Good day, and thank you for standing by. Welcome to the PrairieSky Royalty Ltd. announcing their fourth quarter 2021 financial results conference call. At this time, all participants are on a listen-only mode. After the speaker presentation, there will be a question-and-answer session. To ask a question during that session, you will need to press star one on your telephone. If you require any assistance during the call, please press star zero. I would now like to hand the conference over to your speaker today, Mr. Andrew Phillips. Mr. Phillips, the floor is yours.
Thank you, Chris. Good morning, everyone, and thank you for dialing into the PrairieSky Q4 2021 year-end conference call. On the call from PrairieSky are Cam Proctor, COO, Pam Kazeil, CFO, and myself, Andrew Phillips. Before we get started, there are certain forward-looking information in my notes today, so I'd ask investors to review the forward-looking statements qualifier in our press release and MD&A for Q4 and the year ended December 31, 2021. Q4 saw strong organic growth in our crude oil royalty portfolio as a result of increased drilling activity across the Western Canadian Sedimentary Basin. Volumes were up 10% from Q3, reflecting the strong trailing activity number of 193 spuds from the third quarter. Q4 also had a strong activity number with 166 spuds versus 74 from a year ago.
Activity was broadly spread across the basin geographically and also across operators in play type. 2021 was a successful year for PrairieSky. We executed on approximately CAD 1 billion of accretive M&A transactions, adding producing and undeveloped assets in the best parts of the cost curve, including 3 million acres of oil-prone, predominantly fee title lands, while issuing less than 10% of our outstanding shares. Our strong cash flow per share growth and unhedged commodity portfolio has allowed us to increase the dividend by 33% and still pay down all the debt incurred on the Heritage fee title asset acquisition within two years. The new quarterly dividend is CAD 0.12 per quarter or CAD 0.48 per share per year. By using the excess cash flow to reduce our debt, we'll be well-positioned to execute on quality opportunities as they become available.
Our technical team is busy prospecting and identifying new opportunities across the vast PrairieSky land base. Strong industry cash flows have operators looking for new opportunities to expand their asset bases. In addition, there are numerous new start-up companies working in the basin. Our total proved plus probable reserves grew to 66.25 million barrels at year-end, up 37% year-over-year. This included the addition of 10.5 million barrels related to the 2021 acquisitions, as well as the 9.7 million barrels related to third-party drilling and technical revisions, which more than exceeded our 2021 royalty production volumes. There was also an incremental 5 million barrels added due to strong pricing.
At year-end, the NPV of our total proved plus probable reserves discounted 10% totaled CAD 1.6 billion, 88% above 2020, and this represents, of course, only the producing wells on our lands, no future wells. Our early entrance into the Clearwater Play differentiates us, as we have near-term development lands that will see our net royalty oil volumes grow to over 1,600 barrels per day by year-end 2022 on the play. Our proved plus probable reserves in the Clearwater grew to 2.6 million BOE from 435,000 last year. Excluding the 1.45 million barrels we purchased in Martin Hills, our Clearwater reserves grew over 2.7 times in a single year. In addition to these already developing areas, we are the largest holder of exploration acreage in the Clearwater Fairway.
The active exploration across this acreage will result in sizable new developments over the next few years at no additional cost to PrairieSky owners. We are hard at work on our newly acquired fee title lands and expect to enter into numerous leases with qualified counterparts to enhance the growth profile of our oil-prone assets. We'd like to thank our shareholders, existing and new, for their support as we build the premier North American royalty business, as well as the team at PrairieSky for their hard work and crisp execution during an active year for the company. I'll now turn the call over to Pam to summarize the financial highlights.
Thank you, Andrew. Good morning, everyone. As Andrew mentioned, there are certain forward-looking information in my notes today. I would remind investors to review the forward-looking statements qualifier in our press release and MD&A for Q4 and the year ending December 31, 2021. PrairieSky generated record funds from operations in Q4 of CAD 101.8 million, or CAD 0.45 per common share. This was 54% above Q3. The increase in funds from operations was as a result of strong royalty revenue of CAD 94.2 million, generated from average royalty production volumes of 20,340 BOE per day, as well as our income tax recovery in the quarter of CAD 12.4 million.
