Peyto Exploration & Development Corp. (OTCPK:PEYUF) Q2 2022 Earnings Conference Call August 11, 2022 11:00 AM ET

JP Lachance - President and COO

Todd Burdick - VP, Production

Lee Curran - VP, Drilling and Completions

Derick Czember - VP, Land

Riley Frame - VP, Engineering

Jeremy McCrea - Raymond James

Thank you for standing by and welcome to Peyto's Second Quarter 2022 Financial Results Conference Call. [Operator Instructions] As a remainder, today's program may be recorded.

Now, I'd like to introduce your host for today's program Darren Gee, Chief Executive Officer. Please go ahead, sir.

All right. Well, thank you Jonathan. And good morning, ladies and gentlemen, and thanks for tuning into Peyto's second quarter of 2022 results conference call. Before we get started today, I would like to remind everybody that all statements made by the company during this call are subject to the forward-looking disclaimer and advisory set forth in our company's new release issued yesterday.

In the room with me today, we've got most of the Peyto management team. A couple of people are on holidays, but we've got our President and Chief Operating Officer, JP Lachance, here to answer your questions; as is Kathy Turgeon, our Chief Financial Officer; Todd Burdick, our VP of Production is here; and Lee Curran, our VP of Drilling and Completions; Derick Czember, our VP of Land, is here; Riley Frame, our VP of Engineering; and of course, our newest addition to the management team, Tavis Carlson, VP of Finance, is also here. So fire away with your questions when we get to that section.

But maybe before I get started with my comments about our results, I do want to recognize the efforts of both our office and field personnel this past quarter. This was a particularly wet spring in the Brazeau and Edson area. I looked at the average rainfall map for that part of Alberta yesterday, and I was pretty shocked to see just how much rain fell somewhere between 200 and 300 millimeters of rain in the quarter, which got classified as a once in a 50-year rainfall.

So there's no wonder we were stuck in the mud trying to get drilling and completions done in the latter part of the quarter, especially and forget about laying pipelines and doing tie-ins in that kind of wet condition.

Obviously, what that meant for our field people was they were working extra hard slogging through the mud to keep things flowing and to try to keep our capital program going. We did spend a little bit of extra money, obviously, to keep operations moving forward. But considering where bonding prices are, I think it was worth it. Thankfully, we got our Chambers plant up and running before all that rain hit in June, so that didn't interrupt that start-up. But I do want to send out a big thank you to the entire Peyto team for that extra effort in Q2 in light of the challenging conditions.

So on to the quarter, despite the rain, we still manage to keep drilling. We drilled 23 gross wells, but we saw more partner participation this quarter than we've seen for the past few years. Obviously, with such strong economics, we are seeing full partner participation now, which is definitely a change - our average working interest in the wells that we drilled in the quarter was down from previous quarters.

We were also targeting some lower working intersections close to our Chambers plant in the quarter in order to develop those reserves nearest to the plant. So going forward, we'll be moving to higher working interest locations for the back half of the year.

So our five drilling rigs are going to make a bigger impact on production here as we go forward. Drilling was very focused on the Cardium and Wilrich and Chambers and the Notikewin and Wilrich and Sundance, Greater Sundance because that was all we could really get to. In the back half of this year, we'll be spreading that focus around a little more. We've got some interesting new zones to test, the Dunvegan being one of those.

We've got some really high production prolific wells in Cecilia that we're getting after right away here. And then we've got obviously some more Wilrich and flare that we're going to be testing out in our Whitehorse Minehead area and around Sundance and some other interesting tests that we're going to do.

So we're going to spread things around a little more in the back half of the year. New well connections in the quarter obviously slowed down, but we're catching that back up now. As a result, we're only just now starting to really see the production gains from all this drilling and should see that production ramp up nicely to the end of the year from here.

Operationally, I would say things are going really well. We're trying to keep the inflation costs at bay. That's obviously challenging for the whole industry, regardless of what other people are telling you. Labor is very tight, and there are still issues with supply chains for materials.

We're trying to stay in front of that as much as we can and hope that by the end of the year, some of that pressure will start to ease as things return to a more normal state. The big problem is, of course, that higher energy costs are embedded everywhere as people are really feeling these days from food to gasoline to manufacturing of goods to even the mining of raw materials and that cost inflation gets passed along the whole way even to the things that we consume. So it's a bit of a double-edged sword. We get much higher commodity prices for what we're selling, but we pay more for what we're consuming and buying.

