Perpetual Energy Inc. Reports Second Quarter 2019 Financial and Operating Results

CALGARY, July 31, 2019 /CNW/ - (TSX:PMT) – Perpetual Energy Inc. ("Perpetual" or the "Company") is pleased to release its second quarter 2019 financial and operating results. Highlights include:

• The Company took advantage of dry early spring conditions to accelerate capital activity plans. Exploration and development spending for the second quarter of 2019 was $5.2 million, of which 75% was directed towards the drilling, completion and tie-in of three (3.0 net) heavy oil wells and a re-entry to add two additional laterals to an existing oil well at Mannville. The four wells were brought on-stream late in the second quarter and have ramped up to approximately 300 boe/d at the end of July. Two additional six-leg multi-laterals targeting heavy oil in Eastern Alberta will complete the summer drilling program in mid-August.
• Heavy oil production in Eastern Alberta grew 27% relative to the prior year second quarter and 7% from first quarter 2019 levels, driven by positive results from heavy oil focused drilling and waterflood investment during the second half of 2018 and first half of 2019.
• Perpetual's market diversification contract provided an 82% uplift ($0.84/Mcf) over average AECO Daily Index prices, adding $3.4 million of incremental revenue and contributing to a realized natural gas price in the second quarter of $2.25/Mcf. Perpetual has extended the term of its market diversification contract by two years. From November 1, 2022 to October 31, 2024, Perpetual will deliver 40,000 MMBtu/d at AECO and receive Malin, Dawn and Emerson daily index prices less US$0.0775/MMBtu and transportation costs from AECO to the market price point.
• Cash flow from operating activities in the second quarter of 2019 was $4.3 million ($0.07/share) and adjusted funds flow was $3.6 million ($0.06/share).
• On June 11, 2019, Perpetual completed the early redemption of the $14.6 million 2019 Senior Notes due July 23, 2019. The redemption was funded by the issuance of $15.7 million 2022 Senior Notes.
• Perpetual's Application for Summary Dismissal of the Sequoia litigation relating to the Company's disposition of shallow gas assets in October 2016 to an unrelated third party was heard during the fourth quarter of 2018. The Court's decision is scheduled to be received on August 15, 2019.

A complete copy of Perpetual's unaudited condensed interim consolidated financial statements and related Management's Discussion and Analysis ("MD&A") for the three and six months ended June 30, 2019 can be obtained through the Company's website at www.perpetualenergyinc.com and SEDAR at www.sedar.com.

SECOND QUARTER 2019 HIGHLIGHTS

Capital Spending, Production and Operations

• Perpetual's exploration and development spending in the second quarter of 2019 was $5.2 million, above Previous Guidance as dry conditions in Mannville allowed for an accelerated start to the summer drilling program.
• Capital spending in Eastern Alberta was $4.7 million, $3.3 million higher than the comparative period in 2018. Capital activity included the drilling and completion of three (3.0 net) single leg horizontal heavy oil wells, and one re-entry to add two additional lateral legs to an existing heavy oil well at Mannville. Spending also included the installation of automated leak detection monitoring equipment at several water transfer and water injection pipelines in the Mannville area.
• Spending at the East Edson property in West Central Alberta was $0.4 million and was directed towards compressor optimization work and non-operated facility turnaround costs at the Rosevear plant.
• Perpetual also spent $0.4 million (Q2 2018 – $0.4 million) on abandonment and reclamation projects. As part of Perpetual's focus on well and pipeline abandonment and reclamation, four reclamation certificates were received from the AER during the second quarter of 2019 (Q2 2018 – five reclamation certificates) which will result in the cessation of associated property tax and surface lease expenses. The Company's combined ratio of deemed assets to deemed liabilities as per the AER's Licensee Liability Rating was 4.5 at June 30, 2019.
• Production averaged 9,370 boe/d in the second quarter of 2019, down 12% from the comparable period in 2018. The decrease was driven by natural declines resulting from limited capital investment on the Company's natural gas assets during 2018 and the first half of 2019 to preserve value during this period of depressed natural gas pricing in Alberta. In addition, Perpetual voluntarily shut-in an average 175 boe/d of East Edson production (2% of total production) during the quarter to take advantage of short-term situations when natural gas could be purchased at minimal cost to satisfy pre-sold volume commitments at attractive margins, resulting in an increase in realized revenue of $0.03/Mcf while retaining reserves for future production.
• Production at East Edson is expected to decline throughout 2019. Two new wells are planned for the fourth quarter to come on-stream in November when gas prices are expected to be higher, driven by seasonal heating demand.
• Crude oil production in Eastern Alberta was 27% higher than the second quarter of 2018, reflecting increased production from the 2018 drilling program and lower base declines at Mannville due to waterflood operations. Compared to the first quarter of 2019, Eastern Alberta crude oil production was 7% higher, reflecting decreased maintenance and downtime from winter freeze-ups, combined with the impact of larger downhole pumps installed late in the first quarter. Crude oil production in Eastern Alberta is expected to increase in the second half of 2019 as new production from the 2019 heavy oil drilling program comes on-stream.
• Production and operating expenses were up by $0.6 million (14%) relative to the same period in 2018, as Eastern Alberta heavy oil production increased by 27% over the prior year period, comprising 13% of total production in the second quarter (Q2 2018 – 9% of total production). West Central production and operating expenses were essentially flat relative to the first quarter of 2019 at $2.0 million, reflecting the largely fixed cost nature of the East Edson property.

