Pine Cliff Energy Ltd T.PNE

President message to shareholders...

[zack50]

I hope everyone had a safe, enjoyable summer and are doing well. Pine Cliff is happy to report our second highest quarterly adjusted funds flow in history at $34.9 million in Q3 2022 and the second dividend increase since we implemented the dividend this past June.

Highlights from the nine-months ended September 30, 2022 include:

• generated $34.9 million ($0.10 per basic and fully diluted share) and $123.0 million ($0.36 per basic and $0.34 per fully diluted share) of adjusted funds flow for the three and nine months ended September 30, 2022, compared to $13.3 million ($0.04 per basic and fully diluted share) and $32.8 million ($0.10 per basic and $0.09 fully diluted share) for comparable periods in 2021

• generated net earnings of $18.6 million ($0.05 per basic and per fully diluted share) and $84.3 million ($0.24 per basic and $0.23 per fully diluted share) for the three and nine months ended September 30, 2022, compared to net earnings of $2.3 million ($0.01 per basic and fully diluted share) and net earnings of $0.9 million ($0.00 per basic and fully diluted share) for comparable periods in 2021

• paid dividends of $9.9 million ($0.01 per common share per month) during the three months ended September 30, 2022;

• ending the quarter with positive net cash of $35.1 million while maintaining debt free status throughout the quarter;

• production volumes for the three and nine months ended September 30, 2022 were 21,276 Boe/d and 21,004 Boe/d, 16% and 15% higher respectively than comparable periods in 2021

• completed a summer drilling program that saw Pine Cliff drill four gross (2.8 net) operated Pekisko horizontal oil wells, of which three gross (2.1 net) were on production by the end of the third quarter; and

• participated in the drilling, completion and tie-in of five gross (0.9 net) non-operated natural gas wells in Edson.

Future Capital Allocations
The Pine Cliff strategy on future capital allocation continues to evolve with commodity price fluctuations and market opportunities available to us. We know that our shareholders have tasked us to manage the capital allocation process with the goal of attempting to increase shareholder value based on all the data and information available to us. We do not take this responsibility lightly. I find it interesting that other management teams in our industry are now discussing capital allocation and return of capital to shareholders after years of being pure growth models. For Pine Cliff, nothing has changed. We have always been focused on seeking the best return on our invested capital and building the optimal business model to return capital to our investors.

We have often said that “Pine Cliff is a public company that we run like a private company”. Our high insider ownership has set up a natural alignment with our investors and therefore it should not have come as a surprise to any of our long-term shareholders when we paid down all of our debt in the first half of 2022 and then instituted a material dividend in June. We are proud of the accretive growth of Pine Cliff and the establishment and increase of our current monthly dividend (8% annualized yield as of today’s closing stock price) but we are not content. Our goal is to continually evaluate commodity prices and acquisition opportunities with the purpose of determining the best allocation of capital to attract new shareholders while staying loyal to the shareholders that have been with us all along.

Here are some of our current considerations concerning capital allocation:

a) Capital Expenditures

Pine Cliff’s 2022 capital program of $31.5 million consists of the drilling of four gross (2.8 net) Pekisko wells, seven gross (1.5 net) Edson gas wells, recompletions, optimizations, maintenance capital and abandonment projects. The focus of our 2022 drilling program was to maintain our production level with the possibility of some moderate growth, and we have achieved those goals. The 2022 capital program success would not have been possible without our strong vendor relationships and our skilled internal field and operations staff. Although our drilling success this year might have been a catalyst for some companies to accelerate drilling expenditures, we remain comfortable with staying the course and see no reason to change our corporate strategy at this time. We have begun to budget our 2023 capital program and believe the same goals that drove this year’s programs, sustainability with the possibility of moderate growth, are likely to drive the 2023 program as well.

b) Asset Purchases

Asset purchases have been the main contributor to the growth of our business. We are proud of the 11 material acquisitions we have made since 2012 that have grown our production base from 100 Boe/d to close to 22,000 Boe/d. Each acquisition has made Pine Cliff stronger and were completed at accretive metrics. We are always seeking to add to our two million acre asset portfolio, and it is rare that we are not in discussions with potential vendors or participating in a data room analyzing assets. Our team has proven time and time again that our biggest competitive advantage is taking mature assets and improving their operating efficiency. We have proven our purchasing discipline over the past 11 years by our willingness to walk away from negotiations when we believe the vendor’s asking price has risen outside our comfort level. In multiple instances, this discipline has resulted in us purchasing the same assets later at a more beneficial purchase price to Pine Cliff.