PrairieSky's oil royalty production grew to 8,311 barrels per day, a 10% increase over Q3 2021, and included 190 barrels per day of incremental acquisition volume and 48 barrels per day of increased sliding scale pricing volume. The quarter included only one day of contribution from the Heritage acquisition, which was effective December 31st, 2021. We will see the full impact from this acquisition in Q1 2022. The remainder of the oil royalty volume increase was due to organic growth on the royalty property following an active Q3 drilling program by third-party operators. These higher volumes and strong benchmark pricing combined to generate oil royalty revenue of CAD 61.3 million, 22% above Q3.
We are very encouraged by the growth already seen in our oil royalty volumes in Q4 and by the level of activity through the fourth quarter and already into Q1. Natural gas royalty volumes averaged 60 million a day, an increase of 3% over Q3. Higher production volumes and strong AECO pricing generated CAD 22.2 million in royalty revenue, a 42% increase over Q3. Revenues from natural gas alone were more than enough to fund our Q4 dividend. NGL royalty volumes averaged 2,029 barrels per day, down from Q3, primarily as a result of ethane curtailment. Due to strong benchmark pricing for PrairieSky's NGLs, royalty revenues still increased 6% over Q3 to CAD 10.7 million.
There were 951 BOE per day of prior period adjustments in Q4, which were 32% liquids in the quarter. These prior period adjustments included 357 BOE a day from compliance activity and an additional 594 BOE a day of other prior period adjustments related to new wells on stream and better well performance. The compliance group recovered missed and incorrect royalties through forensic accounting, collecting CAD 1.4 million in the quarter and bringing 2021 annual collections to CAD 4.2 million. There were 166 wells spud in Q4, which were 95% oil. The Viking was the most active play with 60 wells, and that was followed by the Clearwater with 44 spuds. Additional activity took place across the basin with wells spud in the Manville, Mississippian, Duvernay and Cardium.
In 2021, there were a total of 548 wells spud on PrairieSky lands, 95% oil. This is up from 288 wells in 2020. PrairieSky estimates that CAD 783 million of gross capital and CAD 37 million of net capital was spent on our lands in 2021. We anticipate that third party capital budgets in 2022 will be higher than 2021, and we expect to benefit from this incremental activity across the land base, including on the additional 3 million acres of royalty properties added to the portfolio in 2021. Looking forward, PrairieSky's 2022 annual price and sensitivity, which are all net of G&A and taxes, are as follows. A $5 change in US dollar WTI would increase or decrease funds from operations approximately CAD 19 million.
A CAD 0.25 per Mcf change in AECO would increase or decrease funds from operations approximately CAD 4 million, and a CAD 0.01 change in the U.S. to Canadian FX rate would increase or decrease funds from operations approximately CAD 3.5 million. Other revenue totaled CAD 6.4 million in the quarter and included CAD 2 million in lease rentals, a half a million CAD of other income, and CAD 3.9 million of bonus consideration for entering into 48 new leases with 42 different counterparties. This brings annual other revenues to CAD 16.2 million. In 2021, we entered into 139 new leasing arrangements, up from 85 in 2020. New leasing is typically a precursor to increased field activity, and we anticipate near-term drilling on many of these new leases in 2022.
PrairieSky is forecasting other revenue in the range of CAD 20 million in 2022, including lease rentals, bonus consideration and other revenue. Compliance recoveries will be incremental to this amount. Cash administrative expenses totaled CAD 5.4 million or CAD 2.89 per BOE. This brings annual cash administrative expense to CAD 20.2 million or CAD 2.79 per BOE. We expect cash administrative expenses to be well below CAD 3 per BOE again in 2022. PrairieSky recorded a CAD 12.4 million current tax recovery in Q4 through the use of the tax pool deductions from the Heritage acquisition. This brings 2021 annual current tax to CAD 4.6 million. Entering into 2022, PrairieSky has CAD 1.75 billion of tax pools to offset future taxable income.
During the quarter, PrairieSky declared dividends of CAD 21.5 million or CAD 0.09 per share with a resulting payout ratio of 21%. Annually, PrairieSky generated CAD 273.4 million in funds from operations, which were used to fund dividends of CAD 70.5 million and repurchase shares for CAD 22.7 million, with remaining cash flow put towards acquisitions. PrairieSky's net debt at December 31, 2021 was CAD 635 million, which we expect to reduce in 2022 with excess funds from operations over our increased annual dividends of approximately CAD 115 million or CAD 0.48 per share. Due to our updated Sustainalytics ESG report, which ranks us number 68 in the world with a rating of negligible risk, PrairieSky will receive the full pricing reduction related to our sustainable credit facility.