Financial Highlights

• Realized revenue was $21.26/boe in the second quarter of 2019, 6% lower than the comparative period of 2018 ($22.58/boe). The decrease was due to lower realized pricing across all products, despite the higher proportion of oil and NGL in the production mix (Q2 2019 – 21%; Q2 2018 – 17%).
• Natural gas revenue of $9.0 million in the second quarter of 2019 comprised 47% (Q2 2018 – 54%) of total P&NG revenue while natural gas production was 79% (Q2 2018 – 83%) of total production. Natural gas revenue decreased 20% from $11.3 million in the second quarter of 2018, reflecting lower natural gas prices and the impact of the 16% decrease in natural gas production volumes. Perpetual's market diversification contract contributed $3.4 million of incremental revenue ($0.84/Mcf) over the AECO Daily Index price in the quarter (Q2 2018 - $5.1 million and $1.06/Mcf).
• Oil revenue of $6.7 million represented 35% (Q2 2018 – 24%) of total P&NG revenue while oil production was 13% (Q2 2018 – 9%) of total production. Oil revenue was 33% higher than the same period in 2018, due to the 24% increase in crude oil production combined with the 5% increase in the Western Canadian Select ("WCS") average price. The 5% increase in the WCS price was mainly due to the tightening of the WCS differential by US$8.59/bbl to US$10.68/bbl in response to the Government of Alberta's introduction of production quotas effective January 1, 2019. Perpetual did not fully participate in the improved WCS differential, as hedges were in place protecting a WCS differential of US$25.22/bbl on 750 bbl/d for 2019.
• NGL revenue was $3.5 million, representing 18% (Q2 2018 – 22%) of total P&NG revenue while NGL production was just 8% (Q2 2018 – 8%) of total Company production. NGL revenue decreased by 21% from the prior year period while NGL production decreased only 6%, reflecting the 16% decrease in Perpetual's realized NGL price compared to the prior year period. Compared to the first quarter of 2019, realized NGL prices increased by 60% as prices for condensate recovered in the second quarter, close to parity with Cdn$ WTI prices. Condensate production comprised 66% of NGL production in the second quarter (Q1 2019 – 58%). Propane, butane and ethane prices remain disconnected from WTI light oil prices, reflecting excess NGL supply produced from Western Canada and the United States. This oversupply condition is expected to continue.
• Perpetual's operating netback of $9.1 million ($10.69/boe) in the second quarter of 2019 decreased 32% from $13.4 million ($13.85/boe) in the comparative period of 2018. This decrease was due to a 6% reduction in realized revenue per boe, due to lower realized pricing across all products combined with higher costs per boe due to the 12% production decline against a largely fixed cost base. The higher percentage of oil and NGL in the production mix was less impactful during the second quarter of 2019, as realized oil prices were 6% lower than the prior year period due to realized hedging losses on crude oil derivatives of $1.2 million ($11.30/boe).
• Net loss for the second quarter of 2019 was $36.3 million ($0.60/share), compared to a net loss of $1.3 million ($0.02/share) in the comparative period of 2018. The increase in net loss from the prior year period was largely driven by an impairment charge of $22.6 million triggered by lower forecast natural gas prices, combined with the $6.6 million decrease in the fair value of the TOU share investment compared to an increase of $2.8 million in the comparative period of 2018, and lower operating netback performance.
• Cash flow from operating activities in the second quarter of 2019 was $4.3 million ($0.07/share), down $4.1 million from the prior year period of $8.4 million ($0.14/share) due to the impact of the 12% decrease in production, as the impairment loss and changes in fair value of the TOU share investment that impacted net loss did not impact cash flow from operating activities. Adjusted funds flow in the second quarter of 2019 was $3.6 million ($0.06/share), down $4.2 million (53%) from the prior year period of $7.8 million ($0.13/share). On a unit-of-production basis, adjusted funds flow was $4.28/boe in the second quarter of 2019, down 47% from the prior year period of $8.12/boe due to the combined impact of lower commodity prices and the effect of a largely fixed cost base against lower total production, partially offset by the increase in higher netback heavy oil.
• On June 11, 2019, the Company successfully completed the early redemption of all of the $14.6 million 8.75% senior unsecured notes due July 23, 2019 (the "2019 Senior Notes"). Pursuant to the early redemption, Perpetual issued $15.7 million of 8.75% senior unsecured notes due January 23, 2022 (the "2022 Senior Notes") to fully redeem the 2019 Senior Notes. After giving effect to the senior note refinancing, there are $33.6 million 2022 Senior Notes outstanding.
• At June 30, 2019, Perpetual had total net debt of $112.5 million, unchanged from December 31, 2018 and $10.2 million higher than March 31, 2019. The increase in net debt from the first quarter of 2019 was mainly attributable to the $6.6 million decrease in the fair value of the Tourmaline Oil Corp. ("TOU") share investment during the second quarter of 2019, combined with capital expenditures which exceeded net cash flow from operating activities during the period.
• As at June 30, 2019, 70% of net debt outstanding was repayable in 2021 or later. Perpetual's net debt to trailing twelve-months adjusted funds flow at the end of the second quarter increased to 4.8 times (December 31, 2018 – 3.7 times; March 31, 2019 – 3.7 times), due primarily to the impact of lower adjusted funds flow.
• Perpetual had available liquidity at June 30, 2019 of $27.6 million, comprised of an unutilized revolving bank debt Borrowing Limit of $13.5 million and the market value of its TOU share investment, net of the principal amount of the associated TOU share margin demand loan, of $14.1 million.

