Canadian Natural Resources Limited
Q1 2017 Earnings Call Transcript

Published: 4 May 2017

[Operator:]

Good morning, ladies and gentlemen, and welcome to the Canadian Natural Resources Q1 2017 earnings results conference call. After the presentation, we will conduct the question-and-answer session. Instructions will be given at that time. Please note that this call is being recorded, today May 4th, 2017 at 8 o'clock a.m. Mountain Time. I would now like to turn the meeting over to your host for today's call, Mark Stainthorpe, Director, Treasury and Investor Relations of Canadian Natural Resources. Please go ahead, Mr. Stainthorpe.

[Mark A. Stainthorpe:]

Thank you, Sally. Good morning, everyone, and thank you for joining our conference call, where we will discuss our operational and financial results for the first quarter of 2017, and provide an update regarding our ongoing projects and operations. With me this morning are Steve Laut, our President; Tim McKay; our Chief Operating Officer; and Corey Bieber, our Chief Financial Officer. Before we begin, I would like to refer you to the comments regarding forward-looking information contained in our press release, and also note that all amounts are in Canadian dollars, and production and reserves are expressed as before royalties unless otherwise stated. With that, I'll pass the call over to Steve Laut. Steve?

[Steve W. Laut:]

Thanks, Mark, and good morning, everyone. And thank you for joining the call this morning. The strength of our well-balanced and diverse portfolio combined with Canadian Natural's ability to effectively and efficiently execute continues to deliver with a good first quarter. In Q1, cash flow was strong, and exceeded capital expenditures by just under CAD 800 million. As a result, our balance sheet is strengthening quickly. Oil production was up 9.3% over Q1 2016, and BOE/d production was up 3.8% as natural gas production was impacted by third-party facility reliability issues. Canadian Natural has grown our production, and at the same time effectively lowered our cost structure across the board. A major driver of these strong numbers is Horizon execution. At Horizon, production continued to exceed nameplate capacity of 182,000 barrels a day, with Q1 production at 192,481 barrels a day. Horizon operating costs were also excellent, with Q1 cost at CAD 22.08 a barrel, down 17% over Q1 2016, and setting us up to meet our target at or below CAD 20 a barrel once Horizon Phase 3 is on-stream and lined out. Clearly, Canadian Natural is in a very strong position in 2017. The most difficult portion of our transition to long-life, low decline assets, Horizon Phase 2B, is now complete and running smoothly. As a result, the size and sustainability of our cash flow has increased substantially. The 80,000 barrel a day Horizon Phase 3 is set to come on-stream in roughly six months, on budget,\ and on schedule. Combined with our recent acquisition of 70% of the Albian Oil Sands mining and upgrading operations, which is targeted to close in Q2 2017, subject to normal regulatory approvals, we take another significant step change upward, and sustainability becomes even stronger. In today's commodity price world, long-life, low decline assets are very valuable and give Canadian Natural a competitive advantage. Reservoir risk is low to non-existent, and the scale of these operations matters, allowing Canadian Natural to leverage technology and use continuous improvement processes to maximize utilization, reliability, and deliver ever-increasing effective and efficient operations. In addition, we're able to use Canadian Natural's size to drive economies of scale. Add in the Albian mining and extraction operations, and we expect to capture additional synergies. In our view, Horizon and Albian Oil Sands mining and operating operations are very effective, and combined with our long-life, low decline nature of the assets with no reservoir risk, make Horizon and Albian competitive with any oil play in the world. The impact of long-life, low decline assets on a sustainability should not be under-estimated. The larger portion of Canadian Natural's asset base being long-life, our average corporate decline rate drops to 9%. As a result, our maintenance capital to hold production flat is significantly less compared to a typical E&P company, making Canadian Natural more robust and generating more free cash flow. The size, scale, and diversity of our assets matters in today's world, allowing Canadian Natural to leverage our infrastructure and economies of scale to drive effective and efficient operations. Canadian Natural has a unique combination of asset-based strength, diversity, and balance. Combined with our strategy and competitive advantages, effective capital allocation, and a management team that is more aligned with shareholders than any of our peers, allows us to deliver the best of all worlds. And delivering the best of all worlds means delivering sustainable production, sustainable free cash flow from our long-life, low decline assets that are very resilient to price volatility. It also means delivering high returns from Canadian Natural's large, high-quality inventory of low-capital exposure projects in primary heavy oil, natural gas, and light oil in Canada and Côte d'Ivoire, which provides significant capital flexibility, quick payouts, and higher returns on capital, particularly when we can leverage our infrastructure advantage to keep costs low. Canadian Natural may be the only company in our peer group that has the quality in both asset types, the technical and operational expertise to execute in both asset types, to deliver effective and efficient operations, and importantly, the discipline to effectively allocate capital to grow production and maximize cash flow. The strength, size, and power of both asset types, combined with our effective capital allocation, makes Canadian Natural very robust and maximizes cash flow. A key component of Canadian Natural's strategy is to balance and optimize the allocation of cash flow to maximize value for shareholders. We strive to balance and optimize what we call the four pillars of cash flow allocation

