PRESIDENT’S MESSAGE TO SHAREHOLDERS
I hope all of Pine Cliff’s shareholders and families are safe during these difficult times. I want to start by reassuring you that our staff has to date remained coronavirus (COVID-19) free. More than 2/3 of Pine Cliff’s staff are in our field operations. They have adjusted to working while social-distancing by adopting best practices for COVID-19 and we, as a management team, are impressed with their ability to continue to operate Pine Cliff’s well-sites during these times. The transition to working from the office to home for many of our head office staff has been impressively smooth, which has minimized disruptions.
The first quarter of 2020 for Pine Cliff had a promising start with the production performance of all three of our Pekisko oil wells continuing to outperform our internal expectations. This good news however was dampened by the fact that this past winter was the sixth warmest United States winter on record and as a result, natural gas prices were not as strong as they were in Q1 2019. This past quarter’s news however was dominated by the unprecedented collapse of crude oil and liquids prices due to global over-supply combined with demand destruction from the COVID-19. Despite the fact that 91% of our Q1 production volume was natural gas, those price drops had a material impact on our revenue and cash flow. These negative impacts however were mitigated to some degree by an increase in natural gas prices, which resulted in Pine Cliff still generating positive cash flow.
Highlights from Pine Cliff’s first quarter ended March 31, 2020 include:
• generated $1.2 million of adjusted funds flow for the three months ended March 31, 2020, despite the AECO 5A benchmark averaging only $2.02 per Mcf for the quarter;
• produced an average of 19,169 Boe/d (91% natural gas) in the three months ended March 31, 2020, a 2% increase compared to the same period in 2019; and
• tied-in production from the second of two Pekisko oil wells and one Edson oil well drilled in the fourth quarter of 2019.
Increase in Natural Gas Prices
The most positive development for natural gas producers has been the strong inverse relationship that the forward natural gas strip has taken to the WTI crude oil price. This development was accelerated at the end of this last quarter and has continued into the current quarter. On January 1, 2020, the forward strip price for AECO natural gas for 2020 and 2021 was $1.93/Mcf and $1.97/Mcf, respectively. As of this morning, those two prices are $2.59/Mcf and $2.64/Mcf. The primary force behind this move is the market view that the drop in crude oil prices will result in a dramatic drop in the natural gas that is produced with oil production, also referred to as associated natural gas. This perception appears to be moving to reality. At this time last year there were 1,050 oil and gas rigs operating in North America. Today there are 435. In addition, we are seeing large crude oil producers in both Canada and the United States curtail existing production rather than sell their products at a loss. Although we have not seen the full impact of these changes, the forward natural gas markets have risen on the expectation that the drop in associated gas supply will be greater than the natural gas demand loss caused by the COVID-19 pandemic. This dynamic is something we will be watching closely.
Reconnection of Canadian and US Natural Gas Markets
The other trend we are monitoring is the “reconnection” of the Canadian and American natural gas markets. Over the past few years, Canadian natural gas production was in a state of oversupply and lacked pipeline capacity creating a differential between the Canadian AECO price and the US NYMEX price that at times was over US$2.50/Mcf. With Canadian natural gas supply declining in 2019 for the first time in six years and TC Energy increasing Western Canada pipeline capacity, the differential has now narrowed to approximately US$0.60/Mcf. This important development is another reason why we are seeing the AECO natural gas price increase, based on the expected decrease of natural gas supply in the United States as its crude oil production declines.
Many of you will have read or heard about the various federal and provincial government relief programs that are being made available to the Canadian oil and gas sector. Pine Cliff has applied for the Federal Government’s Canada Emergency Wage Subsidy that if accepted would provide us with a subsidy of 75 percent of employee's wages (up to a maximum of $847 per employee per week) for up to eight weeks. Pine Cliff has also been working with oilfield service contractors to access the Alberta Site Rehabilitation Program to clean up inactive wells. We do not know whether our applications for these programs will be accepted but we will continue to assess all of Government programs as we are made aware of their details to see if it is appropriate for us to apply.
2020 has had the most volatile start to a year that Pine Cliff has ever experienced. Although Q2 and Q3 may still experience unpredictable moves in natural gas pricing, we have entered into physical sales contracts for approximately 40% of our natural gas production during those two periods. The increase in AECO forward pricing to levels we have not seen for several years has raised our optimism for increased cash flow for later in 2020 and into 2021. At this time we do not have any material fixed price contracts beyond Q3 2020.
With the AECO natural gas strip price currently at $2.64/Mcf for 2021, our operations team is beginning to refocus on economic capital programs that will allow Pine Cliff to grow within its cash flow while also starting to pay down term debt that does not become due until 2022. If we experience a crude oil price recovery in 2021, we will consider drilling more Pekisko oil wells, but we know there will be competition for our excess capital from potential asset acquisitions and internal natural gas recompletion and drilling opportunities. As always, our capital decisions will be based on where our team thinks we can achieve the greatest return on our investments for our shareholders.
Thank you for your continued support as shareholders and stay safe. We look forward to updating you on our progress as we navigate through these chaotic times.
President and Chief Executive Officer
May 6, 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.