the trip yesterday, or last week, I think you can probably understand that the usual question started with the letter T and ended with the letter T and there wasn't much else discussed.

The acquisition itself, the big prize for us in the acquisition was two fold. One was the Coleville bochen [ph] field, which is the largest bochen field in Western Canada, and it just goes with our trend of acquiring large reserves of oil where we think we can do something with enhanced recovery and both secondary and tertiary.

The second part of it is that there's a tremendous efficiency on both the land base and the facilities in the area. The reserves that they have are mostly proven, developed producing. They do not have a lot of -- do not have a lot of [inaudible] associated with them.

There would be some -- there would be a moderate amount of write-down related to the Coleville unit, because -- Coleville reserves because they are long-term, long life reserves by the shallow deep mine involved in them. Which may -- somebody looking at the outside in -- which may throw the optics on a dollars per flowing barrel off because we did get long-term reserves -- lower decline reserves in this acquisition.

I hope I answered your question, Chris.

I guess the other way we can back into it, you give your segmented reserves in terms of heavy oil, most of it is adjacent to your production, such as extrapolate on the reserve life of the heavy that you reported at year end. Is that a fair way to go about it?

It is. One thing I will caution there, Chris, is that the Coleville -- and it might be worth your while just to look up that particular unit because it is a long life and it's different, a little different from the normal bochen and manual that we do play in the area.

We do have a number of decent-sized fields like that that are under active water flood, but there is also a mix in there of bochen field that are under primary recovery with much sharper declines. It proves very differently.

Okay. Switch gears, can you give us a sense what if the taxable looks like at year end '03.

I'll flip you over to Gerry for just a second.

About 1.1 billion in taxes at the end of the year. 60% of that is [inaudible].

I'm sorry, what was that percentage?

60%.

Okay. Do you have any in D split?

Not handy, but the rest is basically D and UCC. Pretty evenly.

Okay. And lastly, Bill, just a question on yesterday's news on the CO2 Grant by the government. $30 million seems pretty small potatoes. Give us a perspective in terms of capital requirements to fully implement a larger CO2 flood plan at Pembina for Penn West?

To basically get us -- to get us to the point where we'd be injecting CO2 in the ground, we would anticipate expenditures somewhere around a half a billion dollars. We would expect total expenditures over the period -- I think when one looks at a miscible flood or any sort of tertiary flood, you don't do it all at once. You do patterns and it's a constant process of extracting oil out of one pattern then and moving to another, and developing as you go. So it's a -- you're looking at a multi-year process, both to develop the initial project, and then also many years of development activity.

So about a half a billion dollars initially, about a half a billion dollars more over the life of the project from Penn West's point of view. That assumes that we would have some participation in the midstream portion of the asset. And there is capital, and I'm not going to speak for the other end because we are under some confidentiality. There is certainly capital involved, if the CO2 was to come out of kind of heavy industry row on the eastern side of Edmundton and up through Fort Saskatchewan, there would have to be a retrofit of plants to extract CO2, and then obviously this is into the multiple millions of dollars to do that.

The other couple of alternatives for CO2, one is Fort McMurray, and you're looking at a pipeline to Fort McMurray. So again in the several hundred million, couple of hundred million dollar range plus.

Do you expect more to come from the Canadian government, the Federal Government?

I am going to get to your question, I'm sorry.

Basically I think the initial part -- initial part was just that they recognized that we are doing pilot, and other companies are looking at different methods of sequestering CO2 under pilot schemes.

I view the money that -- first of all is forthcoming, and Alberta government led the pack there by about one month with their announcement of money for the industry to help offset some of the research and development costs, which was what we view the pilot projects as. And I view the money that the Federal Government announced yesterday in the same light, in that obviously as we get further down the road, we would look at this type of project no different than an oil [inaudible] mega project in that there would be ongoing discussions at both the provincial and Federal level, which there are.

Okay. Thanks, guys. Appreciate it.

Your next question comes from Brian Dutton, UBS. Please go ahead.

