DNO ASA (OTCPK:DTNOF) Q2 2022 Earnings Conference Call August 11, 2022 5:00 AM ET
Company Participants
Jostein Løvås – Communication Manager
Haakon Sandborg – Chief Financial Officer
Bijan Mossavar-Rahmani – Executive Chairman
Conference Call Participants
Teodor Sveen-Nilsen – SpareBank 1 Markets
Tom Erik Kristiansen – Pareto
Jostein Løvås
Good morning. Welcome to DNO’s Second Quarter 2022 Earnings Call. My name is Jostein Løvås. I am the Communication Manager of DNO, and I will share some practical information. All participants in this meeting are muted by the organizer and will not be able to unmute themselves chat or share their screens.
We will start with a brief results presentation by CFO, Haakon Sandborg. After which, we will open for questions from shareholders and analysts. Executive Chairman, Bijan Mossavar-Rahmani is also present on the call.
If you want to pose the question, please raise the tiny virtual hand on your screen. When chosen by the organizer, you will be notified on your screen that you are allowed to unmute, after which you will have to remember to unmute yourself, too.
With that, I leave the stage to the CFO.
Haakon Sandborg
Good. Thank you, Jostein. Hello, everyone. I hope you all are enjoying a great summer and thanks for taking the time to attend this discussion for DNO’s Q2 operations and financials. At this time, we have kept the presentation fairly short and to the point, so I will focus on the main Q2 highlights and on the key financials for the Group.
As Jostein said, there will also be a Q&A session at the end to cover any questions that you might have. It’s a nice photo that you see on the front page on our presentation is from truck loading of crude from our Baeshiqa license. And you may know that DNO has been known as fast truckers for our field developments, but now we are also known as fast truckers, so that’s good to see.
Let’s move on to the next page — slide, Jostein. Okay, to get started, let’s begin with the Q2 highlights. We clearly had a strong second quarter with a further cash flow growth and significant strengthening of our balance sheet. We are thereby now in a net cash position for the first time since 2018.
Obviously, the high oil and gas prices are powering this positive development, but this also saw the contributions from our high performance operations and the regular contractual payments from the KRG.
As such, our operator Tawke license in Kurdistan, we continue to deliver high production from the Tawke and Peshkabir fields, with some growth in production now to over 80,000 barrels of oil per day. We are pleased to see that the natural field decline is being rested and even reversed through our drilling and development programs, including at the Tawke field.
As you can see on the slide here for our North Sea operations, the Q2 net production dropped a bit to 11,600 BOE per day from 12,700 barrels per day in Q1. That was primarily due to planned maintenance at the Ula field.
For the new assets, as I mentioned, we also certainly at least started off production and trucking from the Baeshiqa license in mid-June and that’s initially producing from the Zartik-1 discovery well. We will now be drilling additional wells and engage in further field development and basal work to build up production from this exciting license.
We further maintain high development activity in several North Sea licenses, including on the Brasse project. We are now past stage two on this project, work is ongoing on the feed studies and we are on track for the planned PDO sanction for the year end this year.
If we move on the next slide and now moving over to our financial reporting, these are some of the key figures for Q2. We are again pleased to deliver high quarterly revenues at $361 million, up 6% from the first quarter.
Kurdistan accounted for $239 million of the Q2 revenues. That was up from $209 million in Q1, mainly on the solid production and the higher oil prices. North Sea revenues came in at $121 million in the second quarter, down from $131 million in Q1. And the main drivers here include the lower achieved gas prices this time, partly offset by higher oil prices and higher crude liftings.
Now on the other hand, unfortunately, we had a big drop in operating profit in Q2, down to $81 million from $236 million in Q1. This is primarily due to impairments of $127 million mainly on the Ula field, but also from exploration expenses at $48 million, mostly from expensed exploration wells.
So with these impairments and exploration expenses, our net profit also dropped significantly in the second quarter to a level of $72 million, but this is after some offset from tax income in the quarter.
Just to mention that also important that on a year-to-date basis through the first half of this year, it should be noted that we have basically doubled our revenues, operating profit and net profit from the same period last year, and we had strong operations and higher commodity prices.
Fine, let’s go on to cash flow, and as you may know, and as we have mentioned in the past, this has long been one of the key strengths of our company here in DNO on the cash flow side. And for Q2, we are pleased to show further increase in operational cash flow very strong level of $341 million.
This is up by $65 million from Q1 admittedly with new support coming from a $54 million positive working capital change that in turn was partly coming from reduced KRG receivables due to the payments we received in the quarter.
We have paid two Norwegian or NCS tax installments of total $25 million in Q2. So, with this, we completed the repayment of tax refund adjustments for 2021. During the second half of this year, we currently expect to pay $5 million in Norway for the first three tax installments of the tax year 2022. In addition in the second half of this year, we will receive a $19 million tax refund from the U.K.
