Good afternoon, ladies and gentlemen. Welcome to the third quarter results conference call. I would now like to turn the meeting over to David Spyker. Please go ahead.
Yeah. Good afternoon, everyone, thank you for joining us. We have on the call from Freehold are David Hendry, our CFO, Rob King, our Vice President of Business Development, and Matt Donohue, our Manager of Investor Relations and Capital Markets. Before we get into the highlights for the quarter, and it was a really good quarter for us, we wanted to note that alongside government and public health officials, we are actively monitoring COVID-19 and following the latest guidance. For the health and safety of our employees, we directed all employees to work from home initially. As a result of public health measures relaxed in June, our return to office task force worked diligently to develop office safety protocols in alignment with government and public health guidelines. We were able to reopen our office in July with a reduced staff complement and updates to follow the latest guidelines.
We want to thank our shareholders for their ongoing support. Despite these ongoing concerns associated with COVID-19 and the prevailing commodity prices, Freehold continues to deliver strong focus on the sustainability of our providing a consistent income source for our shareholders, while reducing the overall risk profile by reducing leverage and positioning our royalty land ahead of the drill. We continue to highlight that during these periods of weaknesses, our strong margins and simple business model stand the test of time. Operationally, production on our royalty lands averaged 9,096 BOE a day, essentially flat previous quarter and down approximately 10% versus the same period last year. Shut-in production on our royalty lands averaged about 5% during Q3, an improvement from 9% in the previous quarter, and we exited the quarter with only about 3% shut-ins.
Through the remainder of the year and into 2021, we see volumes stabilizing in our core North Dakota. Volume entering the third quarter with 32 wells drilled. We note this quarter had no drilling activity after excluding adjustments as producers responded to weaker crude oil prices. For the first nine months of 2020, we had 261 wells drilled on our royalty lands, slightly higher than our initial expectations. What we're seeing is activity continue to be focused on our core Viking Play and Duvernay lands, but we also saw increased drilling in core plays in Southeast Saskatchewan, Western Saskatchewan heavy oil, Cardium oil in West Central Alberta, and in liquids rich natural gas in the Deep Basin.
We believe that with the lower volatility within the crude oil price environment and the stronger natural gas pricing through the winter months, producers will continue to remain active on our royalty lands into breakup of 2021. Given the backdrop for shut-in volumes and uncertainty around the pace of third-party drilling, Freehold announced early in Q2 its previously released 2020 guidance was no longer applicable. We are continuing to suspend 2020 guidance at this time with the expectation that we will resume 2021 guidance as more information is unveiled on spending levels associated with some of our top drillers. We expect to provide the next update to investors as part of our Q4 2020 results, which will be released in March 2021.
As part of our Q3 results, we are increasing our monthly dividend by 33% from CAD 0.015 to CAD 0.02 per share starting in January 2021 for shareholders on record as of December 31st, 2020. At the revised monthly dividend level, Freehold's funds from operations are forecast to be at the low end of the annual payout range of 60%-80%. With two months remaining in the year, it is our expectation that dividend levels will be at the low end of our payout range for 2020 as well. While increasing the dividend, we continue to maintain the strength of our balance sheet and will continue to pursue value-enhancing acquisitions. At current commodity prices and the revised dividend levels, we expect to pay down approximately CAD 2 million-CAD 2.5 million in debt per month, with leverage remaining below 1.5 net debt to funds from operations.
I'll now pass the call to Dave Hendry to walk through some of the financial highlights.
Thanks, Dave, and good afternoon, everyone. Financially, as crude oil prices stabilize and natural gas prices improve, Freehold continues to deliver on the core aspects of its return proposition, a meaningful dividend while providing investors with a lower-risk investment, differentiating itself from traditional oil and gas E&P companies. In the third quarter, Freehold generated CAD 23.1 million in royalty and other revenue, up 56% versus Q2 2020, reflecting improved liquids and natural gas pricing, lower cash costs, and stable production volumes. Our royalty portfolio generated an operating netback of CAD 27.20 per BOE during the third quarter, up 61% when compared to Q2 2020. Funds from operations for Q3 2020 totaled CAD 19.9 million, or CAD 0.17 per share, up 87% and 89%, respectively, versus Q2 2020. Our payout on a dividend paid basis was 27% in the third quarter of 2020, down from 92% during Q2 2020.
We target Freehold's payout to remain at the lower end of our outlined range of 60%-80% for 2020, with our year-to-date payout at 67%. As previously mentioned, we increased our monthly dividend for 2021 from CAD 0.015 per share to CAD 0.02 per share, reflecting an improved and less volatile crude oil price environment and positive momentum associated with third-party capital on our royalty lands, while still remaining cautious and measured. Cash costs for the quarter totaled CAD 3.70 per BOE, an all-time low for Freehold. This was down noticeably from CAD 4.79 per BOE in Q2 2020. The decrease versus Q2 reflects both lower operating and financing charges. The reduction in cash costs was most materially impacted by the disposition of working interest production during the previous quarter, with the forecasted impact on operating costs expected to be approximately CAD 0.35 per BOE.
