Canadian Natural Resources Limited (CNQ) Q2 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Canadian Natural Resources 2013 Second Quarter Conference Call. I would now like to turn the meeting over to Mr. Doug Proll, Executive Vice President of Canadian Natural Resources. Please go ahead, Mr. Proll.

Thank you, operator, and good morning. Thank you for joining the Canadian Natural Resources conference call, where we will discuss our 2013 second quarter operation and financial results and provide an update of these operations as we move into the second half of 2013. With me this morning are Steve Laut, our President; and Corey Bieber, our Chief Financial Officer and Senior Vice President of Finance. Before we begin, I would refer you to the comments regarding forward-looking information contained in our press release. And also note that all dollar amounts are in Canadian dollars and production and reserves are expressed as before royalties, unless otherwise stated. As you will hear from Steve and Corey, we exited the first half of 2013 in a very strong position, operationally and financially. We executed on our planned drilling and tie-in programs, completed our first major turnaround at Horizon and completed the Septimus gas plant expansion. We also continued to execute on Kirby South and the Horizon Phase 2/3 expansion. I will now turn the meeting over to Steve for his detailed review.

Thanks, Doug, and good morning, everyone. The second quarter was a solid quarter for Canadian Natural. Production volumes are at or above expectations, operating costs were down and pricing was stronger than in Q1. Looking forward into Q3 and Q4, we expect production volumes to increase and the oil pricing environment to be significantly stronger, driving quarterly cash flow at potentially record levels. Before I touch on the highlights for each area, I'll make a few comments about Canadian Natural overall. The strength of our assets, robustness of our plan and the enviable position we're in relative to most of our peer group. As you know, Canadian Natural has and will continue to build a premium value, defined growth independent. We're one of the few companies in our peer group that has the assets to deliver free cash flow on a sustainable basis, a direct result of the strength of our assets through us and our [ph] business model and strategies and our ability to effectively execute these strategies. It all starts Canadian Natural's diversified and well-balanced asset base, which is delivering significant cash flow. And at the asset base, we're able to grow by utilizing less than half of our cash flow, generating significant free cash flow. Free cash flow is set to increase dramatically as a result of the effective and strategic capital allocation choices. As you know, Canadian Natural has essentially 4 free cash allocation choices -- or cash flow allocation choices: Development of our large asset resource base, which receives the lion's share of the capital allocation at this point, which, in turn, increases the strength of our asset base and increases our ability to generate even greater amounts of cash flow and, due to long-life, low-decline nature of these resources, even creates greater amounts of…

Thank you, Steve, and good morning, everyone. As Steve noted, the second quarter of 2013 included many operational highlights with record production at many of our operations. From a pricing perspective, the market developed largely as we had forecasted several months back. As the quarter had closed, the Brent WTI differential has largely narrowed as had the heavy oil differentials. Corporate heavy oil realizations increased by about 35% to 40%, depending on the quality of the crude. The net result was a cash flow $1.7 billion, largely in line with CapEx of $1.8 billion. The trend of production growth accelerates as we entered the third quarter, with production increases anticipated in almost all segments. In fact, based upon midpoint Q3 guidance, we currently expect about 19% sustainable growth in liquids production versus Q2 of '13. This additional crude oil production comes at a favorable time, as Steve pointed out, from a pricing perspective. Positive movements for Q3 and Q2, to reiterate, include the benchmark WTI currently showing an 11% improvement, narrowing heavy oil differentials currently indicating about 16% versus 20% in Q2; condensate diluent premium costs reducing by about 78%; and continued pressure on the Canadian dollar. Putting these production and pricing factors together ultimately results in very strong levels of cash flow anticipated over the last half of this year. When combined with remaining targeted capital spending, which includes $2.3 billion on long-term projects, such as Horizon and Kirby, which currently do not add production in 2013, debt levels will exit 2013 very similar to where we were in 2012. Put simply, in 2013, we're growing production, buying back shares, increasing dividends and investing substantial amounts in future growth initiatives, all while maintaining our current debt levels. Speaking of our debt levels, during the second quarter, we issued $500 million of medium-term notes at a coupon yield of 2.89% and further diversified our borrowing base through the expansion of our well-received U.S. commercial paper program. Additionally, the term of our $3 billion credit facility was extended by 2 years to June 2017. Available liquidity remains strong, with available lines of credit approximately $2.4 billion at the end of June and no further debt maturities until late 2014. Finally, I believe our prudent commodity hedging program protects investment returns and ensures ongoing balance sheet strength and supports the company's cash flow for its capital expenditures programs. Over 50% of forecasted 2013 crude oil volumes are currently downside-price protected using WTI and Brent price collars at $80. Additionally, 150,000 barrels a day of 2014 are downside-price protected at $75 per barrel. Additionally, physical crude oil hedges locked in WCS differential on about 18,500 barrels a day at $21.35 for the remainder of 2013 are in place and over 9,000 barrels a day have locked in at just over $21.30 for 2014. Details of our commodity hedging program can be found on our website. With those comments, I'll pass it back to you, Doug, for any questions.

