Painted Pony Energy Ltd.
Annual Report 2018

Plain-text annual report

1 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2 TSX | PONY 20 18 A N N U A L R E P O R T Table of Contents 1 2 6 29 30 32 36 61 Financial and Operational Highlights Message to Shareholders Management's Discussion and Analysis Management’s Responsibility for Financial Statements Independent Auditors' Report Financial Statements Notes to Financial Statements Corporate Information Corporate Profile Painted Pony is a publicly-traded natural gas corporation based in Western Canada. The Corporation is primarily focused on the development of natural gas and natural gas liquids from the Montney formation in Northeast British Columbia. Painted Pony's common shares trade on the Toronto Stock Exchange under the symbol “PONY”. Annual General Meeting Painted Pony Energy Ltd. invites shareholders and interested parties to attend its Annual General Meeting to be held in the Bennett Room at the Ranchmen's Club, 710 – 13th Avenue SW, Calgary, Alberta, at 3:00 pm (Calgary time), on May 9, 2019. Shareholders not attending are encouraged to complete the voting instruction form and deliver it in accordance with the instructions therein at their earliest convenience. “Plowing through the Challenges” - By Paul Van Ginkel Cover painting "Plowing through the Challenges", oil on canvas by Paul Van Ginkel www.paulvanginkel.com 3 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 1 Financial and Operating Highlights Year Ended December 31 $ millions, except per share and shares outstanding Financial Petroleum and natural gas revenue (1) Cash flows from operating activities Per share - basic (3)(8) Per share - diluted (4)(8) Adjusted funds flow from operations (2) Per share - basic (3) Per share - diluted (4) Net income and comprehensive income Per share - basic (3) Net income and comprehensive income - diluted Per share - diluted (4) Capital expenditures Working capital (5) Bank debt Senior notes Convertible debentures - liability Net debt (6) Total assets Shares outstanding (millions) Basic weighted-average shares (millions) Fully diluted weighted-average shares (millions) Operational Daily production volumes Natural gas (MMcf/d) Natural gas liquids (bbls/d) Total (MMcfe/d) Total (boe/d) Realized commodity prices before financial risk management contracts Natural gas ($/Mcf) Natural gas liquids ($/bbl) Total ($/Mcfe) Operating netbacks ($/Mcfe) (7) Corporate netbacks ($/Mcfe) (7) 2018 404.4 169.0 1.05 0.99 174.6 1.08 1.03 7.1 0.04 7.1 0.04 154.4 32.9 163.1 143.1 46.1 348.5 2,055.4 161.0 161.0 169.9 316.5 5,128 347.3 57,879 2.54 59.43 3.19 2.16 1.71 2017 249.2 106.9 0.76 0.74 109.2 0.78 0.76 122.4 0.87 123.2 0.85 302.6 33.0 149.2 141.6 44.9 363.9 2,031.6 161.0 140.7 144.1 235.8 3,587 257.3 42,882 2.13 50.53 2.65 2.01 1.54 Change 62 % 58 % 38 % 34 % 60 % 38 % 36 % (94%) (95%) (94%) (95%) (49%) — % 9 % 1 % 3 % (4%) 1 % — % 14 % 18 % 34 % 43 % 35 % 35 % 19 % 18 % 20 % 7 % 11 % 1. Before royalties. 2. Adjusted funds flow from operations and adjusted funds flow from operations per share (basic and diluted) are non-GAAP measures used to represent cash flow from operating activities before the effects of changes in non-cash working capital and decommissioning expenditures. Adjusted funds flow from operations per share is calculated by dividing adjusted funds flow from operations by the weighted average number of basic or diluted shares outstanding in the period. See “Non-GAAP Measures” in Management Discussion and Analysis for the year ended December 31, 2018. 3. Basic per share information is calculated on the basis of the weighted average number of shares outstanding in the period. 4. Diluted per share information reflects the potential dilutive effect of stock options and convertible debentures. 5. Working capital is a non-GAAP measure calculated as current assets less current liabilities. See “Non-GAAP Measures” in Management Discussion and Analysis for the year ended December 31, 2018. 6. Net debt is a non-GAAP measure calculated as bank debt, senior notes, liability portion of convertible debentures, and working capital, adjusted for the net current portion of fair value of risk management contracts and current portion of finance lease obligation. 7. Operating netbacks is a non-GAAP measure calculated on a per unit basis as natural gas and natural gas liquids revenues, adjusted for realized gains or losses on risk management contracts, less royalties, operating expenses and transportation expenses. Corporate netback is calculated as operating netback less finance lease expense per unit. See “Non-GAAP Measures” and “Operating and Corporate Netbacks” in Management Discussion and Analysis for the year ended December 31, 2018. 