Freehold closed the quarter with a CAD 14.4 million reduction in net debt from Q2 2020. Net debt totaled CAD 81.7 million at September 30, 2020, representing a one-time net debt to funds from operations. The decrease in net debt quarter-over-quarter reflects stronger funds from operations. With oil prices likely to remain range-bound for the remainder of 2020 and into the first half of 2021, we expect our long-term debt-to-EBITDA ratio to comfortably remain covenant compliant. Freehold's prudent strategy is maintaining long-term debt to cash flow below 1.5x and a dividend payout range of 60%-80% of funds from operations, providing cushion for potential volatility that may pick up in commodities. Updating our Canada Revenue Agency reassessments, amounts are consistent with those recorded last quarter. Freehold's corporate income tax filings for 2015, 2018, and 2019 were reassessed by the CRA in 2021.
Pursuant to these million dollars of non-capital losses by Freehold were denied, resulting in reassessed taxes, interest, and penalties totaling CAD 29.3 million, in addition to a denial of CAD 129.9 million of carried forward non-capital losses. Freehold has filed its objection of the reassessment, which required deposits totaling CAD 14.7 million to have been paid to the CRA during the third quarter. Freehold has received legal advice that should be entitled to deduct the non-capital losses. As such, management remains of the opinion that all tax filings to date were filed correctly and that it expects to be successful in its objection to these reassessments, and therefore, the deposits paid to the CRA should be refunded with interest. Freehold anticipates the proceeding through the CRA will take approximately one year to resolve. Furthermore, the payment of these deposits does not impact Freehold's earnings or funds from operations over net debt.
Now back to Dave for his final remarks.
Thanks, Dave. Looking forward, we expect the next three to six months to remain challenging for the industry, although improving sharply from the oil price low of Q2. Setting ourselves apart, Freehold provides investors relative stability as royalties represent a higher margin business. We continue to maintain flexibility in our balance sheet while maintaining sustainability in our dividend. At current share price levels, we feel the return proposition is an attractive entry point for investors. With today's increase to our 2021 monthly dividend, we highlight how the royalty model is sustainable through all commodity cycles, as we have demonstrated since we went public in 1996, nearly 25 years ago. We continue to execute on the core aspects of our strategy moving forward with the goal of maximizing returns for our shareholders.
We would also like to encourage all people to take a moment tomorrow to remember some of the sacrifices made by our Canadian heroes through Remembrance Day ceremonies. Many of us may not be able to attend in person, given some of the restrictions associated with COVID-19, we think it is important for people to take a moment to recognize some of the tremendous sacrifices Canadian soldiers have made to provide us with the incredible freedom and quality of life we maintain in Canada today. We will now entertain any questions that you may have.
Thank you. We will now take questions from the telephone lines. If you have a question and you're using a speakerphone, please lift your handset before making your selection. If you have a question, please press star one on your device's keypad. If at any time you wish to cancel your question, please press the pound sign. Please press star one at this time if you have a question. There will be a brief pause while the participants register for questions. Thank you for your patience. The first question is from Jeremy McCrea. Please go ahead. Your line is now open.
Yeah, hi there. Can you give me an indication of how many new lease agreements you've signed here for the quarter or looking to sign? Just have you noticed any increase in activity on some of your gas-weighted lands here? I'm thinking maybe Edson or in some of those other areas there.
Thanks, Jeremy. It's Rob speaking here. Maybe I'll answer your second question first. In terms of gas-oriented drilling, we've seen a little bit of activity in the Deep Basin with a couple of the producers that we're close with. I'd say it's probably not been the key focus of our activity. It's really continued to be in the Viking, in the Cardium, in the Southeast Saskatchewan, and we're beginning to see more activity in Clearwater. Those are certainly, I would say, the big four that continue to be the most dominant in the portfolio. Some of those Cardium locations obviously have a fair amount of gas in them as well. Whether it's the gas economics or the liquids economics that are driving it, unclear, but the important thing is they are being drilled.
As related to new leases, let me just have a look at it handy here. It was a modest amount in terms of what we were able to secure in terms of new leases, certainly from a dollar amount, in terms of the lease bonus revenue.
Yeah. It was just more just trying to see how much activity has really started to pick up. Have guys started to come approach you and say, "We're getting comfortable with drilling again. Let's look to sign these new leases or these lands over here.
Yeah.
Just generally how that's changed.
Sure. Maybe I'll answer it a bit of a different way in terms of actual drilling, because where we've seen activity pick up in Q4 here, we're now on pace halfway through Q4. We have about 50% more drilling on our lands relative to Q3. Same areas are still the dominant areas of activity. Viking, Sparky, Cardium are kind of the big three, followed by Southeast Saskatchewan. We've talked to a number of our Clearwater players. Two in particular have talked about 10 to 15 wells in the winter drilling program here. Yeah, I think we certainly are seeing signs of activity picking up in terms of drilling.
Okay. No, that's good. Thank you.
Thank you. Once again, please press star one on your device's keypad if you have a question or comment. The next question is from Zai. Please go ahead. Your line is now open.
Hey, folks. Great quarter. Wondering why not institute an NCIB, just given PrairieSky's been doing something similar, and it seems like there's not many acquisitions going on.
