CALGARY, ALBERTA–(Marketwired – Oct. 26, 2017) – Surge Energy Inc. (“Surge” or the “Company”) (TSX:SGY) is pleased to announce the acquisition (the “Acquisition”) of a low decline, high netback, waterflooded, crude oil producing asset (the “Assets”) in its core Sparky area of Central Alberta for a purchase price of $37.2 million, which closed on September 8, 2017. Surge has identified up to 38 net Sparky development drilling locations on the Assets.
The Assets have current core production of more than 780 boepd (95 percent oil), an annual decline of less than 15 percent, and a netback of more than $25 per boe at US$55 WTI pricing. The Acquisition is accretive to Surge on all key per share metrics. The Assets have internally estimated original oil in place (“OOIP”1) of over 100 million barrels, and are laterally adjacent to Surge’s high netback, large OOIP, crude oil Sparky property at Eyehill.
Surge is also pleased to announce that it has entered into a $40 million bought-deal financing (the “Convertible Debenture Financing”) of five-year convertible unsecured subordinated debentures (the “Debentures”) with a syndicate of underwriters (the “Underwriters”) led by National Bank Financial Inc. (“NBF”). The Debentures will have a coupon of 5.75 percent per annum, and a conversion price of $2.75 per Surge common share (“Common Share”).
In conjunction with the Acquisition, Surge is also revising upward the Company’s 2017 exit production guidance from 15,150 boepd to 15,850 boepd (82 percent oil).
Further, Surge is now projecting that production in 2018 will average more than 16,150 boepd, with a 2018 production exit rate of 16,650 boepd (see “UPWARD REVISION TO 2017 GUIDANCE; PRELIMINARY 2018 GUIDANCE” below).
THE SPARKY ACQUISITION
The Acquisition is entirely consistent with Surge’s stated goal of acquiring high quality, operated, large OOIP, conventional crude oil reservoirs with low recovery factors. The Assets are located in the Company’s estimated half a billion barrel net OOIP, Sparky/Lloyd fairway in Central Alberta; they are immediately offsetting Surge’s core Sparky Eyehill property; and they have the following attributes:
- More than 100 million barrels of internally estimated OOIP; with an estimated recovery factor of 16 percent;
- 780 boepd (95% oil) of operated low decline, oil-weighted production (i.e. less than a 15 percent annual decline);
- Long life reserves – over 4.1 mmboe of internally estimated proved and probable reserves as of September 8, 2017 (i.e. >13 year RLI);
- A portion of the production is under successful, active waterflood (with additional waterflood upside in the primary Sparky MM pool – which is currently producing with a 40 percent oil cut);
- Up to 38 net developmental drilling locations, of which 20 are included in Surge’s internal estimates above;
- Operating netbacks > $25 per boe at US$55 WTI;
- Sustaining capital of $2.5 million, with anticipated annual cash flow from operating activities of more than $7.25 million;
- Implied free cash flow yield of more than 65 percent.
Macquarie Capital Markets Canada Ltd. and NBF are acting as financial advisors to Surge with respect to the Transaction. McCarthy Tétrault LLP is acting as legal advisor to Surge with respect to the transaction.
ATTRACTIVE DEAL METRICS
The $37.2 million Acquisition has the following transaction metrics:
|Current Production Multiple||780 boepd (95 percent oil); $47,700 per flowing boepd|
|2017 Annualized Adjusted Funds Flow from Operations Multiple2||5.1x|
|Total Proved Plus Probable Reserves Multiple (Internally Estimated)||$9.07/boe|
|Reserve Life Index (RLI)||>13 years|
This Acquisition is accretive on all key per share metrics, including four percent on internally estimated proved plus probable reserves, and five percent on 2017 adjusted funds flow from operations and production per share, respectively.
STRATEGIC FIT WITH SURGE’S CORE SPARKY ASSETS
Production in Surge’s Sparky core area has increased 120 percent over the last 18 months, from 2,850 boepd to over 6,350 boepd (85 percent oil) today. Each of Surge’s core assets depicted below can be characterized as a high quality, low risk, operated, large OOIP, conventional sandstone reservoir.
To view, SURGE’S CORE SPARKY ASSETS, please visit the following link: http://media3.marketwire.com/docs/Sparkyarea.jpg.
