Good morning. My name is Samara, and I will be your conference operator today. At this time, I would like to welcome everyone to the Vermilion Energy Q2 conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question, please press star then the number two. Thank you. Mr. Dion Hatcher, you may begin your conference.
Thank you, Samara. Well, good morning, ladies and gentlemen. Thank you for joining us. I'm Dion Hatcher, President of Vermilion Energy. With me today are Lars Glemser, Vice President and CFO, Darcy Kirwan, Vice President, International and HSE, Bryce Krempien , Vice President, North America, Jenson Tan, Vice President of Business Development, and Kyle Preston, Vice President of Investor Relations. We'll be referencing a PowerPoint presentation to discuss our Q2 2022 results and our return of capital framework we announced this morning. Presentation can be found on our website under Invest With Us and Events and Presentations. Please refer to our advisory on forward-looking statements at the end of the presentation. It describes forward-looking information, non-GAAP measures, and oil and gas terms used today, and it outlines the risk factors and assumptions relevant to this discussion.
As shown on slide two, we delivered another quarter with record fund flows of CAD 453 million and record free cash flow of CAD 340 million, which is over CAD 2 a share. That's up 16% and 12% respectively from the previous quarter. The increase was mainly driven by strong commodity prices as global oil prices and North American gas prices were strengthened during the quarter. European gas prices remained strong in Q2 and relatively consistent with the prior quarter with TTF in excess of CAD 38 per MMBtu. Over the past several months, European gas forward prices have nearly doubled, which will bode well for Vermilion. I will review the fundamental drivers for this later in my presentation.
Production during Q2 averaged 84,868 boe a day, which is down slightly from the previous quarter, mainly due to planned and unplanned downtime. Key notable event during the quarter was the closing of the Leucrotta acquisition on May 31st. We have successfully integrated the Leucrotta assets and assembled the Mica asset team, which is now focused on completing the six-well pad that was drilled in Q2. We're excited to have these high-quality assets in our portfolio and look forward to scaling up our developments. The Leucrotta acquisition was mostly funded by free cash flow generated in the quarter. As a result, net debt increased only slightly in Q2 to CAD 1.6 billion. However, our net debt to fund flow ratio decreased to 1.1 times as a result of our increasing fund flows from operations.
We remain on track to achieve our next debt target of CAD 1.2 billion by the end of 2022. With this clear line of sight, we are pleased to outline our return of capital framework. Before I get into the details of our return of capital framework, slide three reviews some of the key strategic objectives we accomplished over the last two years that will position Vermilion to deliver very strong returns over the long term. These objectives were part of the strategic plan we developed during the 2020 downturn. Our number one financial priority was to reduce debt and strengthen the balance sheet. We have reduced debt by approximately CAD 1 billion relative to Q2 2020 by the end of this year, while also funding over CAD 1 billion of strategic acquisitions without issuing any equity.
We increased our international weighting and European gas exposure through the Corrib acquisition, which we expect to close in Q4 this year. Our international assets now represent over a third of our production base and contribute approximately two-thirds of our fund flow and free cash flow. This international diversification is what differentiates Vermilion from our peers. We reinstated a base dividend in Q1 of this year, and today we're excited to announce a 33% increase in our Q3 quarterly dividend to CAD 0.08 Per share. The dividend is very resilient at less than 3% of our fund flows and leaves ample room for ratable increases over time. We completed the Leucrotta acquisition in Q2. This Mica asset significantly increases the depth and quality of our North American inventory, which will further enhance our free cash flow profile and underpin our long-term return of capital.
Finally, we said that we would increase our return of capital when we achieved a line of sight to our CAD 1.2 billion mid-cycle debt target. With less than two quarters remaining in 2022 and a robust outlook for 2023, let me now review the return of capital framework on slide four. Vermilion has a long history of returning capital to its shareholders. In the past, this has been primarily through base dividends, which we've delivered over CAD 40 a share. Going forward, base dividends will remain a key component of our return of capital framework. However, we want to ensure the base dividend is resilient over the long term through the commodity cycles while allowing for ratable increases over time without placing a burden on our business or the balance sheet.