Thankfully, Peyto starting from a lot lower cost base than the majority of the industry. So the same percentage increases are a lot smaller for us than they are for many of the others. And that's obviously been one of the strengths of our business. As far as commodity prices go, it was a roller-coaster ride this past quarter.

At the start of April, Henry Hub spot prices were around 550 in MMBtu. And by early June, they had risen to $9 and then the explosion at Free Point's LNG facility shut down a couple of Bcf of North American exports and the price dropped by the end of June to about $5.75. So that's almost where it began the quarter. Oil did a similar thing.

WTI, at the start of the quarter, was around $100 a barrel. It rose to about $120 mid-June and then fell back to about $100 at the start of July. So a very similar sort of path. And I think this is just a sign of things to come with more extreme commodity volatility on the horizon. That just means that at Peyto here, we're going to have to be extra diligent in focusing on keeping our costs low, so we can enjoy the ride. We still have a bunch of our gas hedged at lower prices than what we're seeing today. So we're eager to have those roll off, we should start to see our realized price and that of the spot market come together this winter.

And then in 2023, we should actually start to beat at least the AECO strip with our blend of realized prices. Financially, this quarter was good despite the large hedging loss. In fact, $206 million of funds from operations, it was a record for us in both absolute and on a per share basis. Our previous high was back at, I think, $1.17 a share in 2014.And remember, it was just 2020 when we did $213 million funds from operations. That wasn't too long ago. So we have definitely come a long way to be able to do $200 million in the quarter.

And yes, the hedge book was painful. It will be until this fall, but we have to remember, again, it was only a year ago when the future ship was $2.50 to $3 as far as the eye could see. And quite frankly, that was a great price for us that allowed us to pursue this year's capital program that grows our business and to permanently retire about 1/3 of our debt at that price. So we took it. We didn't, obviously, foresee Russia was going to invade Ukraine, but we are going to eventually get to realize those prices at the current prices that we've got to.

And then we will be setting massive new company records for cash flow. And that time is actually just around the corner as these current hedges roll off. Firstly, I think it's more important for us to focus on costs. That's what we've always done at Peyto, and we continue to control our cash costs and did so in the quarter, holding them at that sub-$0.90 level before royalties, which obviously scale with commodity prices.

As I mentioned in the release, we've held them at approximately that level for the past 3.5 years, so a lot of volatility, and we still managed to keep our thumb right on top of the costs. Royalties were another $0.95 this quarter, actually more than all the rest of our cash costs, and that's reflective of the high gas and oil prices with commodity prices pulling back into Q3 here, we should see our royalties fall quite a bit. In fact, I think this past quarter was the highest royalty bill on a per unit basis that we expect to see going forward with this forward strip that we're looking at today.

As far as the other cost components go, we expect to make some gains on op cost as we move forward and grow our production, obviously, that's mostly through increased utilization of our gas plants, and we're going to have to try and keep obviously our power costs at day.

Those are quite high in Alberta right now. I think power pool prices are $125 or something like that or maybe even higher, closer to $150. It's too bad. The Cascade power plant isn't running right now. It will be up and running hopefully this time next year because at these pool prices, we'd be realizing some incredible gas prices.

That's - in some ways, that's a nice hedge against the higher power prices when we do get there. Interest costs are also expected to fall significantly going forward despite higher forecast interest rates and that's because we continue to pay down our debt. Over the last 12 months, we paid back $156 million. And I expect that we'll retire well over double that amount over the next 12 months. So that's going to drop our per unit interest cost down substantially and completely remove any balance sheet concerns that the market may have.

So the combination of those higher commodity prices and still industry-leading low cost is driving a big jump in profits for us. Earnings this past quarter of $95 million put us in a great position to do over $400 million this year, which will be a big record for us, and that's very exciting. As we all know, it's profits that drive dividends into the pockets of our shareholders. So that's what we're striving for.

Obviously, for this year, as we stated, we're going to retain most of those earnings to pay down debt. But after this year, which is already half done, we're going to be in a great position to flow the majority of the earnings out to shareholders. And I'm expecting that is going to be a very nice surprise for our shareholders going forward. Anyway, that's probably enough of me rambling on about the quarter.

