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Surge Energy Inc. Announces $28.4 Million Sparky Core Area Acquisition; Upward Revision to 2018 Exit Guidance; Increase to Dividend


CALGARYMay 15, 2018 /CNW/ – Surge Energy Inc. (“Surge” or the “Company”) (TSX: SGY) is pleased to announce the execution of a formal purchase and sale agreement for the acquisition (the “Acquisition”) of high netback, waterflooded, crude oil producing assets (the “Assets”) in the Company’s core Sparky area of Central Alberta for a purchase price of $28.4 million, which is expected to close on or about May 31, 2018.

Current production from the Assets is more than 620 boepd (83 percent oil), with over 75 percent of the production focused in Surge’s large original oil in place (“OOIP”1), high netback, core Sparky crude oil properties at Eyehill and Macklin. The Assets have an annual decline of less than 27 percent, and a netback of more than $30 per boe at US $65 WTI2 per barrel oil prices. The Acquisition is accretive to Surge on all key debt adjusted per share metrics. Surge has identified more than 35 net low-risk Sparky development drilling locations on the Assets. The Assets have a large internally estimated OOIP of over 85 million barrels, and an average gravity of 27o API.

In conjunction with the Acquisition, Surge is also revising upward the Company’s 2018 exit production guidance from 16,650 boepd to 17,175 boepd (82 percent oil).

In addition, as a result of better than anticipated Q1 2018 drilling and waterflood results (as Press Released on May 8, 2018), the Sparky core area Acquisition, significantly higher strip crude oil prices than estimated, and the narrowing of WCS differentials to near historical levels, Surge is generating substantial free adjusted funds flow, (resulting in an estimated dividend simple payout ratio of less than 15 percent) at current strip crude oil prices. Accordingly, Surge’s Board of Directors has approved an increase to the Company’s annual dividend from $0.095 per share per year ($0.0079 per share per month) to $0.10 per share per year ($0.0083per share per month).

______________________

1

Original Oil in Place (“OOIP”) is the equivalent to Discovered Petroleum Initially In Place (“DPIIP”) for the purposes of this press release.

2

2018 guidance and Acquisition metrics are based off of US$65/bbl WTI, US$47/bbl WCS, 0.78 CAD/USD FX, $1.40/GJ AECO.

THE SPARKY ACQUISITION

The Acquisition is consistent with Surge’s business strategy of acquiring high quality, operated, large OOIP, conventional crude oil, sandstone reservoirs with low recovery factors.

The Assets are located in the Company’s Sparky core area trend in which Surge currently has over 700 million barrels of internally estimated net OOIP. The Eyehill and Macklin properties included in the Acquisition represent over 75 percent of the current production from the Assets, and directly offset Surge’s current production and drilling operations. Surge has identified over 35 net low-risk drilling locations, with additional waterflood upside on these two key properties. The Assets are characterized by the following attributes:

  • More than 85 million barrels of internally estimated OOIP with current recovery factors of less than 2 percent at Eyehill and Macklin (and an internally estimated recovery factor of 10 percent on primary, and up to 30 percent with waterflood);
  • 620 boepd (83 percent oil) of 100 percent operated, high working interest, low decline, oil-weighted production;
  • Long life reserves – over 2.9 mmboe of internally estimated proved plus probable reserves (i.e. 13 year RLI);
  • A portion of the production is under successful, active waterflood (with additional waterflood upside at both Eyehill and Macklin);
  • More than 35 net low-risk, development drilling locations, of which 11 are included in Surge’s internal reserve estimates above;
  • Operating netbacks of more than $30 per boe at US $65 WTI;
  • Sustaining capital of $3.25 million, with anticipated 2H 2018 annualized adjusted funds flow of more than $6.0 million; and
  • Implied free cash flow yield of approximately 45 percent.

ATTRACTIVE DEAL METRICS

The $28.4 million Acquisition has the following transaction metrics:

Current Production Multiple

620 boepd (83 percent oil);
$46,000 per flowing boepd

2H 2018 Annualized Adjusted Funds Flow Multiple3

4.7x

Total Proved Plus Probable Reserves Multiple (Internally Estimated) 4

$9.79/boe

Recycle Ratio

3.1x

Reserve Life Index (RLI)

13 years

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3

2018 guidance and Acquisition metrics are based off of US$65/bbl WTI, US$47/bbl WCS, 0.78 CAD/USD FX, $1.40/GJ AECO.

