Gear Energy Ltd. is pleased to provide the following fourth quarter operating update and reserves summary to shareholders.
MESSAGE TO SHAREHOLDERS
The fourth quarter of 2020 provided continued recovery from the setbacks experienced earlier in the year as the result of an oil price war and a Covid-induced global economic downturn. After coming into the year with strong oil prices and an ambitious $50 million capital budget, the Gear team was quick to respond to the commodity price downturn by deferring both production and capital spending while waiting out the uncertainty. With a solid commodity price recovery having recently occurred, the Company is now well positioned to resume its strategies and planned activities to capitalize on its depth of opportunities.
Gear halted its drilling program in early March 2020 after only 9 wells, and in April, Gear materially reduced costs and was well on the way to shutting in and storing oil to preserve value through the low oil price period. Through these defensive moves, Gear was able to not only preserve, but also improve the economic foundation of the company. By the end of 2020, the Company restarted the majority of its shut-in production, sold stored oil at significantly higher prices and reduced outstanding net debt by over 24 per cent from year end 2019. In addition, Gear completed the semi-annual borrowing base redetermination of its syndicated credit facilities with a maturity extension to May 2022 and negotiated the extension of the outstanding convertible debentures to 2023. The drilling activity that was completed during 2020 included a combination of low-risk infill drilling, core area step-out drilling and the exciting first-well discovery of a new medium oil play in Provost, Alberta . with multi-well potential.
Gear's current $20 million capital budget for 2021 builds on the recent sector recovery and includes multiple follow up drilling and waterflooding activities to further advance upon prior year's success. Underpinning these operational activities, oil prices have increased significantly, with WTI moving up from US$35.79 per barrel on October 30, 2020 to today's price of over US$60 per barrel, a level not seen in well over a year. Heavy oil differentials also continue to narrow with the forward curve approaching a Western Canadian Select heavy oil differential of US$11 per barrel this summer. All of this has translated into a forecast of 2021 funds from operations ("FFO") that is more than twice the current guided 2021 capital expenditures.
Whereas 2020 was dominantly a defensive year of survival for many junior oil weighted producers, 2021 is shaping up to be a year of opportunity, where Gear should again have the option of balancing excess FFO towards multiple strategic directions including continued debt reduction, accelerated capital investment and associated growth or other returns to shareholders. Although the price recovery is still relatively recent (and we will continue to monitor it diligently), the Gear team is very excited and poised for the opportunity to refocus efforts again towards creating value for its shareholders in 2021 and beyond.
FOURTH QUARTER HIGHLIGHTS
• Generated FFO for the fourth quarter of $8.3 million or $15.41 per boe. With minimal capital expenditures, Gear decreased net debt by an additional $7.7 million to $52.9 million. Annualized quarterly net debt to FFO ratio was 1.6 times.
• Extended Gear's syndicated credit facilities maturity date to May 2022 with a current borrowing base of $65 million. Presently, Gear is drawn $48 million and anticipates having ample liquidity to execute the 2021 capital program.
• Successfully extended Gear's $13.2 million convertible debentures with a three year maturity date extension to November 30, 2023, an increase in the coupon rate from 4.0 per cent to 7.0 per cent and a revision to the conversion price from $0.87 to $0.32 per Gear common share.
2020 HIGHLIGHTS
• Generated $33.4 million of FFO or $17.24 per boe through a highly volatile commodity price year where WTI hit a historical low of negative US$37 per barrel in April 2020. FFO was supported by a continued focus on maximizing revenue for every barrel produced, maintaining a low cost structure and delivering record high realized gains on risk management contracts of $17.2 million.
• Posted year-end net debt of $52.9 million with a net debt to FFO ratio of 1.6 times for the year. This represents a substantial $16.9 million or 24 per cent reduction from year end 2019.
• Delivered production of 5,298 boe per day for 2020, hitting the upper end of the annual guidance range of 5,200 – 5,300 boe per day. Also achieved the lower end of the operating and transportation cost guidance of $17.00 – $18.00 with actual full year operating and transportation cost of $17.00 per boe. This was achieved through prudent operating practices and better than expected run-time on Gear's wells.
• Drilled nine gross (nine net) wells including seven heavy oil wells consisting of four single lateral wells in Paradise Hill, two multi-lateral wells in Lindbergh, and one single leg lined well in Frenchman's Butte, all in the Lloydminster area of Alberta; and two medium oil wells consisting of one multi-stage fractured well in Killam and one multi-lateral well in Provost, all in the east central area of Alberta. The Provost well was a discovery well in a new area on an eight section block of land. Gear anticipates significant future development potential with this discovery under both primary and secondary recovery schemes. Multiple new wells are planned to be drilled in Provost in 2021.