Why don't we open it up, Jonathan, to questions from those listening in.

[Operator Instructions] And our first question comes from the line Jeremy McCrea from Raymond James. Your question please.

Hi guys. A couple of questions here. The first one is this new inventory that you've picked up in the Minehead, area, how does that inventory look to compare versus Sundance in Brazil? And then how do you think of allocating capital to that area over there versus kind of the historical areas? And then second question is, just given the volatility that we've seen with AECO here, just it seems like every year, how do you think of diversifying more of your gas here? Is there plans to slowly more and more get off AECO? And just how you're thinking about that right now?

Sure. Those are two very good questions, Jeremy. Maybe I'm going to let JP talk to the first one on Minehead.

Sure, Jeremy. Yes, so we identified right now on the lands that we've amassed in that area, in that Whitehorse Minehead area. Two townships of land we've amassed over the last several years. We've been down there off and on with the rig at the time. We were using older designs. And so our plan going forward is to use that extended reach horizontal well designed, and we've been holding up in the other areas of - other place. So that really makes - it's a game breaker for that area for us, and that's why we're excited about all the opportunity down there.

So when you think of it from the perspective of our other core areas, and I would argue that this is setting up to have the right ingredients for a new core area for Peyto. We've got the stock down there. And if it's backstopped by a bunch of Wilrich locations that we can use to drill through on our way down and sort of help to map these other horizons above us like the Viking, like the Notikewin and the flares, it's going to set up for a really nice new play for us.

So - and the great part of all that is we've already got the plant in a sense of all the major equipment is purchased. There's a few things we've got to get. But right now, it's just a matter of further delineation in that area to give us the critical mass we need and we'll go out sometime later next year, build that facility and start bringing things on and do what we do best, right, which is control - only control our production, and we'll get that stuff onstream cheaply, and we'll see the great return. So that area really looks like it's shaping up quite nicely for us right now.

So we already have a meter station built, ready to go. so...

We probably built a plant site there. We have a meter station existing that's already there. And that's no small feat when you think about - that's pretty important...

18 months, two-year time delayed to get those built.

Exactly. Exactly. It can take a long time - long lead time for those to get build. So that's already in place. It matches the capacity of the plant, we're going to move over there. So we're going to save money on moving this new equipment or our existing equipment in. We're going to avoid the risks around shop space and all the supply chain issues that others might see. So I think this is looking really, really positive.

How many wells over the next year?

So we'll likely park the rig down there. We're going to certainly go down and we're actually moving right now down there with a rig. And so we'll drill a few wells down there to help delineate. And then we're - it's likely that all next year will park a rig down and continue to delineate, play and get production.

So we're justifiably excited about this play area, Jeremy. It wasn't three or four years ago when Brazeau was sort of at this stage, where it was a new identified area. We'd like to look at the resource. We drilled a couple of wells to test it out and we were going to build a new plant and I mean, look, what Brazeau is now, 250 million a day of processing capacity and growing fast and lots of opportunity down there.

So this is, I think, a great new sort of stepping off area for us that we can build around. Hopefully, in three to five years, we've got another $200-and-some million a day of processing capacity built in this area and lots of production coming from a bunch of zones, and just more organic growth, very similar to how Peyto's always done it.

Your second question, Jeremy, was around AECO and diversification, and I just put a new presentation up on the website last night, and the marketing section is updated, too. So that's got a new graph that just shows our diversification going forward.

Yes, we haven't really liked the look at the AECO market here for a long time, and we've been diversifying away from it. I haven't had any real volumes exposed to it and the volatility that we can see at that market when it really disconnects, which is pretty severe right now.

Going forward, I think our plan is to continue to lay in a low-cost basis, financial basis that gets us to a lot of other markets. We've been doing that recently, we can get basis deals at around USD 1 an MMBtu that takes us all the way to Henry Hub. That's arguably less than the bike tolls, and there's no delivery risk physical risk for us when we do that, and then we can hedge it at those markets.

And we put what we thought was extremely high cost basis and back in 2018 for about three years to get us through the initial disconnect of the AECO market. We're on the very tail end of some of that stuff right now. It was - at the time, it looked really expensive at $45 in MMBtu.