SPARKY AREA – A CONVENTIONAL RESOURCE GROWTH ENGINE
Over the last 18 months, Surge has had better than anticipated success in growing the Company’s Sparky core area – turning its key producing Sparky asset base into a low cost, high netback, conventional resource growth engine. Over the past six months, Surge has completed two separate Sparky core area acquisitions, purchasing over 1,600 boepd (90% oil) combined, for approximately 5.0x forward adjusted funds flow from operations. The combination of these transactions, together with Surge’s highly successful development drilling program, have allowed the Company to amass an exciting core growth area with the following characteristics:
- Since mid – 2016, Surge has increased the Company’s internally estimated net OOIP in the Sparky core area to over 600 million barrels, and added more than 90 Surge internally estimated drilling locations (i.e. four additional years of Sparky drilling inventory at the Company’s current pace);
- Surge’s internally estimated proved plus probable oil reserves in the Sparky core area have grown 58 percent from 18 million boe (independently engineered 2015 Sparky area reserves), to an internal estimate of more than 28.6 million boe today;
- Production from Surge’s Sparky core area has increased by over 120 percent in the last 18 months from approximately 2,850 boepd to over 6,350 boepd today (85 percent oil);
- Today Surge has more than 250 internally estimated, low risk, Sparky area, development drilling locations – providing shareholders with a 10-year inventory of high rate of return (and excellent profit to investment ratio) locations at strip oil prices; and
- In addition, Surge is now experiencing significant economies of scale based upon regional dominance in this key growth area in terms of services, land, infrastructure, and existing production.
Management see’s further opportunity to both expand and consolidate Surge’s position in the Sparky core area, utilizing the following strategies: 1) organically grow through land acquisitions and follow-up development drilling; and 2) actively pursue, evaluate, and transact on accretive acquisitions of large OOIP, long life, low decline, conventional sandstone reservoirs.
At a land sale on July 19, 2017, Surge acquired five sections of prospective Sparky acreage. This newly acquired Crown land has existing vertical well control, and is directly adjacent to the Assets, as well as Surge’s existing Eyehill property. Surge has identified a minimum of 10 drilling locations on these lands, with full waterflood upside.
Additionally, at a recent land sale on September 27, 2017, Surge acquired 2.5 additional key sections of highly prospective Crown land at the Company’s core Lakeview and Eyehill assets. Surge estimates these lands have 11, low risk, development drilling locations, and full waterflood upside.
Further, in the last few weeks Surge has executed two strategic swap transactions to ‘top-up’ in the Company’s core Sparky lands.
Surge has now identified several distinct assets in its Sparky core area that will underpin growth for the foreseeable future. The Company’s key operated assets at Eyehill, Lakeview, Sounding Lake, Sounding Lake East, Betty Lake, Provost, and Macklin all possess multi-year development drilling inventories, exciting growth prospects, and waterflood upside.
The additional available room under the Company’s credit facility following the partial repayment of the outstanding indebtedness thereunder using the net proceeds of the Convertible Debt Financing will help facilitate Surge’s aggressive Sparky growth plan. Projects that have been identified include a seismic shoot and new battery at Betty Lake, a new battery at Sounding Lake East, and a battery expansion at Eyehill.
Early in Q4 2017 Surge conducted 3D seismic operations, and successfully drilled the Company’s first well, at it’s operated, 100 percent working interest, 80 million net barrels of internally estimated OOIP Sparky asset at Betty Lake.
Overall, the Company anticipates its Sparky core area to grow from 6,350 boepd currently, to over 10,000 boepd over the next three to four years.
CONVERTIBLE DEBENTURE FINANCING
Surge is pleased to announce that it has entered into an agreement with a syndicate of Underwriters, led by NBF pursuant to which the Underwriters will purchase $40.0 million principal amount of Debentures at a price of $1,000 per Debenture, on a “bought deal” basis.
The net proceeds from the Convertible Debenture Financing will be used to pay down a portion of the outstanding indebtedness under the Company’s revolving term credit facility.
The Debentures will mature and be repayable on December 31, 2022 (the “Maturity Date”) and will accrue interest at the rate of 5.75 percent per annum payable semi-annually in arrears on December 31 and June 30 of each year (each an “Interest Payment Date”), with the first such payment to be made June 30, 2018. The Company has the option to satisfy its obligation to repay the principal amount of the Debentures, in whole or in part, due on the Maturity Date upon at least 40 days’ and not more than 60 days’ prior notice, by delivering that number of freely tradable Common Shares obtained by dividing the principal amount of the Debentures by 95% of the volume weighted average trading price of the Common Shares on the TSX for the 20 consecutive trading days ending on the fifth trading day preceding the Maturity Date.