2021 OUTLOOK
• Through the first six weeks of 2021, Gear has successfully drilled eight heavy oil wells in Paradise Hill, with the first four of those wells being completed and already starting to show initial oil production. Gear anticipates drilling two more wells in Paradise Hill prior to shutting down for spring break up.
• Gear's budgeted capital program details were released on December 16, 2020 using an estimated WTI oil price of US$45 per barrel and a WCS differential estimate of US$14 per barrel. Those prices were expected to yield funds from operations in excess of capital and further reduce debt to contribute to Gear's already strong balance sheet. With the spot market WTI oil price now trending approximately $15 per barrel higher and WCS differentials tightening by over $2 per barrel, the newly forecasted funds from operations are well over double the current $20 million capital forecast. Details of current 2021 estimated results using existing guidance and various WTI price scenarios are as follows:
• Current forward strip pricing supports an estimated $46 million of FFO in 2021, yielding a forecasted $26 million of free FFO in excess of the current $20 million capital budget. This provides Gear with the ability to reduce outstanding debt through 2021. With continued market stability and the completion of the Spring credit facilities renewal, Gear will consider a return to growth through investment in its deep inventory of drilling across the three core areas, as well as the acceleration of decline-reducing waterflood opportunities in Killam and Wildmere.
• Through 2021, Gear plans to invest a total of $5.9 million towards abandonment and reclamation activities through a combination of $1.1 million of Gear funding and an additional $4.8 million of Government funding under the Site Rehabilitation Programs.
• Gear currently has hedged approximately 2,550 boe/d for 2021 under various structures of 3-way collars, enhanced swaps and swaps. The risk management program has been cultivated to provide both downside price protection along with participation to a WTI price recovery. The current hedge contracts protect approximately 53 per cent of forecasted production after royalties with details as follows:
YEAR END RESERVES EVALUATION
During 2020, Gear responded to the unprecedented commodity price weakness and volatility by curtailing its planned $50 million budget in early March. Gear generated $33.4 million of funds from operations in 2020 and reinvested only $13.4 million, or 40 per cent, consisting of $12.4 million of development capital and $1.0 million directed towards abandonment and reclamation activities (not including any government funding provided during the year). The limited capital investment resulted in a 24 per cent reduction in outstanding net debt at the expense of a decrease in annual production and reserves year-over-year.
Compounding the reduction in reserves as a result of declines, was a significant reduction in the evaluator average price forecast that negatively impacted net present values and reserves amounts due to economic limit cut-offs. New Canadian Oil and Gas Evaluation Handbook ("COGE Handbook") recommendations state that evaluator's price forecasts should now be within 20 per cent of the strip price forecast at year end. In this case, the average evaluator forecast for the WTI oil price was 2.4 per cent lower than the strip price for 2021, 7.3 per cent higher for 2022 and16 per cent higher for 2023. Although this evaluator forecast could have been considered reasonable at the time, the forecast for WTI is disjointed from prevailing market realities and is now over US$10 per barrel lower than the current forward strip for 2021 and does not achieve current spot price levels of approximately US$60 per barrel until the year 2029.
Consistent with 2019, and as per guidance in the COGE Handbook, the independent reserves report includes the full corporate abandonment and reclamation costs ('ARO'), including all of the ARO associated with both active and inactive wells regardless of whether such wells had any attributed reserves.
RESERVES SUMMARY
Year-end 2020 reserves were evaluated by independent reserves evaluator Sproule Associates Ltd. ("Sproule") in accordance with the definitions, standards and procedures contained in the COGE Handbook and National Instrument 51-101 Standards of Disclosure for Oil and Gas Activities ("NI 51-101"). A reserves committee, comprised of independent board members, reviews the qualifications and appointment of the independent reserves evaluator and reviews the procedures for providing information to the evaluators. The reserves evaluation was based on an average of price forecasts prepared by Sproule, GLJ Petroleum Consultants Ltd. and McDaniel & Associates Consulting Ltd. effective at January 1, 2021. Reserves included herein are stated on a company gross basis (working interest before deduction of royalties without inclusion of any royalty interests) unless noted otherwise. Additional reserves information required under NI 51-101 will be included in Gear's Annual Information Form to be filed on SEDAR on or before March 31, 2021.
FORECAST PRICES AND COSTS
Sproule has adopted changes to the COGE Handbook that are expected to come into effect in April 2021. This updated pricing guidance recommends that forecasting not deviate more than 20% from the current strip pricing for the first two years of the forecast. Discretion can be incorporated for the third year based upon the judgement of the issuer. Pricing beyond the third year should be adjusted by forecasted inflation in the given year.
The evaluator average crude oil and natural gas benchmark reference pricing, inflation, and exchange rates was utilized again this year by Sproule. Gear's main product components under Sproule's evaluator average forecast are down 26 to 28 per cent from the previous year's price forecast.
