Ladies and gentlemen, thank you for standing by, and welcome to the Peyto second quarter 2020 financial results conference call. At this time, all participants are in listen only mode. After the speaker presentation, there will be a question and answer session. I would now like to hand the conference over to your speaker today, Darren Gee, President and Chief Executive Officer. Please go ahead, sir.
Thanks, Josh, and good morning, ladies and gentlemen. Thanks for tuning in to Peyto's second quarter 2020 results conference call. Before we get started today, I would like just to remind everybody that all the statements made by the company during this call are subject to the forward-looking disclaimer and advisory set forth in the company's news release issued yesterday. In the room with me, we've got the entire Peyto management team. Kathy Turgeon, our Chief Financial Officer, JP Lachance, our Chief Operating Officer, Dave Thomas, our VP Exploration is here, Todd Burdick, our VP of Production, Lee Curran, VP Drilling and Completions, Tim Louie, VP of Land, he's here, and so is Scott Robinson, our VP of Business Development. If you got questions for any of those guys, fire away today.
Before we get started, though, with my comments on the quarter and our results, I did want to recognize the efforts of our field personnel and the rest of the Peyto team. This is a very difficult time in our industry, obviously. The weather in the second quarter was very challenging also. I just want to take this opportunity on behalf of Peyto's shareholders to thank all of our field people and all of our team here in Calgary for the fantastic job they're doing every day. As one of the larger natural gas producers in Alberta, it's critically important that Peyto continues to provide the energy that Albertans need to power their homes and hospitals and schools and supermarkets. In Alberta today, over 55%, I think, of the electricity that Albertans use is generated by natural gas. We're very much dependent on our natural gas industry.
A big thank you to our guys for continuing to keep the lights on. Onto our second quarter results. Operationally, the second quarter was quite wet, actually. In a typical year, once the snow melts and surface conditions dry out, we're usually able to move all of our heavy equipment around again, so long as we don't see too many spring rainfalls. Not the case this year. Up in the Edson country, we saw a lot of spring rain that swelled rivers and field ditches and water was flowing over roads. Obviously that meant moving heavy equipment around, particularly heavy stuff like frac pumpers, was very difficult. We didn't want to spend a whole bunch of money dragging the heavy gear around. We did manage to continue to drill from some pre-constructed pad sites.
As I mentioned, getting frac equipment in to complete was a problem. That meant we had a bit of a backlog for completions by the end of the second quarter and on into July that we are still working on. With the wells that we were able to complete and tie in, we were able to hold our production relatively flat. Since gas prices did not fall nearly as much as oil prices, we did not have to shut in any production during the quarter like many of the oil producers did. Thankfully, condensate kept flowing as well. We did build some storage just in case. We drilled some interesting wells in the quarter, had some very nice results down in our Brazeau area.
As I mentioned in my monthly report this month, we've seen production in Brazeau climb about 50% from 10,000 barrels a day up to 15,000 throughout the first half of this year. That's evidence of the good results that we're seeing down there, and we plan to continue to have a very active year in Brazeau. That will be an area with growing production, I think, for the next many quarters. As mentioned in the release, we also drilled some extended reach horizontals in the Wilrich Formation during the quarter, trying to test out this concept of opening up more reservoir with each well bore. This is expected to give us better productivities and increased reserve recovery for each well and for every CAD of capital that we spend.
We're looking closely at those wells over the next few months, and then we'll decide whether we want to continue in that vein with even longer horizontals. I think these three wells just came on production this week, so we'll be watching them closely. Thankfully, we did find ourselves aligned with good service companies that remained a growing concern in the quarter. Sadly, the extremely low commodity prices and low levels of activity are really decimating our oil field services industry. We need to pick and choose our counterparties carefully. Hopefully enough companies do survive this so that when commodity prices recover, we can, as an industry, increase our activity again. It's a very delicate situation right now for many. We are planning on increasing our capital program next year, assuming the current strip for gas prices comes to fruition.