Given current commodity prices, we expect to repay the debt used for the Heritage acquisition within 24 months. Since IPO, PrairieSky has generated approximately CAD 1.7 billion in funds from operations and returned CAD 1.4 billion to shareholders through dividends and buybacks. We will now turn it over to the moderator to proceed with the Q&A.
Thank you. As a reminder, to ask a question, you need to press star one on your telephone. To withdraw your question, please press the pound key. Stand by as we compile the Q&A roster. Our first question comes from Patrick O'Rourke of ATB Capital Markets. Your line is open.
Hey, good morning, guys. Thanks for taking my question here. Just in terms of the dividend bump here and sort of the messaging in terms of capital allocation and debt repayment, just wondering, you know, what was the catalyst for the dividend increase here? Obviously, activity levels were very strong in the quarter based on spuds, but commodity prices are also strong. Is it one or the other? Is it some combination of both? As we think out into the future here and sort of the path of shareholder returns and how you're thinking about it, how you're leaning in terms of that debt repayment and further dividend increases kinda through 2022 here.
I know that, you know, debt repayment has been an important part of the thesis and strategy for the company post the Heritage acquisition.
Yeah, thanks for the question, Patrick. On the dividend, we, you know, we're fortunate that since the Heritage acquisition, the excess cash return to shareholders is in line with the increased cash flow generating ability of the business. We still almost have the exact same debt repayment schedule, so it's just directly in line with that. You know, when you look out 3, 5, and 10 years, we should have pretty strong dividend growth when you think about the business. This is a business that has paid 85% of cash flow out as a dividend in times when we can't find high-quality acquisitions to increase the per share value of our business. The dividend growth could be pretty substantial.
We'll obviously be paying down a huge amount of debt in the next 2 years at the current commodity prices. Even lower commodity prices, we'll still pay it down quite quickly. I think that'll bode well for future shareholder returns in the form of a dividend. We kind of looked from a buyback perspective. We almost looked at this acquisition as pre-funding the buyback rather than fully advertising the deal. 2/3 of it was done with just over 2% leverage, and now we're paying that down. We almost did the buyback, we look at it, in the thirties.
Okay. Just on the activity levels in the quarter and looking forward here, you guys obviously have, you know, your thumb on the pulse of activity in the basin. I'm wondering, you've got the core four plays there, but with the run in prices here, maybe some better capital access, are you seeing a bit of an uptick in activity in terms of maybe the secondary plays in the portfolio?
For sure we are, Patrick. I think, you know, we had 42—like, just in the last quarter alone, we had almost CAD 4 million in lease issuance volume. That's 42 leases with 42 different counterparties, 48 different leases. We're leasing across the entire basin from Manitoba all the way to Northern Alberta. It was quite a broad leasing program. Then when you look at the spuds across the basin, it's been on every play, every geographic region. It's a more balanced recovery than it was in 2017 when it was very concentrated in a few core plays. The other thing we're seeing that's kind of unique is given the recycling of a lot of the teams over the last year, there's a lot of privates that had sold and some public mergers.
We're seeing a lot of new teams starting up. We're very busy here presenting to numerous teams on the acreage potential and potential leasing opportunities, and our seismic data room's busy again. We're starting to see those new startups enter the market as well.
Okay, thank you very much.
Thanks for your question.
Thank you. Next, we have Jeremy McCrea of Raymond James. Your line is open.
Yes. Hey, guys. I was wondering if you could comment more on the M&A, you know, environment here today, just with commodity prices. Is it as easy as to do deals now with a lot of the operators having the cash flow? Is there still as many opportunities out there? And anything on those kind of lines there.
Yeah. I'd hate to speculate on what the whole year looks like, Jeremy, but I think when you think about the M&A environment, some of the manufactured type royalties were a result of, you know, the very low trading multiples of some of the public producers, but them still wanting to enhance the value of their business. I think some of that likely becomes available. For sure there's gonna be higher expectations given this higher price deck, and we typically discount that a little bit. I think it'll probably be a little thinner this year, would be my guess, just given the industry cash flows and people paying down bank lines. I guess time will tell.
Okay. No, that's perfect. That's all I have here for today. Thank you.
Thanks, Jeremy.
Thank you. Up next, we have Luke Davis of RBC. Your line is open.
Hey, good morning. Thanks for having me. Just wanted to clarify, did you say current or exit Clearwater volumes would be at about 1,600 barrels a day this year?
