Headwater Exploration Inc. Announces Dividend Policy, 2023 Budget, Operations Update And Third Quarter Results

Headwater expects approximately 38% production per share growth in 2023 while underspending anticipated cash flow. As a result of continued exceptional results, Headwater’s Board of Directors (the “Board”) has implemented a return of capital strategy with the declaration of Headwater’s inaugural quarterly cash dividend of $0.10 per common share. The first dividend will be payable on January 16, 2023, to shareholders of record at the close of business on December 30, 2022. This dividend is designated as an eligible dividend for Canadian income tax purposes. The Board expects that the regular quarterly dividend can be maintained in conjunction with our anticipated growth profile at a long term WTI oil price of US$55/bbl. Based on Headwater’s closing common share price on November 2, 2022, of $7.21 per share, this represents an annual yield of approximately 5.5%.

Headwater drilled a successful exploration test at 16-22-075-02W5 in Marten Hills West which has extended our proven pool boundaries by approximately 3.5 miles. This well has achieved an average 30-day production (“IP30”) rate of 330 bbls/d of oil, providing payout in approximately 4-5 months at US$80/bbl WTI.

We also drilled two successful 1.5 mile extended reach step-out wells in our Marten Hills core area. The 12-08-075-24W4 well has achieved an IP30 rate of 377 bbls/d and the 11-08-075-24W4 well will complete its 30-day initial production period mid-November. The wells have extended our core area pool boundaries by approximately 1.5 miles.

In our Marten Hills central area we drilled two successful pool extension wells. The wells at 02/16-14-075-26W4 and 03/16-14-075-26W4 have confirmed our geotechnical interpretation of this pool which covers approximately 5 sections of 100% owned Headwater lands. These wells achieved IP30’s of 130 bbls/d, providing payout in approximately 8-9 months at US$80/bbl WTI.

In assessing our continued success and our initial return of capital strategy, the Board has approved an initial capital budget for 2023 of $200 million resulting in 2023 annual average production of 18,000 boe/d (92% heavy oil).

The capital budget is expected to generate 38% production per share growth at a reinvestment rate of 60%-70% of 2023 forecasted adjusted funds flow from operations at US$75/bbl to US$85/bbl WTI.

At US$75/bbl to US$85/bbl WTI, Headwater forecasts 2023 adjusted funds flow from operations of $285–$330 million and free cash flow of approximately $85–$130 million resulting in estimated positive exit 2023 adjusted working capital of $105–$150 million.

Selected financial and operational information is outlined below and should be read in conjunction with the unaudited condensed interim financial statements and the related management’s discussion and analysis (“MD&A”). These filings will be available at www.sedar.com and the Company’s website at www.headwaterexp.com

Financial and Operating Highlights

THIRD QUARTER 2022 HIGHLIGHTS

• Realized adjusted funds flow from operations ⁽¹⁾ of $58.4 million ($0.25 per share basic) and cash flows from operating activities of $72.1 million ($0.31 per share basic) representing an increase of 85% and 158%, respectively, over the third quarter of 2021.
• Recognized net income of $31.5 million ($0.14 per share basic) representing an increase of 21% from the third quarter of 2021.
• Achieved an operating netback ⁽²⁾ of $56.54/boe and an adjusted funds flow netback ⁽²⁾ of $54.39/boe representing an increase of 22% and 21%, respectively, over the third quarter of 2021.
• Production averaged 11,612 boe/d (consisting of 10,842 bbls/d of heavy oil, 4.3 mmcf/d of natural gas and 55 bbls/d of natural gas liquids) representing an increase of 51% from the third quarter of 2021.
• Executed a $71.0 million capital expenditure ⁽³⁾ program including 9 successful exploration wells in Marten Hills West plus 8 injection wells in Marten Hills as part of Headwater’s enhanced oil recovery project.
• Added 8.25 sections of additional crown lands prospective for Clearwater oil in the Greater Peavine area.
• As at September 30, 2022, Headwater had adjusted working capital ⁽¹⁾ of $118.0 million, working capital of $113.4 million and no outstanding bank debt.

Marten Hills West

In addition to the previously discussed successful exploration extension well at 16-22-075-02W5, an additional 5 wells were drilled in the Clearwater A in the third quarter of 2022. The IP30 rates on these wells have continued to exceed our expectations, achieving average rates of >175 bbls/d of oil.

Headwater has continued to delineate the Clearwater B formation with a total of 3 wells being drilled in the quarter. IP30 rates on these wells have averaged 100 bbls/d of oil which is consistent with expectations for the Clearwater B.

A pilot waterflood to assess the enhanced oil recovery potential in the Clearwater A is contemplated for the first quarter of 2023.

Marten Hills Core

We have continued operations in the Marten Hills core area with the development of the upper bench in section 24-074-25W4. Six wells were drilled during the quarter with exceptional results.  On average the wells have achieved IP30 rates of >350 bbls/d per well.

Waterflood implementation in the core area has resulted in production stabilization of approximately 2,000 bbls/d (20% of current core area production). The production stabilization witnessed over the last several months is consistent with expectations and it continues to demonstrate that enhanced oil recovery is a viable option for the Clearwater formation that is expected to materially increase ultimate oil recovery. Headwater plans to continue to implement additional waterflood patterns with expectations that all of the core area will be under waterflood by the middle of 2024.

Greater Peavine Area

Our first exploration test, a stratigraphic test at 06-16-074-18W5 in our Shadow prospect is currently drilling.  Immediately following this well, the rig will spud our first multi-lateral horizontal well in the same prospect area. Headwater has one drilling rig assigned to continue drilling exploration prospects through year end and into the first quarter of 2023. The current schedule will see this rig drill a total of three horizontal wells at Shadow, prior to moving to test additional prospects at Peavine, Utikima Lake and Seal. The initial seven exploration wells are expected to be rig released by early February.  We look forward to providing results on the exploration program throughout the first quarter of 2023.

Since the start of the fourth quarter, Headwater has added an additional 6 sections of land in Peavine, increasing our total land position in the Greater Peavine area to 117.5 sections.

McCully

McCully is scheduled to be placed back on production at the end of November. We have hedged approximately 4.3 mmcf/d representing 57% of our estimated winter season’s production at a price of Cdn$28/mcf. McCully is anticipated to deliver record free cash flow of approximately $28 million over the winter season ⁽¹⁾. This asset is long-life, low decline and adds to the sustainability of Headwater’s dividend.

The Company remains on track to achieve its previously released annual production guidance of 13,000 boe/d. Capital expenditures for the year are now expected to be $245 million which represents an increase of approximately 6.5% from our previously released capital budget of $230 million. The increase in the capital budget is a result of approximately $7.5 million of additional costs associated with inflation and an additional $7.5 million of spending on equipment inventory and civil construction work to prepare for an active first quarter in 2023. With the $15 million increase in capital and the declared $23 million dividend, the forecast exit adjusted working capital is now approximately $113 million.

Headwater has executed a commitment letter for a credit facility in the amount of $100 million with a senior lender. With the 2023 guidance as outlined, Headwater does not intend to draw on the credit facility.

The positive working capital balance and credit facility provide a war chest to continue to provide Headwater the optionality to organically expand its Clearwater resources base, pursue accretive acquisitions and implement additional enhanced oil recovery schemes.

2023 will be another exciting year for Headwater as it targets 38% production growth while testing material exploration potential. Based on current strip pricing, we anticipate generating significant free cash flow above our capital expenditures and committed quarterly dividend which will allow the optionality to continually increase our regular quarterly dividend and/or provide special dividends while pursuing incremental opportunities.