We don't think it will take much more than the four rigs we're currently running. We figured it was better to keep all this equipment and all the crews on that equipment working this year, even if it was intermittently. We have it for next year when we want to speed up. That way we don't run any risk that when we go to speed up and if everyone else goes to speed up, there won't be any equipment or crews available. We expect that with the higher prices on the strip and growing production this year, we'll have significantly more cash flow to fund a larger capital program next year. We're excited about that. Financial results for the second quarter were clearly impacted by COVID and the pandemic impact on global and North American energy consumption, and the commodity prices for all that energy.
Most producers wish they were better hedged, and so did we. Unfortunately, natural gas prices have been weak for a while. Obviously, AECO prices from 2017 to 2019 were extremely weak, and so created an [audio distortion] want to lock very much of that price in. We [audio distortion] . Now that prices have recovered some, we're hedging a lot more going forward, [audio distortion] . Cost-wise, I think we did a very good job maintaining our industry-leading low costs in the quarter. Operating costs are still obviously strongly dominated with government costs as we go through COVID and our G&A.
We're working with industry groups and the government to see if we can bring those down. Particularly the municipal taxes, that's an area that's of concern. The municipalities in Alberta are sitting on a collective CAD 17 billion war chest, a surplus that they've accumulated over the last several years, yet they continue to overcharge our industry with taxes. Clearly that has to change going forward. We're working with government to make those changes. Our field operations are already running very efficient. We're going to keep grinding away and looking for more ways to cut costs. We've got several initiatives underway that we're working on that front. Todd can probably elaborate on that a little later.
We're having success optimizing our transportation costs, most of which is just firm NGTL receipt service at this point, but we definitely carried a bunch of extra service, in case during the NGTL expansion, there was service restrictions, which we had anticipated. We're starting to let that extra service go now, and we're starting to find that we can work with other operators to optimize the remaining term of our service and their service, which is also helping to actually reduce our costs. As far as G&A goes, we're [audio distortion] in Calgary. We need all those people as we increase [audio distortion] next year. As we do increase those capital [audio distortion] per-unit cost shrink as production rises going forward in all categories.
With increased prices, that just means our cash netback will see all of the gains, really, if we have no costs that are going to scale up with higher prices. We get to see it all on the bottom line, which is nice. While this quarter was a tough one from a price and cash flow perspective, we do expect this was the low point and really it's blue skies and straight up from here. We're excited to get this one in the rearview mirror and get to future quarters that look much better for us. Basically that was the quarter just in a quick summary. We're excited to get on with Q3 and Q4. Maybe without me talking too much more, operator Josh, could we maybe turn it open to the listeners for any questions they have?
Yes. As a reminder, to ask a question, you'll need to press star one on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from Timothy Hurckes with John W. Bristol & Co . You may proceed with your question.
Good morning, thank you for taking my question. It seems like from the disclosure, the market diversification costs should run about CAD 30 million per quarter, through the first three quarters of 2021. Is that estimate about correct for the cost of diversification?
Tim, I'd have to go back and check that against our marketing. We did update the market diversification information here on the website last night. We can go back and check that. If you want to send me an email, I can double-check that for you. We do have, obviously, some fairly expensive exposure to the NYMEX that we put in place back in 2018. You'll recall that was really at the depths of when AECO was projected to be a non-economic market forevermore, quite frankly. We had gas prices at that point that never rose over about CAD 1.50, so we had to get out of AECO. We put a bunch of our gas to the NYMEX at basis deals that typically were about three years. They run out actually in the fall of 2021.
You're right, we do have a bit of high-cost market diversification in front of us, and then that rolls off quite substantially. I'd have to double-check exactly what that [audio distortion] .
Okay. Thank you.
You bet.
Thank you As a reminde to ask a question you need press star one on your telephone. Our next question comes from Alex Hitchen with Necrons. You may proceed with your question.
Hello. Can you hear me well?
Yeah.