That's correct. Yeah. We expected we were in and around 1,000 BOE of net royalty oil production. It's probably a conservative number because it includes no exploration or development on some of the new discoveries that have been made across the basin across our Clearwater anchorage. But just with kind of Nipisi and Martin Hills, which are our two core areas right now, we're expecting it to grow by 60% this year from 1,000 to 1,600 exit this year.
Gotcha. That's helpful. I know, you know, your biggest royalty deal would be Spur, but can you provide some commentary on other producers that are operating in that play, that you have exposure to?
Yeah, you bet. I think, you know, there have been a couple of other discoveries made in the South Clearwater just west of Peavine as well, and then a little bit of work in some other exploration areas that we can't comment on just because it's been conducted by privates. The play has expanded, and I think the South Clearwater is probably the one that's seeing the most development right now. You know, Rolling Hills has made some pretty good discoveries and some compartmentalized pools that we think will be really conducive to polymer floods. That's expanded pretty dramatically as well. I think in the two core areas, what you're seeing is just tight curves across substantially each new wells.
The EURs are 35% higher than they were the year before. That's where we got the big uptick in reserves on just the proven.
Gotcha. That's helpful. Thanks.
Thanks for the question, Luke.
Thank you. Next, we have Aaron Bilkoski of TD Securities. Your line is open.
Morning. I had a couple questions just following up on some of Pam's comments. In terms of lease expiries, is there anything significant that's up for renewal this year that you guys think could be meaningful, especially now that we're sitting at, I guess, $90 WTI?
Yeah, that's a good question. I think we did see a nice uptick in lease issuance quotes in Q4, almost CAD 4 million. We do have a large expiry west of the Homeglen-Rimbey Reef in the Duvernay Shale. We're working with a couple of counterparties on some smaller leasing arrangements there, but there is a large piece of land available there, and there's been some pretty significant results. Of course, the play is very sensitive just given the very high initial rates and then the higher declines because it's a multi-stage multi-frac well. It's very sensitive to first year oil price and gas price, and of course, both of those are very strong right now. We do expect some leasing opportunities there with industry.
I'd just hate to speculate as to when those happen. In the next 12 months, we do expect some leasing there. Then I think, you know, one of the things we saw in 2020, our compliance team was really active and really busy making sure that we got back all the rights we could in the downturn. As a result of that, we got back over 4,000 leases in 2020. Now industry is looking to re-lease a lot of those smaller pieces of acreage across the basin to reactivate wells, to reactivate a water flood, et cetera. We're expecting that to be busy as well on the conventional side.
Perfect. Thanks. That's really helpful. If I could ask another question. I know it's early days on the recently acquired assets, but I'd be curious if you had any initial comments on the potential magnitude of complementary revenue from those properties.
Yeah. That's on the compliance; it's that is one that takes quite a bit of time. Sometimes a contract can be 100 pages, and you got to go through every little detail of it to understand it. We did a lot of work prior to the acquisition. We worked on it obviously for almost six months last year. We did identify a number of opportunities. These are situations where you got to make sure you're a long ways advanced, so you know exactly what the opportunity is there. We think it's significant. I don't think you'll see a significant bump in compliance revenue from that specific asset in 2022, but I do think you're going to see some strong numbers come out of there past that.
Thanks. If I can ask one more question, this is sort of a follow-up to, I guess, Patrick's first question. When I look at the royalty space, most of your peers have a targeted dividend payout range. I think even B level producers are starting to, I guess, increasingly outline targets that return a portion of free cash flow back to shareholders. Do you foresee PrairieSky becoming more formulaic in its strategy around shareholder returns?
Yeah, it's a good question. I don't think we will, Aaron. I think, you know, one of the reasons we like to be flexible is because we like to do what's best for the business and what's best per share for shareholders. I think when you get too formulaic, you get boxed in. Even when it is a variable dividend, you end up. It's basically a dividend that you've committed to, and it. The formulaic approach doesn't allow you to change your strategy slightly when the opportunity presents itself. I think last year it was very unique. We had a very low payout ratio. We did CAD 1 billion in M&A and diluted shareholders by less than 10%. It really allowed us to grow the business and compound the business over time.
You know, in 2017, 2018 and 2019, we had around an 80% payout ratio, paid CAD 185 million in annual dividends, and just because we couldn't find the right opportunities and did very little M&A in those years. When you get back to that's the opportunity at the time. I don't see us getting more formulaic. I don't see special dividends being reflected in multiples. We're just, we'll do what's best for the business, on that front.
Perfect. Thank you very much.
Thanks for the question, Aaron.