And today, it's wildly in the money, which is just crazy. I mean, obviously, for a while there, it wasn't. But I think we have to continue to use our size to diversify away from this kind of disconnection. And until - really we get to LNG Canada online and hopefully some more expansion in the Western Canadian egress system, we're going to get these kind of disconnections that we really don't want to be a party to.

So we continue to diversify away and make sure - we've got a big chunk of Empress service as well that allows us to get off the de novo system and really get out of the AECO market. That's relatively low-cost service. At times, it's just insurance perhaps, but it really keeps us from being exposed to some of this volatility, and that's the big desire and the big win for us.

So I think the strategy going forward is to definitely continue to not be exposed to this volatility. I know at times, AECO can look really good. In Q2, arguably, there were some really strong AECO prices and the basis didn't look that bad. But then you get bit when NGTL doesn't allow access to storage because they're doing maintenance or what have you, and then all of a sudden, you get these massive price disconnections. So we just don't really want to be exposed to that.

[Operator Instructions] And this does conclude the question-and-answer session of today's program. I'd like to hand the program back to Darren Gee for any further remarks.

Thanks, Jonathan. This is a new system. So again, if anybody still has any questions, try and get in, we're still working with a little bit of a different audio/video sort of system for the webcast and for the conference call today, but hopefully, people are managing to navigate it.

There was a couple of questions that came in overnight that I did want to address. One of them was with respect to our new Chambers plant. And so I'm going to ask this of Todd. We did comments in the press release, Todd, that we had tested the upper limits of our Chambers plant throughput looked like it was beyond the initial spec. So it just - there was a question about expansion and what would it take to expand the Chambers plant even further? And what did we find when we were testing our plant there.

Yes. So we're really happy with the plant. As you know, its design capacity was about 50 million cubic feet a day. We did put some provisions in place during the construction to be able to expand it up to 100 million cubic feet a day sort of some of the key infrastructure within the plant that would allow us to do that.

We always do that when we first build the plant. We've done - we did the same thing at Chambers. So we found that we can process about 65 million cubic feet a day without compromising any of the efficiencies within the plant, liquid recoveries and that sort of thing. We can push the plant to about $75 million and probably lose a little bit of that efficiency, but we can do that right now without any incremental capital.

If we saw a need to take the plant past up to, say, $100 million, which seems to be a possibility with some of the results that we've been seeing for quite some time up there. We would have to install some new equipment, specifically compression, refrigeration, ancillary equipment to accommodate some of that equipment that would be installed.

Typically, that kind of takes around 8- to 12-month time frame. And even if we wanted to take the plant beyond that, say, north of $100 million, we would probably still be in that 8- to 12-month time frame. So we had a lot of inventory equipment for Chambers and as JP mentioned, for potentially a Whitehorse plant.

So we would have to buy new. But I think before even doing any kind of plant expansion, we would first look to optimize the existing plants that we have out there being - that have capacity, which is our new Aurora plant and Brazeau. So those three plants, Chambers; Aurora; Brazeau are now connected. Their gas gathering systems are connected. So we're able to move gas around a little bit. So we'd look to optimize and use that spare capacity as much as we can first before moving to that expansion sort of base.

Okay. Great. Thanks, Todd. I mean, it really speaks to, I think, the embedded value that we have here at Peyto, all of our infrastructure is a huge asset for us that oftentimes gets overlooked but goes to a Bcf a day of processing capacity now and growing. So that's fantastic.

The other question that was asked of me that maybe we can touch on, on this call was really about the success of this year's drilling program where we've seen above-average results. And how does that translate into the back half of the year and into drilling plans for 2023. So I thought I might ask Riley, can you elaborate a little bit on some of the results we've seen so far in the drilling this year and maybe how that translates into the rest of the year and next year?

Yes, sure. So yes, we've seen really good results this year coming in on the drilling program from the performance and the economic perspective to give a little bit of a sense for that performance at the end of Q2, roughly 21% of the wells we brought on stream and '22 already have already paid out.

And there is another sort of 10% to 15% that have paid out to date. That's really encouraging. And those sort of payouts really go a long way to reduce the price risk of our drilling opportunities, which is awesome. So a couple of the highlights, which have already been touched on a little bit by the other guys here is our success in Chambers.

