All participants, please stand by. Your conference is now ready to begin. Good morning, ladies and gentlemen, and welcome to the Freehold Royalties Ltd. Third Quarter Conference Call. Please be advised that certain statements on this call constitute forward-looking information. These statements relate to future events or our expectations for future performance. All statements other than those of historical facts may be forward-looking. We caution the listener. I will now pass the call over to Tom Mullane, Chief Executive Officer of Freehold. Please go ahead, Mr. Mullane.
Thank you, good morning. Also joining me from Freehold are David Spyker, our Chief Operating Officer, Bob Lamond, our Vice President of Asset Development, Alan Withey, our Chief Financial Officer, Matt Donohue, our Manager, Investor Relations and Capital Markets, and myself, of course. We will summarize our third quarter results, and then we'll be happy to answer questions. Some quarterly highlights include funds from operations totaling CAD 28 million or CAD 0.24 a share, down slightly from the previous quarter. The key drivers behind the variance included moderate reductions in commodity prices and a slight decline in production volumes. Based on our share price at quarter end, we estimate our free cash flow yield at approximately 12%. Dividends were 67% of funds from operations for the quarter. This compares to 62% in Q2 and 101% in Q4 2018.
At current commodity price levels and with our dividend at current levels, we continue to generate significant free cash flow. We will continue to evaluate our payout quarterly, but given the volatility associated with Canadian energy producers' activity levels, we have chosen to maintain our dividend at current levels. Through 2019, we are forecasting a payout of approximately 65%. We will unveil our 2020 guidance in March 2020 as part of our Q4 2019 results. On the operations front, Q3 2019 royalty production averaged 10,149 BOEs a day, down 2% versus the previous quarter and the same period last year. The decrease in royalty volumes quarter-over-quarter was driven by reduced third-party drilling during the second quarter, which impacted volumes. The third quarter is typically the weakest period for production volumes during the year, as third-party activity is reduced during Canadian spring breakup.
Oil volumes grew 4% year-over-year and 4% quarter-over-quarter, indicating our oil portfolio strength. Royalty interest accounted for 97% of production and 100% of operating income in Q3 2019. We completed a Canadian royalty transaction late in Q2 and our first U.S. royalty transaction during Q3 for $9.8 million. We expect volumes associated with our U.S. deal to ramp up into the year-end and into 2020. While we are happy with the development in production volumes associated with our Canadian acquisition completed in the previous quarter. Based on broader uncertainty in Canada associated with drilling activity, we are maintaining our 2019 production guidance of between 10,000 and 10,500 BOEs a day. Within Canada, Freehold saw continued strength in activity on our royalty lands during the first nine months of 2019.
In total, we've had 455 gross, 16.3 net wells drilled on our royalty lands during the period. Of these, 181 gross, 6.1 net wells were drilled during the third quarter of 2018. This represents a 3% improvement on a gross measure and a 3% decrease on a net measure over the same period in 2018. Together, Saskatchewan and Manitoba represented approximately 60% of our gross drilling in 2018, 77% on a net basis. Drilling continues to be weighted towards the Viking in west central Saskatchewan, with 116 gross, 9.7 net wells drilled year to date. We're currently forecasting 20 net wells as part of our 2019 guidance. Both the Canadian Association of Oilwell Drilling Contractors and the Petroleum Services Association of Canada are forecasting material reductions in drilling activity in 2019, greater than a 25% drop year-over-year, whereas drilling levels on our lands have been essentially flat.
I will now pass the call to Alan to walk through our financials.
Thank you, Tom. Good morning, everyone. This quarter, we continued to demonstrate the strong financial flexibility of Freehold. As Tom mentioned, during the third quarter of 2019, Freehold generated funds from operations of CAD 28 million, or CAD 0.24 per share. Revenue from oil and NGL production represented 92% of total revenue in the third quarter, up from 89% during the same period in 2018. A retreat in natural gas prices during the quarter, along with oil production and oil-weighted acquisition growth within our royalty portfolio, was the driver behind this increase.
