CALGARY, May 16, 2016 /PRNewswire/ - PENN WEST PETROLEUM LTD. (TSX – PWT; NYSE – PWE.BC) ("Penn West", the "Company", "we", "us" or "our") is pleased to announce its financial and operational results for the first quarter ended March 31, 2016. All figures are in Canadian dollars unless otherwise stated.
President's Message
During the first quarter of 2016, we continued to ride the momentum built in 2015 to deliver strong production volumes and execute on approximately $230 million of asset dISPositions. Our operational performance exceeded expectations, as the initiatives completed over the last several years to improve production reliability and lower costs are being realized. We continue to work on capitalizing on our operational progress to date and strengthening our financial position for the future.
During the first quarter, operating results were better than anticipated with average production of 77,010 boe per day. The production was led by the continued strong performance in Cardium and Viking wells drilled in the fourth quarter. Additionally, our ongoing FOCus on reducing our costs and better run times through improved field operations across our asset base allowed us to economically produce volumes that had been earmarked for shut-in at budget time. These positive results demonstrate the effects of our streamlined culture that is focused on safety and operational excellence.
In the first quarter we entered into agreements for the sale of the Slave Point area, with associated 2016 production of 3,900 boe per day, for total proceeds of approximately $148 million, subject to closing conditions. We also disclosed the sale of other non-core assets for total proceeds of approximately $80 million, subject to closing conditions. Since the beginning of last year, we have now raised over $1 billion in CASh proceeds from our disposition program.
We are engaged in discussions with our lenders to ensure that we have the necessary access to capital for the remainder of 2016 and beyond. These discussions are ongoing and we are targeting to have agreements with our lenders amending our financial covenants signed prior to the end of the second quarter. These amendments would be a key milestone and allow us to continue to focus on strengthening our balance sheet and reducing our debt levels.
The first quarter operating and general and administrative ("G&A") costs came in significantly under expectations at $13.02 per boe and $1.97 per boe, respectively. These cost savings are a result of several successful cost reduction initiatives, further re-alignment of our staff for anticipated activity levels and higher production. We also benefited from a lower than anticipated cost environment which meaningfully reduced costs in the last four months of 2015 below our accruals. We believe we are on track to meet our target to reduce our absolute operating costs by approximately 20 percent on a year over year, same field basis, which excludes the impact of dispositions, and to reduce our annual G&A costs by a further $15 to $20 million from the prior year.
During the first quarter we experienced the lowest crude oil and natural gas prices in over a decade. We were able to reduce the effect of this low pricing environment with our hedging program. We had approximately 25 percent of our crude oil production hedged at $73 per barrel and 15 percent of our natural gas production hedged at $3 per mcf. This program resuLTEd in a $5.75 per boe increase to our corporate netbacks.
As a result of our operational performance in the first quarter, we are updating our 2016 full year guidance metrics. Our annual production guidance remains unchanged at 60,000 - 64,000 boe per day despite A&D activity announced year to date. We now expect our operating costs for the year to be between $17.00 - $18.00 per boe, down from $18.00 - $18.75 per boe. Our G&A target is unchanged for the year between $2.50 - $2.90 per boe.
Financial and Operational Highlights
Select Metrics in Core Areas
The table below outlines select metrics in our core areas for the three months ended March 31, 2016 and excludes the impact of hedging:
Operated Development Activity
Viking and Cardium
During the first quarter, Viking and Cardium activity was limited to completing and bringing on production from previously drilled wells with 21 wells and five wells brought on production, respectively.
In the Dodsland area of our Viking play, continued application of the 12 ton, 12 stage completion technique on the one-half mile laterals allowed additional cost reductions to be realized. Of the 21 wells brought online in the first quarter, eight were drilled and completed utilizing a one mile wellbore design, with the stabilized wells exhibiting production performance to date that is in excess of their respective type curves. We believe that this application of the one mile lateral design on our high-graded reservoir acreage will result in a reduction of our go-forward finding and development costs by 30 percent. We will continue to monitor the performance of these wells, but currently anticipate implementing this design, where supported by our land position, as we move forward with the expansion of our Viking play.
In the Cardium, we brought one well on production in the Crimson area and four wells in the J-lease area in the first quarter. Our Crimson wells drilled in the fourth quarter of last year continue to exceed expectations with production well above type curve. Waterflood implementation and design work is proceeding in our Crimson area.
Our current J-Lease program, including the wells brought on production in the second half of last year, continues to exceed our expectations with strong performance and low decline rates. Last year, our J-Lease program was impacted by infrastructure constraints in the area as we experienced several gas gathering line failures which restricted our production volumes. Accordingly, in the first quarter we replaced seven kilometers of the Station 8 pipeline to improve the reliability of the gas gathering system. This project was completed under budget and significantly ahead of schedule. The pipeline has generated positive results by increasing oil production by approximately 1,000 boe per day post repair, with several fourth quarter 2015 wells still being optimized.
In our J-Lease area, we continue to experience improved well performance as we moved from an open hole to a cemented sleeve liner system with slickwater fractures. We expect that the cemented liner system will improve waterflood performance and project economics through greater water injection control.
Peace River Oil Partnership ("PROP")
In collaboration with our joint venture partner, we are running a two rig program in the Peace River area this year. In the first quarter we drilled seven wells (3.9 net) and brought 10 wells (5.5 net) on production.
Over the past year we have improved our drill, complete, equipping and tie-in process consequently achieving significant improvements in cycle times. We have improved our spud to first production cycle time from 90 days to 14 days primarily through improved simultaneous operations. These changes have resulted in per well savings of approximately $1 million.
