CALGARY, April 19, 2017 /CNW/ – Surge Energy Inc. (“Surge” or the “Company”) (TSX: SGY) announces the acquisition (the “Acquisition”) of a low decline, high netback, waterflooded, crude oil producing asset in its core Sparky area of Central Alberta. In addition, Surge has acquired two net undeveloped sections in the Company’s core operated Eyehill asset (collectively the “Assets”). Surge has identified up to 29 low risk, development drilling locations on the Assets.
The purchase price for the Assets is $37 million, subject to standard closing adjustments. The closing of the Acquisition occurred on April 12, 2017 (the “Closing”). The Acquisition is accretive to Surge on all key per share metrics. In addition, the two undeveloped sections at Eyehill are strategic to Surge for continued consolidation of this large, high quality, 130 million barrel OOIP, 29° API crude oil asset. The purchase of these two sections will allow the Company to continue its excellent Eyehill Sparky development drilling program, and the Company’s successful ongoing waterflood activities.
As a result of Surge’s successful drilling and waterflood activities in the Company’s three primary operating areas, together with the core Sparky area asset Acquisition referred to herein, Surge will now be delivering production growth of more than 24 percent from Q2/16 to the end of Q4/17.
With current core production of more than 745 boepd (97 percent oil), and an annual decline of less than 12 percent, the Assets provide Surge with substantial free funds flow. Accordingly, pursuant to the Company’s conservative dividend policy, Surge’s Board of Directors will look to increase the Company’s dividend by 11.8 percent from $0.085 per year ($0.00708 per month) to $0.095 per year to ($0.00792 per month).
Surge’s increased dividend equates to a simple payout ratio of 16 percent of forecast 2H/17 funds flow, which compares favorably with the Company’s peer group average simple payout ratio of approximately 25 percent.
STRATEGIC RATIONALE FOR ACQUISITION
Over the last 30 months of the extended crude oil price downturn, Surge management strategically created financial liquidity of over $750 million to reduce debt and position the Company’s balance sheet – without issuing treasury shares in a depressed market.
Management have also materially increased Surge’s netbacks over $8 per boe by focusing on rigorous cost cutting initiatives for operating costs, G&A, and interest expenses. Further, the Company has delivered excellent operational results by delineating Surge’s high quality, large OOIP, light and medium gravity crude oil reservoirs through top tier development drilling results, combined with successful waterflood activities.
These capital allocation decisions, cost cutting initiatives, and excellent operational results have now strategically positioned Surge to begin deploying growth capital into accretive, core area acquisitions on very attractive terms.
The Acquisition is entirely consistent with Surge’s stated goal of acquiring high quality, operated, large OOIP, conventional crude oil assets with low recovery factors. The Assets are located in the Company’s half a billion barrel net OOIP, Sparky/Lloyd play in Central Alberta, and are characterized by the following attributes:
- More than 56 million barrels OOIP; 17 percent recovery factor;
- 745 boepd of low decline, oil-weighted production (i.e. less than a 12 percent annual decline);
- Long life reserves – over 4.4 mmboe of internally estimated proved and probable reserves;
- 97 percent oil weighting;
- Production is 100 percent owned and operated;
- Majority of the production is under successful, active waterflood;
- Up to 29 low-risk developmental drilling locations; and
- Highly accretive operating netbacks (i.e. > $30 per boe netbacks at US$55 WTI).
Surge’s ongoing Eyehill Sparky drilling and waterflood program at its operated, 130 million barrel OOIP, 29° API gravity oil asset, has significantly exceeded expectations. The Company recently drilled six consecutive successful development wells in Q1 of 2017. Current production rates at the Eyehill battery recently exceeded 2,000 bopd net to Surge, up from approximately 385 bopd in Q2 of 2016.
Operating costs at Eyehill are now budgeted at less than $5.00 per boe for 2017, down from $7.40 per boe in 2016. With over 65 net remaining locations at Eyehill, this area will continue to underpin Surge’s production per share growth for the foreseeable future. Risked rates of return for Sparky development wells are now over 150 percent at strip pricing for primary reserves only.
ATTRACTIVE DEAL METRICS
The $37 million Acquisition has the following transaction metrics:
Current Production Multiple |
745 boepd (97 percent oil); $49,600 per boepd |
2017 Annualized Funds Flow Multiple1 |
4.5x |
Total Proved Plus Probable Reserves Multiple (Internally Estimated) |
$8.40/boe |
Recycle Ratio |
3.57x |
Reserve Life Index (RLI) |
>16 years |
In addition, the Assets generate substantial free funds flow, and further strengthen the sustainability of Surge’s production base and dividend. We estimate the Acquisition will positively impact Surge’s annualized 2017 forecast guidance as follows:
Average Annual Production |
745 boepd |
Funds Flow From Operations |
$8.2 million |
Development Capital (to maintain production) |
$1.2 million |
Surplus Funds Flow |
$7.0 million |
This Acquisition is accretive on all key per share metrics, including five percent on total proved plus probable reserves, and five percent on 2017 funds flow and production per share, respectively.
UPWARD REVISION TO 2017 GUIDANCE
As a result of continued excellent drilling results at the Company’s Shaunavon, Sparky, and Valhalla core areas, combined with successful ongoing waterflood activities, on December 13, 2016 Surge revised upward the Company’s 2017 average daily production estimate to 14,000 boepd from 13,500 boepd, and Surge’s 2017 production exit rate target to 14,450 boepd from 14,150 boepd.