Continuing a multiyear trend, Freehold's royalty production amounted to 97% of total production and all of the operating income in the third quarter, which is up from 93% of total production and 99% of operating income in the third quarter of 2018. Freehold declared dividends of CAD 18.7 million, or CAD 0.1575 per share in the third quarter of 2019, implying a 67% payout ratio, well within the targeted payout range. As part of our results, we updated our WTI and Edmonton oil price assumptions and are estimating a 65% payout ratio expectation, which is at the low end of our targeted payout range for the full year of 2019. Freehold closed the quarter with net debt of just over CAD 105 million, representing one-time net debt to funds from operations.
The net debt figure increased by just over CAD 70 million versus the prior quarter, reflecting acquisition activity that was closed during the period. Acquisitions of just over CAD 15 million, exclusively related to mineral titles acquired in North Dakota, were funded by this debt and by free cash flow generated in excess of dividends paid during the period. For year-end 2019, based on our forecast and assuming no additional acquisitions in the fourth quarter, we expect net debt to funds from operations to reduce towards 0.8 times. For the three and nine months ended September 30, 2019, there is a modest amount of current income tax expense compared to zero last year. This is due to Freehold's activities in the United States.
Also related to tax, but in Canada, Freehold does not have an update related to the proposal letter received from Canada Revenue Agency, where CRA indicated its intention to reassess and deny Freehold's deduction of certain non-capital losses claimed and carried forward in the tax return filed in 2015. Freehold is vigorously defending its tax filing position. However, we anticipate that proceedings with CRA could take considerable time to resolve. Now I'll turn it back to Tom for his final remarks.
Thanks, Alan. In closing, we continue to execute the core aspects of our strategy. We completed our first U.S. royalty transaction over the quarter utilizing free cash flow. We reiterate to our shareholders that the move to the U.S. will be measured with the goal of improving the quality of our royalty portfolio. We see Williston Basin providing strong opportunities for our shareholders. In addition, given the broader industry weakness, we are very happy on how activity levels have maintained themselves on our land, a testament to the quality of the underlying royalty portfolio. We expect with better-than-forecast activity levels and acquisitions completed earlier in the year, our volumes will remain steady into year-end. Looking forward, we remain focused on maximizing shareholder value by investing our free cash flow into dividends, value-enhancing acquisitions, and/or paying down our debt. Overall, Freehold offers investors a lower-risk royalty investment vehicle.
I'll now pass it over to the moderator for questions.
Thank you. We will now take questions from the telephone lines. If you have a question and you are 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 while the participants register. We thank you for your patience. The first question is from Dennis Fong from Canaccord Genuity. Please go ahead.
Hi, good morning, and thanks for taking my questions. I've got two here. The first was, I noticed that you guys had a little bit of current income tax in this quarter. Could you just make a bit of a comment as to how we should be thinking about corporate taxes going forward, as well as providing a little bit of context around the U.S. component of your assets in that relation? I've got a second follow-up. Thanks.
Hi, Dennis. This is Alan. The U.S. tax is the current income tax for the period. It's from the U.S. operations. We expect that the U.S. operations tax will max out at about 8% for the first four to five years in terms of percentage of operating cash flow. It is a taxable operation. It's intended to be profitable, and as a new entrant, I would expect that to be in that 8% at a maximum.
That's the U.S. cash flow?
Yeah, it's a U.S. cash flow stream.
Which is about 2% of our cash flow today.
Correct.
Okay. Thanks. The second question is just related to the level of production. You guys have been doing a pretty good job maintaining activity levels across your land base. Can you just talk a little bit more about some of the potential other initiatives that you're working on in addition to providing a little bit of royalty incentive in exchange for activity on your lands that's helping you offset, frankly, the significant decline we're seeing in activity across the Western Canadian Sedimentary Basin?
Hi, Dennis. It's Dave Spyker here. I'll answer your question. Really, if you're familiar with our regional work, we've really been focused on continuing to build a really high-quality oil portfolio in the most economic plays in Western Canada and North Dakota. What we're doing now, we're just taking quite a collaborative approach with our primary operators in these oil plays to get a better understanding of their development plans and ensure that the royalty structure and the quality of opportunities on the Freehold lands can compete with their other investment options.
Some of the things that we talk about, this may take the form of royalty incentives for drilling commitments. We're looking at potential royalty incentives for implementation of enhanced recovery schemes, whether that's waterflood schemes or tertiary schemes, or for recompletion or reactivation initiatives. These are opportunities where we see that we can add additional value by prioritizing development on these assets, that we think that we can strengthen the NPV of the portfolio with specific incentives regarding these types of things.
