PRESIDENT’S MESSAGE TO SHAREHOLDERS
Our management team enters 2019 more optimistic about Pine Cliff’s outlook than we have been in a couple of years. Our natural gas market diversification strategy was successful in generating positive funds flow in 2018 despite enduring the lowest AECO natural gas prices in the past 19 years, and 2019 natural gas prices have started this year at materially higher levels than we experienced at this time last year. We were also able to use our extensive seismic database to expand our prospect inventory by identifying a number of operated, drilling locations on our existing land base. On the macro side, LNG Canada announced in the last quarter of 2018 that it will be proceeding with a $40 billion LNG project in Western Canada that will initially export two Bcf per day of Western Canada gas. This project is one of Canada’s largest infrastructure projects ever undertaken and will play a significant role in addressing the issue of getting Canadian natural gas to the world. Other significant Pine Cliff highlights from the fourth quarter and 2018 include:
• generated $4.4 million of adjusted funds flow ($0.01 per basic share) for the three months ended December 31, 2018;
• generated $10.5 million ($0.03 per basic share) of adjusted funds flow during the year ended December 31, 2018;
• realized a $2.51 per Mcf gas price for the three months ended December 31, 2018, 44% higher than the AECO 5A benchmark of $1.74 per Mcf;
• realized a $2.07 per Mcf gas price for the year ended December 31, 2018, 34% higher than the AECO 5A benchmark of $1.54 per Mcf;
• achieved average production of 19,684 Boe/d (94% natural gas) in 2018, only 8% lower than the 21,408 Boe/d in 2017, despite incurring only $6.5 million of drilling and recompletion capital spending in 2018, over half of which was spent in the fourth quarter of 2018 with no corresponding increase in production from that specific spend until 2019;
• completed a private placement of $19 million of term debt to Alberta Investment Management Corporation and extended $12 million of insider debt to 2020 to eliminate $18 million in bank debt, ending 2018 with $3.6 million in cash; and
• drilled and completed a 100% working interest horizontal oil well that was successfully brought on production in January, 2019.
Capital Allocation/Operations Update
Since 2012, Pine Cliff has grown by acquisitions as we have historically been able to purchase existing production at more accretive metrics than growing organically. In 2018, our team focused on identifying growth opportunities within our Central Alberta land base using the 420 square kilometers of 3D and 813 kilometers of 2D seismic we own or license in the area. This work resulted in Pine Cliff drilling our first horizontal oil well (100% working interest) targeting the Pekisko formation which came on production on January 14, 2019. Although the well was initially restricted for the first 14 days, it flowed at an average rate of 410 BOE/d for the first 30 days of production, consisting of 238 Bbl/d of 30 degree API oil and 940 Mcf/d of raw natural gas. This well produced at an average rate of 390 Boe/d (63% oil and NGLs) for the first 57 days of production.
The Pine Cliff team currently estimates that there are approximately 19 gross (15.8 net) Pekisko and Basal Quartz oil well locations on our Central Alberta lands that would be economic to drill at today’s commodity strip pricing, with 3 (2.5 net) of these locations booked in our Reserve Report prepared by McDaniel & Associates Consultants Ltd at December 31, 2018. We own extensive infrastructure, operations and seismic in Central Alberta and we will continue to evaluate further development and acquisition potential in this area.
I think the success of this well is yet another example of how Pine Cliff has focused on optimizing the allocation of capital to create value for our shareholders. We have built a business that has consistently generated positive cash flow in volatile commodity price environments and our entire company views our job as allocating excess cash to the areas of our business where we think it can deliver the greatest return. Between 2012 and 2015, we felt that growth by acquisition was the best use of capital. When natural gas prices dropped in 2016 through 2018, we pivoted and focused on diversifying Pine Cliff’s natural gas markets with our internal infrastructure, strengthening our balance sheet by reducing our $156 million in bank debt to zero and bringing in strong equity partners to hold Pine Cliff’s term debt. In 2019, we will continue to evaluate acquisition opportunities as well as opportunities to generate value on our existing lands through more drilling activity, all while maintaining a strong balance sheet. We believe that adding the option of oil drilling does not alter our value creation strategy in any way, but instead upgrades our portfolio of capital allocation options to generate positive returns. The fact that we were able to successfully deploy resources in such diverse areas of the energy industry in the past seven years is an affirmation of Pine Cliff’s “bench strength” and I would like to commend each of our team members who have been involved in these initiatives.
Natural Gas Outlook
Many areas of Western Canada have just experienced the coldest February in 40 years. In February, Pine Cliff achieved realized natural gas prices over $3.00 per Mcf and storage inventories in Canada are 21% lower than we saw at this time in 2018. Unfortunately, with the cold weather we also experienced well freeze offs that impacted our production, but that is a trade we will always take. With the cold weather this past winter, natural gas storage in North America is currently below the five year average storage levels in both the United States and Canada, all at a time when the US is set to double their LNG export capacity from less than four Bcf/d to over eight Bcf/d. It appears it could be another volatile year in natural gas prices, but forward strip pricing currently indicates it should be a better year for natural gas prices than in 2018, which would translate to extra cash flow for Pine Cliff.
Thank you again from the Pine Cliff team for your patience as our shareholders and be assured that we will continue to do everything we can to build long term value in your investment in our company.
President and Chief Executive Officer
March 13, 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.