PRESIDENT’S MESSAGE TO SHAREHOLDERS
After a strong first quarter, the second quarter of 2019 was challenging with AECO 5A natural gas pricing averaging $1.03 per Mcf, the lowest quarterly average in decades. Pine Cliff prides itself on being a low cost operator. We continue to take steps to further reduce costs and adjust our sales points to somewhat offset lower AECO prices, however, despite these efforts, the second quarter of this year resulted in negative funds flow for only the third quarter in the past 29 quarters. Significant highlights from Pine Cliff’s second quarter were:
- realized $1.69 per Mcf gas price for the three months ended June 30, 2019, 43% higher than the AECO 5A benchmark of $1.03 per Mcf;
- realized $2.27 per Mcf gas price for the six months ended June 30, 2019, 24% higher than the AECO 5A benchmark of $1.82 per Mcf;
- closed an acquisition of oil and natural gas assets in the Ghost Pine area of Central Alberta for cash consideration of $8.6 million (after estimated closing adjustments) on May 31, which added over 1,600 Boe/d as of the closing date and increased the Company’s Pekisko oil locations to 28 gross (27.0 net) from eight gross (six net);
- issued 14,492,754 flow-through common shares at a price of $0.276, resulting in gross proceeds of $4.0 million;
- issued 6,215,652 common shares at a price of $0.23 per share for gross proceeds of $1.4 million, of which $550,000 was from Pine Cliff directors and officers; and
- exited the quarter with $7.9 million of cash in the bank and no bank debt.
Last year, we drilled our first Pekisko oil well in Central Alberta and it continues to exceed our expectations. In its first 180 days, it has produced 325 Boe/d, consisting of 190 Bbl/d of oil and natural gas liquids along with 810 Mcf/d of gas and generated approximately $1.7 Million of adjusted funds flow. The cost of this well to drill, complete and tie in was approximately $3.0 Million, with projected payback of approximately 14 months based on current strip pricing. Subject to commodity prices, Pine Cliff plans on drilling at least one more Pekisko oil well in the fourth quarter of 2019.
Industry/Government Initiatives Involving Shallow Gas Producers
The new administration of the Alberta Government has recognized the importance of a strong natural gas industry to Alberta’s future and has been working with Pine Cliff and other natural gas producers to find solutions to some of the issues facing natural gas producers today. The government appointed an Associate Minister of Natural Gas for the first time ever and has since announced an approximate 35% reduction in property taxes paid on certain shallow gas wells and pipelines. The tax reduction is not a rebate but an adjustment recognizing that the Alberta municipal tax assessment system for natural gas assets is not equitable given the current asset valuations in the marketplace. We do not yet know how much this change in municipal taxation will impact Pine Cliff. For reference though, last year we paid approximately $12 million in property taxes based on a total assessed value of our Pine Cliff assets of over $650 million. That assessed value is six times our current enterprise value (market capitalization plus net debt) of approximately $110 million. The government is undertaking a review of the municipal tax assessment system and we are optimistic that they will arrive at a permanent structure that is more equitable to shallow gas producers.
The Government of Alberta is also involved in other discussions with natural gas producers and pipeline companies to attempt to strengthen the competiveness of the Alberta natural gas industry. Although we cannot predict the outcome of these discussions, I can comment that the change in the Alberta Government has resulted in more constructive discussions with natural gas producers than with the previous administration. I believe that the current Government understands that the health of the Alberta natural gas industry is important, not just to participate in the impending growth of LNG, continued oil sands expansion and the coal-to-gas shift in power demand on the horizon, but also for provincial revenues. In the 2005-2006 fiscal year, natural gas royalties contributed over $8.4 Billion to the Alberta Government. In the 2018-2019 fiscal year, this number had been reduced by 94% to just over $0.5 Billion.
The third quarter of 2019 has started out with the similar volatility in AECO pricing that we have experienced in the past two summers. During the six day period from July 21st to the 26th, AECO average daily prices moved from $0.18 per Mcf to $2.01 to $0.03 to $1.45. Owning and operating critical infrastructure and pipelines during these volatile periods has allowed us to modify our sales points between AECO and the Saskatchewan TEP market on short notice to maximize revenue.
Cooler temperatures in Q1 2019 contributed to higher natural gas prices and thus higher Pine Cliff revenue, but another advantage to the colder weather was the reduction in Western Canadian gas storage levels. When you combine those weather impacts with the reduced producer capital expenditures and reduced field receipts in Western Canada, the result was that Canadian natural gas storage levels at the end of July 2019 were approximately 60 Bcf (20%) less than July 2018. This is another indicator that natural gas prices could have a similar or higher trajectory as last winter when we experienced higher natural gas prices than strip pricing had predicted in the summer of 2018.
US LNG growth has been impressive over the past three years, hitting a high of 6.4 Bcf/d on July 19, 2019. LNG development in Canada has also deservedly attracted significant headlines in the past six months. We think that these developments, along with projected increases in oil sands growth, new petrochemical facilities and coal-to-gas shifting in Alberta bode well for natural gas producers who will be asked to increase production at unprecedented levels to meet this growing demand in the upcoming years.
With another quarter of low AECO prices, it is not easy to stay optimistic, especially when the natural gas industry is dealing with its current stresses, but we remain confident that our business model is built for longevity. We have no bank debt today and we have seen several positive developments in the Western Canada natural gas industry in the last few months. Pine Cliff management believes our company is well positioned to reap the benefits of these encouraging changes. We will continue to manage our balance sheet as we navigate the company closer to what we feel will be a more robust natural gas marketplace in Western Canada. We thank you for investing with us and you can be assured that we will continue to look at ways to strengthen our business to ensure long term shareholder value.
President and Chief Executive Officer
August 6, 2019
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.