Peyto's JP Lachance On M&A Integration, Performance and What's Next

Speaker 1:
Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.
Aaron Bilkoski:
Hey everyone. I'm Aaron Bilkoski. I'm a Calgary based research analyst at TD Cowen specializing in the Canadian oil and gas sector. We're here live at the TD Energy Conference in New York. With me today is JP Lachance from Peyto Exploration Development. It's an Alberta based Deep Basin natural gas producer. JP has been with Peyto for well over a decade. He's held multiple roles at that company. He's been VP Exploration. He moved on to be Chief Operating Officer before becoming president and CEO at the beginning of 2023. Thanks for coming.
Jean-Paul Lachance:
Thanks for having me.
Aaron Bilkoski:
You're following in the footsteps of some of the bigger personalities the basin has seen in a long time. You're new to the business. How would you describe yourself?
Jean-Paul Lachance:
This is a trick question right off the bat. You know what? I think I'd like to think of myself as being someone who means what they say and does what they say. So for me, it's about letting the numbers do the talking as opposed to me doing a lot of talking about what we think we can do, but let's just show you what we can do. So for me, it's always been around let's let the numbers do the talking. And at the end of the day, that's what matters, right? So yeah, for me, I took this role on back in the beginning of 2023. Had some big shoes to fill for sure, but we were successful later that year in acquiring a nice asset, and I think since then things have been going really, really well.
Aaron Bilkoski:
Perfect. So you alluded to it quickly after you became president. You made a relatively large acquisition of what was left of Repsol's interest in Canada. What was that like being somewhat new to this president CEO suite, advocating for something that really was transformative to the business and really, you were testing the public equity markets at the time too? How was that perceived internally? How'd you fight for it?
Jean-Paul Lachance:
First of all, it's perceived very well internally. I remember one of the guys said to me who wasn't part of the process, woke up the next day when we made the announcement and said it was like Christmas morning. We had all these new presents under the tree to go play with. And we've been coveting those assets for quite some time, but it really was no different than what we've always been sort of aspiring to do with other tuck-in type acquisitions. I call this one a tuck-in. It's a bit bigger. We spent $700 million at the end of the day to acquire these assets, but they were vastly under drilled and we saw all kinds of opportunities. I said earlier today, we think we know the assets better than they do because naturally they're right amongst our existing production and our existing infrastructure. So it was something that was really just a natural extension of what we've been doing all the way along.
So our ability to get that across the line and the team to get that across the line was challenging. What could have been challenging was the market. We hadn't tested the market. We came right out to buy that right after Labor Day. I think it was the second day after Labor Day. So was it Tuesday of the first week of September? And we weren't sure how the market would respond to an equity offering, and it turns out it was wildly oversold and just like we saw it, the investment community saw it the same way, all kinds of opportunity and best [inaudible 00:03:42] pay those hands to go develop it and extract value from it and we haven't looked back. It's been great.
Aaron Bilkoski:
I agree. It was a natural fit. Yeah, very clearly articulated the benefits to the business and now you've had it for, well, almost a year. You've drilled some wells, you've allocated a bunch of your capital program to it. How is it performing relative to what you expected at the time you entered the transaction?
Jean-Paul Lachance:
I would say it's probably performing a little bit better than we expected. We did expect a lot from it, to be fair, right? Like I said earlier, this was vastly untapped. I mean, they had drilled some wells, but since the advent of horizontal drilling, they hadn't done much on their lands and they were right around us and we were around them. So we had stopped drilling right up to the borders as it were. And then we're looking across, we're looking through the door and saying, oh boy, we should like to get our hands on that. And finally we did. So we did expect a lot from those assets, but I would say it has actually outperformed even our expectations at the time. So we're getting about 40% improvement on the average well result that we're drilling. Like a sustained improvement, not just a one-time, short-term improvement, but this is a sustained improvement on the wells that we're drilling as compared to our prior year programs, so I would call the legacy programs on Peyto's. Peyto only lands in the past.