Our next question comes from Amar Sheth of Bellw ood Partners. Your line is open.
Hi. Hope you're well. Thanks for taking my question. I was wondering if you could comment more on the Heritage acquisition. I saw just from the purchase agreement, a couple assets were held back and, you know, just more about what's the long-term kind of potential of why you guys really thought it was an attractive acquisition.
You bet. It's a good question. I think it's one of those—it's the premier fee title asset in the oil portion of the Western Canadian Sedimentary Basin, so it's a very oily asset. There's been a major step change in technology with multilateral drilling and better drilling fluid systems that have really unlocked the potential of it. It's at 2,700 barrels per day of net royalty production. Without us doing anything, we think it's on a modest growth profile. We think with a strong leasing program over the next 10 years, we can grow it in the higher single digits. We think it's a great growth asset with no future capital. It's only 20% leased.
We just believe it's undermanaged from the standpoint that we can get a lot more of those lands leased. What's great about it is that it's a very strong cash flow profile. It's over a 10% free cash yield on the purchase price we pay, but 80% of the lands are currently not generating revenue. That's the potential for shareholders. That's the difference between this and a lot of other royalty asset acquisitions is not only do you get this really strong cash flow stream at a very reasonable discount rate, but then you also get in 2030, you've got the growth potential on those undeveloped lands. That was the rationale behind it. It's something we've coveted for a long time.
We bid on it jointly with Franco-Nevada on this asset in 2015, and they were the successful acquirers. We've kinda wanted to own it ever since. Something we can add, very scalable, scalably. We add zero staff in order to manage another 1.9 million acres, so we're well set to own it.
It's extremely helpful. I guess my last question is, you know, in some of the presentations you guys presented an extraordinarily helpful slide about production over time on PrairieSky lands. It, you know, obviously with this recent downturn has been declining. I'm just wondering in terms of what's you guys' view on, is there an inflection happening currently, of that trend?
Yeah, we have seen an inflection in activity in the basin. We kinda started to see it in the middle part of last year, where we saw some growth across a lot of the basin. I think, our view is that there's enough activity right now in the basin to grow production on our lands. Which is great, we have seen an inflection on the conventional activity. The other thing that's differentiated us a little bit is we've invested all our acquisitions in the lowest cost parts of the cost curve on the oil cost curve. Which allows us to outperform the basin. Assets like the Clearwater, again, have the lowest full cycle OPEX in the basin.
On the light oil side, it's the Viking, and we're the largest royalty owner on both of those. That allows us to outpace the basin as well. We should see a stronger inflection on PrairieSky's acreage.
Okay, thank you very much.
Thanks for your questions, Amar.
Thank you. Next we have Matthew Weekes of iA Capital Markets. Your line is open.
Hi, thanks. I just think I wanted to clarify something said earlier. You said exiting 2021, your net production on Clearwater acreage was about 1,000 BOE a day. Is that correct?
Correct. Yeah, that's correct, Matthew.
This is expected to grow to about 1,600 net by the end of 2022.
That's correct. Yeah. The Clearwater alone should grow to 1,600 and of course it's a reasonably conservative estimate because we're kinda just including the core areas of Nipisi and Martin Hills. Of course, we have a huge acreage position outside of that as well. That total is only 100,000 acres of our over 1 million acres on the play. There is potential of, upon seeing further developments, for upside there. I think that's a reasonable estimate.
Do you have an estimate on how many rigs in the industry were operating on PrairieSky lands in the quarter and compared to what you're seeing now?
Yeah, we don't actually, we don't put that out. Part of the reason is it can sometimes be misleading because of course sometimes you can have a rig or two operating in a unit where you have a 0.2% interest. Sometimes you can have four rigs running in an area where you have 17.5% royalty. It's, we don't put out that specific number. Because of our broad swathe acreage from Manitoba all the way to BC, we get a pretty significant share of that rig count. Today there's 225 rigs running versus 180 this same day last year.
Obviously there's an uptick, so it looks like capital spend will be higher in the basin this year and we'll get our share of that as a PrairieSky acreage owner.
Okay, thanks, I appreciate it. That's all my questions. We'll turn it back.
Thanks for the questions.
Thank you. As there are no further participants in the queue, I will return the conference back to the speakers.
Well, thank you everyone for dialing into the PrairieSky Q4 2021 conference call. Please feel free to call Pam or myself if you have any further questions. Have a good day.
This concludes today's conference call. Thank you all for participating. You may now disconnect and have a pleasant-