All participants, please stand by. Your meeting is about to begin. Good morning, ladies and gentlemen. Welcome to the Freehold Royalties Ltd. first quarter 2019 conference call. Please be advised that certain statements on this call constitute forward-looking information. These statements, other than those of historical facts, may be forward-looking, and we caution the listener. I will now pass the call over to Tom Mullane, Chief Executive Officer of Freehold. Please go ahead, sir.
Thank you, good morning. Thanks for joining us. Also joining me from Freehold are David Spyker, our Chief Operating Officer, Robert Lamond, our Vice President, Asset Development, Alan Withey, our interim Chief Financial Officer, and myself. We will summarize our first quarter results. We will be happy to answer questions. Some quarterly highlights we want to expand upon include on the operations front, Q1 2019, royalty production averaged 10,139 BOEs a day, down 9% versus Q1 2018, and 2% versus the previous quarter. The variance in royalty volumes year-over-year was driven by a combination of natural declines, reduced audit function additions, weather-related shut-ins, and lower third-party drilling during the second half of 2018. Royalty interests accounted for 95% of production and 99% of operating income in Q1 2019.
On the working interest side, we expect to remain active in further dispositions through the remainder of the year. We also expect to shed in some natural gas working interest volumes through the summer months, with the expectation that pricing will not justify returns. We continue to forecast 2019 royalty production between 9,900 and 10,300 BOEs a day. Given the level of activity on our lands through the past two quarters, we believe royalty production should stabilize. Freehold saw continued strength and activity on our royalty lands over the quarter. In total, we had 147 or 7.3 net wells drilled on our royalty lands during the period, down 38% on a gross measure, but up 14% on a net measure versus the same period in 2018, and flat versus the previous quarter. Our average royalty rate on non-unit wells totaled 6.4% versus 4.1% in the same period last year.
Activity through the first three months of 2019 was primarily focused on Saskatchewan oil prospects, including Viking at Dodsland, Mississippian plays in southeast Saskatchewan, and Shaunavon in southwest Saskatchewan, representing 32% of the total gross wells drilled. Together, Saskatchewan and Viking locations represented greater than 65% of our gross non-unit drilling in the quarter. Developing plays remain active with four East Shale Basin Duvernay and two northern Alberta Clearwater wells drilled on our acreage. We are currently forecasting 20 net wells as part of our 2019 guidance unveiled in March. We feel we are off to a good start through the first quarter. On the leasing side, we completed 20 new agreements over the quarter, with much of the focus on our oil prospective lands in southeast Saskatchewan and in Viking. We are typically seeing lease rates between 12% and 16% as part of these agreements.
On our dividend, with improving commodity prices through the quarter, our funds from operations improved materially relative to Q4 2018. Dividends represented 64% of funds from operations for the quarter. This compares to 101% during the previous quarter. We will continue to evaluate our dividend quarterly, but given the volatility associated with Canadian energy, particularly associated with pricing, we have chosen to maintain our dividend at current levels. Through 2019, we are forecasting a payout of approximately 60% versus our previous guidance of 76%. We have set a dividend strategy of between 60%-80% of funds from operations for 2019. We remain at the lower end of this range. I will pass the call to Alan to walk through our financials.
Thanks, Tom. Good morning, everyone. This quarter, we continue to position Freehold with strong financial flexibility and as a lower risk investment. During the first quarter of 2019, Freehold generated funds from operations of CAD 29.3 million or CAD 0.25 per share. Revenue from oil and NGL production represented 81% of total revenue for Q1. As a result of our acquisition program over the last two years, we have added higher quality oil barrels, improving our netback. Freehold reported a loss in the first quarter, driven by a CAD 14.1 million non-recurring impairment charge, partly offset by a CAD 3.8 million deferred tax recovery, all related to the conversion of a production volume royalty contract into a gross overriding royalty. We anticipate this first quarter loss to be fully recovered within the next two quarters.
Freehold declared dividends of CAD 18.7 million, or CAD 0.1575 per share for Q1, implying a 64% payout ratio. As part of our Q1 2019 results, we updated our West Texas Intermediate and Edmonton oil price assumptions for the balance of 2019. As a result, we are forecasting a payout of approximately 60% at the low end of our payout range for the year. Freehold closed the quarter with net debt of CAD 78 million, representing 0.7 times net debt to funds from operations. Net debt decreased 13% versus the same period last year, reflecting free cash flow over and above our dividend and acquisitions in the interim. For year-end 2019, based on our forecasts and without additional acquisitions, we forecast net debt to funds from operations of approximately 0.3 times. Subsequent to the quarter end, we extended our CAD 180 million credit facility to mature May 31st, 2022, one year further.
One additional item of note, Freehold received a proposal letter from the Canada Revenue Agency where the CRA stated that it intends to reassess Freehold's deduction of certain non-capital losses and non-capital loss carryforwards in the tax returns filed for 2015. Freehold will vigorously defend its tax filing position and believe it is without merit. No provisions have been made in the financial statements relating to this proposal letter. Back to Tom for his final remarks.
Thanks, Alan. In closing, we executed on our strategy in Q1. We continue to position Freehold in some of the highest netback plays in Western Canada that will continue to see development. This is evidenced by strong drilling on our royalty lands in Q1. With the improvement in commodity prices, our payout is still comfortably at the low end of our guided thresholds. In the near term, we'll strive to maximize value for our shareholders by investing our free cash flow in the form of dividends, value-enhancing acquisitions, and/or paying down our debt. Overall, Freehold offers investors a lower risk oil and gas investment vehicle with upside oil prices. I'll now pass it on 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 the 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 the 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 participant registers her questions. Thank you for your patience. We have a question from Amir Aref. Please go ahead. Your line is now open.
