Canadian Natural Resources Limited (CNQ) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2013 Third 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. Good morning, and thank you for joining the conference call to discuss our third quarter financial and operating results; receive an update on certain projects, including Kirby South at Horizon Phase 2/3; an update on Primrose; and the 2014 production and capital budget. 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 releases and also note that the dollar amounts are in Canadian dollars and production and reserves are expressed as before royalties, unless otherwise stated. I would like to make a few brief comments on the third quarter before turning the call over to Steve and Corey. A PDF copy of the slides is available on our website, and for those of you turned to our webcast, please refer to Slide 4. Cash flow from operations amounted to $2.45 million (sic) [$2.45 billion] for the quarter or $2.26 per share. Cash flow for the 9 months was $5.7 million -- $5.7 billion or $5.23 per share, an increase of 28% over the same period in 2012. Net earnings and adjusted net earnings from operations for the third quarter were also very strong at $1.07 and $0.93 per share, respectively. This record quarterly cash flow was driven by new levels of production from each of primary heavy oil, Pelican Lake, Septimus liquids, thermal in situ, and Horizon Oil Sands. These achievements resulted in record quarterly production of 509,000 barrels per day of liquids and 703,000 barrels of oil equivalent -- barrels of oil equivalent per day. We also realized significantly higher netbacks for crude oil, natural gas liquids and synthetic crude oil, driven by higher WTI and data…

Thank you, Doug, and good morning. Turning to Slide 5, as Doug noted, the third quarter of 2013 provided exceptional cash flows as well as record production levels. From a pricing perspective, the market developed largely as we had forecast, and our production growth accelerated from Q2 levels by 17%, with production increases realized in almost all segments except in, as expected, international. This growth was delivered just as WTI pricing was increasing and heavy oil differentials were narrowing. This record cash flow of $2.45 billion, combined with proceeds received -- realized on the South African property farm-out, helped facilitate a reduction in our debt by about $600 million from June 30 levels. That was even as we expended $1.9 billion in capital expenditures to further grow our business. The net result is that our balance sheet continues to strengthen, with debt-to-book cap, flat; and debt-to-EBITDA targeted to end in 2013 at approximately 1x versus the 1.2x recorded at the end of 2012. These key metrics are expected to continue into 2014, with virtually no change despite an increase in dividends and a robust capital program which Steve will discuss shortly. Further, financial liquidity remains very strong, with available liquidity of approximately $2.9 billion under our committed bank lines, and very good access-to-market continued through our recently renewed shelf prospectuses in both Canada and the U.S. Our team has confidence in our ability to deliver the defined plan. We have a proven track record showing we are nimble through the -- even the low end of the business cycle, be it $2 natural gas or 45% heavy oil differentials. We have also proven we are just as adept at capturing market opportunities, such as acquisitions, and at preserving value and optionality of assets at the low end of our business…

Good morning, everyone, and thanks, Corey and Doug. As Doug and Corey have both pointed out, our second quarter was a very strong quarter for Canadian Natural and we expect 2014 to be a strong year as well. Before I get into highlights of the budget, I'll start by making a few comments about Canadian Natural's business model, starting on Slide 7. As you know, Canadian Natural has, and will continue to build, a premium value, defined growth in the tenet. 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, the robustness of our business model and strategies and our ability to effectually execute these strategies. It all starts with Canadian Natural's diversified and well-balanced asset base that is delivering significant cash flow. An asset base we're able to grow by utilizing roughly half of our cash flow, generating significant free cash flow. Free cash flow that is set to increase dramatically as a result of the effective and strategic capital allocation choices we have made. Canadian Natural has essentially 4 free cash flow allocation choices. The development of our large resource base, which receives a lion's share of the capital location 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 greater amounts of more sustainable free cash flow going forward. Secondly, we can and have returned free cash flow to shareholders. It has grown significantly at a 31% CAGR the last 5 years, as we've announced today, increase significantly in 2014. Reflection of our increasing free cash flow, the confidence…

Thank you, Steve, and Corey. Jake, I would look to open up the call for questions, please.