With this philosophy in mind, we plan to limit the annual base dividend outlay to approximately 10% of our mid-cycle fund flows. For reference, this would equate to approximately CAD 100 million based on the current asset base, but could increase if our asset base grows or if we see a fundamental shift in our mid-cycle commodity price assumptions. In conjunction with our Q2 release, we announced a 33% increase to our Q3 quarterly dividend to CAD 0.08 per share. This equates to an annual dividend of CAD 0.32 per share or approximately CAD 53 million based on the current number of shares outstanding. At this dividend per share level, we have the capacity to increase the base dividend, and we look forward to providing ratable increases over time.
With our debt approaching target levels, we will pivot from allocating free cash flow for debt reduction to the return of capital. Maintaining a strong balance sheet is a core principle of Vermilion, and we'll remain focused on that going forward. We plan to enhance our return of capital to shareholders going forward while continuing to reduce debt to a target of CAD 850 million by the end of 2023, which implies approximately another CAD 350 million of further debt reduction beyond our year-end 2022 target. It also implies that we will be undrawn on our CAD 1.6 billion credit facility, leaving just our term U.S. notes outstanding. The amount of free cash flow available for return of capital will increase as debt levels decrease based on the illustrative grid outlined on slide four.
The grid is not intended to be prescriptive quarter to quarter, but will be used as a tool to guide near-term return of capital allocation decisions while taking into account other capital requirements such as further debt reduction, asset retirement obligations, and acquisitions. As you can see from this grid and near-term debt targets I discussed, a significant portion of our future free cash flow will be available to the return to shareholders. Based on a return of capital allocation grid, recent commodity strip, and internal estimates, we anticipate returning up to 25% of free cash flow in the second half of 2022 and up to 50%-75% of free cash flow in 2023 while achieving our debt targets. Our goal is to return capital in the most beneficial method to shareholders.
We will consider various options to return capital, including share buybacks through the Normal Course Issuer Bid, regular and special dividends, and a potential Substantial Issuer Bid. Based on our review of a number of data points, we will initially allocate the vast majority of this capital return to share buybacks. Given the structural improvements in our business, combined with the strong fundamental outlook for commodities, global commodities, we believe Vermilion is very well positioned to generate significant free cash flow in the years ahead. However, we do not believe this value proposition is accurately reflected in our share price today, and therefore, at this time, we view share buybacks as the most compelling use of free cash flow that will benefit long-term shareholders.
In early July, we announced the approval of our Normal Course Issuer Bid for the purchase of up to 16 million common shares, representing approximately 10% of Vermilion's public float. To date, we have repurchased 1.25 million common shares for CAD 35 million. As we reduce our share count, this will also enhance our ability to increase the base dividend while adhering to our annual CAD limit of 10% mid-cycle fund flows. We look forward to providing continued updates on our return of capital initiatives through the second half of this year and throughout 2023 as we carefully weigh capital allocation decisions against various uses of excess free cash flow with a view of acting in the long-term interests of our shareholders.
Slide five is from our investor relations presentation, where we provide an updated financial outlook for 2022 based on the actuals to date and our estimates for the balance of the year using the current commodity strip. As you can see, on a pro forma basis, including the full year impact from the Corrib acquisition, we are forecasting pro forma fund flows of CAD 2.4 billion and free cash flow of CAD 1.8 billion, or approximately CAD 11 per share. We also show our year-end debt target of CAD 1.2 billion, which incorporates the return of upwards of 25% of free cash flow in the second half of this year.
We have not yet provided any formal guidance for 2023, but if you assume production is held flat at our exit rate forecast of 95,000-100,000 BOE a day, and you honor the backwardation in the commodity price forward strips, we are looking at generating similar amounts of free cash flow in 2023, which is consistent with the analyst estimates. As outlined on slide six, looking at our cumulative free cash flow over a three-year period from 2022 through to 2024, assuming flat production from our existing asset base and applying the forward pricing, we expect Vermilion to generate over CAD 5 billion of free cash flow over this time, represented by the blue bars. This amount of free cash flow is equal to our current market capitalization.