4

RLI defined in Reserves Data/Oil and Gas Metric

This Acquisition is accretive on all key debt adjusted per share metrics.

STRATEGIC FIT WITH SURGE’S CORE SPARKY ASSETS

Production in Surge’s Sparky core area has increased 145 percent over the last 2 years, from 2,850 boepd to over 7,000 boepd (85 percent oil) today. Each of Surge’s core assets depicted below can be characterized as a high quality, low risk, operated, large OOIP, conventional sandstone reservoirs.

Core Sparky Assets - Map. (CNW Group/Surge Energy Inc.)

SPARKY AREA – CONTINUED GROWTH MOMENTUM

Over the last 2 years, Surge has successfully grown production in the Company’s Sparky core area by more than 145 percent – turning its key producing Sparky asset base into a low cost, high netback, conventional sandstone resource play.

Over the past 12 months Surge has successfully completed three separate accretive Sparky core area acquisitions, purchasing over 2,200 boepd (90 percent oil) combined, for an average of less than five times forward adjusted funds flow from the acquired assets. The combination of these transactions, together with Surge’s highly successful development drilling program, have allowed the Company to amass an exciting core growth area with the following characteristics:

  • Since year end 2016, Surge has increased the Company’s internally estimated net OOIP in the Sparky core area to over 700 million net barrels, and added more than 125 internally estimated drilling locations;
  • Surge’s proved plus probable oil reserves in the Sparky core area have grown by more than 75 percent from 18 million boe (independently evaluated year end 2015 Sparky area reserves), to an internal estimate of more than 32 million boe today;
  • Production from Surge’s Sparky core area has increased by over 145 percent in the last 2 years from approximately 2,850 boepd to over 7,000 boepd today (85 percent oil);
  • Today Surge has more than 340 internally estimated, low risk, Sparky area, development drilling locations – providing shareholders with a 12-year inventory of high rate of return (and excellent profit to investment ratio) locations at strip oil prices; and
  • In addition, Surge is now experiencing significant economies of scale based upon regional dominance in this key growth area in terms of services, land, infrastructure, and existing production.

Management sees further opportunity to both expand and consolidate Surge’s position in the Sparky core area, utilizing the following strategies: 1) organically grow through land acquisitions and follow-up development drilling; and 2) actively pursue, evaluate, and transact on accretive acquisitions of large OOIP, long life, low decline, conventional sandstone reservoirs.

Surge has now identified and delineated several distinct assets in its Sparky core area that will underpin growth in the area for the foreseeable future. The Company’s key operated, large OOIP, sandstone reservoirs at Eyehill, Lakeview, Sounding Lake, Sounding Lake East, Betty Lake, Provost, and Macklin all possess multi-year development drilling inventories, exciting growth prospects, and waterflood upside.

Overall, the Company anticipates its Sparky core area to grow from 7,000 boepd currently, to over 10,000 boepd over the next three to four years.

UPWARD REVISION TO 2018 EXIT GUIDANCE

Based on better than anticipated drilling and waterflood results, (as Press Released on May 8, 2018), Surge’s Q1 2018 production of 16,027 boepd again exceeded managements budgeted expectations.

In accordance with the Acquisition, Surge is now revising upward the Company’s 2018 production exit rate from 16,650 boepd to more than 17,175 boepd. Surge has now revised upward the Company’s production estimates five times in the last 2 years (i.e. two times organically and three times pursuant to core area acquisitions).