[Operator Instructions] First question is from Greg Pardy from RBC Capital Markets.

Steve, just a couple of questions. Dividend increased, obviously, very large, just curious as to what prompted you to increase dividend in that order of magnitude? And the second question, just around your 2014 cash flow guidance. I may have missed it, but could you tell me what you're using in terms of your WCS dip for 2014?

Thanks, Greg. As I said in the call, the dividend increase is large and it does reflect the strength of our asset base. The amount of free cash flow that we have and then the sustainability of that free cash flow, particularly going forward, you're going to see that increase. It's also a reflection of how we're making that transition to longer-life assets. Horizon, as we said before, we're at the 30% mark in terms of completions. We've got quite a bit of capital behind us. We have basically incurred -- committed to over half the project with lump sum contracts, so we've got very good cost certainty there. And we are at the, basically, contract negotiation stage, or AFE stage, for another 1/3. So about 67% of the expansion, we have pretty good cost control going forward and we see good market in construction going forward. Plus Kirby is on, so we made another step up in our long-life assets. Pelican is stabilized and is growing. And we can see that our plan is unfolding as we expect it and that plan includes increasing free cash flow that we're seeing, and that gives us the confidence to increase dividends. And obviously, our free cash flow will increase as we go forward but that, obviously, depends on commodity prices. The differentials we use are on the website, and we also have hedging to balance off that 2014 cash flow. But the differentials we're using are 24% WCS differentials.

The next question is from Phil Skolnick from Canaccord Genuity.

Two questions on Horizon. How long will it take for the new coker expansion to ramp-up once that comes online and to reach peak? And then, also, how should we think about op costs given the large fixed nature of this project?

Thanks, Phil. So we expect the -- we're going to take 20 to 25 days. We may be able to do it faster to do the tie-ins. And the actual ramp-up will be very quick. I would think within a month, we'll be up to the volumes because, really, what we're doing is we're bringing on 2 more coke drums and 2 coker furnaces. So really, the only difference is we're running 6 coke drums instead of 4, and we're adding additional coker furnaces that are all tied into our systems, so that should very quick and very effective. And we got teams working on it here for the last year, ensuring that we have all the operational issues identified and our procedures modified for a 6-drum operation versus 4 drums. Operating costs will be essentially almost linear, except for mining cost, because as you produce more oil, you need more trucks and more people to run it. But the rest of the plants will be essentially on a fixed cost, there'll be chemical costs as that will go with production, but it's largely fixed. So as we increase production, the operating costs for the bitumen extraction and the upgrading portion will be relatively the same or on a total basis. But on a unit basis, will go down. We believe that over the course of 2014, we'll be able to reduce the operating costs, that's why you're seeing a drop to range. And we believe, over time, we can actually get better. We're still very focused on reliability and being conservative in that approach. As we move forward, we expect to more be focused on production optimization and then you're going to start to see operating costs come down. We're very confident that we can do a lot better job on operating costs but we're not promising anything at this point for 2014 other than that 12% drop.

Okay. And I'm not sure if you'd mentioned this, but how much would have Horizon averaged in October if it wasn't for the TransCanada outage?

We would've probably been in about 115,000 to 116,000 barrels a day.

The next question is from Mark Polak from Scotiabank.

The first question, just, again, on the dividend. Historically, you guys have always increased in March. Is this the sort of timing around the year-end that we can expect going forward, is it possible for another increase in March?

Thanks, Mark. Traditionally, we always review the dividend policy in the March time frame at that board meeting. We'll continue to do that. This was probably a unique case. As I said earlier, our cash flow is strong. We've got lots of free cash flow and our sustainable free cash flow looks pretty good going forward. And particularly Horizon, capital spending is well behind us, a lot of big chunk of it, plus Kirby coming on. And Pelican, a stabilized production to lower decline rates gives us that confidence to do it now. We will again look at it in March.

And then just in terms of Primrose, just in terms of your conclusion, just curious on your discussions with the AER, if they're in agreement with you to date, and when do you expect that review to be completed?