As discussed and in line with our guidance for this year, we increased investments further in Q2 to $134 million. This was mainly for CapEx at $78 million and for capitalized exploration at $36 million. In addition to the decomm work on the Schooner and Ketch fields in the U.K. accounted for $20 million in Q2.
The net finance outflows of $230 million were primarily for buying back $203 million of the DNO03 bond in Q2. So, all in, we thereby continue to finance higher investments and debt reduction through our strong cash flow. But at this time with the high bond buybacks in this quarter, we had some use of cash a $47 million in Q2. But I’d say with — we are still in good place with cash balances of $801 million at the end of the quarter.
Our free cash flow increased again to $167 million in Q2. And looking forward, we see a positive outlook for continued strong free cash flow generation also in the second half of this year.
Next one, here, we have our capital structure. We continue to strengthen our balance sheet through the increasing cash balances, reducing our debt. And as I mentioned, we turned net cash positive in Q2.
We have thereby had a remarkable look from net interest-bearing debt of $396 million a year ago to a net cash position of $129 million at the end of the second quarter. As you see on the right here, we also have increased our equity ratio significantly to 42%.
With the bond buybacks, we canceled $224 million of the DNO03 bond in Q2 and that left a remaining outstanding balance of $176 million [Technical Difficulty] since bought back an additional $25 million in DNO03 and that reduced the current outstanding amount to just over $150 million. I think I told that before, but in addition to the strong balance sheet, this material reduction of debt, that obviously also reduced interest expense and freed up cash flow for other purposes.
Fine so next slide, looking ahead and on the back of current high activity and drilling of new production wells in the Tawke license, we now expect gross production from Tawke and the Peshkabir fields for this year to come in between 107,000 barrels of oil per day to 109,000 barrels of oil per day. That’s well above the previously guided level of 105,000 barrels per day. I can note here that we have added another drilling rig with the Tawke license in June, so we currently have four rigs in operation here.
For the North Sea, we drilled four exploration wells in the first half of this year that added one good discovery and we will follow with three additional exploration wells in the second half of the year. We have right now so give the value creation through four NCS discoveries over the last two years, so our exploration program is really starting to pay off.
With the Kveikje discovery this year, we have now added to our strong position in the attractive West petrol area, and we look forward to drilling another exploration well in this area in Q4 this year. Otherwise, we have this less projected operational spend for the full year of $800 million and that’s in line with the guidance that we gave earlier in the year.
We have — based on the shareholder approval of an increased dividend authorization at the DNO AGM in May. We have now further announced a NOK0.25 per share quarterly dividend to be paid later this month. In dollar terms, this equals about $25 million in total for this quarterly dividend.
Okay. So to sum up, we are growing organically through exploration and development. We are paying dividends, we are buying back bonds and we are building cash balances. In addition, we are certainly also looking to grow further by use of our financial strength to invest in new business opportunities. This will be within our core oil and gas competence.
For this purpose, we are now active in the business development discussions in the North Sea and we are also looking at investment opportunities in new areas outside of our existing operations. So, we will, of course, revert to you when we have progress to report on these new investments.
So, again, thanks for your attention. I think we can now move on to the Q&A session.
Question-and-Answer Session
A – Jostein Løvås
Okay. I think at this stage we have a question coming up from Teodor Sveen-Nilsen. He’s an analyst with SpareBank 1 Markets. So Teodor you might pose your question.
Teodor Sveen-Nilsen
Hi, Haakon and Jostein. Thanks for taking my questions and thank you for the update. I have three questions. First one on just your balance sheet, of course, you have a very strong balance sheet now as you alluded to a net cash position. Should we expect DNO to run with a net cash position going forward or should we expect increased buybacks or dividends? So that’s the first question. Second question is on these rulings, so I seen encouraging some like we saw the Supreme Court ruling in February and the car commercial court ruling now recently. Just wondering what’s your thoughts are around these rulings and does that impact your strategy or appetite for investments in Kurdistan at all? Third question is on Baeshiqa and thanks for the update there. As far as I remember, you mentioned that exit rate of 8,000 barrels per day in your first quarter. Is that still valid that you expect to be able to produce 8,000 barrels per day by end this year? Thanks.
Haakon Sandborg
Yes. Thanks, Teodor. I will start on the first one on the balance sheet. Yeah. Well, as I said, we are very pleased and happy with the strong strength of the balance sheet that we have achieved over the last couple years. They are now sort of back to where we were several years back when we had a strong position.
So whether we will run with a net cash position or not, that’s not really the target. There will always see discussions on capital allocation and new investments and share buyback, bond buyback.