We're seeing great results across all the zones down there. That really backstops the plant construction that we did down there, and there's lots of opportunity for multiple years to drive the drilling program. The other success we're having is with the extended reach horizontals as we've also touched about both Sundance and Brazeau.

We've been able to apply this reasonably broadly, mostly in the Wilrich with great results, both from a performance perspective and an economic perspective. So we'll continue to apply that across the board. So overall, I'm very happy with where we're at to date on that.

Looking forward to 2022, we'll continue to run five rigs that we've talked about here with that focus being in Sundance and Brazeau. Sundance specifically here since the road bans have come off, we've shifted back to the high deliverability in Notikewin and flare targets in Cecilia like we've mentioned, at this point, we brought on four wells down there. The results are right up there with what we saw in 2021 where we drilled some of the best wells we've seen in Peyto's history, which is great.

So again, trying to apply the Extended Reach Horizontal technology where we can. We drilled a couple of long Dunvegan wells here that are both waiting on completion. So we'll get those production results here in the next few days actually, it would be great. But from what we're seeing right now, those look like they're going to be awesome. And down in Brazeau, yes, we'll continue to drill a mix of the Cardium, Wilrich and Notikewin drilling forward here. I think obviously, we'll pivot to some higher working interest stuff like you mentioned.

And with the interconnectivity of the plants we're seeing that we've built in down there now. We'll be able to move the rigs around and sort of distribute that gas into the gathering system and see those gains, which would be great. The other thing we're doing down there right now as well as we're drilling a couple of middle flare wells in Braz area, which is a huge resource, lots of potential there, and we think Extended Reach Horizontals are really going to be the ticket to unlocking that potential and allowing us to tap into that. So that's good.

And then as JP mentioned there, we also have a rate that we've just moved down to the Minehead there. So he kind of elaborated on the program down there, and we'll test those up and see what we get and go forward. So overall, that looks good, and we're looking forward to a lot of the good wells in progress and lots of more good wells to come here so.

And then looking forward to '23, we'll continue to have a steady diet of Brazeau and Sundance in the typical Cardium, Notikewin and Wilrich with likely a rig shifting to Minehead in Whitehorse to dedicate rig time there to be ready to fill up the plant when we get it on and commissioned next year, hopefully, so. So overall looking good.

Good. That's good color. Interesting to see some of those middle and lower flare results. I know we're not the only one in that play right now. There's a couple of guys in the Deep Basin that are going hard on those plays, and I think our results are likely to be comparable to what those guys are seeing, too. We've got a similar type of rock and resource. So yes, that's an exciting new formation really for the whole industry to start to pursue. And of course, we've had that teed up for quite some time. Are there any other questions, Jonathan, that we could address?

Yes, indeed. [Operator Instructions] And our next question comes from the line of [indiscernible] from Burgundy Asset Management. Your question please.

Yes. Darren, where do you see year-end debt for the company?

It's a good question. I mean, obviously, we've been modeling these future commodity prices flowing through our financials. They're going up and down quite a bit. Obviously, year-end debt looked really low on June 7 or whatever, which was the high watermark for the future strip, and then that pulled back substantially when the free-point outage occurred.

And then we saw NYMEX really sort of climbed its way back up to close to that level here over the last couple of weeks. I'd say it softened a little bit in the last week. But yes, we're looking for net debt to be really significantly less even than 1x debt to EBITDA by the end of the year. That's going to put us in a very strong position from a balance sheet perspective. I look back over the last 23 years of Peyto, I don't think we've ever had debt that low quite frankly.

We've always carried more debt than that. So we're going to be in a bit of a unique position corporately for where that's going to be at. And it's going to be an exciting time. We'll be able to pivot I think at that point, from taking these prices and changing our balance sheet to be able to worry far less about the balance sheet and start to concern ourselves a lot more with flowing those earnings out to shareholders, which is historically what we've done.

As you know, you guys have been a long-time shareholder of Peyto, and we've made some $2.9 billion in earnings over our history, $2.5 billion of that has flowed out to shareholders in dividends and distributions. So we want to start catching up to that and getting the majority of those earnings into the pockets of our shareholders.