Approximately 90 percent of our working interest expenditures continue to be paid for by our partner in the PROP joint venture.
The table below provides a summary of our operational activity during the first quarter:
Senior Secured Debt
We continue to remain in compliance with all our financial covenants at March 31, 2016, including the Senior Debt to EBITDA covenant that was 4.4 times, relative to a 5.0 times limit. If the current low commodity price environment continues, we anticipate that we will not be able to certify, following the end of the second quarter, compliance with the Senior Debt to EBITDA or Total Debt to EBITDA financial covenants at June 30, 2016. We are engaged in discussions with our lenders with a view to entering into agreements to amend these financial covenants prior to the end of the second quarter of 2016, which if successful will mitigate the risk of default. In order to reduce the risk of default, we will continue to pursue our strategy of reducing absolute debt levels through further dispositions of assets and we will also continue to consider other options such as pursuing additional sources of capital from strategic investors. However, as there is a risk that the Company will not be in compliance with its financial covenants at the end of the second quarter of 2016 and there is no guarantee that the Penn West will be successful in negotiating amended financial covenants with its lenders or in pursuing other options, there is a risk of default under the Company's bank facility and noteholder agreements. This has resulted in uncertainty on the Company's ability to continue as a going concern.
The table below outlines the calculation of our Senior Debt to EBITDA covenant as at the end of the first quarter:
Updated Hedging Position
Our hedging program continues to help reduce the volatility of our funds flow from operations, and thereby improve our ability to align capital programs going forward. We target having hedges in place for approximately 25 percent to 40 percent of our crude oil exposure, net of royalties, and 40 percent to 50 percent of our gas exposure, net of royalties in the current year. We have not layered on additional hedges in response to low commodity prices experienced in the first quarter and preceding negotiations with lenders.
Our positions as of March 31, 2016 are as follows:
Updated 2016 Guidance
We have reduced our operating expense guidance to $17.00 - $18.00/boe from $18.00 - $18.75/boe. Annual average production guidance remains unchanged despite dispositions announced year to date.
Our guidance for 2016 is as follows:
This guidance does not reflect any potential disposition activity.
We continue to focus our operational strategy based on current commodity price levels. Despite this focus, we believe our enterprise continues to offer significant torque to a potential recovery in oil prices as outlined in the following table:
All caSES assume average 2016 AECO price of C$2.45 per mcf and average 2016 FX of C$1.45/US$.
Conference Call and WebCAST DetaILS
A conference call and webcast presentation will be held to discuss our first quarter results at 9:00am MT (11:00am ET) on Monday, May 16, 2016.
To listen to the conference call, please call 647-427-7450 or 1-888-231-8191 (toll-free). This call will be broadcast live on the Internet and may be accessed directly at the following URL:
http://event.on24.com/r.htm?e=1185677&s=1&k=A0F472C7FAE5BBF7AD9D98F70F69BAD8
Additional Reader Advisories
Oil and Gas Information Advisory
Barrels of oil equivalent ("boe") may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of crude oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Given that the value ratio based on the current price of crude oil as compared to natural gas is significantly different from the energy equivalency conversion ratio of 6:1, utilizing a conversion on a 6:1 basis is misleading as an indication of value.
Non-GAAP Measures
This news release includes non-GAAP measures not defined under International Financial Reporting Standards ("IFRS") including funds flow, funds flow from operations, funds flow per share-basic, funds flow per share-diluted, funds flow from operations per share-basic, funds flow from operations per share-diluted, netback, EBITDA and gross revenues. Such terms are explained under the heading "Non-GAAP Measures" in the attached Management's Discussion and Analysis. Non-GAAP measures do not have any standardized meaning prescribed by GAAP and therefore may not be comparable to similar measures presented by other ISSuers.