I think our perspective on the NCIB is that our preferred method of returning value to shareholders is through the dividend. That's first priority. We want to continue to manage our balance sheet is second priority, and I think that we're actually seeing quite a good number of opportunities that are out there right now. We do think that there are opportunities there. Our long-term view that we think by allocating some capital by key acquisitions, then we think that's a better allocation of capital than NCIB at this point in time. Certainly, every opportunity that we look at, we compare it to an NCIB. Right now we think that there's opportunities to do business out there that would make our company better.
No, I totally understand. Thanks for that color. Just wondering, as we get past OPEC and you have more line of sight on COVID-19, would you be targeting a 60%-80% payout ratio on the dividend? The CAD 0.02 increase was good, but just thinking about it longer term.
Definitely. Our strategy is still that 50% to 80% payout. What we're looking at here is more of a bit of a measured dividend increase. We still have a conservative view on commodity prices. We're not 100% sure how COVID-19 is going to play out, despite some of the optimism this week with the Pfizer announcement, really we need to see how that plays out. We need to see how our quarter plays out, we're going to reevaluate in Q1 once we have a little more confidence that the environment ahead of us is stabilized and is sustainable. The target is still there, 60% to 80%. How we ramp up to that through a measured approach is how we're going to handle that.
All right, thanks. That's all for me.
Thank you. The next question is from Luke Davis. Please go ahead your line is open.
Hey. Thanks for taking my questions here. Just a few quick ones for me related to the last caller. How are you thinking about setting the dividend, just from a modeling perspective? Are you typically kind of targeting the lower end at 60% and I'm thinking about the balance, the 80% as kind of a volatility cushion, or how should we be thinking about that going forward?
I think that's a fair comment, Luke. Definitely, for now, given the rapidly evolving business environment that's a little bit more comfortable operating at that bottom end, the low end of the payout range provides ourselves a little bit of cushion, I think, in case we do see a retracement of commodity prices again. Also we think that there's a good opportunity to make some smaller acquisitions that enhance our portfolio. We wanted to just leave a little bit of room there as well. It's a balance of a number of factors that are driving us, initially just hitting that lower end as we just watch how the environment unfolds.
Right. Makes sense. Then, I guess following that, any change in terms of how you're thinking about hedging, just particularly as we see commodity pricing that sort of appears more constructive and I would say more so on the gas side?
Yeah. We've not historically hedged, and it's not an area of focus right now, being that the prices are still volatile enough in either direction that we don't think that hedging is the right thing for us right now. By the nature of our conservative business model and the high net debt that we achieve, hedging is not as a key part of our portfolio as it would be, say, for a traditional E&P producer, where we've got a really good, stable production base that doesn't have an operating cost component to it and doesn't have a capital draw associated with it. For us, hedging is not a priority right now.
Right. Makes sense. I guess final one for me, just can you maybe frame out what you've seen in the acquisition markets to date? Any kind of changes in recent months, and can you kind of frame out how we should be thinking about that going forward?
I'm going to just turn that over to Rob, because he and his team have been really looking at a lot of opportunities in the last little bit here, and maybe he can just give some color on what you're seeing.
In terms of since our last update in August, we've certainly seen an uptick on both sides of the border as it relates to potential transactions. These are both marketed processes, but also proactive conversations that we've been having. On the Canadian side, a lot more, as you've gathered, on the manufactured core opportunities, and probably a lot more receptivity as it relates to proactive conversations with a number of counterparties, particularly on the private side. I'd say a fair amount of dialogue. There's still a fair bit of spread that's definitely out there. With every month, we're optimistic that spread will narrow. In the US side, a lot of opportunities are coming across our desks. I'd say more packages that are also looking fairly attractive, that have a pretty interesting mix of near-term production, tangible upside, and future upside. That's not just a Bakken comment.
We've really been expanding our efforts and our capabilities to be looking outside of North Dakota, and have been looking at a number of opportunities that are in other basins that are seeing capital being actively allocated in this current commodity price environment. That's providing some encouraging opportunities that we're actively looking at.
Right. Makes sense. I guess final one, I can appreciate this might be a little bit more sensitive, but when you speak to spreads, can you maybe provide some broader ranges in terms of where the market's sitting and around where you'd like to execute transactions at?
Yeah. Maybe I'll just kind of talk more from one of the key tenets as Dave talked about, that when we're looking at acquisitions, it really has to be accretive to our free cash flow yield. If I kind of use our free cash flow yield in that 15%-ish range, plus or minus , depending on the day, it has to be superior to that. I think that's a bit of a data point to kind of point in terms of where we need to see acquisitions to be attractive and be competitive for us. They're probably a little bit inside that right now.
No, it makes sense. Thanks very much, guys. Appreciate it.
Thank you. There are no further questions registered at this time. I'll turn the meeting back over to Mr. Spyker.
Okay. Well, thanks everyone for attending the call this afternoon, and thank you for your interest in our story, interest in our company, and for the value proposition that we offer. We had a good quarter, and we look forward to talking to you guys again throughout the coming weeks.
Thank you and good night.
Thank you. Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.
You can cough a little now, Matt.