So we are ongoing in the review and, obviously, we need to get surface access to a lot of these wells to get onto them. And we're waiting for that. Part of it is, it's -- obviously, summer is wet, so that some of you wait for frost. I would say, the Alberta Energy Regulator is working very well with us. Obviously, we're collecting data everyday and we provide that data to AER in increments, at specific times. So I think what the AER will tell you is that, so far, they're happy with the review and they're waiting for more data. And we'll get the full report and they'll make their conclusion at that point. But I would say the AER has been working very well with us. And my view from the information I get, in meetings I have with them, I think we're all on the same page. As I said earlier, this is all governed by rock mechanics and the basic laws of physics. So it's pretty hard to go against the law of physics. So we're planning that to our 2014 budget is set, assuming that we get this completed here by the end of the year, early into Q1, get a report in, have the revised plan, which I kind of scoped out how we're going to go forward. I get that approved by the AER and other regulatory bodies that are required, and then start proceeding. So as I said earlier, this is a totally solvable challenge and we will able to handle it going forward.

The next question is from Chris Feltin from Macquarie Securities.

Maybe just a quick follow-up to Mark's question there on Primrose. I can see how those old strat wells provide that conduit to get up above the shallower Colorado. But just in terms of the potential that you mentioned to be losing some bitumen from the Clearwater into the Grand Rapids, and then looking at that as a conduit into those strat wells, and I know that you mentioned that you're looking at maybe revising your steam injection practices to make sure that you stay within the Clearwater. But just kind of curious if you've seen evidence, one way or the other, like what that pathway is? Is it from the Clearwater into the strat wells or the Grand Rapids? And I guess, secondly, with these revised practices, like what do you -- does this have an impact on what the injection pressures will be in that project? And I guess, just a final tagalong would be, is there any clarity on timing of when you'll get that steam into the ground here, is it going to be before the end of this year? Are we looking more like Q1 '14?

Okay. Thanks, Chris. So lots of questions. We believe that the conduit is through the old strat wells or a failed wellbore. Strat wells, we think it comes through mostly to the Grand Rapids. If we'd had a conduit through a filled strat well directly from the Clearwater, I think the response would be different, and we're going to see a much quicker release. So we're done seeing that, so we believe it's going through the Grand Rapids and we could actually see that with our observation. And when you go back and look at our history here, when you have a release into Clearwater, it does tie with some of the releases to seepages to surface. Injection pressures for steam flooding, which we're looking to do, will be less than the high-pressure steaming and then we're using that at Primrose East. That Primrose East has a very, very thick Clearwater sand. And after you have the initial steam cycles, that is actually the optimum way to go and we have planned to do that anyway, so that will be part of the plan going forward. As far as regulatory approval, obviously, we have to get the causation review completed and that will take time. And we've got -- we can't predict all these, but we expect to be -- I would think it's going to be more likely to be Q1 2014 than by the end of the year.

Okay. And I guess with those modified practices, the targeted rates from Primrose are now 110 to 120, does that have an impact on where the ultimate rate is from that project now? Like I understand how, longer term, this won't have an impact on the recoverable resource, but would that have more of an impact in terms of the near-term rates at all?

Not really because what we do is that the major part of the modified strategy will be how we grow the volumes, so it probably change how many cycles we have during the year. So the cycles will be smaller injections and smaller production flowbacks. But you have more cycles in the year rather than what we have now, which are very much larger steam injections and larger production cycles. So really, you're just going at smaller volumes but at a greater frequency in the cycle.

The next question is from Mike Dunn from FirstEnergy.

A couple of questions. First, maybe on Pelican Lake. If I look at just referencing back to your Investor Day slides at June, you're spending less next year at Pelican Lake than what you had suggested in your slides at June. And the average production looks lower, too. Is that merely capital allocation decision for next year or are there other reasons why maybe you're not being as aggressive there at Pelican Lake next year?