So it's - after this year, I don't think the balance sheet will be much of a concern to anyone. And we'll manage it, obviously, carefully, as we always do. But I think it's going to be a focus on the dividends from here out, which is going to be great.

You bet. Thanks for the question.

Thank you. Our next question comes from the line of [indiscernible]. Your question please. And please state your company. And your line is open.

Sorry, I had some difficulty getting through and I was not sure if I was on the line. So my name is [indiscernible]. I'm a private investor. And I have a few questions, two simple ones and two a little bit more complicated. So on Page 4 of your press release, the tables that show your benchmark gas prices and your realized prices, it seems like the gap between the benchmark and realized prices for NYMEX and Emerson are really high, like the benchmark prices are around $7 and the realized prices are around $3 something. Can you explain why the gap is so big?

So I think the table you're referring to shows our realized price before diversification and hedging at $6.47 per Mcf. And to your point, some of the different benchmarks are higher than that. Typically, the difference between those two is our fixed price physical transactions that we've done. So we only capture under the hedging financial hedges there, any fixed-price physical deals where we deliver gas to certain markets and then fix the price is caught up in the realized price. And so we did some of that.

We had some basis that got us to Henry Hub and Malin and some of the other markets that at the time when we looked at it, those markets were trading at fairly strong prices, maybe not relative to today, but relative to what historically they have been at a year ago when we fixed a lot of these. And so we took a lot of those deals off the table.

And when we have a basis that goes to those markets and we lock it to a fixed price, we turn it into a fixed-price physical realization for us. And so that's what translates then into that realized natural gas price. Did I got that correctly?

Sorry, I think you may be looking at the different tables that I'm looking at. So it's on Page 4 of your news release. So you have one table, which shows benchmark commodity prices at various markets. And then you have the list of AECO, NYMEX, Emerson, et cetera. And then below that, you have Peyto realized commodity price by market?

So if you look at Emerson, for example, it's like $7.39, the benchmark price and then the realized price is only $3 44. So even - I mean the basis is like $1 or $1-something. So why the pricing difference around $4?

Yes. And so that is where we fix the price. So when we did a physical fixed-price transaction at NYMEX, we would have fixed the price at that level. So you got to remember, I mean, when we did the transactions, it was a year ago when we were doing a lot of our hedging and fixing a lot of our prices that would have secured the cash flows we needed for this year's capital program that we were planning.

And a year ago, I mean, NYMEX on the future strip was $2.50 to $3. So we were fixing NYMEX prices at about that $3 to $4 level. Our average was $3.44. Yes, we get to today and the actual spot price ended up being for the quarter $7. So we gave up an opportunity to sell it for a lot more than that. But at the time when we were fixing these prices, obviously, we were trying to secure our cash flows for this year's capital program, this year's dividends and to be able to obviously retire a significant portion of our net debt - we were making at the time.

What you're saying is the $3.44 actually includes the hedging part of it also.

It's a fixed price physical deal, so it doesn't get caught in a financial hedge bucket, but it is a fixed price. So it is...

Effectively is like a hedge.

Okay. I get it now. Because the description says just net of diversification. So I didn't realize that it included the hedge that's right. Okay. So I guess this also answers my second question, which is that if I look at note 12 of your financial statements, which shows the - your hedges. Those numbers don't exactly line up with the hedge positions as shown in your marketing summary. So I guess the difference is because of this fixed space contracts.

You're exactly right. And so we've captured in the financial statements, all of the financial hedges but the fixed price physical you will see on our hedging slide in the presentation, that's where we've taken basis deals and locked the price there and combined the two into one sort of fixed price transaction that shows up on our presentation for sure. So we're looking in both places, correctly.

Understood. So do I have time for a couple of more questions?

Okay. So as your debt position improves and the balance sheet is derisked, do you see any changes to your hedging strategy? For example, I noticed that you - when you talk about well economics in your presentations, you use market strip prices. But because of your hedging program, the well economics that you show, don't necessarily reflect the prices that you're actually getting. So given that you are showing very short payouts with the current drilling program, does it make sense to like shorten your hedging program only to the point perhaps of where you get the payback and then take the market risk on the remaining production.

I think in a way it does. And I think as the risk of the balance sheet goes away, you're right, there's less incentive to have to hedge. I think we will still want to have some security of planning our capital program.