OUTLOOK

Perpetual has reduced its 2019 capital expenditure and adjusted funds flow guidance from a range of $21 to $25 million and $22 to $27 million respectively, provided in a press release dated May 8, 2019 (the "Previous Guidance") to $18 to $21 million due to the 15% decline in NYMEX natural gas price expectations for the remainder of 2019. Approximately 80% of Perpetual's natural gas volumes are priced in NYMEX based markets outside of Alberta. The Company continues to anticipate spending 50% of the 2019 capital program in Eastern Alberta targeting heavy oil development. The remaining capital expenditures are planned for East Edson in the fourth quarter, developing liquids-rich natural gas reserves in the Wilrich formation if AECO natural gas prices support investment, or alternatively, will be directed to an expanded heavy oil drilling program. Annual abandonment and reclamation spending of $1.5 to $2.0 million to address decommissioning obligations associated with non-producing wells is expected to provide future surface lease rental and property tax expense reductions, while maintaining regulatory compliance.

Forecast capital activity in Eastern Alberta for the second half of 2019 includes the drilling and completion of two exploratory (2.0 net) multi-lateral heavy oil wells in July. As a result of the drilling program, heavy oil production is forecast to increase by 20% to 30% in the second half of 2019 over first half levels.

At East Edson, the Company has budgeted a two (2.0 net) well drilling program in the fourth quarter of 2019. The two wells will be monobore, extended reach horizontal ("ERH") wells with approximately 2,500 meters of lateral length to optimize the drilling and completion design. The planned drilling will not have a material impact on production in 2019, as new wells are forecast to come on-stream late in the year when AECO natural gas prices are expected to be stronger due to winter heating demand. Natural declines and capital spending deferrals to late 2019 result in lower forecast 2019 production in East Edson with an average of 7,000 to 7,200 boe/d (10% oil and NGL). Despite reduced production in East Edson and a substantially fixed operating cost base, operating costs are forecast to remain low in 2019 at less than $3.25/boe.