Yes. Good morning, Bill. Could you just comment on your commentary, I guess one of the conditions in terms of looking at a trust situation that you're looking for tax rulings ahead of making any such proposal. Are you concerned that rules may be changing here?

I think you know, Brian, we've talked about this before, and I've talked to many of the other people on the line that certainly one of our concerns about income trust is the sustainability of the income trust, and one of the items there is the tax treatment, so we're just trying cover a few bases here.

Given your history of using partners, et cetera, do you have any risk then of having a significant bullet payment due on taxes if in fact you were to convert into a trust?

No, I don't think that's -- I don't think that's the issue.

Then, I guess it was mention there a few minutes ago you had about $1 billion of tax pools if I heard right. Given the current commodity price environment your spending plans for this year, can you hazard a guess as to what you might consider your taxability or your cash taxes for 2005?

Every time we guess on taxes, we're off by a factor of about ten times the wrong way. This year we're expecting 20 to $40 million. I don't expect, I don't expect a significant jump next year.

Okay. And I guess lastly, you alluded to in discussions, your opinions in the past in terms of converting the company to a trust. I think at the time, certainly in presentations gone by you've talked about the asset base of the company and there's lots of things to be accomplished.

Do you still hold that view, or what would you advise shareholders at this point as to what the company should do?

It's pretty difficult for me to advise the shareholders. They'll make up their own minds when we get the fact in front of them. I've always stated that we built this company for the long haul. We have been doing that.

It's clear that I made a strategic error in the first quarter last year in that we put too much of our -- too much emphasis on exploration for natural gas in the North on places other than Wildboy and we did not have any luck, or very little luck doing that, and it's more than luck, we basically didn't have the results.

Going forward, I still think there's good opportunity in the base, and I recognize that a lot of people feel it's a mature basin. We do have a tremendous land picture, but in saying that we have to be able to efficiently evaluate our land and move forward to development on it. The other thing we have to do obviously is achieve better finding and development costs than we experienced last year, and we have to move to a little more efficiently.

Okay. And, I guess last question, just the split on your guidance on production this year, oil versus gas?

Oh, yes, just a second.

And you mentioned looking at existing this year around 335 million a day. Can you toss out an exit for liquids volumes as well?

It would be roughly in the 52 to 55 range, so somewhere down the -- average of that, 53 and a bit, 53,000 and a bit. For the year, and I'll base it on 108,000, rather than take the whole range, on 108,000 the split would be roughly 330 on gas and about 53,000 on liquids.

Okay. Great. Thanks a lot.

We take a little up and down from there.

The next question comes from David Patton [ph], Canadian Press. Please go ahead.

I think a lot of my questions have been answered, but I'll just ask again. It sounds like if it weren't for the shareholder bringing forward this proposal that you were to consider and invest income trust that your board wouldn't have necessarily gone ahead with that plan at this stage. Is that a fair assessment?

From the outside looking in, it would be but it's not a fair assessment. The -- I think we looked at a lot of things. We looked at movement in the share price. We look at a bit of a flattening out on our growth over the last year, and as a board we felt it was a good time to take a look at some strategic alternatives for the company.

And you mentioned --

So it wasn't -- I don't think there was a spector of a shareholder out there that was forcing our hand. Obviously we are aware of the letter, and aware that we had a request from the shareholder, but the main -- the main thrust of the discussions that we've had -- and we've had these discussions and then it's been no secret to the shareholders that we've talked about it on other telephone conferences as well, that we have had discussions on structure and going forward with the company. The decision of the board yesterday was that it was a good time to look at strategic alternatives.

Okay. And you mentioned some of the down side of being a possible tax implications, but what are some of the possible up sides of going to a trust format?

I think from the people that champion the trust, if you look at Penn West we -- our strengths have been in the strengths that you look for in a trust. Some of our strengths have been the ability to acquire reserves, the ability to efficiently role them into the company and then optimize them, and that's one of the key strengths of a trust. I think again the outside view would be that, work to one of the strengths of the company.

And your alternatives also include a possible merger. Where would you rank that in the priorities?