First of all, congratulations on surviving. I have great confidence in Peyto, and I hope that the next 21 years prove to be as interesting as the last 21 years. I think that surviving catastrophic risks so you're around to fight another day is clearly the most important priority for what otherwise is a very efficient company. I wonder if you can provide some color on what it is that you're doing specifically, which is perhaps a board-level question, on ensuring that survival in cases of, say, gas prices again dropping to $1 .5 , over a reasonably long period of time.
That's a great question, Alex. One that we think about a lot. We're in this commodity business where we don't actually get to set the price of the products that we sell. It would be great if we were producing iPhones or something, we could just go out and say that we wanted X for them and that may cover all our costs. That's not the case. We're dealing with energy here, which really is a privatized industry in North America in some other countries of the world, isn't privatized everywhere. We're competing against a lot of different countries, in fact, where the state owns all the energy and develops it, not for profit. Here we are trying to develop it for a profit.
I think, right from day one, we understood at Peyto that the key to success in this industry was really controlling costs. That's the only real thing we do control. We've always been focused on our cost structure, both the capital that we spend, and the cost to develop new reserves, as well as the cost to produce them and get them out of the ground and sell them. All of those pieces we've always been focused on. We've stayed very lean as a company. We've controlled all of our asset on purpose. We've built and owned our infrastructure on purpose, because it was a way in which we could keep all of our costs down to try and keep that margin as high as possible. That's the only real insulation that we have.
Obviously, access to capital is a cost that these days has ballooned for the industry. That's something that we've obviously survived for 21 years by having good access to capital. Cash flow is the best capital we have access to, coming off of our asset. Keeping costs low and cash flows high obviously gives us the best access to capital. We've had good support from bankers along the way and good support from investors along the way, too. I think, as long as we can continue to do our job, we should continue to have that support from those capital providers. Obviously, in this kind of environment, capital's incredibly tight. There's very little liquidity available to producers, and so everyone's working with cash flow. We're seeing the effect of that. We're seeing how much development can really occur with just cash flow.
Obviously, over the last decade, the industry has been overfunded, with capital coming from other sources over and above cash flows, and that's allowed the industry to grow and in some cases be wasteful. We've, I think, been particularly good at staying really lean and efficient with our capital deployment. We've enjoyed relatively low cost of capital throughout our life. I think, when you don't control the commodity prices, the cost structure is the only thing you can focus on, and that's what we've always focused on, building a solid quality business with good assets that have very low cost associated with them.
Okay. Just a short follow-on question. The one area that I think is built into Peyto's DNA is to keep costs as variable as possible or as practical in a capital-intensive industry. Obviously, being able to turn production on and off and modify the production is one aspect of that, but another one is the longer-term aspect of capital spending on various things. At that point, your hedging needs to cover the period of inflexibility that you are forced into versus the period of flexibility that you have some control over. Of course, you want to keep some minimum staff level to maintain your competitive advantages as a company. Do you have any comments on that?
No, you're absolutely right, Alex. It's a good observation and we've definitely designed Peyto that way. We have a very long reserve-like asset, arguably close to 10 years of producing reserves, close to 30 if you include the undeveloped component at this production level. We do hedge actively, like you say, in the short term. We would prefer and would have preferred to be more hedged even through some of this short-term uncertainty and volatility that we couldn't predict. Like I say, we went through a period from 2017 to 2019 when the gas market in Alberta was broken, when really there was such a huge disconnection that the price wasn't representative of what was going on in the grander North American market. We were caught, quite frankly, without an ability to get out of that market. We're not going to let that happen ever again.
We're smarter now. I think we'll make sure that we can continue to be well-protected in the short term, while still having good exposure, obviously, in the long term. As you suggest, variability of cost structure with commodity price is really important and something that we've strived for. We want to get away from having fixed costs that don't scale when you need to scale. We've always pushed to have as much variable cost component in our business as we could, and to be as flexible and as nimble as we could. Part of obviously owning and controlling all of our asset base gives us that flexibility. We've definitely seen the fixed component creep into our business more and more.