The table below summarizes actual and anticipated capital spending and drilling activities for the first and second half of 2019.

2019 Exploration and Development Forecast Capital Expenditures

Perpetual is managing the 2019 capital program to be funded by adjusted funds flow. Average production of 9,200 to 9,500 boe/d in 2019 is close to Previous Guidance, with oil and NGL production growing to represent approximately 20% to 24% of the production mix. Natural declines and heavy oil focused investment is anticipated to result in an 11% year-over-year reduction in average daily production relative to 2018, but includes a 27% increase in heavy oil production. The Company expects to exit the year at approximately 10,500 boe/d as natural gas and NGL production ramps up again driven by fourth quarter capital spending targeting seasonal natural gas price optimization. The Company may continue to voluntarily shut-in natural gas production in response to weak AECO daily price conditions that may arise during the second half of 2019 to preserve reserves and purchase natural gas to satisfy existing sales obligations at attractive cash margins.

Cash costs of $17.00 to $18.00/boe continue to be forecast for 2019, up approximately 13% to 16% from 2018 due to the impact of lower forecast 2019 production on a substantially fixed operating cost base. Increased heavy oil production in the second half of 2019, which is higher cost compared to the West Central deep basin liquids-rich gas operation, is expected to contribute to increased cash costs per boe in the second half of 2019.

Perpetual has diversified its commodity and natural gas pricing point exposure (net of royalties) away from AECO as detailed below:

Market/Pricing Point

The market diversification contract is expected to continue to provide higher natural gas pricing and enhanced risk management through future periods of volatile natural gas prices in Western Canada related to market access constraints.

2019 annual guidance assumptions are as follows:

Commodity price assumptions reflect forward market price levels as follows:

Year-end 2019 net debt (net of the estimated market value of the Company's TOU share investment of approximately $28 million), is forecast at $114 - $119 million, up $7 million from Previous Guidance due to the decrease in the TOU share price during the second quarter. Current guidance is based on the following assumptions:

• Net debt at June 30, 2019 of $112.5 million;
• Forecast adjusted funds flow for the remainder of 2019 of $7 to $10 million;
• Forecast capital spending for the remainder of 2019 of $10 to $13 million; and
• Forecast decommissioning expenditures for the remainder of 2019 of $0.8 to $1.3 million.

The following sensitivities can be applied to estimate changes to 2019 annualized cash flow from operating activities and adjusted funds flow, assuming no change in differentials to Perpetual's market pricing points:

• For every US$0.25/MMBtu increase or decrease in the 2019 average  NYMEX Daily Index price, annualized adjusted funds flow increases or decreases by $4.8 million;
• For every US$2.50/bbl increase or decrease in the 2019 average  WTI light oil price, annualized adjusted funds flow increases or decreases by $1.5 million;
• For every 2.5 MMcf/d increase or decrease in 2019 average natural gas production, annualized adjusted funds flow increases or decreases by $1.5 million;
• For every 100 bbl/d increase or decrease in 2019 average crude oil and NGL production, annualized adjusted funds flow increases or decreases by $1.6 million; and
• For every $0.05 increase or decrease in the 2019 average Cdn$/US$ exchange rate, annualized adjusted funds flow increases or decreases by $1.5 million.

ADDITIONAL INFORMATION

About Perpetual

Perpetual is an oil and natural gas exploration, production and marketing company headquartered in Calgary, Alberta. Perpetual operates a diversified asset portfolio, including liquids-rich natural gas assets in the deep basin of west central Alberta, heavy oil and shallow natural gas in eastern Alberta, with longer term opportunities through undeveloped oil sands leases in northern Alberta. Additional information on Perpetual can be accessed at www.sedar.com or from the Corporation's website at www.perpetualenergyinc.com.

The Toronto Stock Exchange has neither approved nor disapproved the information contained herein.