And in the past, we used to hedge to a high level because of our spending and our capital program used to be equivalent to our funds flow and at times even exceeded our funds flow significantly. We're now in an environment where with these five rigs that we have running today, and we couldn't go find another rig tomorrow if we wanted to. But quite frankly, we can only spend half our cash flow at this level.

So do we need to have as much hedges in place to protect that, no, we don't. And I think we've - as I sort of alluded to in the one slide in our presentation deck, I think we've kind of changed the market that we're in. We've gone from arguably a supply-driven market to a demand-driven market again. Russia has changed the world in terms of how oil and gas flows go forward, who we trust to buy our energy from generally as a globe. And I think that's put a lot of onus on North America to help supply a lot of natural gas to a lot of the rest of the world who wants to have it come from a place that isn't run by a dictator.

So I think we've moved, especially with the LNG export capacity in the U.S., we've moved to more of a demand-driven market. In general, in that market, I think you see backwardated forward curves. You tend to see rising spot prices.

And I think there's less incentive for us to hedge into that kind of a market because you're taking basically prices off the table that are lower tomorrow than they are today. And quite frankly, we're not having to protect nearly as much of our capital program because it's smaller relative to our cash flow, and we're not having to worry about our balance sheet. So in that environment, you're absolutely right. We don't need to hedge as much.

And I don't think we will be as hedging as aggressively the forward curve as we move through into that environment. Now we just moved into that environment in the last year too, I think with confidence, we can say we're there. Before that, we were still in a - really a supply-driven market that was pushing spot prices down. And we still have to be diversified definitely with where we're selling our gas. I think the risk of the AECO market disconnection has not gone away. That's still very much in front of us and may be for quite some time.

So I think it behooves us to make sure that we've diversified to other markets to sell our gas, but I don't know that we have to necessarily fix the prices as much at those markets as we have in the past.

Yes. But having said all that, I think I am with you also in the sense that when prices are good, there's a danger that we become too optimistic about the future. And I think the hedging strategy serves you well in the past 20 years. So it might not necessarily be a good idea to like be too relaxed about dropping it either?

No, you're absolutely right. And I'm not suggesting at all that we're going to go to an unhedged situation at Peyto. We've always had a hedging policy here that governs our behavior, and we set targets for ourselves. Maybe we don't have to hedge up to 75% or 80% of our production going forward. But definitely, if our capital program is, say, 50% of our cash flow, then I would say we want to make sure that 50% of our production is hedged going forward so that we've got good coverage of that capital program in the short term.

Makes sense. And this brings me to my last question, which is, in a way, kind of related and it's about dividend strategy. I think the past few years have shown the risk of being in a cyclical business and - but having a very high dividend payout policy because when the cycle turns down, then unless you are able to respond very quickly and reduce the payout, then you kind of like get stuck. So going forward, are you looking at maybe introducing available dividend strategy as some other oil and gas companies have done?

I think that's the wrong approach to dividends. Me personally, I've always been a big fan of flowing our profits to shareholders. And when you use earnings as a governor to dividends, it's amazing how you don't tend to get in too much trouble with where your dividend levels are. Obviously, when commodity prices tank and your earnings go down a lot, you need to adjust your dividends down.

And at Peyto, we've done that in the past. Our earnings haven't been that volatile. I suppose that we've had to adjust our dividends that extremely at times. But over the last few years, obviously, that it did drop a lot. We went to a loss in 2020.And so our dividends had to basically shut right down for that year.

But I think over the long term, if you look at most companies' earnings and you look at their dividend flows, and whether those match up, there tends to be a big disconnection there. Most companies actually dividend out a lot more than they earned, which makes absolutely no sense. And that's what gets them into trouble

At Peyto, we've been governed by our earnings, by our profits. And quite frankly, our profits are maybe more accurate than a lot of companies because we do hedge accounting, we only realize or recognize realized earnings, not - we don't flow the unrealized mark-to-market every quarter through our income statement.

So we don't have our earnings wildly varying back and forth based on how commodity prices - the future strip of commodity prices goes up and down. So we're only actually seeing real earnings being shown, and that's what we're marking our dividends too. So I think that's a logical policy going forward. Does it mean that our earnings are going to go up and down with commodity prices? Yes. Does it mean our dividends are probably going to move a bit with the commodity prices? Yes. This is a commodity business.