The gray bars show the cumulative free cash flow we currently plan to allocate to debt reduction. As you can see, the majority of the free cash flow was allocated to debt reduction in 2022, including the funding of over CAD 1 billion of acquisitions, whereas for 2023 and 2024, we will pivot, and majority of the free cash flow will be available for return of capital to shareholders now that we have a much stronger balance sheet. As I mentioned in my earlier remarks, the fundamentals for European gas are very strong. Slide 7 shows the historical pricing of European gas and Asian LNG, which have traded in a similar band since 2015, compared to the Canadian benchmark price of AECO. The blue bars represent the average premium that Vermilion receives on its total gas sales relative to AECO.
This premium was approximately CAD 6 per Mcf in 2021 and is forecast to be approximately CAD 19 in 2022. We also show the forward pricing for the balance of 2022 and 2023, which has increased significantly from historical levels. Second half 2022 TTF is CAD 75 per MMBtu, and 2023 is now over CAD 70 per MMBtu. For every dollar increase in euro gas prices, this adds in an incremental CAD 37 million of fund flows to Vermilion on an annual unhedged basis. Our hearts, thoughts, and prayers are with the Ukrainian people, and our hope is that a negotiated settlement can be achieved quickly. The tragic events in Ukraine are undoubtedly contributing to the price increase. However, the underlying fundamental drivers for high European gas prices were in place prior to the invasion.
The chart on slide eight shows the 2023 and 2024 forward price for TTF and how much it has increased since the beginning of the year. Calendar year 2023 TTF price has increased from under CAD 20 at the beginning of the year to over CAD 60 today. This will have a significant impact on Vermilion's fund flows in 2023, and we have been adding more European hedges in 2023 in recent weeks. We believe the structural drivers will be supportive for European gas prices for many years to come. Europe consumes approximately 45-50 Bcf a day of natural gas, with approximately 40% of that being supplied from Russia in 2021. In recent events, the E.U. Is now trying to significantly reduce its dependence on Russian gas.
E.U. Recognized natural gas as a transition fuel, which we believe will help facilitate the permitting and development of domestic supplies over time as countries increase use of natural gas for power generation. Examples of this transition include Germany shutting down nuclear and accelerating the phase out of coal from 2038 - 2030, and Ireland committing to build nine gas-fired power generators by 2024. With domestic supply in Europe continuing to decline, the only viable option to replace Russian gas is to increase LNG imports. There is limited new LNG supply coming on the market prior to 2025 and 2026. These new projects require significant and longer-term contracts, significant capital. In order to attract LNG to Europe, buyers need to compete with Asia, which is driving European gas prices even higher.
Short term, we expect Asian LNG demand to increase as they look to build inventories prior to this winter. More importantly, mid to longer term, Asian demand for LNG is forecast to significantly increase. As mentioned, we are starting to layer in more 2023 European gas hedges to lock in some of our fund flows at these higher prices. As shown on slide nine, since our last update, we have increased our 2023 Euro gas hedge position from 32% - 45%. Those recent hedges were executed primarily with wide collars, with an average floor of about CAD 40 and ceiling of about CAD 70. Due to the higher gas prices, we may further increase our 2023 Euro gas hedge position to 60% to lock in even more fund flows.
At the corporate level, given our low debt levels and current outlook, we intend on keeping our total hedge percentage at the lower end of our target range of 25%-50%, which will leave us with exposure to sustained higher oil prices. Going back to our Q2 results, we have provided a brief summary of our operational highlights on slide 10 and 11. The most notable activity in our international operations in Q2 was at our offshore drilling program in Australia. This program was scheduled to start early in the second quarter, but was delayed approximately one month due to unexpected maintenance and repairs on a third-party contracted rig. During a routine inspection prior to moving the rig to our location, the operator identified some maintenance requirements and had to mobilize the rig to Singapore for repairs.
We commenced drilling late in the second quarter, and drilling operations are progressing. However, the delay did result in some deferred production and higher costs. We expect to finish drilling in early September and we'll start the wells shortly thereafter. It was a relatively quiet quarter in Europe as the teams focused their efforts on preparing for our second half of 2022 drilling campaign, which will include two wells in the Netherlands, three wells in Hungary, and two wells in Croatia. Subsequent to the quarter, a forest fire near our Cazaux field in southern France resulted in approximately 1,500 bbls of production being temporarily shut in. Our staff in France worked closely with emergency responders to ensure the safety and security of our employees, our contractors, and installations, ensuring there were no HSE incidents.