Forward-Looking Statements
Certain statements contained in this press release constitute forward-looking statements or information (collectively "forward-looking statements") within the meaning of the "safe harbour" provisions of applicable securities legislation. Forward-looking statements are typically identified by words such as "anticipate", "continue", "estimate", "expect", "forecast", "budget", "may", "will", "project", "could", "plan", "intend", "should", "believe", "outlook", "objective", "aim", "potential", "target" and similar words suggesting future events or future performance. In addition, statements relating to "reserves" or "resources" are deemed to be forward-looking statements as they involve the implied assessment, based on certain estimates and assumptions, that the reserves and resources described exist in the quantities predicted or estimated and can be profitably produced in the future. In particular, this document contains forward-looking statements pertaining to, without limitation, the following: under "President's Message", continuing to work on capitalization on operational progress to date and strengthening our financial position for the future, the positive results in Cardium and Viking demonstrate the effect of our streamlined culture that is focused on safety and operational excellence, targeting to have agreements with our lenders amending our financial covenants signed, that the amendments would be a key milestone and allow us to continue to focus on strengthening our balance sheet and reducing debt levels, our belief that we are on track to meet our target to reduce our absolute operating costs by approximately 20 percent on a year over year, same field basis, which excludes the impact of dispositions, and will reduce our annual G&A costs by a further $15 to $20 million from the prior year, maintaining or updating our 2016 full year guidance metrics (including annual production range, operating cost and G&A cost ranges per boe); under "Financial and Operational Highlights", maintaining our 2016 average production target, updating our operating cost per boe range, maintaining total expenditures guidance for 2016, maintaining G&A per boe range given that we anticipate lower production volumes later in the year; under "Operated Development Activity", the belief that the application of the one mile lateral design on our high-graded reservoir acreage will result in a reduction of our go-forward finding and development costs by 30 percent, continuing to monitor the performance of the wells in the Dodsland area and anticipating implement the lateral design, where supported by our land position, as we move forward with the expansion of our Viking play, continuing to experience improved well performance as we moved from an open hole to a cemented sleeve liner with slickwater fractures, the expectation that the cemented liner system will improve waterflood performance and project economics through greater water injection control; under "Senior Secured Debt", anticipating that we will not be able to certify following the end of the second quarter of 2016 if current low commodity price environment continues, compliance with the Senior Debt to EBITDA or Total Debt to EBITDA financial covenants at June 30, 2016, entering into amending agreements to amend the financial covenants prior to the end of the second quarter of 2016, which if successful will mitigate the risk of default, reducing the risk of default by continuing to pursue our strategy of reducing absolute debt levels through further dispositions of asset and considering other options such as pursuing additional sources of capital from strategic investors, the possible risk of default under the Company's bank facility and noteholder agreements and the resulting uncertainty on the Company's ability to continue as a going concern; under "Updated Hedging Positions", that our hedging program continues to help reduce the volatility of our funds flow from operations, and thereby improve our ability to align capital programs going forward, targeting certain hedges to be in place for our crude oil and gas exposure; under "Updated 2016 Guidance", the update or maintaining of the range for the annual average production guidance, liquids weighting, capital and decommissioning expenditures and expectations for our operation and G&A cost ranges, continuing to focus our operational strategy based on current commodity price levels and our belief that our enterprise continues to offer significant torque to a potential recovery in oil prices.
The forward-looking information is based on certain key expectations and assumptions made by Penn West, including expectations and assumptions concerning: prevailing and future commodity prices and currency exchange rates; applicable royalty rates and tax laws; interest rates; future well production rates and reserve volumes; operating costs; the timing of receipt of regulatory approvals; the performance of existing wells; the success obtained in drilling new wells; anticipated timing and results of capital expenditures; the sufficiency of budgeted capital expenditures in carrying out planned activities; the timing, location and extent of future drilling operations; the successful completion of acquisitions and dispositions; the availability and cost of labour and services; the state of the economy and the exploration and production business; the availability and cost of financing; and ability to market oil and natural gas successfully.
Although Penn West believes that the expectations and assumptions on which such forward-looking information is based are reasonable, undue reliance should not be placed on the forward-looking information because Penn West can give no assurances that they will prove to be correct. Since forward-looking information addresses future events and conditions, by its very nature it involves inherent risks and uncertainties. Actual results could differ materially from those currently anticipated due to a number of factors and risks. These include, but are not limited to: the risks associated with the oil and gas industry in general such as operational risks in development, exploration and production; the possibility that we breach one or more of the financial covenants pursuant to our amending agreements with the syndicated banks and the holders of our senior, unsecured notes; delays or changes in plans with respect to exploration or development projects or capital expenditures; the uncertainty of estimates and projections relating to reserves, production, costs and expenses; health, safety and environmental risks; commodity price and exchange rate fluctuations; interest rate fluctuations; marketing and transportation; loss of markets; environmental risks; competition; incorrect assessment of the value of acquisitions; failure to complete or realize the anticipated benefits of acquisitions or dispositions; ability to access sufficient capital from internal and external sources; failure to obtain required regulatory and other approvals; reliance on third parties; and changes in legislation, including but not limited to tax laws, royalties and environmental regulations. Readers are cautioned that the foregoing list of factors is not exhaustive.
Additional information on these and other factors that could affect Penn West, or its operations or financial results, are included in the Company's most recently filed Management's Discussion and Analysis (See "Forward-Looking Statements" therein) , Annual Information Form (See "Risk Factors" and "Forward-Looking Statements" therein) and other reports on file with applicable securities regulatory authorities and may be accessed through the SEDAR website (www.sedar.com) or Penn West's website.
The forward-looking statements contained in this document speak only as of the date of this document. Except as expressly required by applicable securities laws, we do not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. The forward-looking statements contained in this document are expressly qualified by this cautionary statement.
See also "Forward-Looking Statements" in the attached Management's Discussion and Analysis.
This management's discussion and analysis of financial condition and results of operations ("MD&A") of Penn West Petroleum Ltd. ("Penn West", the "Company", "we", "us", "our") should be read in conjunction with the Company's unaudited interim condensed consolidated financial statements for the three months ended March 31, 2016 (the "Consolidated Financial Statements") and the Company's audited consolidated financial statements and MD&A for the year ended December 31, 2015. The date of this MD&A is May 13, 2016. All dollar amounts contained in this MD&A are expressed in millions of Canadian dollars unless noted otherwise.
Certain financial measures such as funds flow, funds flow from operations, funds flow per share-basic, funds flow per share-diluted, funds flow from operations per share-basic, funds flow from operations per share-diluted, netback, EBITDA and gross revenues included in this MD&A do not have a standardized meaning prescribed by International Financial Reporting Standards ("IFRS") and therefore are considered non-GAAP measures; accordingly, they may not be comparable to similar measures provided by other issuers. This MD&A also contains oil and gas information and forward-looking statements. Please see the Company's disclosure under the headings "Non-GAAP Measures", "Oil and Gas Information", and "Forward-Looking Statements" included at the end of this MD&A.