Thanks. Good morning, guys. Just a couple of quick questions for you, Tom. First of all, just the valuations in the space have come down, you would think that would increase producers' willingness to do some deals. At the same time, there's more producers who are trying to live within cash flow. Just curious how those two opposing forces are result in terms of your outlook on the acquisition market for royalties right now.
Thanks, Amir, for the question. When we look at the fiscal prudence of producers, I think that's a good sign for producers. Producers are also trying to develop their lands and live within cash flow. One of the means that we can help producers to develop their lands is with a royalty. We see that there's still quite a few people that'd like to drill more or showcase their lands more. We are seeing a number of producers that are looking to do royalty deals. We didn't do any substantial deals in Q1, there is pretty good deal flow out there.
Okay, thanks for the color. Just a second question on that CRA proposal letter that came in. For now, it's just for 2015. Is there any concern or chance of that increasing to other years post-2015? Or is it just specific to that one year?
No, we expect the loss carryforwards to impact later years. The reassessment will be 2015 with no impact on 2016 or 2017. Going forward, if the letter turns into reassessment, it would affect the loss carryforwards, which we use to reduce tax to nominal or zero amounts in forward years. We're at an early stage on that point. We haven't hit reassessment yet. We expect that that would only occur later in the year. The exposure that we'd have would be a reduction of our tax pools of approximately CAD 160 million.
Okay, sounds good. Then the one final question, if I may. I know, Tom, you mentioned the use of free cash flow for debt reduction or acquisitions dividends. How would you rank those today in the current environment in terms of where you'd like to be using that free cash?
Thanks, Amir, for that question. Right now, we like where our dividend is. It's at the low end of our payout threshold, our payout targets. When we look at the next use of proceeds, we do believe that we will execute on acquisitions through the year, we believe that we will use our excess free cash flow towards acquisitions during the year. Timing is something that we can't predict, but we think there's plenty out there that we should and use that excess free cash flow towards acquisitions. By default, we pay down our debt, and only if our debt is down, I guess to zero or something, and starting to build cash, would we consider buybacks, et cetera. It all depends on the level we trade at at the time as well.
Yep, makes sense. Okay, thanks for the color.
Thank you. Once again, please press star one on the telephone keypad if you have a question or comment. We have a question from Dennis Wong from Canaccord Genuity. Please go ahead.
Hey, good morning, guys, and thanks for taking my question. Just the first one here that I have is just on PPAs and compliance. You said revenues and volumes associated with that were lower this quarter. Just kind of curious as to how you're thinking about that on a go-forward basis. Should we expect that to decline continuously or kind of level out here? How are you guys forecasting and focusing on that component of the business? Thanks.
Yeah. Thanks, Dennis, for the question. I think you're referring to our audit and compliance barrels in revenue that we typically get through the quarter through our audit function. As you noticed in previous years, we had higher reported audit and compliance production numbers or PPAs. We believe that's probably in the 100-200 range a year going forward on a barrels per day on compliance. That's quite a bit lower than it was in previous years because we haven't done a major acquisition that had lots of title lands.
Okay. We should be expecting just as we get further away from a historical transaction, that that should be a little bit declining?
Yeah, a little smaller, yeah. We're thinking 100 to 200 BOEs a day.
Okay, perfect. The second question that I had is just on H2 CapEx and how you guys are going to maybe try and up your net wells essentially drilled, or even take a larger share of second half CapEx as producers start or continue kind of drilling for the remainder of this year.
Dennis, it's Dave Spyker. I'm going to take your question there.
Sure.
Dennis, we've had a lot more dialogue recently with operators. We're trying to position ourselves to compete for drilling dollars. A lot of things that we're looking at is, if we look at our lands where we see the drilling activity is a little bit less than offsetting lands, that want to have those discussions with the operators to see if we can put some well-specific royalty incentives in place in exchange for drilling commitments. It is very early on in the process, but the discussions have been quite constructive, and really, we see just a willingness from both parties part to understand each other's business objectives. We think that we are gonna see some additional net wells out of that this year and into next year as well. It's been quite constructive.
Okay, perfect. Are there certain areas that you believe producers are focusing in on that you want to maybe potentially think about further incenting incremental activity?
I think that our focus area really is on the light oil areas in southeast Saskatchewan. That's where we see the biggest opportunity right now, and with a lot of older leases in there with royalties in that 20% plus range. If we can just draw those back a little bit, then we can compete with other lands, and we compete with Crown opportunities.
Okay, perfect. Final question here, and I'll turn it over after this, is how should we be thinking about the remaining working interest production that you guys have and how you're gonna manage around that for either further dispositions or around the remaining production and so forth? Thanks.
Yeah. On the dispositions, Dennis Wong, Dave here again. We are going to be marketing the remaining assets outside of the Anderson assets. There will be a package that's coming out on The Street this quarter. The goal is to have a good chunk of those sold before year-end.
Okay, perfect. Thank you.
Thanks, Dennis Wong.
Thank you. We have no further questions registered at this time. I would like to turn back the meeting over to you, Mr. Mullane.
Well, thank you everybody for joining us on this conference call. We had a quarter that was in line. We believe that our drilling activity was above basin average because of our light oil targets. We believe that we are an investment that in oil and gas, it has a lower risk, and we continue to have a long-term option value with the many prospects that we have in our lands. Thank you.
Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.