8. Cash flows from operating activities per share - basic and diluted are non-GAAP measures calculated by dividing cash flows from operating activities by the weighted average of basic or diluted shares outstanding in the period. 3 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 1 Message to Shareholders Despite predictions coming into 2018 of a very challenging year, we delivered record adjusted funds flow per share, reduced debt, cut costs, and grew production and PDP reserves year-over-year. We realized a natural gas price of $2.54/Mcf in 2018 which significantly exceeded the average natural gas price at the main Canadian sales hub at AECO (5A) that averaged just $1.50/Mcf for the year. Our much higher realized natural gas price was made possible through the market diversification strategy we began pursuing several years ago in response to our growing concern about being tied to just two sales locations. Natural gas strip prices in western Canada remain low and that has resulted in another year of forecasted lower capital investment by industry, which we believe is likely to result in lower overall natural gas production levels from industry. We will continue to diversify our sales points while also seeking long-term sales contracts with large-scale end-users, as we did with our 14 year supply contract with Methanex Corporation. Cold weather, slowing supply growth, and increasing US exports have forced natural gas storage levels well below the 5-year average in Canada and in the US. We believe this positions Painted Pony for better realized prices than the AECO 5A daily spot price in 2019. It is because of this economic backdrop that we plan, once again, to constrain capital spending to internally generated adjusted funds flow, while retaining our optimism for the future of clean, energy efficient Canadian natural gas. We stated clearly in late 2017 that any adjusted funds flow in excess of capital spending in 2018 would be used to reduce debt levels, which I am pleased to report we did. We believe 2019 is not the time to grow our production, rather it is a time to continue to ‘Plow Through The Challenges’, as illustrated in our annual painting on the cover of this report. Sales Diversification Our 2018 adjusted funds flow of $1.08 per share was a record for us and was delivered through a combination of increased production volumes, capital discipline, and diversification of sales points. We structured a sales diversification portfolio for 2018 that included fixed price and basis contracts, and firm transportation that took Painted Pony natural gas to the Dawn market in southern Ontario and to the Sumas sales hub on the BC / Washington state border as well as to Station 2 and AECO as well as our contract with Methanex Corporation. In October 2018, LNG Canada announced a positive Final Investment Decision (“FID”) on the construction of their West Coast LNG project. This was a great day for Canada, for the Canadian natural gas industry, and for Painted Pony. With construction well under- way in Kitimat, BC and on the Coastal GasLink Pipeline, we continue to expect that some portion of gas supply for LNG Canada will be sourced by producers in British Columbia. Long-term LNG contracts would fit into our 2 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 3 day in and day out“ “ Success is the sum of small efforts, repeated -- Robert Collier focus on delivery diversity and our strategy of increasing profitability through direct sales diversification. Capital Expenditures Our 2018 capital investment program totaled approximately $154 million, which was $21 million less than our 2018 adjusted funds flow of $175 million. Activities included the drilling of 22 (22.0 net) wells, the completion of 28 (28.0 net) wells and investment into associated facilities and infrastructure. We stated in early 2018 that we would limit 2018 capital spending to match adjusted funds flow and that any cash generated above our planned capital spending would be used to reduce debt. I am proud that through prudent and disciplined capital spending we were able to reduce our net-debt from the third quarter of 2018 to the end of the fourth quarter of 2018 by $37 million, a change of 10%. Health, Safety and Environment I cannot stress enough the importance we place on the health and safety of our employees and contractors at Painted Pony as well as protection of the environment. We foster a culture of safe work, making it a top priority in all that we do. We are proud that in 2018 we had no material incidents and zero lost time incidents. Our total recordable injury frequency averaged 0.70 in 2018 compared