Forward-Looking Information

Certain information regarding Perpetual in this news release including management's assessment of future plans and operations may constitute forward-looking information or statements under applicable securities laws. The forward looking information includes, without limitation, anticipated amounts and allocation of capital spending; statements pertaining to adjusted funds flow levels, statements regarding estimated production and timing thereof; statements pertaining to type curves being exceeded, forecast average production; completions and development activities; infrastructure expansion and construction; estimated FDC required to convert proved plus probable non-producing and undeveloped reserves to proved producing reserves; prospective oil and natural gas liquids production capability; projected realized natural gas prices and adjusted funds flow; estimated decommissioning obligations; commodity prices and foreign exchange rates; and commodity price management. Various assumptions were used in drawing the conclusions or making the forecasts and projections contained in the forward-looking information contained in this news release, which assumptions are based on management's analysis of historical trends, experience, current conditions and expected future developments pertaining to Perpetual and the industry in which it operates as well as certain assumptions regarding the matters outlined above. Forward-looking information is based on current expectations, estimates and projections that involve a number of risks, which could cause actual results to vary and in some instances to differ materially from those anticipated by Perpetual and described in the forward-looking information contained in this news release. Undue reliance should not be placed on forward-looking information, which is not a guarantee of performance and is subject to a number of risks or uncertainties, including without limitation those described under "Risk Factors" in Perpetual's Annual Information Form and MD&A for the year ended December 31, 2018 and those included in other reports on file with Canadian securities regulatory authorities which may be accessed through the SEDAR website (www.sedar.com) and at Perpetual's website (www.perpetualenergyinc.com). Readers are cautioned that the foregoing list of risk factors is not exhaustive. Forward-looking information is based on the estimates and opinions of Perpetual's management at the time the information is released, and Perpetual disclaims any intent or obligation to update publicly any such forward-looking information, whether as a result of new information, future events or otherwise, other than as expressly required by applicable securities law.

Financial Outlook

Also included in this news release are estimates of Perpetual's 2019 adjusted funds flow and year-end 2019 net debt, which is based on, among other things, the various assumptions as to production levels, capital expenditures, and other assumptions disclosed in this news release. To the extent such estimate constitutes a financial outlook, it was approved by management and the Board of Directors of Perpetual on July 31, 2019 and is included to provide readers with an understanding of Perpetual's anticipated adjusted funds flow and sensitivities based on the capital expenditure, production, and other assumptions described herein and readers are cautioned that the information may not be appropriate for other purposes.

Non-GAAP Measures

This news release contains the terms "adjusted funds flow", "adjusted funds flow per share", "adjusted funds flow per boe", "available liquidity", "cash costs", "net working capital deficiency (surplus)", "net debt", "net bank debt", "net debt to adjusted funds flow ratio", "operating netback", "realized revenue" and "enterprise value" which do not have standardized meanings prescribed by GAAP. Management believes that in addition to net income (loss) and net cash flows from operating activities as defined by GAAP, these terms are useful supplemental measures to evaluate operating performance. Users are cautioned however that these measures should not be construed as an alternative to net income (loss) or net cash flows from operating activities determined in accordance with GAAP as an indication of Perpetual's performance and may not be comparable with the calculation of similar measurements by other entities.

Adjusted funds flow: Management uses adjusted funds flow and adjusted funds flow per boe as key measures to assess the ability of the Company to generate the funds necessary to finance capital expenditures, expenditures on decommissioning obligations and meet its financial obligations. Adjusted funds flow is calculated based on cash flows from (used in) operating activities, excluding changes in non-cash working capital and expenditures on decommissioning obligations since Perpetual believes the timing of collection, payment or incurrence of these items is variable. Expenditures on decommissioning obligations may vary from period to period depending on capital programs and the maturity of the Company's operating areas. Expenditures on decommissioning obligations are managed through the capital budgeting process which considers available adjusted funds flow. The Company has also deducted the change in gas over bitumen royalty financing from adjusted funds flow to present these payments net of gas over bitumen royalty credits received. These payments are indexed to gas over bitumen royalty credits and are recorded as a reduction to the Corporation's gas over bitumen royalty financing obligation in accordance with IFRS. Additionally, the Company has excluded payments of restructuring costs associated with surplus office lease obligations, which management considers to not be related to cash flow from operating activities.