But I think to me, one of the things I look for is the equity ratio. We are now well above 40%. I think that’s something we would like to try to maintain a strong balance sheet by having a good equity ratio like that. That’s what also we will guide you on we will be on the debt levels.
But in general, we are quite interested in more of the bond buyback opportunities. That will depend on the pricing and the market developments that we see, of course, also our use of our funds.
But in general, interested in bond buybacks and I know some of the investors have contacted me directly for possible discussions on that and I am available. So I’d like to say, here’s my phone and give me a call. I will be able to discuss with you on the bond buybacks.
But I think we are happy with where we are now in general and the balance sheet. So I think it might go up and down, the net interest-bearing debt or net cash situation Teodor, but in general, where we are now in a good place with our capital structure. On the Supreme Court ruling, I am not sure…
Teodor Sveen-Nilsen
Okay. Could I just add that follow-up on that also so it’s — just to be clear, is the pecking order rates that bond buyback is probably higher on the agenda than dividends or buybacks, if I understood you correctly?
Haakon Sandborg
No. No, I wouldn’t say that. We haven’t announced the quarterly dividend today, that’s important. Also managing the debt level is important, and again, looking at new investments. So, as I say, the capital allocation here the use of our financial strength, we have to weigh these opportunities against these others. So I wouldn’t say, one is more important than the other, like you are saying. But this is a total consideration that we go through.
Teodor Sveen-Nilsen
Sure. Understood.
Haakon Sandborg
Okay. On the Supreme Court discussion around the Kurdistan, any comments from you, Bijan on that?
Bijan Mossavar-Rahmani
I don’t have very much to add to this issue that has already been very widely reported. And I know those of you who follow the company, the shareholders or analysts are well familiar with the issues.
I can only say that as long as I have been Chairman of DNO, which is going on about 10 years now and while we are fighting in term of these issues in one form or another or have been raised. We will continue to do what we do best operate and increase production and being part of the Kurdistan economy and the oil sector and that all continues.
Our operations continue as before. Our investments continue as before. We are firmly committed to Kurdistan. This time the challenges aren’t different than the prior challenges. There have been court hearings and in which we have not participated. We have not been represented.
As far as we are concerned, our contracts were signed with the Kurdistan regional governments. They are governed by English law and we are not part of the political process that has led to some of these challenges and issues, and we have the full support of the Kurdistan Government.
We continue in terms of our operations and our commitment and our investments and our business as usual basis. I believe that is the position of all the other companies that are active, if not all the companies are active in Kurdistan and we will watch developments as they occur.
But for us, it’s business as usual, and we believe in sharing contract regime is a positive one. We are around there. It’s been part of the reason Kurdistan has been so successful trading in a very active and successful oil and gas industry without sharing their contracts or invested in Kurdistan. They have been around 70 years, 80 years. There must be 70, 80 countries around the world that have provided sharing contracts.
As the legal structure of the — of their international oil and gas structure with respect with the international oil company participation, it’s worked well for them. There’s a reason for us of sharing contracts are the contracts of choice.
They are — they create the right incentives for companies to invest and to be rewarded on the success and so there is — we believe that’s we are — within that international legal and operational structure and it’s worked well for all parties and that we would hope and expect that that would continue.
Haakon Sandborg
Good. Thank you, Bijan. The third question was on Baeshiqa and what to expect on production ramp-up. So we are currently producing fairly lower volumes from the first discovery well, as I mentioned. And we will be drilling three more wells. We expect to have those mostly done by the end of this year.
So there’s been a bit of a delay here the other way around getting everything in place so ramping up. So I will be a bit careful by giving you a precise estimate on the exit rate, on the production rate at the end of the year. It sort of depends on how fast and how successful we are in drilling these three wells and the results that we will see from these wells, of course.
So there’s a learning curve with any new assets like this to understand and address, so what do we have here and we think we have a good idea, but there’s more work to be done and to understand this is better.
So as we become more familiar with this, we will be able to come back to the investors and discuss a bit more on how we see production coming out going forward. But we are happy to be in development phase now and in production and drilling has started and it’s working well so far.
And as you know, we truck it up to our Fish Khabur export terminal and ship it out with the pipelines from there. So, all in all, things are moving forward, but I will be a bit reluctant to give you an answer at this stage.
Bijan Mossavar-Rahmani
I think…
Teodor Sveen-Nilsen
Okay. Thank you.
Bijan Mossavar-Rahmani
Baeshiqa and DNO’s operations is that, because of our operational style and culture, and because these are onshore fields that we — even as we have learned more about the fields through the development drilling, we produced and learned at the same time.
So our line, of course, as you all well know, an offshore project where you can drill multiple wells and have a huge rather confidence and a sense of what’s the band is of your production before you order the platforms and spend much larger sums and try putting a development project base.