Our team meets on a weekly basis to review all asset sales in Western Canada that we believe could potentially improve Pine Cliff’s business model. We know from experience that carrying a certain amount of cash on our balance sheet will aid us in negotiations as vendors typically prefer the certainty of cash over the uncertainty of a purchase being subject to financing. As large shareholders of Pine Cliff, management is also sensitive to share dilution and would rather use cash for purchases than equity. How much is the right amount of cash to keep available will vary over time and depend on potential acquisitions we see coming available to Pine Cliff. For confidentiality reasons we often can’t speak to our shareholders about what we are working on or the possible timing of any acquisitions but be assured that that information is part of the overall considerations we make on capital allocation decisions.

c) Dividend Structure

Each quarter, Pine Cliff’s management and Board look at our current dividend rate and we discuss the viability of raising that base dividend. Sustainability of Pine Cliff’s base dividend is ultimately the determining factor for any possible dividend increases. We cannot predict future commodity prices, but we do look at a possible range of prices and the likelihood of that range occurring based on what we know today. The time we look out to is typically the future 24-month period as commodity future markets are quite “thin” beyond that time period and therefore the value of data beyond that is less reliable. It was this process that led us to our decision to raise the Pine Cliff dividend again this quarter.

If there are instances where we feel our cash balance is sufficient given the possible asset acquisitions we see on the horizon, and if we are not feeling comfortable with raising our base dividend at that time given the volatility of commodity prices, we may consider the implementation of a “special", flexible or variable dividend. Again, our capital allocation decisions will always be made on what we think will deliver the most long-term value to our shareholders.

d) Share Buybacks

While share buybacks have been a capital strategy used by some companies in our industry, Pine Cliff’s belief is that now is not an optimal time to be purchasing our own shares given our high level of insider ownership. We will continue to monitor the liquidity of our public float and discuss this capital allocation option, but at this time, we believe our shareholders will be rewarded with a better return with the first three shareholder capital allocation strategies outlined above.

North Twining Pekisko Unit Update

Pine Cliff has brought the first five (3.5 net) horizontal North Twining Pekisko Unit wells on production in 2022 increasing this Unit’s gross production from four boe/day in February, 2022 to over 2,100 boe/day in October 2022, with one well still pending initial production. Well results have been considerably above expectations, including the 102/09-29-032-24 W4 well which came on production in August 2022 with IP30 productivity over 850 boe/day and was identified as one of the top new wells in the Province of Alberta. Although Pine Cliff is not a drilling “story”, I am proud of the way our team has systemically increased ownership of Twining assets to make it our key operated core area for replacing production at impressive rates of return.

Passing of Chris Lee

This past quarter had many highlights, but it also brought with it the saddest event in Pine Cliff’s history. Chris Lee, our Vice President of Exploration, and my very first hire at Pine Cliff over ten years ago, passed away on October 24. Our entire Pine Cliff team has been mourning this tragic loss alongside Chris’s family. Chris brought incredible energy, humour and expertise to Pine Cliff. Anyone who was fortunate to meet or work with Chris know they are one of the lucky ones and should be both grateful and thankful for that time. I most definitely am. Chris will be dearly missed.

Outlook

As the world continues to wrestle with the geopolitical and energy implications of the Russian invasion, energy security concerns, natural gas pipeline sabotage, climate change, decarbonization efforts and lack of sufficient supply response from oil and gas producers, global commodity prices continue to be extremely volatile. Although Europe has successfully been able to refill its natural gas storage this summer by paying record prices for LNG, natural gas storage remains below its five-year average levels in both Canada and the United States as we head into this winter. LNG exports out of the United States are expected to return to record levels in the next couple months after dealing with a summer fire that removed 15% of exports from the US. The resumption of those LNG exports will assist Europe this winter to keep storage full, but it also should put upward pressure on North American gas prices as we enter the winter with less domestic supply available for use.

Weather will ultimately dictate how high natural gas prices go this winter, but we are becoming increasingly optimistic on the prospects of being a natural gas producer in the upcoming decade as North American LNG exports ramp up in 2025 in Canada, Mexico and the United States. The world is recognizing the essential role oil and natural gas plays in maintaining the affluent style of living we enjoy in developed nations and what a critical role natural gas will play in helping developing nations access less carbon intensive power solutions.

In 2022, we enjoyed some of the highest natural gas prices we have seen since 2008 and the year is not over. The AECO spot price this morning was $5.30 Mcf and on today’s 2023 forward strip pricing, Pine Cliff can expect to generate approximately $130 million of adjusted funds flow in 2023. If we assume roughly the same Pine Cliff CAPEX spend in 2023 as in 2022, we would generate approximately $100 million of “free funds flow”, of which only $45.5 million would be allocated to dividends at our current dividend rate.

Thank you to everyone for your continued support and we look forward to working at increasing your shareholder value in Q4 2022 and beyond.

Yours truly,
Phil Hodge
President and Chief Executive Officer
November 9, 2022