Pursuant to the core Sparky area Acquisition referenced herein, Surge is now revising upward the Company’s 2017 guidance as follows:
OPERATIONAL1 |
PRIOR GUIDANCE |
REVISED GUIDANCE |
2017 Average Production (boe/d) |
14,000 |
14,450 |
2017 Exit Production (boe/d) (82 percent oil) |
14,450 |
15,150 |
Total Capital Spending (including acquisitions) |
$85 million |
$124 million |
Operating Expenses – 2H 2017 ($/boe) |
$11.45/boe to $11.95/boe |
$12.00-$12.50/boe |
Transportation Expenses ($/boe) |
$1.50/boe |
$1.50/boe |
Royalties as a % of Revenue |
12% to 13% |
12% to 13% |
FINANCIAL1
|
||
Estimated 2H/17 Annualized Funds Flow from Operations1 |
$129.5 million |
$136.0 million |
Estimated 2H/17 Annualized Funds Flow from Operations per Share ($/share) |
$0.57 |
$0.60 |
Estimated Q4/17 Debt to Funds Flow |
1.20 X |
1.39 X |
Annualized Dividend |
$19.2 million |
$21.5 million |
Sustainability Ratio |
80% |
80% |
Simple Payout Ratio |
15% |
16% |
Surge’s current production rates, pro-forma the Acquisition, already exceed the Company’s upwardly revised 2017 average daily production guidance rate of 14,450 boepd (82 percent oil and liquids).
DIVIDEND INCREASE
Surge’s conservative dividend policy targets a simple payout ratio of 20 to 30 percent of annualized cash flow, and an all-in sustainability ratio in the range of 70 to 90 percent. Additional free funds flow beyond Surge’s targeted six percent annual production growth target is expected to be allocated to an expanded capital program, debt repayment, dividend increases, or share buybacks.
The acquired Assets provide Surge with substantial excess funds flow, after capital required to maintain production levels, due to the low decline nature of the Assets (i.e. less than a 12 percent annual decline). Accordingly, Surge’s Board of Directors will look to increase the Company’s dividend by approximately 11.8 percent per year from $0.085 per year ($0.00708 per month) to $0.095 per year ($0.00792 per month).
The Company’s proposed increased dividend equates to a simple payout ratio of approximately 16 percent of forecast annualized 2H 2017 funds flow, which compares favorably with Surge’s peer group average payout ratio of approximately 25 percent.
It is gratifying for Surge’s management and Board to be able to augment shareholder returns during periods of volatile equity capital markets, and political uncertainty, through orderly increases to the Company’s dividend, based on Surge’s excellent balance sheet, low corporate decline, low cost structure, and excellent production efficiencies.
INCREASE TO BANK LINE
As previously disclosed, in 2016 Surge delivered record FD&A costs of $3.74 per boe, and a recycle ratio of 4.61 times on a total proved plus probable basis – with oil prices averaging US$43.32 WTI per barrel. These excellent operational results provided an increase in the Company’s independently engineered, proved developed producing reserve value of more than 25 percent[2].
On this basis, in accordance with Surge’s annual bank line review process, the Company confirms that its banking syndicate, led by National Bank of Canada, has increased Surge’s bank line limit (pro-forma the Acquisition) from the previous $250 million to $285 million. The increase provides Surge with significant financial flexibility to execute its capital program, as well as, providing ample liquidity for future core area acquisitions. Surge’s next borrowing base review is scheduled for November 1, 2017.
RISK MANAGEMENT
In connection with the Acquisition, Surge has entered into a 1,250 bbl/d WTI crude oil swap transaction at an average price of US$55.18 WTI for April, 2017 through December, 2017. This strategic swap position increases Surge’s second half of 2017 hedge position to 3,750 bbl/d of WTI crude oil – which has now locked in a floor price of over CAD $65.20 per bbl.
Surge’s ongoing risk management program is designed to lock-in and protect cash flows to fund capital expenditures, and the Company’s dividend, as well as, protecting Surge’s significant free funds flow forecast at strip crude oil prices.
OUTLOOK – PER SHARE GROWTH CONTINUES
Management’s goal is to be the best positioned public light/medium gravity crude oil growth and dividend paying company in Canada.
As a result of Surge’s successful ongoing drilling and waterflood activities in the Company’s three primary operating areas, together with the core Sparky area asset Acquisition referred to herein, Surge will now be delivering production per share growth of more than 24 percent from Q2/16 to the end of Q4/17.
Surge’s current production rates, pro-forma the Acquisition, already exceed the Company’s upwardly revised 2017 average daily production guidance rate of 14,450 boepd (82 percent oil and liquids).
In addition, Surge has increased the Company’s dividend per share by 26.7 percent since the start of 2017, while maintaining a simple payout ratio of 16 percent of forecast Q4/17 cash flow annualized, versus a peer group average payout ratio of approximately 25 percent. Surge is also maintaining an annualized Q4/17 debt to cash flow ratio of 1.39 times at strip pricing.
As a result of management’s strategic capital allocation decisions, rigorous cost cutting initiatives, and excellent operational results, we believe that Surge is well positioned to continue delivering solid per share growth, and to pay the Company’s dividend, on a go-forward basis.