to an industry average of 0.75. Never satisfied with the status quo, work is ongoing to improve our overall performance. Recent initiatives include hazard identification and near-miss reporting, integrity management plans for regulatory compliance and we will soon implement a new preventative maintenance program. We continue to focus significant effort on water management initiatives, including recycling an average of 93% of water from completions operations over the past three years. Reserves Growth In 2018, we focused our capital program on converting our Total Proved Plus Probable reserves to Proved Developed Producing reserves and grew this reserves category by 19% to approximately 1.0 Tcfe. As we continuously improve the cost effectiveness and efficiency of operations, our average reserves bookings per well continues to increase. We were able to lower the cost of bringing on future production by reducing future development capital in both the Total Proved Plus Probable and the Total Proved categories. In the Total Proved Plus Probable category alone, we were able to reduce the future development capital requirements by over $650 million, and over $300 million in Total Proved reserves. This is a significant accomplishment as larger reserve bookings per well means fewer wells needed to develop the same amount of reserves. Our recycle ratio is a great measure of our ability to invest capital efficiently. Our recycle ratio is calculated by dividing the annual corporate netback of 2 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 3 35% Growth in Annual Average Daily Production Volumes 2018 Adjusted funds flow $175Million ($1.08 per share basic) $1.71/Mcfe by the annual finding, development and acquisition cost of $0.55/Mcfe. Our Proved Developed Producing recycle ratio of 3.1x is industry leading and is proof of the robustness of our assets in both the near and long term. Production Growth We delivered 35% annual production growth over our 2017 annual average daily production volumes, averaging 347 MMcfe/d (57,879 boe/d) during 2018. Also notable was the 43% increase in our average daily liquids volumes of 5,128 bbls/d in 2018, compared to our 2017 average daily liquids volumes of 3,587 bbls/d. We continue to face low natural gas prices on the forward strip in western Canada and as a result we have decided to allow production volumes to reduce by approximately 4% in 2019 to preserve financial flexibility. While we are forecasting slightly lower production volumes this year, I think it is important to reflect back on just how far we have come over the past 3 years. In 2016 we generated adjusted funds flow of $0.53 per share on 139 MMcfe/d (23,204 boe/d) or 1.39 MMcfe/d per share. In 2018 we generated adjusted funds flow of $1.08 per share on 347 MMcfe/d (57,879 boe/d) or 2.16 MMcfe/d per share. I believe our production growth of over 149% and the corresponding adjusted funds flow per share growth of 104% during the past 3 years speaks for itself. I think our track record of rapid production growth is compelling for our future as demand for western Canadian natural gas increases. 2019 and Forward Despite the headwinds we have faced over the past few years both in western Canadian natural gas pricing and in the capital markets, we remain focused on creating shareholder value through strong adjusted funds flow per share growth and through the pursuit of strategies that will continue to produce profitability for Painted Pony shareholders in the coming years. Finally, a sincere thank you to the staff and Board of Directors at Painted Pony for another year of jobs well done. We also would like to thank our First Nations neighbours, the people of BC, service providers and shareholders for your continued support of Painted Pony Energy. “signed” Patrick R. Ward President and Chief Executive Officer March 21, 2019 4 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 5 Advisories Boe Conversions: Barrel of oil equivalent (“boe”) amounts have been calculated by using the conversion ratio of six thousand cubic feet (6 Mcf) of natural gas to one barrel of oil (1 bbl). Boe amounts may be misleading, particularly if used in isolation. A boe conversion ratio of 6 Mcf to 1 bbl is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Mcfe Conversions: Thousands of cubic feet of gas equivalent (“Mcfe”) amounts have been calculated by using the conversion ratio of one barrel of oil (1 bbl) to six thousand cubic feet (6 Mcf) of natural gas. Mcfe amounts may be misleading, particularly if used in isolation. A conversion ratio of 1 bbl to 6 Mcf is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Forward-Looking Information: This message to