So that's exactly what we expected. We knew their cost structure was going to be higher and it was. And so I think we started out prior to the deal about 45 cents on our operating costs. We jumped to 55 cents right after close because that's directly attributable to the increase in the costs to run those assets and now we're working that down. Our goal is to get down to 45 cents. We should be down to 50 cents as a whole by the end of this year and then further work to get back down to where we were. So on the operations side, so there's obviously the upside, we'd like that. We also, when we do acquisitions, look for synergies where we can own and control. So whether that comes with its own infrastructure or it can easily be put into our infrastructure, right? And it had all that. It had all that. And so that was the real appeal to it all and so far we've been attacking both sides. Great well results, and we're also reducing the operating costs and optimizing production in the field.
Aaron Bilkoski:
On the cost side, what's driving that operating cost savings? Is it just growing the volumes and spreading those volumes across your fixed costs or are you doing things at the field level that are saving cash?
Jean-Paul Lachance:
So both. One of them is optimizing gas plants, moving production around. In one case in Edson gas plant, we actually shut down some high operating cost units. This was the Sulfur recovery unit. And so basically we said, okay, no more sour gas coming into this facility. We had a small amount of our own net production there, about 1500 barrels. We said, okay, this is non-economic right now. It actually is non-economic under most price conditions, so why are we running it? Let's shut that gas in. And we actually had some third party revenue coming in as well, some third party gas to help run that facility. It made it unreliable because if they shut in, we couldn't run.
So we stepped back from this. And this business is about making money, right? So although we shut some production in, it wasn't making us any money and we're better for it. So that helps to save operating costs because now we've pulled that. We made a step change or a structural change to the way that facility operates. That's just one example. But also there's other things we've done out there where we've mostly moved production around, but utilization, increasing utilization, to your point, increasing diluting that fixed cost over a greater volume or amortizing over a larger volume, that's clearly a very important point. And we see that as one of the main drivers of continuing to reduce operating costs in the future would be our ability to increase utilization. Right?
Aaron Bilkoski:
Right. The one benefit of the deal that I didn't fully appreciate at the time of the acquisition was how it'll improve the well results in the legacy land position. Can you talk a little bit about why you're seeing an uplift on the wells that are being drilled on your legacy lands rather than the Repsol lands?
Jean-Paul Lachance:
Yeah, good question. So we had four rigs running prior to the deal, and rather than add rigs and then continue to drill all four rigs on our legacy lands as well as say two new rigs on Repsol, we actually just redirected two rigs over to the Repsol lands. So we're about 50/50 right now on our drilling program on what was old Peyto legacy versus the new Repsol lands. And what that's done is taken a little pressure off. It's taken a little pressure off the four rigs running on Peyto lands. We can be a little more selective, so we can high grade. We don't have to have that third and fourth rig running there, maybe drilling, maybe getting a little too in front of itself a little bit and we're taking more risks than we normally would. This way we can be more calculated on finding new plays and drilling things that maybe don't have as great...
Maybe they're testing some deeper horizons. We recently discovered a flare channel play right in the heart of, I call it downtown Peyto, right in the heart of Sundance, something that's been there for years. We've been out there for 26 years drilling wells and we're still finding stuff. That's the kind of stuff that takes a bit of that pressure because you move two rigs away on the Repsol lands, it takes a little pressure off the existing system to help us to improve those results as well. Not to mention that we're drilling longer wells, we're increasing intensity. So that's helping too. But I would say the bigger part is just the redirection of some of the program away from those lands to help us high grade.
Aaron Bilkoski:
I think generally speaking, investor interest tends to focus around the Montney. You're in the Deep Basin, it's outside of that window. I think it's unjustly overlooked in a lot of cases because the Deep Basin has a lot of benefits that in a lot of cases the Montney doesn't necessarily have. How do you think about your Deep Basin asset relative to the Montney in general?
