Good morning, ladies and gentlemen. Welcome to the second quarter results conference call. I would now like to turn the meeting over to Tom Mullane. Please go ahead.
Yeah, thank you very much. Good morning, ladies and gentlemen. Welcome to the Freehold Royalties Ltd. 2020 second quarter conference call. Thank you for joining us. With me on the call from Freehold are Dave Hendry, our CFO, Dave Spyker, our COO, 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, we want to note that alongside government and public health officials, we are actively monitoring COVID-19 updates and following the latest guidance. In the initial phase of the COVID-19 pandemic, we prioritized the health and safety of our workers by directing all workers to work from home. As Alberta public health measures were relaxed in June, our return to office task force worked diligently to develop office safety protocols in alignment with government and public health guidelines.
With this preparation, we were able to reopen our office in July with a reduced staff complement. We will continue to monitor COVID-19 updates and follow the latest guidance to move to the next phase of return. We appreciate the continued efforts of our staff during this time and want to thank shareholders for their ongoing support. Operationally, the second quarter was challenging with demand weakness for commodities associated with COVID-19, coupled with a supply battle within OPEC, driving global crude prices to multi-decade lows. As a result of this weakness, we saw a number of producers on our royalty lands shut in production in order to preserve economics and reserves. Royalty production for the quarter on Freehold lands averaged 9,150 BOEs a day, down from 10,618 BOEs a day the previous quarter and 10,311 BOEs a day during the same period in 2019.
On a positive note, this period of weakness is behind us. For Freehold, shut-in volumes reached a peak of 20% of total production in May but averaged 11% for the quarter. Through the remainder of the year, we see volumes improving in core areas like the Clearwater, Viking, Southeast and Southwest Saskatchewan, and North Dakota. As mentioned, the lower prices had a material impact on drilling activity on our lands, with no wells drilled during the second quarter. Drilling through the first half of 2020 has totaled 229 gross, 6.6 net wells, down approximately 35% versus the same period last year.
Looking into the second half of 2020, we do expect some activity on our royalty lands driven by traditional payers, with incremental dollars spent on plays in Southeast and Southwest Saskatchewan and Central Alberta. Given the backdrop for shut-in volumes and uncertainty around the pace of third-party drilling, Freehold announced early in the quarter its previously released 2020 guidance was no longer applicable. We're continuing to suspend guidance at this time with the expectation we will resume guidance with the return of clarity and stability associated with the commodity price environment and our royalty payers' drilling programs. During the quarter, reflecting sustained weakness in crude oil prices, Freehold's board of directors revised Freehold's monthly dividend rate from CAD 0.0525 to CAD 0.015 per common share.
At revised monthly dividend level, Freehold's funds from operations are forecasted to exceed dividend outflows for the remainder of 2020 and be at the low end of our annual payout range of 60%-80% for 2020. Adjusting the dividends during the quarter preserved the strength of our balance sheet and enhances our ability to pursue value-enhancing acquisitions. Looking forward, we expect to pay down debt levels in the near term with the expectation to revise the dividend as our forecast for funds from operations improves. At current commodity prices, we expect to pay down approximately CAD 3 million-CAD 3.5 million in debt per month. Although debt levels are expected to stay flat in the third quarter over the second quarter, as we account for the CAD 11.5 million deposit to the Canada Revenue Agency, which Dave Hendry will speak about shortly.
In addition, our board of directors and staff reduced G&A by approximately 15%, which we believe was important to align with our shareholders' experience. Lastly, on April 30th, 2020, Freehold disposed of certain working interest properties with estimated production of 265 BOEs a day. As part of the agreement, the purchaser has agreed to assume decommissioning liabilities of approximately CAD 3.6 million on these properties. The benefits of this disposition include a material improvement in operating costs moving forward and reduced spending associated with asset retirement obligations associated with these assets. Now I'll pass the call to David to walk through some of the financials.
Thanks, Tom, and good morning, everyone. Financially, while we endured a significant retreat in global oil prices over the second quarter, Freehold continues to provide a meaningful dividend, which has differentiated ourselves from many traditional E&P companies in Canada over the period. In the second quarter, Freehold generated CAD 14.8 million in royalty and other revenue, down 58% versus the same period in 2019, reflecting lower liquid prices and lower production, slightly offset by improved natural gas pricing.
Total royalty revenue was comprised of 75% oil and NGL, which also reflected the decline in oil prices. Our royalty portfolio generated an operating net back of CAD 16.86 per BOE in the second quarter, a 52% decline versus the same period in 2019, which mirrored the 53% decline in WTI prices during the same period. Funds flow from operations for Q2 2020 totaled CAD 10.6 million, down 65% from Q2 2019 levels. Our payout on a dividend paid basis totaled 92% in the second quarter of 2020, up from 62% during the same period in 2019.