shareholders section contains certain forward-looking information and forward-looking statements within the meaning of Canadian securities laws (collectively, “forward-looking information”). Forward-looking information relates to future events or future performance and is based upon the Corporation’s current internal expectations, estimates, projections, assumptions and beliefs. All information other than historical fact is forward- looking information. Information relating to “reserves” or “resources” is forward-looking as it involves the implied assessment, based on certain estimates and assumptions, that the reserves or resources exist in the quantities estimated and that they will be commercially viable to produce in the future. Words such as “plan”, “expect”, “intend”, “believe”, “anticipate”, “estimate”, “may”, “will”, “could”, “potential”, and other similar words that indicate events or conditions may occur are intended to identify forward-looking information. This message to shareholders section contains forward-looking information, including, without limitation, information relating to: forecasted lower capital investment by industry, assumptions regarding overall natural gas production levels and realized prices, future capital spending, forecasted production volumes, and estimates regarding the Corporation's growth. Undue reliance should not be placed on forward-looking information, as there can be no assurance that the plans, intentions or expectations on which they are based will occur. Although the Corporation’s management believes that the expectations in the forward-looking statements are reasonable, there can be no assurance that such expectations will prove to be correct. Forward-looking information is based on estimates and opinions of management at the time the information is presented. The Corporation is not under any duty to, nor will it, update the forward-looking information after the date of this document to revise such information to actual results or to changes in the Corporation’s plans or expectations, except as required by applicable securities laws. Any “financial outlook” contained in this message to shareholders section, as such term is defined by applicable securities laws, is provided for the purpose of providing information about management’s current expectations and plans relating to the future. Readers are cautioned that reliance on such information may not be appropriate for other purposes. Non-GAAP Measures: This message makes reference to the terms “adjusted funds flow”, “adjusted funds flow per share”, and "corporate netback" which do not have standardized meanings prescribed by IFRS and therefore may not be comparable with the calculation of similar measures presented by other issuers. Management of the Corporation believes these measures are useful supplemental measures of the net position of current assets and current liabilities of the Corporation and the profitability relative to commodity prices. Readers are cautioned, however, that these measures should not be construed as alternatives to other terms such as current and long-term debt or comprehensive income determined in accordance with IFRS as measures of performance. The Corporation's method of calculating these non- GAAP measures may differ from other companies, and accordingly, may not be comparable to similar measures used by other entities. Management uses “adjusted funds flow” to analyze operating performance and considers adjusted funds flow to be a key measure as it demonstrates the Corporation’s ability to generate the cash necessary to fund future capital investment and to repay debt. Adjusted funds flow denotes cash flow from operating activities before the effects of changes in non-cash working capital and decommissioning expenditures. “Adjusted funds flow from operations per share” is calculated using the basic and diluted weighted average number of shares for the period. These terms should not be considered alternatives to, or more meaningful than, cash flows from operating activities as determined in accordance with IFRS as an indicator of the Corporation’s performance. "Corporate netback" is used as a supplemental measure of the Corporation's profitability relative to commodity prices. Corporate netback is calculated on a per unit basis as natural gas and natural gas liquids revenues, adjusted for realized gains or losses on risk management contracts, less royalties, operating expenses, transportation costs and finance lease expense. This term should not be considered alternatives to, or more meaningful than net income (loss) and comprehensive income (loss) as determined in accordance with IRFS. Independent Reserves