Jean-Paul Lachance:
Well, hear, hear, I agree with you. I think the Deep Basin has been an asset that's not overlooked in a sense, but it also is one that may be a little bit underappreciated because of all the excitement around the Montney and now the Duvernay, all these big resource plays. Meanwhile there's all kinds of opportunity remaining in the Deep Basin. It is generally a cheaper place to drill. I mean, not everywhere. I mean, there's some Montney plays that are also cheap to drill too. But generally speaking, we use I would say a specialized rig, but we use a rig that is not as much in demand. This is a tele double rig versus a triple rig you would see in the Montney plays. Not only does it mean we can move quicker because the rig can come down and move within a day and we spot another well on another location and helps our efficiencies that way, but it also means that that rig isn't in demand the same way the triples are.
So that helps. It's stay rate is a lot cheaper, for example, right? So there's that. There's also the fact that the reservoir quality in the Deep Basin is better. And if you're like, what do you mean by that? Well, I would say the permeability is better. So their words, it may be thinner, but we don't have to put as much water or stimulate as much as, say, the Montney players. We'll use a third of the water that they would use in the Montney or a 10th of the water they would use in the typical Duvernay well, and that's money. It costs money to pump water, to move water around because you can't sell that. So it would cost money to bring it in, to pump it, to take it out, to process it later and all those things. So that's a big element is that stimulation cost.
And where it sits in the system, it's farther down in Alberta, it's closer to the borders, closer to where the egress of the pipe goes, where the gas goes east or south. It means that the hydraulics are better down there too. And it allows us to be able to still get capacity on the system without having to have it be built for us up in the north. And our facilities down there in that area has a lot of operators that moved away. Repsol wasn't drilling, so they were down to 35% utilization on their facilities.
So there's lots of room for gas processing as well. So you've got gas processing, egress, relatively easy, cheaper because we're downstream, so you pay a postage rate on NGTL to use the system. We're much cheaper because farther down but you don't use much of their system to get it to market. So all those things add up to a much, I would say a very attractive... And that's why we're the lowest cost producer, but also one of the lowest cost finders and developers of gas. It's the Deep Basin. I call it the Deep Basin advantage. That's really what I would refer to it more as.
Aaron Bilkoski:
I find that you're perceived to be the standalone Deep Basin producer, but within the EMP world, there's a lot of EMPs that are actually allocating capital to the Deep Basin, whether it's through MNA like we've seen with Tourmaline or Whitecaps allocating capital to the region, I think in a lot of cases for the benefits that you just outlined.
Jean-Paul Lachance:
Yeah, so that's telling you something, right? I mean, that's a signal that says, okay, maybe the Deep Basin is more attractive than we think.
Aaron Bilkoski:
I guess on that front, I touched on consolidation a little bit, but you bought the Repsol assets, Tourmaline bought Bonavista. What, if anything, is there left to be consolidated in the Deep Basin and what's your interest as presidency of Peyto in being a leader in that?
Jean-Paul Lachance:
The Repsol asset came with 800 locations. And when I say 800 locations, I mean mapped locations. These aren't just sticks on a map, there's a section, I'll put four wells on there. No, these are geologically mapped locations. So we have very high confidence in these. So it's not like we need to grow to say 150 to 160 and keep on going from there. We have lots of locations to do that, lots of drilling opportunities. But just the same. You're always looking for, and we were always looking for the opportunities like Repsol was to expand, and those are still out there. Sometimes they're smaller, they're smaller companies. There's some of those that sometimes they're larger. But if they're not spending their efforts there, some of these larger companies, and they're doing things elsewhere, there's an opportunity there at some point in time to maybe get some of those lands [inaudible 00:13:44] and do some kind of acquisition, whatever the case may be.
That's what we're good at. That's what we've been doing for the last 26 years. We've built the whole position we have more or less on swaps and land sales or buying land of crown sales and all those kinds of things and slowly building that position. Repsol was a big lump sum, yeah, but for the most part that's the way we've done it. And so those opportunities still exist. As we expanded our land base, there's even more now that we now touch and now we have facilities that are nearby so it lets us continue with our own and control strategy rate, which is when we drill it, we want to be able to bring it to our facilities so we keep our costs down so we can control production.
