GRAN TIERRA ENERGY INC. quarterly report, Q2 FY2015

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Gran Tierra Energy Inc. — Q2 2015 Form 10-Q

Reporting period: Three and six months ended June 30, 2015. Amounts are U.S. dollars; financial statement amounts are generally in millions below. The company explores and produces oil and natural gas in Colombia, Peru and Brazil. Argentina is reported as discontinued operations following its 2014 sale.

Financial and operating results

  • Revenue: Q2 oil and gas sales were $69.4 million, down 53% from $147.9 million; first-half sales were $145.6 million, down 51% from $299.0 million. Lower realized prices and lower sales volumes drove the declines.
  • Production, sales and pricing: Q2 sales averaged 14,970 BOEPD, down 15%; first-half sales averaged 17,172 BOEPD, down 5%. First-half production NAR was 19,312 BOEPD, down 1%. Realized oil and NGL prices were $51.18/BOE in Q2 and $47.03/BOE for the first half, down 45% and 49%, respectively. Colombia generated 97% of first-half revenue and other income.
  • Profitability: Q2 net loss was $38.6 million ($0.13 per share), versus net income of $9.1 million ($0.03 per share) a year earlier. First-half net loss was $83.4 million ($0.29 per share), versus net income of $54.3 million ($0.19 per share). Continuing-operations pretax losses were $37.8 million for Q2 and $82.6 million for the first half. Non-GAAP EBITDA was $31.7 million for Q2 and $73.1 million for the first half, down 69% and 68% year over year.
  • Costs and impairments: Q2 operating expense was $24.1 million, down 5%; first-half expense was $55.6 million, up 18%. Operating expense per BOE rose to $17.72 in Q2 and $17.88 for the first half. DD&A and impairment expense was $69.5 million in Q2 and $155.6 million for the first half, including Brazil ceiling-test impairments of $25.0 million and $29.3 million, respectively, and Peru Block 95 impairments of $5.3 million and $38.0 million. First-half G&A fell 34% to $17.6 million; severance was $6.4 million and Colombian equity tax expense was $3.8 million.
  • Cash flow and capital spending: First-half operating cash flow was $2.7 million, versus $23.9 million in 2014; non-GAAP funds flow from continuing operations was $50.0 million, down 71%. Investing used $168.7 million, including $91.8 million of capital expenditures. Cash fell $165.4 million to $166.4 million.
  • Margins: Management-reported operating netback was $33.19/BOE in Q2, versus $76.85, and $28.96/BOE for the first half, versus $76.71. The filing identifies netback as a non-GAAP measure, not a GAAP margin.
  • Liquidity and debt: Working capital was $199.6 million, including $166.4 million cash; the company reported no debt and no borrowings under its $150 million reserve-based credit facility. Current assets were $295.2 million and current liabilities $95.7 million. Some cash was held outside Canada and the United States and generally was not available for head-office use without repatriation.
  • Balance sheet: Total assets were $1.479 billion, down from $1.714 billion at year-end 2014; shareholders’ equity was $1.195 billion, down from $1.277 billion. Inventory rose to $33.5 million, including 679 Mbbl of oil, primarily due to pipeline disruptions; the company said this inventory was sold in July.

Material changes and management commentary

  • Oil prices remained depressed: first-half realized oil price was $47.03 per barrel versus $91.74 in 2014. Management attributed weaker results to lower prices and sales volumes.
  • The company increased its 2015 capital program on June 24 to $185 million from $140 million: $115 million for Colombia, $49 million for Peru, $20 million for Brazil and $1 million for corporate activities. First-half capital spending was $91.8 million versus $173.4 million a year earlier. Management expected the program to be funded from operating cash flow and cash on hand under then-current assumptions.
  • Management said it could reduce capital spending further, draw the credit facility, issue debt or equity, or sell assets if cash flow weakened. It also referred to a planned share repurchase program, but the supplied filing text does not provide its size or terms.
  • A new CEO, Gary Guidry, and CFO, Ryan Ellson, were appointed during the quarter following a proxy-contest settlement and board changes. The company reduced staffing substantially in March and recorded additional terminations in Q2.
  • Colombian oil delivery restrictions and OTA pipeline disruptions reduced sales; production also reflected declines at Costayaco and increased water cut at Juanambu. Brazil’s Tiê Field was suspended by the regulator from March 11 to May 15 over alleged health and safety management-system non-compliance.
  • Management said further ceiling-test impairments in Brazil and Colombia were reasonably likely in Q3 and Q4 if other factors remained constant. It did not expect a net downward adjustment to consolidated NAR reserves for 2015 under its stated assumptions.

Risks, contingencies and unusual items

  • Colombian HPR royalty arbitration: Gran Tierra disputes the ANH’s position on royalty liability for Moqueta production. The company began paying the royalty on production above the 5.0 MMbbl threshold reached April 30, 2015. If the ANH’s claims are accepted, estimated compensation is $66.3 million plus $24.8 million related interest using the ANH’s calculation; the company disputes the interest rate. No amount was accrued because management did not consider a loss probable. A separate disagreement over deductible transportation costs could, under the ANH’s interpretation, entail up to $42.1 million; no amount was accrued.
  • Other legal matter: A dispute with Ecopetrol concerning oil allocation was appealed; $2.4 million was accrued. The company reported other claims but did not expect them to have a material adverse effect.
  • Concentration and market exposure: Ecopetrol accounted for 75% of Q2 and 77% of first-half continuing oil and gas sales. Oil-price volatility, pipeline access and transportation tariffs, currency movements, and access to capital are key exposures. Management said pipeline tariff negotiations were ongoing and their impact could not yet be quantified.
  • Other unusual items: Brazil incurred $1.7 million of one-time penalties related to alleged safety-system non-compliance. The filing reports no open foreign-currency derivative positions at June 30. Colombia’s effective tax rate was negative 1.1% for the first half, affected in part by valuation allowances and impairment-related tax effects.

Important facts for investors to verify

  • Whether oil prices, Colombian pipeline availability and inventory levels support the planned $185 million capital program and liquidity.
  • Subsequent impairment charges, especially in Brazil and Colombia, and any reserve revisions as commodity prices and pipeline tariffs change.
  • Developments in the HPR royalty arbitration, including the potential $66.3 million claim, disputed interest and separate transportation-cost exposure of up to $42.1 million.
  • Progress on Peru Block 95 plans, Colombia’s planned drilling, and the status of the Brazil Tiê Field and regulatory matters.
  • The terms and funding of the planned share repurchase program, which are not clear in the supplied filing text.
  • Cash availability across jurisdictions and continued compliance with credit-facility covenants.