At the revised dividend level, we target Freehold's payout to remain at the low end of our outlined range of 60%-80% for 2020. Through the remainder of the year, we expect Freehold's payout to remain below 40% on a declared and paid basis. Cash costs for the quarter totaled CAD 4.79 per BOE, down from CAD 5.06 per BOE during the same period in 2019. The decrease year-over-year reflects lower operating and financing charges. The reduction in cash costs was most materially impacted by the disposition of working interest production over the quarter. Freehold closed the quarter with a CAD 5.7 million reduction in net debt from Q1 2020. Net debt totaled CAD 96 million at June 30, 2020, representing 1.1x net debt to funds flow from operations.
The decrease in net debt quarter-over-quarter reflected the reduction in dividend obligations, the disposition of our working interest assets, and resulting lower asset retirement obligations, offset by weaker production resulting in lower funds from operations. Even though oil prices are likely to remain subdued through 2020, we expect our long-term debt to EBITDA ratio to remain covenant compliant. Freehold's prudent strategy of maintaining long-term debt to cash flow below 1.5 times and a dividend payout range of 60%-80% of funds flow from operations provides cushion for volatile prices. Freehold incurred a second quarter 2020 net loss of CAD 5.8 million, compared with a CAD 3.4 million net income recorded during the same period in 2019. The higher net loss reflected lower revenues due to the retreat in oil prices and lower production volumes.
During the quarter, Freehold announced that it had received a proposal letter from Canada Revenue Agency. Freehold has now received notices of reassessment from the CRA, in which the CRA has denied the deduction of certain non-capital losses and other tax attributes in computing the company's income for taxation years ending in 2015 and 2018. In order to appeal these reassessments, Freehold is required to make a payment of 50% of the reassessment amounts, CAD 11.5 million, as a deposit to the CRA prior to September 1, 2020. Freehold has received legal advice that it is entitled to deduct the non-capital losses, and as such, management remains of the opinion that all tax filings to date are filed correctly, and that it expects to be successful in its objection of these reassessments.
Therefore, any future deposits paid to the CRA should be refunded, plus interest. Freehold anticipates the proceedings through the CRA could take one year or more to resolve. Further, the payment of any deposits does not impact Freehold's earnings or funds from operations. Freehold is currently in the process of filing its objection of the reassessments. Now back to Tom 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 oil price lows of Q2. Setting ourselves apart, Freehold provides investors relative stability, as royalties represent a higher margin business, as we do not pay typical costs associated with oil and gas operations and reclamation, enabling more returns to be transferred to our shareholders. 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. As we allocate free cash flow, our preference is to ensure sustainable dividends while maintaining a conservative balance sheet with the medium-term outlook shifting to value creation via acquisitions as we grow and improve our royalty portfolio.
The ability to access capital, both equity and debt, remains challenged for many E&P producers, and we believe we can serve as a financing tool through the creation of new royalties in core play areas in Canada and in the United States. The royalty model is sustainable through all commodity cycles, as we've demonstrated since we went public in 1996, nearly 25 years ago. Now we would entertain any questions.
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 telephone 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 for the participant register. Thank you for your patience. The first question is from Amir Arif. Please go ahead.
Thanks. Good morning, guys. Just a couple of quick questions for you here. Just first of all, in terms of the shut-in volumes, we've noticed that some of the processing companies and gathering companies are having to provide some incentives to bring some shut-in volumes back online. Just curious if you're having to do anything on the royalty front to incentivize some of the shut-in volumes to come back when you're drilling to start.
Thanks, Amir. It's Rob King speaking. No, we haven't had any of those, any material discussions in that regard. Certainly, when I think back to the April, May time period, as companies were shutting in volumes, we had a lot of discussions about how or if we may be able to work with them on the royalty rate to think about whether they continue to shut in or not. The reality is we didn't make many changes at all back then. As volumes have come back online, we similarly have not seen anything material from our royalty payers in terms of needing to modify the royalty rate.
Okay. Just secondly, I know in your remarks you did mention that you've seen activity coming back in Clearwater, Viking, Saskatchewan. Just curious, with the improvement in the gas strip, have you seen any pickup in interest in terms of gas drilling on any of your acreage?
We've had a little bit of activity on the gas side. I would say if you think back to our 2019 and Q1 of 2020 drilling activity, well over 90% was focused on oil. While 40% of our production base is natural gas, the reality is most of our drilling activity has been, and we expect will continue to be, on the oil side. That being said, we have had a few wells that have been drilled over half a dozen by the end of the year, we expect in the Deep Basin. There certainly is some gas drilling activity on our land. For the most part, those plays that you mentioned are where we anticipate seeing the bulk of the activity in the back half of the year here.