Adjusted funds flow per share is calculated using the same weighted average number of shares outstanding used in calculating net income (loss) per share. Adjusted funds flow is not intended to represent net cash flows from (used in) operating activities calculated in accordance with IFRS.

Adjusted funds flow per boe is calculated as adjusted funds flow divided by total production sold in the period.

Available Liquidity: Available Liquidity is defined as Perpetual's reserve-based credit facility borrowing limit (the "Borrowing Limit"), plus the fair value of the Tourmaline Oil Corp. ("TOU") share investment, less borrowings and letters of credit issued under the reserve-based credit facility (the "Credit Facility") and the TOU share margin demand loan. Management uses available liquidity to assess the ability of the Company to finance capital expenditures and expenditures on decommissioning obligations, and to meet its financial obligations.

Cash costs: Management believes that cash costs assist management and investors in assessing Perpetual's efficiency and overall cost structure. Cash costs are comprised of royalties, production and operating, transportation, general and administrative, and cash finance expense. Cash costs per boe is calculated by dividing cash costs by total production sold in the period.

Realized revenue: Realized revenue is the sum of realized natural gas revenue, realized oil revenue and realized natural gas liquids ("NGL") revenue which includes realized gains (losses) on financial natural gas, crude oil, NGL and foreign exchange contracts but excludes any realized gains (losses) resulting from marketing contracts associated with the disposition of the shallow gas assets on October 1, 2016 (the "Shallow Gas Disposition") to Sequoia Resources Corp. ("Sequoia"). Realized revenue, including foreign exchange and the market diversification contract, is used by management to calculate the Corporation's net realized commodity prices, taking into account monthly settlements of financial crude oil and natural gas forward sales, collars, basis differentials, and forward foreign exchange sales. These contracts are put in place to protect Perpetual's adjusted funds flow from potential volatility in commodity prices and foreign exchange rates. Any related realized gains or losses are considered part of the Corporation's realized commodity price.

Operating netback: Perpetual considers operating netback to be an important performance measure as it demonstrates its profitability relative to current commodity prices. Operating netback is calculated by deducting royalties, production and operating expenses, and transportation costs from realized revenue. Operating netback is also calculated on a per boe basis using production sold for the period. Operating netback on a per boe basis can vary significantly for each of the Company's operating areas.

Net working capital deficiency (surplus): Net working capital deficiency (surplus) includes total current assets and current liabilities excluding short-term derivative assets and liabilities related to the Corporation's risk management activities, current portion of gas over bitumen royalty financing, TOU share investment, TOU share margin demand loan, current portion of lease liabilities, and current portion of provisions.

Net bank debt, net debt and net debt to adjusted funds flow ratio: Net bank debt is measured as current and long-term revolving bank debt including net working capital deficiency (surplus). Net debt includes the carrying value of net bank debt, the principal amount of the term loan, the principal amount of the TOU share margin demand loan and the principal amount of senior notes, reduced for the fair value of the TOU share investment. Net debt, net bank debt, and net debt to adjusted funds flow ratios are used by management to assess the Corporation's overall debt position and borrowing capacity. Net debt to adjusted funds flow ratios are calculated on a trailing twelve-month basis.

Enterprise value: Enterprise value is equal to net debt plus the market value of issued equity, and is used by management to analyze leverage. Enterprise value is not intended to represent the total funds from equity and debt received by the Corporation upon issuance.

For additional reader advisories in regards to non-GAAP financial measures, including Perpetual's method of calculation and reconciliation of these terms to their corresponding GAAP measures, see the section entitled "Non-GAAP Measures" within the Company's MD&A filed on SEDAR.

BOE Equivalents

Perpetual's aggregate proved and probable reserves are reported in barrels of oil equivalent (boe). Boe may be misleading, particularly if used in isolation. In accordance with NI 51-101, a boe conversion ratio for natural gas of 6 Mcf: 1 boe has been used, which is based on an energy equivalency conversion method primarily applicable at the burner tip and does not necessarily represent a value equivalency at the wellhead. As the value ratio between natural gas and crude oil based on the current prices of natural gas and crude oil is significantly different from the energy equivalency of 6:1, utilizing a conversion on a 6:1 basis may be misleading as an indication of value.

SOURCE Perpetual Energy Inc.

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