Aaron Bilkoski:
So when it comes to looking at acquisition opportunities, how important is maintaining Peyto's culture to you?
Jean-Paul Lachance:
It's massive. That was one of the questions I was asked when I took the job was what do you see as Peyto's important attributes? And I think only in controlling our infrastructure and our culture, that culture where it permeates through the whole organization about keeping costs down, only doing what you need to do. It's not about what you do, it's about what you don't do sometimes that really helps to save money or whether it be everything from having meetings to what you're spending on well completion, you need to think of it that way everywhere throughout the whole organization. So the culture really is important. We're relatively flat. There's not a lot of people between me and every employee that's at the company. And so they're empowered. Folks are empowered, but they're also accountable. You can't have one without the other in my opinion. You've got to be accountable if you're going to be empowered. And so running the organization that way I think is really important for the culture.
So we may have a little different reward systems than some of the others, but it's because we're looking for a certain type of person. We're looking for that entrepreneurial person who will think more about their conversation in the sense of not just their daily, not just their salary, but what can I make here if I can make a difference for the shareholder? The culture is absolutely critical to maintain. So just acquiring someone in a large organization and trying to make that work. We hired 20 people from Repsol in the office. Most are still here, but we were very careful of who we hired to make sure they fit with the right culture of the paid OA as it were. So that's really critical. And in the field, we hired a lot of folks in the field as well because we needed to continue to run there and it came with four operating gas plants. But even those folks, they're getting on board with sort of the paid OA. So yeah, just acquiring somebody and then having that cultural mix is very important. So we'd have to be very careful with that.
Aaron Bilkoski:
I'm going to pivot a little bit. How do you think about hedging within the portfolio? It's obviously been a huge tailwind for you as gas prices have weakened. It's allowed you to basically maintain your business completely unscathed while some of the others had to make tougher challenging decisions. How do you think about hedging going forward?
Jean-Paul Lachance:
We think of hedging as a risk management tool really. Gas is a very volatile business. We've chosen gas because it's simple, there's very little waste and we're good at it in our area of the Deep Basin. But gas is a very volatile business. And so in order to get the kind of costs we get and cost efficiencies we get, we think it's really important to run a steady business. So hedging helps us to achieve that. Hedging gives us some security around our future revenues. So it allows us the ability to plan a capital program within a range. I mean, it doesn't mean we won't react to prices, but it gives us that certainty. And then it also gives us certainty around paying dividend. That is our chosen shareholder return and we can debate that whether that or a buyback program is better.
But we think putting cash in shareholders' hands, letting them decide what to do with it month over month, whether they buy more Peyto shares or whether they diversify, that's up to them. Let's let you make that decision, not me. So that hedging program allows us to have comfort with that hedge level... Sorry, with paying a dividend managing capital program. And then we can operate in those bounds. And so we are very mechanical in our hedging program, very systematic. We don't speculate on prices. Our attention is to smooth out volatility over the long term. So we're hedging up to three years out, six seasons, like gas winter seasons, gas summer seasons. And so that's how we do it.
Aaron Bilkoski:
Now, how would you think about hedging if your forward curve became backwardated and the decision was to hedge say 2027 prices at a lower price than today. Or not today, but a lower price than what you would need to keep the business [inaudible 00:18:37].
Jean-Paul Lachance:
Yeah, lower prices than today and that's kind of scary actually. Actually it's not so bad. Spot prices here, the prompt is up, at least at the hub is up closer to $3. That hunts for us. So that's pretty good. We did it. We did it in '22 when prices were really high, prices were backwardated. Now they were backwardated to three and $4, which again hunts for us in other words, with our low cost structure. We can operate in that environment quite comfortably. In fact, almost prefer it rather than really, really high prices where everybody starts contracting services and all your service costs go up. So there's a sweet spot in there. But to the extent that if we look forward in the curve and prices were somewhere say $2 or even lower, we would probably slow down the pace of which we hedge. We have a range. We have guardrails around our hedging program.