Okay, just on the dividends, I know you've got your 60%-80% payout ratio range and 1.5 for your leverage metric that you'd like to get to. How many quarters below those levels would you need to see before you're comfortable bringing some of that dividend cut back into the dividends? Bringing the dividend back up, I should say.
Thanks, Amir. It's Tom. As far as our dividends go, we revisit our dividends with our board every quarter and give them a forecast outlook. When we look at 2020, with our payout being at the low 60s within our range, and also that the cash flow near the upper end where we're comfortable, we're going to revisit in our third quarter release here later this year on the timing of perhaps increasing our dividend or adjusting our dividend according to the conditions at the time. We'll revisit that in November with our release of our third quarter.
Okay.
We're at the lower end for the year and I guess as we mentioned here, below 40% payout in the back half, but on average within our target range for the year for 2020. Certainly we are below that right now.
Yeah, no, thanks for that color. Just one final question. We've seen a pickup in industry M&A and A&D activity out there. Historically, some companies have used royalties or putting a royalty on some of that acquisition as a financing vehicle. Just curious if you can give us any color on what you are seeing on that front, or if any.
Yeah. I think in terms of Q2 activity, it was pretty quiet. I would characterize it as a modest level of discussions, both in Canada as well as in the U.S. That has definitely picked up in July and August, particularly in the U.S., but also in Canada, with a lot more marketed deals as well as proactive discussions. I would say it's a really tough environment for a lot of companies, and a lot of companies do need money, and we're being fairly discerning in this environment in terms of what we're looking at and what our return thresholds need to be and looking at ways that we can continue to even add even better quality assets to the portfolio.
Okay, perfect. Thanks.
Thank you. The following question is from Luke Davis. Please go ahead.
Hey, good morning, guys. I'm just wondering if you can comment a little bit more on M&A and whether or not you're having issues finding counterparties that you think are viable and are going to be able to provide drilling commitments that actually make sense to you longer term.
Mm-hmm. Yeah, it's a good question, Luke, and that certainly you're kind of hitting the nail on the head in terms of one of the key aspects in terms of being able to bridge that bid-ask spread with the potential counterparties because a lot of the deals we're looking at right now have a higher than we would've had average PDP weighting in the value that we're coming up with. While there still is clearly upside in a lot of the opportunities that we're looking at, the funding ability and when those upside locations will be drilled certainly gets pushed out.
That kind of comes back to that comment on being more discerning in the quality of the asset and the quality of the counterparty, in terms of having some confidence in terms of that they're going to be able to drill. That kind of comes into some of the structuring that we've been talking to people about as well, in terms of ring fencing some of the consideration, with not just to debt repayment on their part, but also to putting it into the ground, so we can more fully ascribe value to those undeveloped locations.
Right. That makes sense. Okay. Just wondering on the CRA proposal. I'm assuming you guys aren't treating anything differently here, so I'm wondering if you can kind of quantify what the downside risk is for the out years, maybe 2019 and 2020, assuming that that comes back and it's not in your favor.
Yeah In a fair amount. Yeah. First of all, it's not uncommon for a reassessment auditor to do this. We still very strongly believe that our position is correct, and we fully believe that we'll get the reassessment. For context, we did file our 2019 tax year, and we did apply CAD 22 million of capital losses to that. I think it was for about a CAD 6 million cash, or for a tax effect of it. It gives you a bit of a context for how that applied for 2019. We obviously just have to wait until an appeals officer gets assigned to our case. That's why it takes upwards of a year. It's not the complexity or any concerns with regards to our case, it's just a matter of getting through the queue until our time is up to resolve the issue.
That's great. Thanks for the color there.
Pleasure.
Thank you. Once again, please press star one at this time if you have a question. The following question is from Adam Gill. Please go ahead.
Good morning, guys. Just in terms of where the opportunities are, Are producers with better balance sheets open to discussions? Do you find the guys that are more open to discussions are the guys with a weaker financial position?
Yeah. I'd sort of say, Adam, it's a bit of both, to be frank. I think there certainly is if you had to put it into a percentage category, I think it probably would be a higher percentage of companies that are maybe in a more challenged liquidity leverage perspective that are kind of actively looking at the GOR side. There are other better capitalized companies that are considering if not as an alternative, given the lack of availability of other capital, both in the bank and equity market. I'd sort of say a meaningful part of our U.S. opportunity focus is on the mineral title side, so that's certainly less relevant in that regard.
Okay, great. Thank you.
Thank you. There are no further questions registered at this time. I'll turn the meeting back over to Mr. Mullane.
Yeah, thank you very much. Thank you, everybody, for joining us on this conference call. Obviously, this is a challenging time. One of the things that you will see in the royalty space is that this model is pretty resilient through all commodity cycles. We will continue to provide our shareholders with a return of capital, primarily in dividends. As cash flow improves, our dividend will improve. Thank you very much for joining us.
Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.