According to alberta.ca, the government owns 81% of oil and gas resources in Alberta and collects royalties from companies when an oil or gas well or oilsands project is in production, and are a major source of revenue for the province.
At the recent CAPP Symposium, there was a panel titled Royalty Companies: Stable Business Models in Volatile Markets with David Spyker, President and CEO, Freehold Royalties Ltd., Andrew Phillips, President and CEO, PrairieSky Royalty Ltd., and Marty Staples, President, and CEO, Topaz Energy Corp.
The panel held an extensive and engaging conversation on various topics related to oil and gas royalties. The panelists described what level of free cash flow their business is expected to generate at current commodity prices and then when you look at that free cash flow how you go about setting your dividends.
They were asked if they like to be able to pay those dividends at certain commodity prices, seeing some dividend levels that move with commodity prices and their approach.
“We use free cash flow in production growth over the next three, five, and 10-year periods. So, we do see increased dividends over the long term, and even then the short, medium-term. When you talk about variable dividends versus fixed dividends, the companies with variable dividends have historically been rewarded. We think it’s a better approach to have a more predictable dividend that people can accept and be able to also have the added benefit of being able to cancel shares below intrinsic value with the excess free cash flow,” said Phillips.
“We looked at our dividend policy rate right now and we’re using a little lower than district pricing in our modeling right now with the $50 VTi. And so that $120 million of free cash flow that we generate, we’re paying $43 million of that back to shareholders through dividends or long term objective is 60% payout ratio and right now we’re below that.
“You know we identify in our portfolio carriers that we want to have that long-term stability and growth in our portfolio. We target acquisition work in the near term, to add those in. We may be a little bit more conservative in the dividend in the short term, but we do review it every quarter, based on your quarterly performance. You do routine dividend payment versus a variable type. I think our investors prefer that to the stability of the monthly payments, and they know what to expect each month,” Phillips added.
Staples was also asked about variables. “We’re also looking at stability via dividends. That’s something we’ve had a focus on, a little bit different between 60 and 90% payout ratio forecast at around 70%. We have $90 million of cash available right now, and no debt at all. We’re really trying to look at this growth ability in front of us. Once we get to that growth and deploy the capital to grow the business then look at the dividend increasing below that 60% payout ratio. As we continue to execute our growth strategy. I think you’re going to see an opportunity for us to increase fixed dividend, but we’re against that variable dividend I think, which makes it a little difficult for investors to predict anything and we want to make sure it’s stable with the other piece of our business also has that infrastructure piece and so we do think that protects our dividend and allows us not to have the commodity risk associated with it,” he said.
One of the uses of cash flow to dividends is acquisitions. The panel was asked to highlight what their acquisition strategy is. If you can maybe describe your last acquisition and now that kind of fit the criteria as well.
“Our latest acquisition was in the wheelhouse of what we do well, which is the mineral title. It’s over 600,000 acres and one of the parts of that base we really like is it’s in the deeper base and there are multi-stacked horizons, and we’re busy integrating that. The purchase price is just under $50 million, which, if you think of the terms of the free cash flow, it’s not even a full quarter of free cash flow before we have to pay that off. We look for IRR as well above our weighted average cost capital. We also want the undeveloped land, which represents the free optionality in the future, it looks more like our existing asset base, and then we also look for assets on the best parts of the cost curve and I think all three of us have been active in the Clearwater, and for that reasons, if they pay out it’s extremely fast and a self-funding play. Our acquisitions need to see the long-term returns of our council chairs, and that’s what we weigh every acquisition against,” Phillips added.
Adding more on approaching acquisitions and highlighting core plays that we want to be involved in and the focus is areas that they think are going to attract capital and continue growing over the next five to 10 years.
Staples: “As I mentioned before, we still have cash on the balance sheet to try and participate in this market and so we’re going to do that. We have $140 million of capital deployment over the next two and a half years that are going to help grow production so we really see a kind of growth inside and we have about 130% growth earmarked for Clearwater lands right now.
The panel transitioned to speaking on human resources as part of their business and the people they employ, and how they add value within the company, and what sort of key functions they perform.
“As we grow, we continue to add staff. This is a company that’s growing right and you’re going to continue to add people along the way, which are great things for us. We have a very good technical staff in our business development. Our company is led by Rob King and he’s put a dozen staff of land engineers and geologists together, and that focus has really been put together in the last year and a half or so they’re really two things that allow us to develop expertise to evaluate the US side of the business and to be looking for different types of opportunities on the Canadian side. We’ve certainly seen the benefit of that restructuring.”
“We also have a very well-staffed compliance team that helps us with identity and compliance. We’re trying to evolve that side of our business with the end goal of getting our lands developed and working with our drillers to make sure that it’s economic for them. It also becomes an important part of how we evaluate your next step,” Staples said.
Canada’s oil and gas sector has some of the highest standards in the world for both the environmental side and the customer.
“It’s always been an important part of the PrairieSky culture. We definitely think it’s a differentiator for us in all our leases we have environmental standards that need to be adhered to. We’re on the net-zero goal and path. We were recognized recently by an independent firm, Sustainalytics, the top energy company from an ESG standpoint and we are in the top 6% for all industries worldwide. That’s an impressive statistic so it’s very important for us and we continue to work hard on it and think it’s something that differentiates our company but also just the Canadian basin in general. We take it very seriously and I think that’s something that makes us different from a lot of other parts of the world when it comes to oil and gas production,” Phillips said.
As the panel concluded, Staples noted the growth of Topaz. “We have seen 45% growth in the company. We are in the growth phase of our company and we see lots of opportunity in front of us. We’re sticking to Canada and we think there’s a tremendous amount of opportunity in front of us in the Canadian basin right now.
“You get a bounce in the step around the office right now. Commodity prices sitting at that $60 level that makes everyone a lot happier. It’s nice to be able to be selective and targeted in the acquisition work that we want to do here to continue to enhance the asset base in our company. With the activity that we see and the outlook that we have for the company, we’re going to be able to grow organically for the first time in a couple of years,” Staples concluded.