We are in the process of making the necessary repairs and bringing this production back online. However, this will have an impact on our France production in the second half of 2022. It was a relatively quiet quarter in Canada as drilling and completion activities in West Central Alberta, Southeast Saskatchewan was limited during the second quarter due to spring breakup. Following the announcement of the Leucrotta acquisition in late March, we assembled our Mica asset team and focused on integrating the assets and working closely with the Leucrotta team in drilling the first 6-well Montney pad. Drilling was successfully completed during the second quarter, and the team is now focused on completion activities that is progressing as per plan. In the U.S., we drilled four wells of our planned six operated Turner wells and completed two wells during the second quarter.
One well was brought on production during the second quarter, while the remaining wells will be completed and brought on production during the third quarter. Overall results to date are in line with expectations. Subsequent to the quarter, we successfully executed drilling and completion activities on three 2 mi laterals, which are significantly more economic than the one-mile laterals. Moving to slide 12, our Q3 2022 capital program is well underway. In Europe, we will start our drilling campaign later this month and continue through the fourth quarter. As mentioned, the forest fire near our Cazaux field in southern France resulted in approximately 1,500 bbls a day of production being temporarily shut in, and we expect to have most of it back online by the end of the year.
Looking at our Q3 production forecast, we will benefit from a full quarter contribution from the Leucrotta acquisition and new production from the U.S. and Southeast Saskatchewan drilling programs, partially offset by the Australia drilling program delay and fire-related downtime in France. Taking all this into account, we expect Q3 production to be in line with Q2. As a result of the forest fire-related downtime in France, offshore drilling delays in Australia, combined with inflationary pressure, we are increasing our 2022 capital budget by CAD 50 million to CAD 550 million. We are maintaining our annual production guidance of 86,000-88,000, excluding the Corrib acquisition volumes. We plan to update our production guidance once we have greater certainty on the timing of the Corrib close, which we expect to occur in Q4.
Our exit rate forecast of 95,000-100,000 BOEs a day, including Corrib acquisition volumes, remains unchanged. Before we open it up for Q&A, I want to make some closing remarks on our upcoming leadership changes. As we announced earlier this year, Vermilion's Executive Chairman and Co-founder, Lorenzo Donadeo, will be retiring from the company effective September 1st. Lorenzo was instrumental in creating what Vermilion is today, along with creating significant value for our shareholders during his tenure. On behalf of the whole organization, I would like to thank Lorenzo for his leadership and guidance of the company over the 27 years. You will be greatly missed by everyone at Vermilion, but if anyone deserves a long, happy and fulfilling retirement, it is Lorenzo. We wish you all the best.
We look forward to providing you with regular quarterly updates as a meaningful shareholder of Vermilion for many years to come. As previously announced, Mr. Bob Michaleski will assume the role of independent chairman on Lorenzo's departure. Bob has 41 years of experience and oversaw Pembina's pipeline transformation from an Alberta-based oil company to one of North America's leading integrated energy transition service companies. He served as the President and CEO of Pembina for 13 years. He joined Vermilion board in 2016 and was appointed as audit chair of the audit committee in 2020. Vermilion's executive committee structure will continue and will fill the role of the Chief Executive Officer. It will be led by myself and will include all the existing members. Well, that concludes my prepared remarks. With that said, we'd like to open it up for questions.
Thank you. If you would like to ask a question, please signal by pressing star one on your telephone keypad. If you are using a speaker phone, please make sure your mute function is turned off to allow your signal to reach our equipment. Again, press star one to ask a question, and we'll pause for just a moment to allow everyone an opportunity to signal for questions. We'll take our first question from Menno Hulshof with TD Securities. Please go ahead.
Yeah. Thanks, and good morning, everyone. I'll start with a question on Corrib. If we assume that it does close, what is your best guess in terms of the purchase price net of accrued free cash flow? We've run some numbers on this, and our estimate is very low, but any thoughts here would be helpful.
Thanks, Menno. Thanks, Menno. I'm gonna pass it over to Lars to address that one.
