PRESIDENT’S MESSAGE TO SHAREHOLDERS
Despite all the negative news these days regarding OPEC oil supply, pipeline protests, politics and the coronavirus, I am pleased to advise you that I am more positive on the Canadian natural gas business than I have been for some time. Notwithstanding that we experienced one of the lowest AECO natural gas pricing environments in 20 years during the summer of 2019, Pine Cliff made significant strides in meeting its long-term goal of enhancing shareholder value. During this past turbulent year, Pine Cliff generated positive adjusted funds flow, added to its inventory of Pekisko oil drilling locations, extended the maturity on its debt and raised equity to fund the development of its Pekisko oil play.
Highlights from Pine Cliff’s fourth quarter and year ended 2019 were:
- generated $5.0 million of adjusted funds flow ($0.02 per basic share) for the three months ended December 31, 2019 and $5.9 million of adjusted funds flow ($0.02 per basic share) for the year ended December 31, 2019;
- realized a $2.15 per Mcf gas price for the year ended December 31, 2019, 23% higher than the AECO 5A benchmark of $1.75 per Mcf;
- closed an acquisition of oil and natural gas assets in the Ghost Pine area of Central Alberta for cash consideration of $8.8 million (after closing adjustments) on May 31, 2019, which added over 1,600 Boe/d (79% natural gas, 12% natural gas liquids and 9% oil) as of the closing date and increased the Company’s undeveloped Pekisko oil locations as at December 31, 2019 by eight gross (8.0 net) booked locations;
- exchanged its $49.0 million subordinated promissory notes for term debt, and extended $42.0 million of debt originally expiring in 2020 to December 31, 2024; and
- drilled and completed two 100% working interest Pekisko oil wells that came on production in December 2019 and January 2020, respectively.
Strengthening of the Balance Sheet and Adding Oil Drilling Inventory
When I reflect on the accomplishments that our team achieved in 2019, the two that stand out the most for me were first, the refinancing of our debt and second, completing a financing and acquisition which added significant economic oil drilling inventory. Both of these events were achieved as a result of our unique shareholders.
It cannot be underestimated how important it was for Pine Cliff to refinance and extend its debt. I have never seen access to capital as constrained as it is right now in our industry, and having debt mature during a low part of the commodity cycle is extremely problematic when capital is constrained. What is quite unique about Pine Cliff is that all of our debt is held by major shareholders (AIMCo, the Chairman of our Board and a third party shareholder who owns more than 10% of our stock), all of whom believe that investing in a natural gas business will provide a good rate of return for years to come. The investment industry likes to use simple ratios to rank and judge companies, but having stakeholders who are willing to extend debt during one of the lowest natural gas price cycles we have ever experienced, does not show up in any ratio or analytic. In addition, to have those same stakeholders, in a year like we just experienced, step up and acquire more Pine Cliff stock alongside management to complete a key strategic acquisition, is a strong testament to the belief they have in our business model. I want to personally thank those partners on behalf of all of our shareholders. Their conviction in our business has made us stronger during a difficult period when others in our industry have been less fortunate.
I have been asked by shareholders whether we are changing our “story” with the oil drilling in late 2018 and in 2019. My short answer is no. We have always run Pine Cliff as owners, and therefore we look to use any excess cash flow where we think the most value can be created. In the early years at Pine Cliff, we felt that building our low decline natural gas production assets was the best use of our resources, so we completed eight transactions from 2012 to 2015 to grow from 100 Boe/d to ~24,000 Boe/d. In 2016 and 2017 we encountered weak natural gas prices, so we pivoted to focus on debt reduction as we lowered our net debt position from $141.8 million at the end of 2015 to $56.8 million at the end of 2018. In late 2018, we drilled our first Pekisko oil well and based on its success, we capitalized on an acquisition opportunity in early 2019 to add significant oil drilling inventory at an attractive price. Our production is still 91% natural gas, and we still believe that producing natural gas will deliver significant value to our shareholders in the coming years, but in the interim, our oil and liquids production in 2019 contributed to 21% of our revenue. By increasing our oil and liquids production and inventory in the past two years, we have improved the sustainability of our business and added more flexibility to where we can maximize value for future capital allocation. We have tentatively planned to drill another oil well in late 2020, but we will only do so if that is the best use of those funds at that time.
There are several major items that are the basis for my cautious optimism. First, 2019 was the first time in six years that Western Canada natural gas production declined. Second, despite a warm winter to date, Western Canada natural gas storage levels are still hitting new five year lows, which is another positive piece of news for Western Canada natural gas producers. Thirdly, the implementation of TC Energy’s Temporary Service Protocol (TSP) in October 2019 was invoked to reduce price volatility, and to date, it appears to be having the desired impact as summer forward prices are currently more than 50% higher than the summer 2019 prices we experienced. And fourthly, a weakening global oil price will reduce US drilling, which in turn will reduce natural gas supply. The single biggest source of natural gas production growth in the US last year was associated gas from oil drilling. These four events are all important steps to bringing our supply/demand dynamic back to a level where prices should show less volatility and have the ability to strengthen.
2020 also brings us another year closer to the projected startup of the LNG Canada project in 2024. Although I am sure there will be more hurdles to jump before Canada is able to join the growing number of global LNG suppliers, I am optimistic that our Canadian natural gas will play a vital role in reducing global emissions.
2020 will not be an easy year for Pine Cliff. We continue to challenge our team to lower operating costs while at the same time maintaining or even raising our level of safety and protection of our environment. Our goal is not just to survive through these difficult times, but improve and come out stronger than ever. Thank you for your patience as our shareholders and we hope that it is of some comfort to you that we are continuing to work every day to strengthen our business and ultimately improve our long term shareholder returns.
President and Chief Executive Officer
March 11, 2020
Please refer to the Management’s Discussion and Analysis for Reader Advisories regarding forward-looking information, non-GAAP measures and oil and gas measurements and definitions.