Government costs, as we characterize them, have increased substantially over the years, and those are the fixed parts that don't scale with the commodity price, and they're very frustrating, obviously. Not necessarily something that we have large control over, but we're definitely, as part of the industry, pushing back on that fixed component. It's really showing its teeth right now, obviously, with it becoming such a large component of the industry's costs. We're making, obviously, governments very aware, and they're seeing the result of their behavior, too. Industry activity is anemic right now. There's nothing going on. The industry isn't providing any jobs really for anybody when it should be, and that's partly because the government has taken such a big fixed piece out of the industry over the last few years, and so that has to change going forward.
We have a government, I think, that's listening, and so hopefully they'll hear that message and we'll make those changes.
Congratulations again on a very tough period. It does appear to be better at the moment, and of course it can get worse. Perhaps you can convince government that they also need to have more variable costs and fewer fixed costs.
We're definitely trying.
Best of luck.
Yeah. Thank you.
Thank you. Our next question comes from David Popowich with CIBC. You may proceed with your question.
Yeah. Thanks, guys. I just had a question about a line in the press release where you guys were talking about you've got four rigs running, you said if these rigs were to run next year, they could drill 40% more wells. I guess I just wanted to understand how you guys are kind of governing activity on those four rigs right now to drill at the current pace, and how easy would it be for you guys to just put the foot on the gas pedal and start drilling more wells?
Yeah, that's a good question, Dave. Maybe I'll just flip that right over to Lee, and he can answer that.
Yeah, sure, Dave. When we laid out the balance of this 2020 capital program and looked at the resources that we needed to execute the program, we decided in this market it was a wise decision to build a little bit of surplus in. There's a couple of reasons for that. Firstly, all of the services and personnel we had working out there were really firing on all cylinders. There was no real gaps that gave us a reason to cull any of that herd. Our field personnel have really embraced this culture of collaboration and healthy competition, and that's a little bit of a knife's edge to walk along. With that, we just wanted to maintain that tribal knowledge through our field operations, and so we kept a little bit of extra resources in play.
We saw this as an opportunity to work as a retention mechanism with our personnel and our services. When the time came, which we forecast it will towards the latter part of this year and into 2021, where we could just step on the gas and not have to risk any performance loss as we often see when we reactivate new equipment and bring new people into our fold. We have a lot of very senior people in the field. That's something we look at as a long-term strategy. How do we start rolling new people in? We're working on that, but we've got a lot of 10- to 15-year people in our field operations, well site supervision at the rig level. Some of them have been with Peyto for in excess of 20 years. It's a little bit of an anomaly in the industry.
We don't want to lose those people because what they know about our operations and the efficiencies they bring to the table are just, to be quite frank, they're irreplaceable. We used that as a bit of a tool. We did not forecast the level of weather-related delays, so it really helped us this year. This year's been very anomalous in terms of the amount of rainfall, precipitation we've gotten up north. What we've been experiencing here in Calgary is really nothing compared to what we've been seeing up in the Edson country. Having the extra resources and essentially we've got about a 30% extra capacity in terms of rig count. We're running the equivalent of three rigs right now with four rigs.
We're metering these gaps in, and some of them are superimposed with weather delays, and some of them are quite intentionally positioned so that we can see feedback from given wells before we embark on another investment. We're pretty much set up that way. Our service contractors have been with us for a long time. They saw it through the same lens that we saw it. It worked for both parties. They had surplus equipment, and they wanted to retain key people. They were very aligned in this initiative, and our field personnel received that message well. They bought into it. It was COVID, summer, and people wanted to spend a little bit of extra time with their families. It's really been a functional program, and we've seen it result in, for me, it was quite surprising.
We've watched our cost per meter on the drilling side decline 10% through the quarter, which was more than I had really anticipated. I think part of that is just the strategy that we implemented. In our completion cost as well, we're down to CAD 37,000 a stage as we reported. From what I'm able to see, in the public domain, that seems to be the lowest cost per stage in the Deep Basin. This has been a really successful program, and I think we'll really see the rewards of that as we do increase our capital program towards the end of the year.