At the holder’s option, the Debentures may be converted into Common Shares at any time prior to the close of business on the earlier of the business day immediately preceding (i) the Maturity Date, (ii) if called for redemption, the date fixed for redemption by the Company, at a conversion price of $2.75 per Common Share, subject to adjustment in certain events (the “Conversion Price”). This represents a conversion rate of approximately 363.6364 Common Shares for each $1,000 principal amount of Debentures, subject to certain anti-dilution provisions. Holders who convert their Debentures will receive accrued and unpaid interest for the period from the date of the last Interest Payment Date prior to the date of conversion to the date of conversion. In addition to the foregoing, in the event of a change of control of the Company, subject to certain terms and conditions, holders of Debentures will be entitled to convert their Debentures and, subject to certain limitations, receive, in addition to the number of Common Shares they would otherwise be entitled to receive, an additional number of Common Shares per $1,000 principal amount of Debentures.
The Debentures will be direct, subordinated unsecured obligations of the Company, subordinated to any senior indebtedness of the Company, including the Company’s revolving credit facility, and ranking equally with one another and with all other existing and future subordinated unsecured indebtedness of the Company to the extent subordinated on the same terms.
The Debentures may not be redeemed by the Corporation prior to December 31, 2020. On or after December 31, 2020 and prior to December 31, 2021, the Debentures may be redeemed by the Corporation, in whole or in part, from time to time, on not more than 60 days and not less than 30 days prior notice at a redemption price equal to their principal amount plus accrued and unpaid interest, if any, provided that the volume weighted average trading price of the Common Shares on the TSX for the 20 consecutive trading days prior to the date on which notice of redemption is provided is not less than 125 percent of the Conversion Price. On or after December 31, 2021 and prior to the Maturity Date, the Debentures may be redeemed by the Corporation, in whole or in part, from time to time, on not more than 60 days and not less than 30 days prior notice at a redemption price equal to their principal amount plus accrued and unpaid interest, if any. Provided that, subject to certain conditions, the Company has the option to satisfy its obligation to repay the principal amount of the Debentures, in whole or in part, due upon redemption, by delivering that number of freely tradable Common Shares obtained by dividing the principal amount of the Debentures by 95% of the volume weighted average trading price of the Common Shares on the TSX for the 20 consecutive trading days ending on the fifth trading day preceding the date of redemption.
The Debentures will be offered in all provinces of Canada, by way of short form prospectus and in certain other jurisdictions as may be agreed by the Underwriters and the Company pursuant to prospectus exemptions. The Convertible Debenture Financing is expected to close on or about November 15, 2017 and is subject to certain conditions including, but not limited to, the receipt of all necessary approvals, including the approval of the Toronto Stock Exchange.
The Debentures offered, and the Common Shares issuable on conversion thereof, have not and will not be registered under the U.S. Securities Act of 1933, as amended (the “Act”), and may not be offered or sold in the United States absent registration or an applicable exemption from the registration requirements under the Act. This press release does not constitute an offer to sell or a solicitation of any offer to buy the common shares in the United States.
As a result of the Financing, Surge expects to have approximately $75 million of availability under its current credit facility (prior to receiving any lending value attributed to the Acquisition).
UPWARD REVISION TO 2017 EXIT GUIDANCE; PRELIMINARY 2018 GUIDANCE
Surge’s Q3 2017 production of 15,007 boepd again exceeded budgeted expectations, with only a small contribution from the Acquisition, which closed on September 8, 2017.
In the past six months, Surge has now completed two accretive, core-area acquisitions in the Company’s large OOIP core Sparky play; adding approximately 1,600 boepd of oil-weighted production. These two acquisitions have added more than 65 (net), internally estimated, highly-economic, low risk, development drilling locations to Surge’s large Sparky/Lloyd drilling inventory. Management forecasts that the development drilling on Surge’s acquired Sparky assets pursuant to the Company’s 2018 capital expenditure program, will reduce Surge’s corporate operating expenses from $13.73 per boe in Q3 2017, to $13.45 per boe in 2018.
The high quality, low decline, large OOIP Lakeview property that Surge acquired in April of 2017 had operating expenses of approximately $16.00 per boe at the time of acquisition. Today, following field optimization and the drilling of one excellent development well, management estimates that the operating expenses at Lakeview are under $12.00 per boe. Surge has 25 low risk additional development drilling locations at Lakeview, and waterflood upside.