And so to suggest that you can have a dividend level that's never going to move up and down despite the fact that the commodity prices move up and down wildly, I think it's a bit naive. I mean that's the industry we're in. So I mean, the goal for us has always been to generate as much earnings as we possibly can for shareholders and then put those in their pocket. And I think over the long term, we can manage that.

Yes. But when I talked about variable dividend, I'm thinking along the lines of you pay a base dividend. And then depending on whether the year is good or not, you can decide after the fact whether to pay a special dividend or not. So it's still leaves you in a position to distribute what you earn, except that you don't do it ahead of time, which is what happened perhaps in the last few years, you are kind of like lagging the profit downturn?

Well, I would argue that we matched up to our earnings pretty well with our dividend policy. I think one of the things, [indiscernible] is because at Peyto, we operate virtually 100% of our production, we are in control of that production. We know how much cash flow we're getting from it.

We have very high level of understanding of the financial performance of our business, we are able to forecast with pretty good accuracy what our earnings are going to be for the year and to set a dividend policy that matches and is appropriate for the profitability. We're not surprised. I don't think at the end of every quarter, what our earnings end up being because we control our business at a very, very high level, much higher than most in the industry, quite frankly.

And so - and I think our margins are pretty consistent. And again, those are within our control. So I don't feel like we have to give ourselves a big cushion with respect to our earnings expectations and our dividend levels that we're setting, I think we can - and quite frankly, the hedging helps this, right? When we do know what our price realizations are going to be because we have a good portion of our production already fixed to the price.

We can plan out what those earnings are going to be from that production, and we know where the dividend should be at. So, yes, it comes hand in hand. If we go to a less hedged future price expectation, then we will have more volatility and less predictability perhaps in those earnings. But I think our history has shown we've been pretty good at predicting them and setting a dividend policy that's appropriate.

Yes. I think it's just - as a shareholder, I feel we missed the opportunity to do some share buybacks at very ridiculous prices. Of course, the debt situation was such that I don't think it was feasible. But going forward, if you do full payouts, then there might be circumstances where you might miss the share buyback opportunities. So as a shareholder, for example, like in the past few years, we've suffered some minor dilution because of stock options and all that, which is fine. I mean, I think management needs to be paid, to be compensated, but it would have been nice if some of the dilution could have been reversed through share buybacks.

Well, and I think we're going to eventually potentially get there. I mean, with what the forward curve is showing us for commodity prices, we're continuing to delever a lot of our debt is going away. I think when you get to a situation, which maybe the most of the industry will eventually get to here, where there is no debt carried by oil and gas companies. Then I think we are in a great position to potentially look at that point, share buybacks. But to be perfectly honest, buying stock is the investors' job.

Our job at Peyto is to deploy cash flow and capital into opportunities that generate a profit and then to return that profit to shareholders and put that profit in their pocket. So that's what you're paying us to do, is to deploy capital into the ground to drill good wells that make good money and make us a profit.

And then you want that profit back. And then hopefully, we've earned the right to go do it over again. I want to be very careful about saying that I've earned the right by you to go into the market and buy and sell stocks. That's not really what you're paying me to do. You're paying me to drill wells. So - perhaps I'll leave the stock buying up to you.

Fair enough. Okay. Those are all my questions and thanks very much for answering them, and thanks also to you and management for doing a great job.

Thanks [indiscernible]. Thanks for listening in today.

Thank you. This does conclude the question-and-answer session. I'd like to hand the program back to Darren Gee for any further remarks.

All right. Well, we've had a good call today and probably taken up a lot of time on people's phones. It's been a busy week, obviously, of releases. So perhaps we'll leave it at that. We are obviously very excited to get through the summer and into the fall. We will start to see much better commodity prices as we put this hedge book behind us, and that's going to put us in a great position. We do have some very exciting things to be investing in here on the balance of this year and into 2023.

So we're going to get after that now that we've been able to take our mud boots off and get after it. So we'll be back to you in November with an update. Obviously, check back on our website for updates to the presentation, and I'll try and keep everybody up to speed with my monthly report.

So thanks for tuning in today, and we'll talk to you next quarter.