Quarterly Financial Summary
(millions, except per share and production amounts)(unaudited)
Calculation of Funds Flow and Funds Flow from Operations
The decrease in funds flow compared to the prior quarter is mainly due to lower revenues as a result of a weaker commodity price environment and lower production volumes due to asset dispositions.
During the first quarter of 2016, the Company monetized a total of US$115 million of foreign exchange forward contracts on senior notes and it permanently disposed of a pipeline commitment it had and received $20 million of proceeds from the sale.
Business Strategy
During the first quarter of 2016, the Company continued to advance on its core strategies as it focuses on debt reduction and the long-term sustainability of the Company. All key targets came in ahead of expectations during the quarter as follows:
Penn West has made significant progress both operationally and financially over the past two years in an effort to strengthen its balance sheet. The Company will continue to seek improvements in its cost structure and its debt levels so that it is well positioned to move forward once commodity prices recover.
Business Environment
The following table outlines quarterly averages for benchmark prices and Penn West realized prices for the last five quarters.
Crude Oil
Crude oil prices continued to decline in the early part of the first quarter of 2016 as increased supply and weak demand moved prices below US$30 per barrel. Crude oil prices strengthened later in the quarter as major OPEC and non-OPEC countries discussed supply restrictions; however, this was tempered by continued high inventory levels.
Canadian light oil differentials weakened from the fourth quarter of 2015 averaging US$3.69 per barrel below WTI for the quarter. Heavy oil differentials traded within US$0.60 per barrel averaging US$14.24 below WTI for the quarter.
As at March 31, 2016, the Company has the following hedging positions in place:
Natural Gas
NYMEX Henry Hub natural gas prices continued their downward trend through the quarter as warm weather in key markets caused higher than average storage levels as the market approached the end of the withdrawal season. The Henry Hub prompt month price started the quarter at US$2.37 per MMBtu and ended trading for the quarter at US$1.96 per MMBtu averaging US$2.09 per MMBtu for the first quarter.
AECO pricing declined further compared to NYMEX as TCPL restrictions were lifted which resulted in additional production volumes in the market. High storage levels also contributed to further downward pressure on AECO prices. At the start of the first quarter the AECO Index price traded at $2.31 per mcf declining to $1.66 per mcf near the end of the quarter and AECO daily pricing averaging $1.33 per mcf in March.
Penn West had the following financial hedging positions in place for natural gas as at March 31, 2016.
Average Sales Prices
RESULTS OF OPERATIONS
Production
Production volumes were considerably ahead of the Company's expectations in the first quarter of 2016 primarily due to exceptional well performance in the Cardium and Viking areas. The Company has continued to experience production results on its second half 2015 development program significantly higher than type curve estimates. Additionally, a lower amount of production volumes were shut-in than previously anticipated which also contributed to the strong result. These factors have resulted in the Company maintaining its 2016 average production target of 60,000 – 64,000 per boe, after the effect of the property dispositions during the first quarter of 2016 and the Slave Point disposition that was closed in April 2016.
Penn West's production levels were lower than the comparative periods mainly due to non-core property dispositions that were closed in 2015 as the Company made progress on its planned disposition strategy and continued to reduce debt levels.
Netbacks
During the first quarter of 2016, the Company's netbacks continued to be affected by the significant decreases in commodity prices, particularly heavy oil. This was partially offset by successful cost reduction initiatives which resulted in lower operating costs, increased commodity gains due to the Company's active hedging program and a reduction in royalties due to the lower commodity price environment.
Production Revenues
Revenues from the sale of oil, NGL and natural gas consisted of the following:
Gross revenues have decreased from the comparative period as a result of a significant decrease in the commodity price environment and lower production volumes due to non-core asset dispositions that were closed in 2015. This was partially offset by the weakening of the Canadian dollar compared to the US dollar from the prior year.
Reconciliation of Change in Production Revenues
Royalties
Royalties have decreased from the comparative period primarily due to a decrease in the commodity price environment and the impact of asset disposition activity completed in 2015. Additionally during the first quarter of 2016, the Company settled outstanding royalty audits which resulted in the release of a $6 million provision that was no longer required. Excluding this impact the average royalty rate for the quarter would have been seven percent.
Expenses
Operating
In 2016, the Company successfully progressed on a number of strategies to reduce operating costs, with a specific focus on reducing repair & maintenance and workover activities. These efforts, combined with favorable weather conditions during the first quarter led to current and prior estimates coming in below the Company's initial expectations. The Company's production results for the first quarter of 2016, which were ahead of its expectations, also supported the reduced per boe figure. Penn West will continue to review its operations and seek further improvements in its cost structure as it moves forward. Due to the strong result in the first quarter of 2016 the Company is reducing its annual operating cost per boe target for 2016 to $17.00 - $18.00 per boe, from $18.00 - $18.75 per boe, despite several required maintenance and turnaround activities in the second half of 2016.
Operating costs were also lower from the comparative periods as a result of the Company's asset disposition program which has removed several non-core, high operating cost properties from its portfolio and a decline in labour costs due to reduced staff levels over the past year.
Operating expenses for the first three months of 2016 included a realized loss of $2 million (2015 – $5 million loss) on electricity contracts.
Financing
At March 31, 2016, the Company had a secured, revolving syndicated bank facility with an aggregate borrowing limit of $1.2 billion and an extendible five-year term (May 6, 2019 maturity date). The syndicated bank facility contains provisions for stamping fees on bankers' acceptances and LIBOR loans and standby fees on unutilized credit lines that vary depending on certain financial ratios. At March 31, 2016, the Company had $686 million of unused credit capacity available.