One of the three. I won't elaborate on that. It's not my intention to elaborate on any of that until we move forward with evaluating all the strategic alternatives. It's basically to let our shareholders know, and also the public know, that there are three options as we view them.

All right. Thank you.

Your next question comes from Catherine Skerritt of Scotia Capital. Please go ahead.

Good morning. I wanted to ask you a couple questions concerning the cash flow guidance that you provided for next year. Could you tell us what your exchange rate assumption was, and also what you were doing with that as far as the interest calculation, are you assuming that it's paid down by cash flow through the course of the year? You only got half a year's cash flows worth of debt at the end of the year.

Yeah, [inaudible]. First of all the exchange rate, the exchange rate is 75 cents. The assumption was that the debt is be reduced through cash flow.

So in that forecast, that is zero long before the ends of the year?

No, because we're carrying debt coming into the year.

Okay. Thank you very much.

You're welcome.

Next question comes from Jeff Jones of Reuters. Please go ahead.

Mr. Andrew, I was just wondering with your decision to explore strategic options, is this a Penn West-specific issue in your view or is the E & P model for a company your size unsustainable in the current environment?

Every company has different management. Every company has different prospects in place.

I think increasingly in the basin, and I'm not the only one to state this it's been stating by a lot of company presidents, we are producing, particularly gas, at a high rate. We're providing a much larger proportion of gas into the United States as their primary market, and this creates a lot of pressure on existing wells, on existing fields and pressure sure to find new sources of gas. So I think from the point of gas, it's difficult to grow gas with a drill bit.

Oil, I'll temper my remarks on oil, and I'm a great believe on the three tremendous resources that we have in western Canada for oil. First being the oil FAS[ph], second being virtually untapped resource of heavy oil, and the third is the work we're pursuing in light oil fields on enhanced tertiary recovery, so I think there's certainly some upside there. The only wildcard on gas, in my mind, is coalbed methane right now and the adds there, but I think it's difficult for any company whether you're a company that's producing 100,000 barrels a day or a third as much, or three times more, or even a third junior.

It's increasingly tough but one comment that Don and I always make from the field is that as you -- having experienced the ups and downs of the business over the past 30 years, I started in the oil business when there was nothing left in the early, mid 70s, and 30 years later we're still at it.

Thank you.

The next question comes from John Michael Leer [ph], Kent Fund and Management [ph].

Hi, Bill. Just wondering if you can you tell us if the board plans to hire independent financial advisors as you move through the process?

I guess depending on my answer, there will probably be a bunch of people leave the line, but we haven't gone that far into the discussion yet.

Okay. But would you expect that to be a part of it?

I'm not going to speculate on that.

Okay. In terms of the alternatives that you would look at, you did out line the three. Would you also include a merger or take over --reverse takeover -- of the company by an existing trust?

I think basically it's vital, and I think you can read into merger any sort of a variation on merger or acquisition that might be out there.

Okay, and to that you would add in whole or in part of the company as well?

I think we had it, if not, that was the intention.

Okay. Well, thank you very much.

Ladies and gentlemen, [Caller Instructions]. You have a follow-up question from Chris Theal, Tristone Capital. Please go ahead.

Bill, do you anticipate a reorganization of the company being tabled for shareholders to vote on at the AGM?

As I talked about earlier we are not at all sure of the timing of this process right now. We're just underway. And as I said, this is a big company and it's not something that you are going to decide overnight, so it's pretty difficult for us to put a definitive time frame. I think you'll have to bear with us that the resolution was done at our Board of Directors meeting yesterday, and we're moving forward with it today.

Thanks.

Mr. Andrew, there are no further questions at this time. Please continue.

Sure. I'd like to just thank everybody. My telephone number in Calgary is (403)777-2502.

I think that you can appreciate that I would ask that any questions regarding the strategic alternative matter be forwarded to myself rather than any member of my staff. Bryan Clake as always at 777-2510; or Gerry Elms at 777-2509, will certainly give you any help with the model or any questions you have in specific about our operating results or reserve results. And I do thank you.

Good bye.

Ladies and gentlemen this concludes the conference call for today. Thank you for participating and please disconnect your lines.