So we have a range between... When we arrive at a current season, we want to be somewhere between 50 to say 75% hedged. And so as we're looking forward and prices are below our threshold where we can really make money, then we would slow down. Right now that's not the case. The prices are in contango, so we're hedging 27, but if that were to reverse on us... But that's a bigger signal. If you think about that, if the market goes there and we're well protected leading up to that point, but if the market really goes and falls and the forward curve actually falls below where it is today, like well below $3, then I think there's going to be a response from other producers before there's going to be a response from us, right? Because they can't afford to drill into that market. And us being the lowest cost producer, we have that advantage of avoiding them out as it were. So there will be a supply response which will drive prices back up again. There has to be, right? So that doesn't keep me up at night. I don't worry about that.
Aaron Bilkoski:
What do you think your marginal cost to supply is to add incremental gas volumes?
Jean-Paul Lachance:
So a lot of our costs are fixed. If you think about our costs, if we're a buck 50, say all in cash costs, I would say 80% of that is fixed. Your interest, maybe not your royalties of course, but somewhere in your operating costs, I'd say about 50% of those were fixed. So off the top of my head, I don't know, $1.20, something like that maybe, maybe a dollar, maybe a little lower. After that, it doesn't make a lot of sense to be producing over the long term. That's just the operating costs. Now I'm talking about cash costs, I'm talking about operating the business, finding development we can find [inaudible 00:21:09] buck. So all in you're looking at two bucks, $2.50 maybe. So that's why we like to sweet spot of say $3.50 to $4 as being a good place to land. It's not too good for some of those producers who have a higher cost structure and aren't as good at [inaudible 00:21:24] as we are. It sort of keeps them from developing too much, but it certainly makes it very profitable for us. Right?
Aaron Bilkoski:
I guess to wrap up, I have a high level question for you. LNG Canada is ramping up relatively shortly. How do you think that's going to impact the WCSB in general and does that impact the way you think about adding volumes to the basin going forward?
Jean-Paul Lachance:
Well, I think it's going to be constructive. I think anytime you can send two BCF a day to another customer is good for business, not having one customer and being sort of captive to the US or Eastern Canada around your gas supply. And we've always been price takers. So I think this is good. It's generally good, but we're also good at adding production to the extent that production two BCF goes away on the West Coast. I think we're pretty good at adding production and we can back fill pretty quickly. What length of time, a year, two years even, maybe months. I mean, if you look at the history, I think we've been able to do that. Whether we have the infrastructure still to do that in a sense of the services and all that, I don't know, but I have a view.
So I think it's going to be constructive for sure on price, but I think it's going to be a constructive thing. We have a lot, we're coming out of winter right now with a lot in storage. We're pretty full. Well actually, coming out of winter. We ought have a winter first. So if we don't have a winter, then this could be really challenging. So we're coming into the winter with a lot of storage, so we need to see that. We need to see our winter first. But I think generally speaking, this will be a good thing for the business. I think we'll see a lot of producers, and you're seeing it already, a lot of producers are at the ready here too. They're poised to be able to grow. So how quickly they do that and how quickly they backfill the gas that moves that goes west will be the most interesting part of this.
And when does it start up? Does it start up in mid... It says mid '25. Is it? I've always said because we don't have much exposure to the eco market on purpose, for us it's more about the LNG build out in the US that we're more excited about, and I think that'll still have a positive effect on the Western Canadian Sedimentary Basin because anytime you can pull gas away from the US off the coast down there, it's going to help our markets too. It's going to help our exports, right? It's going to improve Dawn, it's going to improve those markets to the East. So that'll be good for us too. Right? As long as you can get there. So I think all LNG, not just LNG Canada, it's going to be beneficial for us in the long term.
Aaron Bilkoski:
Perfect. Thanks for coming in. I appreciate this.
Jean-Paul Lachance:
Thanks for having me. It was fun.
Speaker 1:
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.

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