At March 31, 2016, the value of the Company's senior notes was $1.4 billion (December 31, 2015 – $1.5 billion). There were no senior notes issued in either 2016 or 2015.
Summary information on our senior notes outstanding is as follows at March 31, 2016:
Penn West's debt structure includes short-term financings under its syndicated bank facility and long-term financing through its senior notes. Financing charges in 2016 increased compared to 2015 as there was a higher balance drawn under the Company's syndicated bank facility. Additionally, in May 2015, the Company finalized amended agreements with the lenders under its syndicated bank facility and with the holders of its senior notes which resulted in amended financial covenants and led to increases in the fee structure. The fee structure on the Company's senior notes will change during the amendment period (up until March 30, 2017) as follows:
See "Liquidity and Capital Resources – Liquidity" for further details on the amendments.
The interest rates on any non-hedged portion of the Company's syndicated bank facility are subject to fluctuations in short-term money market rates as advances on the syndicated bank facility are generally made under short-term instruments. As at March 31, 2016, 25 percent (December 31, 2015 – 24 percent) of Penn West's long-term debt instruments were exposed to changes in short-term interest rates.
Share-Based Compensation
Share-based compensation expense relates to the Company's Stock Option Plan (the "Option Plan"), Restricted Share Unit Plan ("RSU"), Deferred Share Unit Plan ("DSU") and Performance Share Unit Plan ("PSU").
Share-based compensation consisted of the following:
The share price used in the fair value calculation of the RSU plan under the liability method, PSU and DSU obligations at March 31, 2016 was $1.20 (March 31, 2015 – $2.09). Share-based compensation related to the DSU and PSU was insignificant in both periods.
General and Administrative Expenses
During 2015 and in early 2016, the Company continued to focus its operations and aligned its organizational structure to current activity levels which resulted in a reduction in its workforce and a lower cost structure. In 2016, Penn West also released its 2015 bonus provision totaling $2 million which contributed to the decrease. The Company is continuing to forecast 2016 G&A per boe figure at $2.50 - $2.90.
Restructuring Expense
During the first quarter of 2016, Penn West decreased its workforce in light of lower current activity levels and the weak commodity price environment resulting in increased restructuring expenses.
Depletion, Depreciation, Impairment and Accretion
D&D expense decreased from the comparative period mainly due to impairment charges in 2015 and asset disposition activity as the Company progressed on several initiatives to strengthen its balance sheet and focus its operations.
During the first quarter of 2016, Penn West announced it had entered into a definitive sale agreement to sell certain assets located in the Slave Point area of Northern Alberta. As the sale was not closed by March 31, 2016, these assets were classified as held for sale and an impairment test was required. As the book value of these assets exceeded the fair value received a non-cash impairment charge of $96 million ($132 million before-tax) was recorded. Subsequent to quarter-end, on April 15, 2016, the transaction closed for proceeds of $148 million, subject to closing adjustments. The Company is committed to pursuing additional asset sales as it continues to focus on debt reduction.
Taxes
The deferred income tax recovery recorded during the first quarter of 2016 was primarily the result of the non-cash impairment charges recorded on assets held for sale.
Foreign Exchange
Penn West records unrealized foreign exchange gains or losses to translate the U.S., UK and Euro denominated senior notes and the related accrued interest to Canadian dollars using the exchange rates in effect on the balance sheet date. Realized foreign exchange gains or losses are recorded upon repayment of the senior notes.
The split between realized and unrealized foreign exchange losses is as follows:
The unrealized gain in 2016 is due to the strengthening of the Canadian dollar relative to the US dollar during the quarter.
Net Loss
The net loss in the first quarter of 2016 was primarily due to a non-cash impairment charge as a result of classifying the Slave Point properties as assets held for sale. This was partially offset by unrealized foreign exchange gains due to the strengthening of the Canadian dollar compared to the US dollar.
Capital Expenditures
In 2016, the Company reduced its capital program as a result of the low commodity price environment as the Company is targeting its expenditures to be largely within funds flow from operations. Capital activities in the first quarter were focused on completion and tie-in activities within the Viking and development activity within the Peace River Oil Partnership where the Company has the full support of its joint venture partner and is carried on a portion of its capital expenditures.
The Company advanced its asset disposition program during the first quarter of 2016 closing minor property dispositions. Additionally, it entered into a transaction to sell assets located in the Slave Point area of Northern Alberta for proceeds of $148 million which closed in April 2016.
Exploration and evaluation ("E&E") capital expenditures
During 2016, E&E capital expenditures were insignificant as the Company reduced capital activity levels as a result of the low commodity price environment.
Gain on asset dispositions
In the first quarter of 2016, Penn West completed a number of minor non-core asset dispositions as it continued to reduce outstanding debt and focus its asset portfolio.
Environmental and Climate Change
The oil and gas industry has a number of environmental risks and hazards and is subject to regulation by all levels of government. Environmental legislation includes, but is not limited to, operational controls, site restoration requirements and restrictions on emissions of various substances produced in association with oil and natural gas operations. Compliance with such legislation could require additional expenditures and a failure to comply may result in fines and penalties which could, in the aggregate and under certain assumptions, become material.
Penn West is dedicated to reducing the environmental impact from its operations through its environmental programs which include resource conservation, water management and site abandonment/reclamation/remediation. Operations are continuously monitored to minimize environmental impact and allocate sufficient capital to reclamation and other activities to mitigate the impact on the areas in which the Company operates.