Thank you, Steve and Corey. Sebastian, I would like to open the call to questions.

[Operator Instructions] The first question is from Menno Hulshof from TD Securities.

I'll start with a question on Woodenhouse. So it looks like you're targeting an exit for this year of roughly 22,000 barrels per day, with running room to drill roughly another 50 pads in that area. So what are your thoughts on production capacity in long term, and how quickly do you plan on ramping that up?

Thanks, Menno. It's Steve here. So, yes, we believe we'll be at 22,000 by the end of the year. We do have significant capacity to drill here going forward. And one of the interesting things about Woodenhouse is the declines. As you know, heavy oil production you ramp up to a plateau. And then, when you run a plateau for a period of time and then you drop off very quickly. At this point in time, the plateau volumes at Woodenhouse seem to be longer than normal heavy oil wells, so we haven't actually predicted how far we're going to go, so when we do the budget here in 2014, we'll give you a better guidance on what 2014 would look like, which will be in November.

Okay. And I've got 1 other quick question on Horizon, sustaining capital guidance. It looks like there was roughly a $150 million -- $115 million increase relative to the numbers that you put out in May. So what drove that increase?

What really drove it, Menno, is the -- we're driving here for sustained reliability and enhanced reliability at Horizon. So we made a number of changes here as we go forward. During the turnaround, we've meddled up with some of the exchangers, which cost additional money. We added -- as we talked about here earlier, we went through enhanced catalyst, which cost us more money and we'll get production volume increases for that. We also did some work in the OPPs, so we closed some OPPs make sure they run better in the winter, so that cost more money. We also upgraded the chains -- the drive chains [ph] [indiscernible] and a number of other items such as that, including a hot process water tank. And we did some more work in the hydrogen furnace as well to enhance reliability going forward and drive the replaceable parts, which drives sustaining capital higher.

The next question is from Dillon Culhane from RBC Capital Markets.

Just a couple of quick questions for me. First, at Pelican Lake, I see you're targeting an exit rate of about 50,000 barrels per day in this year. I'm just wondering if you could provide an annual guidance range at Pelican? And then, secondly, on the CapEx, I see there are some midstream expenditures of about $190 million in the updated guidance that weren't included previously. I'm just wondering what those are for?

So I didn't quite catch the second question, but the first question was the guidance for Pelican Lake? Yes, we're looking at that guidance in probably at the midpoint about [indiscernible] 46,000 and 50,000 for Pelican Lake. And so, we'll be at about the midpoint of that for the year. What was the second question again, sorry?

The second one was just on the updated guidance. There's some midstream CapEx of about $190 million that's been broken out.

Yes.

That one wasn't included before. So I'm just wondering what that's for.

As you probably know, we own 15% of the IPF pipeline that takes production from the sort of Primrose, Kirby, Cold Lake area. That pipeline is under expansion, and we're participating in that expansion for a 15% share. That's the largest increase is that expansion that we're participating in. We believe that provides good returns for us -- good long-term returns for the company.

The next question is from Mike Dunn from FirstEnergy.

Another question, I guess, on Primrose. You have talked about your 2014 guidance or expectations coming down about 10,000 barrels a day there. Are you concerned at all about, I guess, longer term beyond 2014 not being able to produce closer to the 120,000 barrel a day, kind of, capacity? Or are you worried about, let's say, at Primrose East maybe modified steaming strategies that might cause higher steam oil ratios, et cetera? Or is this sort of -- you still think this is kind of temporary?