Dave, I'd add one more consideration, and that is the working interest participation. We do have some joint interest, obviously, in some of our land, and over the last year or two, participation in operations has been quite variable. At times, nobody is participating with us, and at other times, guys are participating full on with their working interests. We're obviously trying to design for net capital spending, net operations, net results. Without knowing what those parties are going to do, we can go from being one net rig running to being two net rigs running, depending on whether or not they're participating or not on a well. That's a little bit of the unknown that we have to try and design for.
Having the excess capacity allows us to make sure we can meet our net, depending on whether or not those other parties are participating.
Okay. I don't want to belabor the point, I guess, but just in terms of specifics, so I understand it, you guys aren't drilling the wells slower. Is this some commitment that you guys have made to the drilling companies where you say, "Look, we're prepared to pay the staff, assuming a full capital program, but we're drilling 40% fewer wells"? I guess I'm just trying to understand the specifics there.
We're specifically designing, I think, short breaks in between wells where we shut everything down, we shut the cost down, we shut the activity down. Everybody gets a week at home with their families, then they're back to work for another two or three weeks.
Okay, that makes sense
next year, for instance, those breaks are not going to be hopefully available. I'm sure that people will be happy to have full-time work and full salary commitment as well. This year, we're just fitting in these small breaks on every rig that makes them run at a more intermittent schedule.
Okay. That makes sense. Last question from me is just on spending into the back half of the year. The NYMEX curve's in pretty steep contango. I just want to get a sense of how you guys plan to approach capital spending toward the end of the year. Is there any chance that you guys would see some Q1 2021 capital push into Q4 as you would look to bring some new gas on ahead of that? You guys are return focused, but when you see the curve where it is, perhaps the opportunity to take advantage of some cheaper services in Q4 2020. Is there any chance that you guys would look to increase spending over and above what you've publicly stated as your guidance this year?
Yeah, we do have that capability. We'll watch that closely. We didn't want to take on a lot of debt, obviously, over and above what we have today. We want to grow into the debt level that we currently carry. Obviously, our debt to cash flow ratio is still pretty high, and we want to bring that down. The easiest way to bring it down is to grow our cash flow without growing the debt. We'd like to stay close to being within our means. Practically speaking, winter is a busy season, and we do expect to be more active there. I think we'll keep an eye on that closely. Really, the short-term curve is short term and doesn't necessarily provide a ton for us. What we'd really love to see is the back end of that curve come up.
That's obviously going to be much more impactful long term for us.
Good. Thanks very much, guys. I appreciate the answers.
You bet. Thanks, Dave.
Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Darren Gee for any further remarks.
Okay. Well, thanks, Josh. Been a busy reporting season, so understand everybody is probably fatigued from all the furious company reporting that has come out over the last little bit. As we said in the release, this obviously was a tough quarter for us. We are glad to have it behind us, and we are looking forward to both stronger gas prices, lower diversification costs, growing asset base into the future. We are much more optimistic on that. We have settled with our bankers to give us the relief we needed in the short term, which incorporated, obviously, this quarter. Then from here, it gets much better. We are excited about the future here at Peyto. We are excited about what we are seeing on the North American natural gas landscape.
Obviously, everybody's got to be a little cautious about COVID and its impact continuing beyond, obviously, the first wave of this pandemic, and how that's going to affect commodity markets globally. There's still obviously a problem with oil, and there's still the issue with OPEC. I think from a natural gas perspective, things are looking pretty optimistic right now. Prices are rising. We're taking those off the table actively and getting back to much more Peyto-style hedge protection, which then gives us a lot more comfort into the capital programs, cash flow we're going to generate, and ultimately, we can look at getting much more strong in terms of earnings generation as we go forward. This was the toughest year. Beyond this, we see much more significant earnings coming back to the fold, which is what we've always enjoyed as a company.
While the start of this Necrons 20-year period is a bit of a rough one, things are looking like they're getting better quickly. We're excited about that. We'll be back to you with Q3 in November, and should have some more interesting results to share with you. Thanks for tuning in.
Thank you. Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.