Thanks, Mike. And I'm glad you brought that up because at Pelican Lake, I would earnestly say, we're seeing great response from the polymer flood. As you know, this a leading-edge technical polymer flood. There's only 2 polymer floods in the world with heavy oil, and Pelican Lake is the only one that actually works. So we're getting, as we said many times over the last few years, learning as we go. So the reason the capital allocation is less or the -- less capital this year is facilities are behind us, so that takes out a big chunk, we did that in 2013. Also, we are, in a way, reducing capital allocation and that's by choice. It allows us to give ourselves a bit of a breather here in the first part of 2014 and watch the response we're seeing from the polymer flood. And as you know, at some, areas respond very quickly, some a little slower. And we're going to take some time here. That's one of the beauties of Canadian Natural and our balanced portfolio. We're not driven to do anything just for the sake of growing production volumes. We're here about value growth. So we'll take some time, watch the response as it develops here in the Pelican Lake, and that will have an effect on how we space our drilling program, how we inject our polymer. We're looking at different ways of injecting polymer, reducing polymer viscosity. And in some cases, we have done a small experiment, which will continue in 2014, where we fill the polymer injection with water. This improves injectivity and also reduces our operating costs going forward. So we have a bunch of things we want to make sure we get nailed down. And so that when we do spend capital, ramp it up again, that we have the most efficient and capital-efficient drilling program to unroll the polymer flood going forward. So it's a bit of a slowdown. It's a capital allocation choice, but it also improves our capital efficiency going forward and make sure we get it right at Pelican Lake.

Great. And the OpEx guidance next year, Steve, is sub-$9 a barrel, I believe, I read. Any reason for me to think that that's anomalous or generally just a relationship with production going up and, I guess, probably I'm not sure if there's processing cost that have gone down there or not. But is that -- is there anything anomalous to be below that number for next year?

No, that's the way we see it going forward. Obviously, with the battery being built in 2013, we get better efficiencies. And we're seeing the production response coming, so that costs are lower. That's what we expected.

Great. And if I may, a similar line of question, I guess, on your conventional light oil in Western Canada. Again, back to the Investor Day slides, a little bit less growth next year than maybe you suggested and I'm thinking, June, you didn't have the Barrick acquisition in there. So just maybe walk us through how you're thinking it's changed there versus, let's say, 6 months ago?

Well, we did those capital allocation choice during 2013. As you know, we've got a lot of capital flexibility, so we allocated capital away from light oil just based on some of the response we've seen. And we want to -- as you know, we're drilling a bunch of Triassic plays in Northwest Alberta. We have drilled a lot of really good wells, but what we want to do is get production response or a performance, on a history on that, before we start our drilling programs. So in 2013, we drilled less light oil wells than we expected and as a result, production is less.

[Operator Instructions] The next question is from John Herrlin from Société Générale.

Just a quick one. You'll be generating free cash and, historically, you're a contrarian property buyer. Recently, you did a small bite-sized acquisition with Barrick. Will you be doing more bite-sized type things or it depends on the opportunity in terms of doing something more strategic?

Thanks, John for that question. Really, as you know, our portfolio, our asset base is pretty strong. As I said earlier, we don't have any gaps in our asset base, so there is no need for us to do any acquisition unless it can add value and is opportunistic. And in the case of Barrick, that was clearly a very opportunistic acquisition. And we are able to simulate that into our asset base very quickly. So I don't think -- unless something is very strategic out there and very opportunistic, you won't see us doing much of acquisitions. But again, we always watch and see what's going on.

Are you getting a lot of calls from private equity shops given the diversity of your base?

Not really, no.

There are no further questions registered at this time. I would like to turn the meeting back over to Mr. Proll.

Thank you, Jane, and thank you, ladies and gentlemen, for attending our conference call. As you have seen today, Canadian Natural has a very strong and diverse asset base, a complementary balance of production proportion to light oil and synthetic oil production, heavy oil and natural gas and a strong well-developed plan for the systematic development of this asset base. We concentrate on safe, efficient and reliable operations and a strong financial position, supported by our readily available liquid resources. We are focused on returns to shareholders in the near-, mid- and long-term. And so thank you, all. And if you have any further questions, please give us a call. Thank you, and have a great festive end to holiday season.

Thank you. The conference call has now ended. Please disconnect your lines at this time, and we thank you for your participation.