Liquidity and Capital Resources
Capitalization
Dividends
On September 1, 2015, Penn West announced that its Board of Directors approved the suspension of the dividend until further notice, following the October 15, 2015 payment.
The amount of future cash dividends may vary depending on a variety of factors and conditions which can include, but are not limited to, fluctuations in commodity markets, production levels and capital investment plans. Penn West's dividend level could change based on these and other factors and is subject to the approval of its Board of Directors. For further information regarding the Company's dividend policy, including the factors that could affect the amount of quarterly dividend that it pays, if any, and the risks relating thereto, see "Dividends and Dividend Policy – Dividend Policy" in its Annual Information Form, which is available on its website at www.pennwest.com, on the SEDAR website at www.sedar.com, and on the EDGAR website at www.sec.gov.
Liquidity
The Company has a secured, revolving syndicated bank facility with an aggregate borrowing limit of $1.2 billion and an extendible five-year term (May 6, 2019 maturity date). For further details on the Company's debt instruments, please refer to the "Financing" section of this MD&A.
The Company actively manages its debt portfolio and considers opportunities to reduce or diversify its debt capital structure. Management contemplates both operating and financial risks and takes action as appropriate to limit the Company's exposure to certain risks. Management maintains close relationships with the Company's lenders and agents to monitor credit market developments. These actions and plans aim to increase the likelihood of maintaining the Company's financial flexibility and capital program, supporting the Company's ability to capture opportunities in the market and execute longer-term business strategies.
If the current low commodity price environment continues, the Company anticipates it will not be in compliance with certain of its existing financial covenants by the end of the second quarter of 2016. The Company is engaged in negotiations with its lenders to amend these financial covenants prior to the end of the second quarter of 2016, which if successful will mitigate the risk of default in 2016 and further into the future at prevailing commodity price levels. In order to reduce this risk of default, the Company is continuing to pursue additional asset dispositions and is considering several other options which include obtaining additional sources of capital from strategic investors. As there is the potential that the Company will not be in compliance with its financial covenants at the end of the second quarter of 2016, there is a risk of default under the Company's bank facility and noteholder agreements. This has resulted in uncertainty on the Company's ability to continue as a going concern.
The Company has a number of covenants related to its syndicated bank facility and senior notes. On March 31, 2016, the Company was in compliance with all of these financial covenants which consisted of the following:
The table below outlines the Company's senior debt to EBITDA calculation as at March 31, 2016:
In May 2015, the Company finalized amending agreements with the lenders under its syndicated bank facility and with the holders of its senior notes to, among other things, amend its financial covenants as follows:
The Company also agreed to the following:
Financial Instruments
The Company had the following financial instruments outstanding as at March 31, 2016. Fair values are determined using external counterparty information, which is compared to observable market data. Penn West limits its credit risk by executing counterparty risk procedures which include transacting only with institutions within its syndicated bank facility or with high credit ratings and by obtaining financial security in certain circumstances.
The components of risk management gain (loss) were as follows:
In the first quarter of 2016, the Company monetized a total of US$115 million of foreign exchange forward contracts on senior notes and unwound AECO swap contracts totalling 14,100 mcf per day.
Outlook
Due to strong well performance and production results, the Company's annual production guidance between 60,000 – 64,000 boe per day remains unchanged after the effect of the property dispositions closed during the first quarter of 2016 and the Slave Point disposition that was closed in April 2016. Additionally, as a result of successful cost savings initiatives and production results in the first quarter of 2016, the Company is reducing its annual operating cost per boe target to $17.00 - $18.00 per boe, from $18.00 - $18.75 per boe. For 2016, the Company's exploration and development capital expenditures budget of $50 million and G&A per boe of $2.50 - $2.90 remain unchanged, as previously disclosed in its January 28, 2016 press release.
This outlook section is included to provide shareholders with information about Penn West's expectations as at May 13, 2016 for production, exploration and development capital expenditures, operating costs per boe and G&A per boe in 2016 and readers are cautioned that the information may not be appropriate for any other purpose. This information constitutes forward-looking information. Readers should note the assumptions, risks and discussion under "Forward-Looking Statements" and are cautioned that numerous factors could potentially impact Penn West's capital expenditure levels, production, operating cost and G&A expenditures performance for 2016, including fluctuations in commodity prices and its ongoing asset disposition program.
All press releases are available on Penn West's website at www.pennwest.com, on SEDAR at www.sedar.com, and on EDGAR at www.sec.gov.
Sensitivity Analysis
Estimated sensitivities to selected key assumptions on funds flow for the 12 months subsequent to the date of this MD&A, including risk management contracts entered to date, are based on forecasted results as discussed in the Outlook above.
Contractual Obligations and Commitments
Penn West is committed to certain payments over the next five calendar years and thereafter as follows:
The Company's syndicated bank facility is due for renewal on May 6, 2019. In addition, the Company has an aggregate of $1.4 billion in senior notes maturing between 2016 and 2025. If the Company is unsuccessful in renewing or replacing the syndicated bank facility or obtaining alternate funding for some or all of the maturing amounts of the senior notes, it is possible that it could be required to obtain other facilities, including term bank loans.
The Company is involved in various litigation and claims in the normal course of business and records provisions for claims as required.