We have put a discovery well on the production as we drill additional wells. So we will put them on production. We have, as Haakon mentioned, a trucking system in place to move it immediately to market as soon as we are given the go ahead.
It didn’t take very long for us to start production and start exporting and start earning revenues on the sales of the oil, which is under the same regime as the pricing foreign regime as the Tawke and Peshkabir fields in the Tawke Line facility. Expect that whenever we do, we are going to have production as we continue to drill and we are still very much excited about the opportunities with the Baeshiqa.
Hopefully, at some point when we are further along, we will arrange to be done pass to organize analyst and shareholder trips to Baeshiqa. It’s a wonderful and historic part of Kurdistan and Northern Iraq, and it’s always to me, personally, is a pleasure to go there and then there is so much history. We saw the history and nature.
And so I would hope in not too distant future, we will have an opportunity to invite those to go out there see for yourself and once we drilling at Baeshiqa and catch up on what we have done further at Tawke and the private license is at Peshkabir. It’s a pretty impressive operation leverage with product and continue to expand.
Jostein Løvås
Okay. I believe the next…
Haakon Sandborg
Yeah. I would add just, we might send an invitation on the next trip, but let’s go to the next question.
Jostein Løvås
Yeah. I believe the next question comes from Tom Erik Kristiansen at Pareto. Unless and you have to unmute yourself I think.
Tom Kristiansen
Thank you and thanks for the chance to ask question. With the growing cash pile you have now, you clearly have a lot of capacity to do M&A and you can do big transactions compared also to the size of the existing business that is substantial, of course. Can you say something about what you are seeing out there, where you are looking? I think a lot of people have expected Norway to be a direction you are looking, of course. But can it also be offshore West Africa or other places where you can use your long history in emerging markets as well?
Bijan Mossavar-Rahmani
Could be, I think, because of the strength of our balance sheet, because of the cash flow stream, for us looking at options it’s not just a question of aren’t going out into the market looking for things. The market’s coming to us.
Others — other companies look at our balance sheet and they know that we are in a position to move and they have — they want to move fast on other opportunities. So both are pushing and pull, and there are opportunities that we are looking at.
And some on crude oil basis, others in more advanced basis and then, Haakon mentioned, when we have something to report, obviously, to all of you in early falls, of course, you will be the first to know. But we are actively looking and we are — it’s both strength for us from the market and other peer group companies.
Haakon Sandborg
And of course, from a point of view that it’s more important that we don’t find and engage the transactions that we had a new value and looking to grow our production in Norway is high on the priorities list.
But as we mentioned also looking at elsewhere now and also actually see like Bijan is mentioning that we are getting an incoming interest coming our way. So like to look at it and work on. So, hopefully, we will come back to you quite soon on if you have success and are making good progress. I think we have other questions, Jostein.
Jostein Løvås
We don’t so unless Tom Erik…
Tom Kristiansen
I have…
Jostein Løvås
… has a follow-up question, sorry?
Tom Kristiansen
Yes. Yes. Please, one follow-up question here before the team here is back to kind of the debt level. Is there an absolute debt level that you feel is appropriate for existing business kind of how much debt would you like to repay or put it another way with just kind of how the cash flows are coming out of Kurdistan and the cash pile is growing, is there kind of a limited, if you cross $1 billion, for instance, of a cash balance, will that trigger dramatically, call it, bond buybacks, buybacks of shares or higher yield one-off dividends, something like that? Is there any kind of figures you should look at that going forward?
Haakon Sandborg
It’s a good question, Tom. But I don’t think I will give you a precise answer on exact debt level. But you have seen that we have been very active in the bond buybacks and with the debt reduction we had in Q2, we have made strong progress in strengthening the balance sheet. It would be kind of natural to look at the shorter dated DNO03 2024 maturity. But we would also look at the 2026 maturity DNO04 potentially.
Tom Kristiansen
Yeah.
Haakon Sandborg
So a price question and what the better return would be. But as I said already in another question, looking at the balance sheet, looking at our equity ratio, there’s no absolute level. If we have a major transaction, we might do up again on the debt level for the temporary levels. We expect to come down again with a good cash flow.
I think we are in a good place where we are now. We can displace any further short-term. But we do want to grow and really want to use our investments, our capital into new investments. So it will sort of fluctuate over time as you see in our balance sheet in the past. But it — certainly it seem to be where we are now and spending further quarter-by-quarter. So we have a lot of financial flexibility now.
Tom Kristiansen
Yeah. Thank you, Haakon. That was all from me. Thanks.
Jostein Løvås
Okay. With that, I think, we will just wrap it up. And thanks to you all for participating and we look forward to seeing you again on a later occasion.
Bijan Mossavar-Rahmani
Bye.
Haakon Sandborg
Bye-bye.
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