Evaluation: GLJ Petroleum Consultants ("GLJ"), independent qualified reserves evaluators of Calgary, Alberta, prepared a reserves estimation and economic evaluation of the Corporation's oil and natural gas properties effective December 31, 2018, which is contained in a report dated March 5, 2019 (the "2018 Reserves Report"). GLJ prepared reserves estimations and economic evaluations of the Corporation's reserves effective December 31, 2018. The 2018 Reserves Report and the prior reserves evaluation were prepared in accordance with the standards contained in the Canadian Oil & Gas Evaluation Handbook and National Instrument 51-101 - Standards of Disclosure for Oil and Gas Activities, which were in effect at the time of the evaluation. Reserves Categories: Reserves means estimated remaining quantities of oil and natural gas and related substances anticipated to be recoverable from known accumulations, as of a given date, based on the analysis of drilling, geological, geophysical and engineering data; the use of established technology; and specified economic conditions, which are generally accepted as being reasonable. Reserves are classified according to the degree of certainty associated with the estimates: • Proved Reserves are those reserves that can be estimated with a high degree of certainty to be recoverable. It is likely that the actual remaining quantities recovered will exceed the estimated proved reserves; and • Probable Reserves are those additional reserves that are less certain to be recovered than proved reserves. It is equally likely that the actual remaining quantities recovered will be greater or less than the sum of the estimated proved plus probable reserves. Each of the reserves categories (proved, probable and possible) may be divided into developed and undeveloped categories: • Developed Reserves are those reserves that are expected to be recovered from existing wells and installed facilities or, if facilities have not been installed, that would involve a low expenditure (e.g. when compared to the cost of drilling a well) to put the reserves on production. 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| ANNUAL REPORT 53 54 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 55 54 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 55 56 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 57 56 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 57 58 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 59 58 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 59 60 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT Corporate Information BOARD OF DIRECTORS Glenn R. Carley Chairman of the Board Independent Director Compensation and HR Committee Nominating Committee Governance Committee Audit and Risk Committee Kevin D. Angus Independent Director Compensation and HR Committee (Chair) Paul J. Beitel Director Joan E. Dunne Independent Director Audit and Risk Committee (Chair) Reserves and HSE Committee Nereus L. Joubert Independent Director Governance Committee (Chair) Nominating Committee (Chair) Compensation and HR Committee Lynn Kis Independent Director Reserves and HSE Committee (Chair) Audit and Risk Committee Arthur J. G. Madden Independent Director Audit and Risk Committee Governance Committee Nominating Committee George W. Voneiff Director Reserves and HSE Committee Patrick R. Ward Director President and Chief Executive Officer DESIGN: ARTHUR / HUNTER OFFICERS Patrick R. Ward President and Chief Executive Officer Stuart W. Jaggard Chief Financial Officer Richard W. Kessy Chief Operating Officer Edwin (Ted) S. Hanbury Senior Vice President, Strategic Projects Tonya L. Fleming Vice President, General Counsel and Corporate Secretary L. Barry McNamara Vice President, Development and Marketing STOCK EXCHANGE LISTING The Toronto Stock Exchange Trading symbol for Common Shares: PONY AUDITORS KPMG LLP BANKERS The Toronto-Dominion Bank The Bank of Nova Scotia Alberta Treasury Branches Canadian Imperial Bank of Commerce Royal Bank of Canada HSBC Bank Canada Wells Fargo Bank, N.A. Canadian Branch EVALUATION ENGINEERS GLJ Petroleum Consultants Ltd. REGISTRAR AND TRANSFER AGENT TSX Trust Company HEAD OFFICE Suite 1200, 520 – 3rd Avenue SW Calgary, Alberta T2P 0R3 T 403.475.0440 F 403.238.1487 TOLL FREE 1.866.975.0440 info@paintedpony.ca E W www.paintedpony.ca PAINTED PONY ENERGY LTD. Suite 1200, 520 – 3rd Avenue SW Calgary, Alberta T2P 0R3 T 403.475.0440 F 403.238.1487 TOLL FREE 1.866.975.0440 E info@paintedpony.ca W www.paintedpony.ca 1 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2018 | PAINTED PONY ENERGY LTD | ANNUAL REPORT 2 

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