In February 2016, Penn West announced it had entered into agreements to settle all class action proceedings in Canada and United States against the Company related to damages alleged to have been incurred due to a decline in share price related to the restatement of certain of Penn West's historical financial statements and related MD&A in 2014. The settlement agreements provide for a payment of $53 million split evenly between Canadian and US investors that is fully funded by insurance coverage maintained by Penn West. As a result, the payment will not impact the Company's cash or financial position. The proposed settlements are subject to the satisfaction of the conditions stated in the settlement documents as well as the receipt of court approval in each of Alberta, Ontario and Quebec and in New York. There can be no assurance that these conditions will be satisfied or that the settlements will be approved by the courts. The receipt of such court approvals is dependent on a number of factors and therefore the timing thereof cannot be predicted at this time.
Equity Instruments
Changes in Internal Control Over Financial Reporting ("ICFR")
Penn West's senior management has evaluated whether there were any changes in the Company's ICFR that occurred during the period beginning on January 1, 2016 and ending on March 31, 2016 that have materially affected, or are reasonably likely to materially affect, the Company's ICFR. No changes to Penn West's ICFR were made during the quarter.
Penn West utilizes the original Internal Control - Integrated Framework (2013) issued by the Committee of the Sponsoring Organizations of the Treadway Commission (COSO) to design and evaluate its internal control over financial reporting.
Future Accounting Pronouncements
The IASB issued IFRS 15 "Revenue from Contracts with Customers" which replaces IAS 18 "Revenue". IAS 15 specifies revenue recognition criteria and expanded disclosures for revenue. The new standard is effective for annual periods beginning on or after January 1, 2018 and early adoption is permitted. Penn West is currently assessing the impact of the standard.
The IASB completed the final sections of IFRS 9 "Financial Instruments" which replaces IAS 39 "Financial Statement: Recognition and Measurement". IFRS 9 provides guidance on the recognition and measurement, impairment and derecognition on financial instruments. The new standard is effective for annual periods beginning on or after January 1, 2018 and early adoption is permitted. Penn West is currently assessing the impact of the standard.
The IASB issued IFRS 16 "Leases" in January 2016 which replaces IAS 17 "Leases". IFRS 16 outlines several new requirements in regards to the recognition, measurement and disclosure of leases. A key principle within the standard includes a single lessee accounting model which requires lessees to recognise assets and liabilities for all leases which have a term more than 12 months. The accounting for lessors, which classify leases as either operating or finance, remains substantially unchanged from the previous standard. The new standard is effective for annual reporting periods beginning on or after 1 January 2019. Penn West is currently assessing the impact of the standard.
Off-Balance-Sheet Financing
The Company has off-balance-sheet financing arrangements consisting of operating leases. The operating lease payments are summarized in the "Contractual Obligations and Commitments section" of this MD&A.
Non-GAAP Measures
Certain financial measures including funds flow, funds flow from operations, funds flow per share-basic, funds flow per share-diluted, funds flow from operations per share-basic, funds flow from operations per share-diluted, netback, EBITDA and gross revenues included in this MD&A do not have a standardized meaning prescribed by IFRS and therefore are considered non-GAAP measures; accordingly, they may not be comparable to similar measures provided by other issuers. Funds flow is cash flow from operating activities before changes in non-cash working capital and decommissioning expenditures. Funds flow from operations excludes the effects of financing related transactions from foreign exchange contracts and debt repayments/ pre-payments and is more representative of cash related to continuing operations. Funds flow and Funds flow from operations are used to assess the Company's ability to fund dividend and planned capital programs. See "Calculation of Funds Flow and Funds Flow from Operations" above for a reconciliation of funds flow to its nearest measure prescribed by IFRS. Netback is the per unit of production amount of revenue less royalties, operating expenses, transportation and realized risk management gains and losses, and is used in capital allocation decisions and to economically rank projects. See "Results of Operations – Netbacks" above for a calculation of the Company's netbacks. EBITDA is Funds Flow excluding the impact of financing expenses, realized gains and losses on foreign exchange hedges on prepayments, realized foreign exchange gains and losses on debt prepayments and restructuring expenses. EBITDA as defined by Penn West's debt agreements excludes the EBITDA contribution from assets sold in the prior 12 months and is used within Penn West's covenant calculations related to its syndicated bank facility and senior notes. Gross revenue is total revenues including realized risk management gains and losses on commodity contracts and is used to assess the cash realizations on commodity sales.
Oil and Gas Information
Barrels of oil equivalent ("boe") may be misleading, particularly if used in isolation. A boe conversion ratio of six thousand cubic feet of natural gas to one barrel of crude oil is based on an energy equivalency conversion method primarily applicable at the burner tip and does not represent a value equivalency at the wellhead. Given that the value ratio based on the current price of crude oil as compared to natural gas is significantly different from the energy equivalency conversion ratio of 6:1, utilizing a conversion on a 6:1 basis is misleading as an indication of value.