Great. Thank you. Appreciate that. Just maybe the last bit is that should frankly translate to obviously being able to reiterate your 20 net well guidance this year. Should we probably be expecting something relatively similar as you guys are kind of looking into the 2020 timeframe?
Yeah, Dennis, it's Tom here. Actually, we're pretty comfortable with our 20 net wells for this year. We are giving our guidance for next year in March, once we gauge what the activity levels will be for all of our producers. Our drilling has been relatively consistent over the last two years. Unless some of our big drillers have a major fall off, I don't see any change in levels into next year.
Great. Thank you.
Sorry. This is Bob Lamond. I just have a tiny bit more color to that, too. Our hope also for next year is to start reporting on a couple of U.S. net wells coming in, and the production from those. As that starts coming up on our number, the value of a U.S. net well could be considerably higher than a Canadian net well. The direction seems roughly the same towards next year. We'll have a better number as the quarter goes on.
Great. Thank you.
Yeah.
Thank you. The next question is from Amir Arif from Cormark Securities. Please go ahead.
Thanks. It's actually a follow-up to the comment that Bob just made here. If you can just give us a little more color in terms of the type of drilling that you do see in the U.S. on your lands relative to the average well that is drilled on the Canadian land. I'm guessing just it being in the Bakken, they're probably a lot more productive, higher rates relative to what you're seeing in the Viking and your conventional drilling on the Canadian.
Thanks for the question. It's Bob Lamond again. Yeah, we do in fact see that large uplift in productivity in a play like a Bakken. Although in places the net royalty interest can be somewhat lower, the productivity from the wells is considerably higher. Our exposure to that, we're very excited about, especially seeing as some of our acreage is right offsetting a couple absolute record wells recently drilled. Currently, we have no new net wells on our land to report just yet, but that will change in a future quarter.
Okay, thanks Bob. Can you give me some color in terms of the U.S. deal flow? I noticed the small additional tuck-in acquisition of some mineral title lands there. Is there a lot of little deal flow that you are seeing, or is it just relative to the Canadian side? If you can just give us some color on that.
Yeah, Amir, it's Tom. We are finding that the deal flow, both in Canada and U.S., is relatively strong right now. At any one time, we're looking at three to five acquisitions. That level hasn't dropped off. Given the limited access to equity for a lot of producers, we are finding that there's good deal flow both in Canada and in the U.S. We are paying a little more attention to the U.S. today than we are in Canada, given the potential profile differences in the basins.
Okay, sounds great. Thank you.
Thank you. Once again, please press star one on your telephone keypad if you have a question. The next question is from Adam Gill from Eight Capital. Please go ahead.
Good morning, gentlemen. Just looking for a little more color on the net wells drilled. Of the 6.1 net drilled in Q3 and the projected 20 for the year, how many of those wells are on the royalty lands that were acquired through Q2 and Q3? Thanks.
Sorry. This is Bob Lamond, calling in. For acquisitions from Q2, Q3, we're very excited in this quarter. One of the operators we did do a large deal with is actually our second-largest driller for the quarter. We are especially excited about our Viking production and drilling around the Alberta-Saskatchewan border. This Sparky zone and the drilling that's happened on that has been a new add for us. We've had roughly 15 wells drilled by this operator on that play in the area, and the initial production results are very favorable with plans to continue. If I can add a bit more color again, the Viking remains very strong on both sides of the Alberta border. We're excited about this Mannville Sparky in particular, more of the heavy oil resurgence in just north of that Viking trend.
We've given some guidance before on our Clearwater acquisition we had made. Happy to report that drilling on that is ahead of expectations. We've had more wells drilled on it than expected to date, and initial production actually is very favorable in that Clearwater trend as well. The Duvernay drilling on that remains at pace as well. While a small portion, we're excited by the results.
Great. Thank you.
Thank you. There are no further questions registered at this time. I will return the meeting back to Mr. Mullane.
Well, thank you everybody for joining us on this call this morning. Given our results for Q3, we're extremely happy with the drilling levels on our land. Again, that's a testament to the quality of our lands. We continue to be a lower-risk investment in the energy space for investors. We are very happy with our results in Q3 and look forward to next year.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.