Thanks, Mike, and thanks for that question. It's a very good question. The short answer is we're not concerned. We are very confident that this is a wellbore failure. We're also very confident we can identify the wellbores that may cause an issue. Obviously, we had to do enhanced screening of some of these old vertical wellbores that are in the area. We believe we can do that and identify those. We also are very confident that, A, we can either repair those wellbores that are at risk, so that we don't have any issues. And if we cannot repair those wellbores, then we can -- as we go by that wellbore at the steam wave in the steam area, we'll alter our steaming strategy around those at-risk wellbores. So as you know, the steaming strategy has been used by the industry for over 30 years. These events are relatively uncommon. And everyone [indiscernible] happened has been due to a wellbore. So we know what we have to do. We know the cause, and we're in the process of working with the regulator to make that happen.

Great. And if -- maybe if I can just follow up on that, Steve. If it is the case that you have to kind of adjust the steaming strategies around those wellbores, is that -- the outcome of that would essentially be -- you'd have a little bit of stranded resource there but otherwise, operations as expected on the rest of Primrose East?

I think that would be the very worst case, Mike, but the most likely case is when we go by these wellbores, we adjust the steaming strategy. So what they'll -- you'll get the reserves, but it may take you longer to get the reserves out versus the existing optimized strategy.

[Operator Instructions] The next question is from John Herrlin from Societe Generale.

Just some quick ones. Transactionally, you said you opened a data room -- or in the process of opening the data room for the Montney. In the event that you get suitable bids, should we hear something by year end on the Montney sale?

Yes, you're right. The data room is going to be opened here in the middle of the month -- middle of August. We'll have 52 [ph], I think, in October. And depending what the bids are and how the negotiations go, that will set the timing. So we're not putting ourselves under pressure, as you know. We're under no financial pressure to sell these lands. So we'll take our time and get the right deal, if the right deal exists.

All right. Got it, Steve. With South Africa, obviously, you can't release much yet. But are you getting a heads-up deal or a carrying cost or some combination thereof since you have been doing G&G [ph] work? Can you address that at all?

I'm not going to address that, John. Sorry. I'd love to, but I can't.

It's worth a shot.

I kind of knew that you're going to do that too.

Yes. I know, that the heck. With this bore [ph], you had a rig issue. Are you going to switch companies or rigs or what regarding that?

We released this rig, and we will -- are in the process of looking for another rig. We're very disappointed in the safety performance and the operational performance of the rig [indiscernible] won't say who it is, but they are a major drilling contractor in the world. So very surprising to us. But we have certain standards here and the safety wasn't where it was and the performance was not there. So we released the rig, and we'll look for another rig to do the work.

Okay. Last one for me is on Block 12. You're shooting some more seismic. You have a high working interest. In the event that you do mature prospects, is this something too where you might farm out, or will you keep that high interest? I know it's early, but just thought I'd ask.

It's early but I think we feel pretty confident with the depth of water and the operations we have in Côte d’Ivoire that we'll maintain our working interest here and operatorship going forward.

The next question is from Phil Skolnick from Canaccord Genuity.

On Horizon, what's the cause of the Tranche 2 reliability timing to be slipped into 2014? And on that note also, we saw the 10,000-barrel a day cover expansion some time last year. It was supposed to be coming online in '14 and now last year you slipped that into '15. Is there something that's causing these little slips here?

Phil, I'm not sure on the second part. The coker expansion, as far as we know, hasn't slipped. So it may be some miscommunication on our part, but that has never slipped. As far as the reliability, really, the reliability was supposed to produce 5,000 barrels a day and in essence, we have that 5,000 barrels a day today. The whole part of the reliability is enhancing the life -- basically enhancing the reliability and life of the project. And you'll see that lift fully in 2014. So maybe that's where we're talking about. But really, to get reliability done in the last part is some major -- just minor parts on the sulfur recovery and things like that, that don't add production. So in essence, we have production capacity today about 5,000 barrels a day. And that's why you see in guidance here for Q3, we're at 111,000 to 118,000 barrels a day to Q3 because our production capacity is a little bit better with part of that reliability already being there with the OPPs.

There are no further questions at this time. I'd like to return the meeting back over to Mr. Proll.

Thank you, Sebastian, and thank you, ladies and gentlemen, for attending our conference call. Canadian Natural has a very diverse asset base, a complementary balance of production and a plan for the systematic development of this asset base. We concentrate on safe, efficient and reliable operations and a strong financial position supported by readily available liquid resources. We are focused on returns to shareholders in the near, mid and long term. If you have any questions, please do not hesitate to give us a call. Thank you again, and have a great summer day.

Thank you. The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.