Forward-Looking Statements
Certain statements contained in this document constitute forward-looking statements or information (collectively "forward-looking statements") within the meaning of the "safe harbor" provisions of applicable securities legislation. In particular, this document contains forward-looking statements pertaining to, without limitation, the following: under "Business Strategy", the Company intends to continue to advance on its core strategies as it focuses on debt reduction and the long-term sustainability of the Company, targeting capital expenditure to be within funds flow from operations at current commodity prices, continuing to assess development plans and adjust activity accordingly, continuing to focus on cost reductions, assessing how to apply disposition proceed pre-payments during the second quarter of 2016, continuing to pursue additional asset sales as a means to further reduce debt and focus operations, continuing to work on several initiatives to further reduce debt levels, continuing to seek improvements in cost structure and debt levels to be well positioned to move forward once commodity prices recover; under "Results of Operations", maintaining average production guidance after taking into account certain dispositions; under "Expenses - Operating", continuing to review operations and cost structure as the Company moves forward through 2016 and maintaining previously disclosed operating costs per boe for 2016; under "General and Administrative Expenses", anticipated range for G&A per boe for 2016; under "Depletion, Depreciation, Impairment and Accretion", remaining committed to pursuing additional asset sales and to continue to focus on debt reduction; under "Capital Expenditures"; targeting expenditures to be largely within funds flow from operations; under "Environmental and Climate Change", our belief that compliance with environmental legislation could require additional expenditures and a failure to comply with such legislation may result in fines and penalties which could, in the aggregate and under certain assumptions, become material, our intent to reduce the environmental impact from our operations through environmental programs; under "Liquidity and Capital Resources", considering opportunities to reduce or diversify the debt capital structure, our belief that our actions increase the likelihood of maintaining our financial flexibility and capital programs, which supports the Company's ability to capture opportunities in the market and execute longer-term business strategies, the anticipation that if the current low commodity price environment continues the Company will not be in compliance with certain of its existing financial covenants by the end of the second quarter of 2016, if negotiations will the lenders are successful it will mitigate the risk of default in 2016 and further into the future at prevailing commodity price levels, reducing default risk by continuing to pursue additional asset dispositions and other considerations including obtaining additional sources of capital from strategic investors, the potential of not being in compliance with financial covenants at the end of the second quarter of 2016 and therefore risk of default under the Company's bank facility and noteholder agreements; under "Outlook", the annual production guidance range, capital expenditure budget, annual average operating costs range per boe and G&A per boe range for 2016; under "Sensitivity Analysis", the estimated sensitivities to selected key assumptions on funds flow for the 12 months subsequent to this MD&A; and under "Contractual Obligations and Commitments", the terms and conditions of our class action settlement and being subject to the satisfaction of conditions stated in the settlement documents as well as court approvals in certain jurisdictions. In addition, statements relating to "reserves" or "resources" are deemed to be forward-looking statements as they involve the implied assessment, based on certain estimates and assumptions, that the reserves and resources described exist in the quantities predicted or estimated and can be profitably produced in the future.
With respect to forward-looking statements contained in this document, the Company has made assumptions regarding, among other things: that the Company does not dispose of additional material producing properties or royalties or other interests therein; that the current commodity price and foreign exchange environment will continue or improve; future capital expenditure levels; future crude oil, natural gas liquids and natural gas prices and differentials between light, medium and heavy oil prices and Canadian, WTI and world oil and natural gas prices; future crude oil, natural gas liquids and natural gas production levels; future exchange rates and interest rates; future debt levels; and the continued suspension of our dividend.
Although the Company believes that the expectations reflected in the forward-looking statements contained in this document, and the assumptions on which such forward-looking statements are made, are reasonable, there can be no assurance that such expectations will prove to be correct. Readers are cautioned not to place undue reliance on forward-looking statements included in this document, as there can be no assurance that the plans, intentions or expectations upon which the forward-looking statements are based will occur. By their nature, forward-looking statements involve numerous assumptions, known and unknown risks and uncertainties that contribute to the possibility that the forward-looking statements contained herein will not be correct, which may cause our actual performance and financial results in future periods to differ materially from any estimates or projections of future performance or results expressed or implied by such forward-looking statements. These risks and uncertainties include, among other things: the possibility that the Company will not be able to continue to successfully execute our long-term plan in part or in full, and the possibility that some or all of the benefits that the Company anticipates will accrue to our Company and our security holders as a result of the successful execution of such plan do not materialize; the possibility that the Company is unable to execute some or all of our ongoing asset disposition program on favorable terms or at all; the possibility that we breach one or more of the financial covenants pursuant to our amending agreements with the syndicated banks and the holders of our senior, unsecured notes; general economic and political conditions in Canada, the U.S. and globally, and in particular, the effect that those conditions have on commodity prices and our access to capital; industry conditions, including fluctuations in the price of crude oil, natural gas liquids and natural gas, price differentials for crude oil and natural gas produced in Canada as compared to other markets, and transportation restrictions, including pipeline and railway capacity constraints; fluctuations in foreign exchange or interest rates; unanticipated operating events or environmental events that can reduce production or cause production to be shut-in or delayed (including extreme cold during winter months, wild fires and flooding); and the other factors described under "Risk Factors" in our Annual Information Form and described in our public filings, available in Canada at www.sedar.com and in the United States at www.sec.gov. Readers are cautioned that this list of risk factors should not be construed as exhaustive.
The forward-looking statements contained in this document speak only as of the date of this document. Except as expressly required by applicable securities laws, the Company does not undertake any obligation to publicly update any forward-looking statements. The forward-looking statements contained in this document are expressly qualified by this cautionary statement.
Additional Information
Additional information relating to Penn West, including Penn West's Annual Information Form, is available on the Company's website at www.pennwest.com, on SEDAR at www.sedar.com and on EDGAR at www.sec.gov.
Basis of presentation (Note 2a)
Subsequent event (Note 4)
Commitments and contingencies (Note 12)
1. Structure of Penn West
Penn West Petroleum Ltd. ("Penn West" or the "Company") is a senior exploration and production company and is governed by the laws of the Province of Alberta, Canada. The Company operates in one segment, to explore for, develop and hold interests in oil and natural gas properties and related production infrastructure in the Western Canada Sedimentary Basin directly and through investments in secur