Surge’s upwardly revised guidance for 2018 is set forth below:

OPERATIONAL

US $65 WTI 2018
GUIDANCE5

US $75 WTI 2018
GUIDANCE6

2018 Average Production (boe/d)

16,585

16,585

2018 Exit Production (boe/d) (82 percent oil)

17,175

17,175

Total 2018 Capital Spending

$105 million

$105 million

Operating Expenses – 2H 2018 ($/boe)

$13.95/boe

$13.95/boe

Transportation Expenses – 2H 2018 ($/boe)

$1.50/boe

$1.50/boe

Royalties as a % of Revenue – 2H 2018

14-15%

15-16%

FINANCIAL

Estimated 2H 2018 Annualized Adjusted Funds Flow

$149 million

$190 million

Estimated 2H 2018 Annualized Adjusted Funds Flow per Share

$0.65

$0.82

Estimated Q4 2018 Net Debt to Adjusted Funds Flow

1.66x

1.2x

Annualized Dividend

$23.1 million

$23.1 million

Sustainability Ratio – 2H 2018 Annualized

86%

67%

Simple Payout Ratio – 2H 2018 Annualized

16%

12%

*Note:

In 2017 Surge budgeted WCS differentials at US$12.75 per bbl.  Surge has now increased its WCS differential
assumption by 41 percent in 2018, to US$18 per bbl in its US$65 WTI budget on a go forward basis.

______________________

5

2018 guidance and Acquisition metrics are based off of US$65/bbl WTI, US$47/bbl WCS, 0.78 CAD/USD FX, $1.40/GJ AECO.

6

2018 guidance and Acquisition metrics are based off of US$75/bbl WTI, US$56/bbl WCS, 0.79 CAD/USD FX, $1.40/GJ AECO.

Based on better drilling results than anticipated at the Company’s core Valhalla light oil property, Surge has added one net Valhalla well in the fall of 2018 to its capital expenditure budget, plus $1 million of incremental facilities capital to handle the associated light oil volumes.

5.3 PERCENT INCREASE TO DIVIDEND

As a result of the Sparky core area Acquisition, along with better than anticipated operational results in Q1 2018, significantly higher strip WTI oil prices than the Company was budgeting, as well as WCS crude oil differentials narrowing close to long term average levels, Surge has much larger free adjusted funds flow in 2018 than management was projecting.

Accordingly, with the ongoing protection from Surge’s strategic commodity hedging program, the Board and management of Surge intend to increase the Company’s dividend by 5.3 percent, from $21.9 million annually to approximately $23.1 million annually, effective June 15th, 2018.

This equates to a simple payout ratio of less than 16 percent of forecast 2H 2018 annualized adjusted funds flow at WTI crude oil prices of US $65 WTI per barrel, including a WCS differential assumption of US$18 per barrel.

OUTLOOK – SUSTAINABLE GROWTH, LONG TERM VALUE, AND INCOME

Management’s stated goal is to be the best positioned light/medium gravity crude oil growth and dividend paying public company in our peer group in Canada.

Over the last seven financial quarters, Surge has now increased production per share by 25 percent, increased its dividend by 31 percent, and upwardly revised production estimates five times – twice times organically, and three times pursuant to accretive Sparky core area acquisitions.

Management attributes the Company’s continued quarterly operational outperformance to be a direct result of applying growth capital to Surge’s high quality, large OOIP, light and medium gravity crude oil, conventional sandstone reservoirs, and successful waterflood implementation.

Management believes that Surge offers its shareholders a unique return based model with multi-faceted, low risk, light and medium gravity crude oil investment opportunity as follows:

  1. Sustainable annual production per share growth of five to seven percent per year pursuant to the Company’s strategic Five Year Business Plan; plus
  2. Very high internal rate of return drilling locations – with very quick payouts (11 year drilling inventory; with a weighted average internal rate of return greater than 90 percent at US $65 WTI flat pricing); plus
  3. Significant incremental long-term value from Surge’s large OOIP conventional reservoirs that have very high profit to investment ratio waterfloods (low risk drilling and waterfloods provide low harmonic declines, and deliver “annuity-type” annual reserve bookings); plus
  4. Current yield of approximately four percent through a sustainable, increasing, compounding dividend; plus
  5. Free adjusted funds flow yield (above US $57.50 WTI flat pricing); plus
  6. Significant financial leverage to higher oil prices; plus
  7. Significant upside for share price appreciation as Surge common shares trade up to (and through) the Company’s new net asset value of $6.06 per share (calculated based on the Company’s December 31, 2017 independently estimated (Sproule) reserve report total proved plus probable value, discounted at 10 percent).

Surge will continue to grow its production base and location inventory in the Company’s three core areas – at Sparky, Shaunavon, and Valhalla – through, organic, low risk, development drilling, combined with strategic, high quality, core area acquisitions.



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