Yeah. Good morning, Menno. You know, I think you're thinking about it the right way in terms of cash to close at December 31st of this year from a modeling perspective, and then obviously full access to the cash flows in 2023. I think the number that is good to use for year-end this year would be a purchase price of CAD 100 million-CAD 150 million if it were to close at the end of 2022, and that would be inclusive of the contingent payment that is in the money for 2023, which was $25 million. I think that's the best way to model it and a good way in terms of how you're thinking about it.
Terrific. Yeah, thanks, Lars. On acquisitions, in the past, you've talked about smaller Eurogas packages potentially becoming available. I know there are limits to what you can say here, but like, at a high level, what are the boxes that need to be checked to pull the trigger on another Euro package? Do you see these opportunities being able to compete with buybacks at the current share price?
Thanks, Menno. I'll pass it back to Lars to address how we're thinking with that relative to our return of capital framework.
Yeah. Thanks, Dion. Maybe I'll just rewind a little bit, Menno. With the return of capital grid, what we really wanted to do was shift focus back to the CAD 11 per share of free cash flow that we're generating. Dion mentioned 1.8 billion of free cash flow in 2022. That's on a pro forma basis. That's probably not a bad proxy to think about free cash flow for 2023. What the return of capital grid is going to do is create discipline in terms of where we are allocating capital. There's flexibility in there in terms of how we return capital. At this point in time, we'll be doing it through share buybacks. You know, as importantly, in terms of acquisitions, when it comes to North America, nothing big.
We think that we have done the heavy lifting in terms of high-grading the inventory here in North America. It'll be more tuck-in bolt-ons in terms of our existing position within North America. Europe, you know, I think we've had good success, a good track record there of making acquisitions. Now that those acquisitions will continue to compete with returning capital to shareholders, we will be looking for, you know, I'd call it deep value type opportunities in Europe as we move forward here. Some announcements have been made in the past in terms of potential opportunities in jurisdictions like Netherlands. Again, it's gonna have to be competitive in terms of where we return capital.
Thank you.
I'll take our next question from Greg Pardy with RBC Capital Markets. Please go ahead.
Yeah, thanks. Good morning. Thanks for the rundown, Dion and Lorenzo. Just all the very best in your, I guess, it's your second shot at your retirement. Maybe just one nitty modeling question is, you know, what kind of book tax rate should we sort of think about, you know, on a consolidated basis? Lars, I wanna ask that, just that tax question. Is it still, I don't know, 11%-12% or so pre-tax?
Yeah. I think for 2022, and I'll sort of correlate these tax rates to the pro forma numbers. We're referencing CAD 2.4 billion of cash flow for 2022. In the context of that, 10%-11% is still a good way to think about it, Greg. For 2023, I would say that rate has gone up in the context of current strip pricing. I would sort of peg it at 13%-15% for full year 2023.
Okay. What about book, sort of like 30% odd or so just as a book tax rate?
Sorry, could you repeat that, Greg?
Yeah, just your book tax rate. I know you're giving me the cash taxes, but just as a book tax rate.
I think a good way to think about it is in the 30% range.
Okay. Okay, great. Maybe just sort of related to Menno's question, with Europe now kind of thinking very differently about gas as a transition fuel, as you mentioned, are policymakers or governments now starting to come to you as one of the long-standing, you know, developers in Europe in terms of just encouraging, you know, domestic supply growth as opposed to just relying upon imports?
Yeah. Thanks, Greg. I'll take this one. You know what? I think what's happening when you look over the last several quarters with the crisis, and I believe it is an energy crisis in Europe, the policymakers have triaged their approach with starting with LNG, which is material, albeit of longer timelines. Next there's been discussions around offshore, and that leads us to your question around onshore. Yes, we are having continued engagement in both Netherlands and Germany in particular, questions that would be framed around, you know, what could Vermilion as an operator in some of those jurisdictions for decades be able to offer with increased activity.
What we've done, we always focus on what we can control, so we've added staff in both Netherlands and Germany, technical staff, to be able to prepare for higher levels of activity. I would caution that timelines are longer in Europe, and so the time from a conversation to action and drills is longer. I would say it's encouraging and somewhat logical that you would see some increased activity associated with the you know, current situation and need for more domestic supply from responsible producers like Vermilion.
Terrific. Thanks very much.
Thanks, Greg.
We'll take our next question from Patrick O'Rourke with ATB Capital. Please go ahead.