Pursuant to the Acquisition, Surge is now revising upward the Company’s 2017 production exit rate from 15,150 boepd to more than 15,850 boepd. Surge has now revised upward the Company’s production estimates four times in the last 14 months.
In order to ensure the availability of fraccing services in the fall of 2017, Surge now plans to drill one additional (100 percent working interest) well this fall at its core, light oil asset at Valhalla – this well had originally been budgeted for drilling in Q1 2018. Further, the Company also plans to drill a Sparky well on the newly acquired Assets, prior to the end of 2017 for lease retention purposes. Consequently, budgeted capital expenditures for 2017 have now been increased from $89 million to $95 million.
Surge anticipates these two additional wells will come on production in early January of 2018. Consequently, production from these two wells is not reflected or included in the Company’s upwardly revised 2017 production exit rate guidance of 15,850 boepd.
Surge’s preliminary guidance for 2018 is set forth below:
|OPERATIONAL||US $55 WTI 2018 GUIDANCE3||US $65 WTI 2018 GUIDANCE4|
|2018 Average Production (boe/d)||16,150||16,150|
|2018 Exit Production (boe/d) (82 percent oil)||16,650||16,650|
|Total Capital Spending||$95 million||$95 million|
|Operating Expenses – 1H 2018 ($/boe)||$13.45/boe||$13.45/boe|
|Transportation Expenses ($/boe)||$1.50/boe||$1.50/boe|
|Royalties as a % of Revenue||13-14%||15-16%|
|Estimated 2018 Adjusted Funds Flow from Operations2||$121 million||$155 million|
|Estimated 2018 Adjusted Funds Flow from Operations per Share||$0.52||$0.67|
|Estimated Q4/18 Net Debt to Adjusted Funds Flow from Operations||1.8x||1.29x|
|Annualized Dividend||$22.1 million||$22.1 million|
|Simple Payout Ratio||18%||14%|
Key operational assumptions for Surge’s 2018 preliminary guidance are set forth below:
Capital Spending ($ mm)
Net New Well Count
- Corporate base decline is currently forecast internally at 23 percent.
- Corporate production efficiency (at $95 million capex/4,450boed) is $21,350/boed.
- 2018 estimates assume a cost escalator of approximately 6.5 percent over 2017.
OUTLOOK – SUSTAINABLE GROWTH, LONG TERM VALUE, AND INCOME
Management’s stated goal is to be the best positioned light/medium gravity crude oil growth and dividend paying public company in our peer group in Canada.
Over the last 16 months, Surge has now increased production per share by more than 24 percent, increased its dividend by nearly 27 percent, and upwardly revised production estimates four times – two times organically, and two times pursuant to accretive Sparky core area acquisitions.
The Company’s consistent production per share growth over the past five quarters has also led to significant increases in Surge’s unhedged adjusted funds from operations per share, which grew by 51 percent from Q2 2016 to Q2 2017.
Management attributes the Company’s continued quarterly operational outperformance to be a direct result of applying growth capital to Surge’s high quality, large OOIP, light and medium gravity crude oil, sandstone reservoirs for low risk development drilling, and successful waterflood implementation.
Management believes that Surge offers its shareholders a unique, multi-faceted, low risk, light and medium gravity crude oil investment opportunity as follows:
- Sustainable annual production per share growth of six to seven percent per year; plus
- Very high internal rate of return drilling locations – with very quick payouts (>10 year drilling inventory; >75 percent IRR at US $55 WTI flat pricing); plus
- Significant incremental long-term value from Surge’s large OOIP conventional reservoirs that have very high profit to investment ratio waterfloods (low risk drilling and waterfloods provide low harmonic declines, and deliver “annuity-type” annual reserve bookings); plus
- Current dividend yield over four percent through a sustainable, increasing, compounding dividend; plus
- Free cash flow yield (at US $55 WTI flat pricing); plus
- Significant financial leverage to higher oil prices; plus
- Significant upside for share price appreciation as Common Shares trade up to (and through) the net asset value of $5.47 per share calculated based on the Company’s December 31, 2016 independently estimated (Sproule) reserve report total proved plus probable value.
Surge will continue to grow its production base and location inventory in the Company’s three core areas – at Sparky, Shaunavon, and Valhalla – through, organic, low risk, development drilling, combined with strategic, high quality, core area acquisitions.