Hey, guys. Good morning, and congratulations to Lorenzo. Obviously a long and well storied career here at Vermilion, so appreciative of all your work. Guys, maybe just to build on Greg's question there, you talked about sort of the regulatory regime and timelines in Europe. As we get into the 2023 budgeting cycle, and as you look at the portfolio, sort of what are the other hurdles to bringing on production in Europe? Where could you allocate capital to sort of capture this windfall gas price that we're seeing over there in sort of the quickest manner? Is it in the Netherlands? Is it in the CEE? What are sort of the infrastructure constraints? I don't think that you would have any in the Netherlands there.
Well, thanks, Patrick. You know, I think first of all, the acquisition with Corrib, you know, to bring on that 7,700 boe a day is probably the most impactful thing, that you know, in hindsight, was very well timed, and we're excited to close that at the end of this year. So again, that's 7,700 boe there. From an organic point of view, I you know, we're focused on every boe to look for opportunities. I think in Germany, we do have a deep inventory of drilling prospects that, again, we've added resources back to look at some of the more, I would say, larger targets, but a little more higher risk. So that's something we're reviewing.
CEE is an area once you know we get these permits in place like SA-10 we're able to follow through and drill wells in shorter timelines. Netherlands you know we used to drill four to six wells in Netherlands. We're drilling two in the second half of this year. You know our view would be less work back to those higher levels of activity. I would say all jurisdictions Netherlands does have the potential to increase activity as well as Germany. We drilled three wells earlier this year and we're looking at on the gas side what we might be able to do in late 2023 and into 2024. Quite excited to be having those conversations.
Again, our near-term focus is getting more staff in those BUs to be able to react once it aligns with the regulatory framework, to be able to put more capital into those business units.
Okay. Maybe shifting over to the return of capital framework here, and in particular, the dividend. You guys refer to ratable dividend increases. You know, the pro forma math that we have on today's dividend increase would, you know, sort of be sub 4% of 2023 free cash flow. I wonder in terms of. Maybe you can provide some goalposts around what you mean with respect to ratable and also sort of the cadence or review period, like how frequently you plan to review the dividend going forward here.
I'll pass that one to Lars to talk about our thoughts on the base dividend.
Yeah. Thanks, Patrick. The way we have framed the base dividend component is not to exceed 10% of our cash flows at mid-cycle pricing. I think that's some discipline that we want to continue to have in the business to ensure that that base dividend is resilient. Based on our current numbers with the increase today, we're about CAD 50 million to fund the increased dividend that we did announce today. That is where, you know, there is ample room to continue increasing that and still be in line with our not to exceed 10%. In terms of the cadence or how we will do that, I would say at this point, you know, we're looking for ratable type increases over time.
We think that also with the return of capital framework that we announced today, there is flexibility in terms of how we return that capital. The base dividend will be one mechanism that we use or one medium that we use. It will not be the majority of capital that will be returned through that. That's where we have flexibility in terms of share buybacks, variable dividends, special dividends. We will err towards buybacks at this point in time, just based on the data points that we're reviewing, where we think capital is best allocated.
Hopefully, that provides a little bit of clarity in terms of the fixed base dividend will be one component of a return to capital, but we truly wanna make sure that base dividend is fixed and resilient in prices that are much lower than what we're seeing today.
Thanks, Lars.
Okay. Thank you.
Thanks, Patrick.
As a reminder, it's star one to ask a question. We'll take our next question from Josef Schachter with Schachter Energy Research. Please go ahead.
Good morning, everyone, and thanks very much for taking my question. In Europe, we're seeing a lot of demand management, you know, U.K. talking about preparing for blackouts, Germany telling certain industries you may get cut back certain percentages of gas, assuming the Russians are aggressive in terms of cutting back. Is there anything going on on the supply management side where they're asking you to hold back and put into storage, near consuming areas gas to bring on later? Or if you have new wells coming on, bring them on close to the winter. Is there any supply management stuff going on that would impact Vermilion in Q3, Q4, and into Q1 of next year?
Hi, Josef. Yeah, I'll take that one. The quick answer is no. We're selling all the gas that we're producing, and there's no discussions around us storing or restricting our production.
Okay. Good. Thanks. That should do it. Thanks very much.
Thanks, Josef.