[Tim S. McKay:]

Thank you, Steve. Good morning, everyone. I will now do a brief overview of our assets and talk through our 2017 first quarter results. Starting with natural gas, our first quarter production of 1.673 Bcf a day was up 2% from our Q4 2016, below our expectation as the quarter was impacted by poor reliability at a third-party plant in British Columbia, where we produced 100 million cubic feet of natural gas sales versus 176 million cubic feet of capability. During the month of April, this poor uptime continued, where we only averaged 49 million cubic feet per day of natural gas sales. They are now targeting to be fully on stream this June. As a result of this continued poor reliability, we have reduced our forecast for this facility and reflected it in our Q2 guidance of 1.675 Bcf a day to 1.73 Bcf a day, which is still up 30 million a day from Q1, as a result of our natural gas drilling activities. In Q1, we completed 11 net gas wells, highlights of the program are at Septimus, our liquid-rich Montney property. Four net wells are on stream at 9 million a day and 450 barrels a day liquids each, filling our plant once again to approximately 150 million cubic feet per day natural gas sales, and 7,700 barrels a days of liquid. At Gold Creek, two net wells are completed and on stream, at a combined rate that's 7 million cubic feet per day, and approximately 1,700 barrels a day of liquids. At Bilbo, two net wells are each flowing 14 million a day each with 500 barrels a day of liquids. Our focus program was very successful with low cost high end to our owned and operated infrastructure. North American natural gas operating costs were CAD 1.20 per Mcf for Q1 2017, which is slightly higher when compared to Q1 2016 at a CAD 1.18 per Mcf. Our North American light oil and NGL production in Q1 2017 was approximately 90,200 barrels, an increase of 3% from Q4 2016 and is comparable to Q1 2016. In all areas, we continue to optimize the water floods that continued to improve our operating costs which are down 3% from Q4 2016 to CAD 13.72 per barrel. In Q1, we drilled 23 net wells. Overall, the program was very successful. A couple of highlights to the program is in Manitoba and Southeast Saskatchewan where nine net wells were drilled this quarter. We have current production of just over a 1,000 barrels a day, or approximately 110 barrels per day per well. In Southern Alberta, seven net wells were drilled, adding 875 barrels a day, or approximately 125 barrels per day per well. Offshore Africa was 22,616 barrels a day, a 4% increase over Q4 2016, as higher up time and optimization activities mitigated the decline in the quarter. Overall, operating costs were CAD 18.59 (sic) [CAD 18

[Corey B. Bieber:]

Thanks, Tim, for that operations update. We also had strong financial performance during the first quarter. Net earnings of CAD 245 million were achieved as the production increased 2% and WTI pricing stabilized in the $50 region. Q1 2017 also included additional depletion for an Ninian North platform in the UK North Sea, where as Tim mentioned, we currently target to commence cessation of production in Q2. Fund flow for the corporation were also a robust CAD 1.6 billion, this translates to free funds flow after CapEx and dividends of CAD 515 million, further translating to reduction in debt levels of approximately CAD 500 million. Over the last two quarters and following the completion of the Horizon Phase 2B, funds flow from operations has exceeded CapEx and dividends by CAD 1.5 billion. Commensurate with this debt reduction, available liquidity to the corporation has increased CAD 500 million to CAD 3 billion from the CAD 2.5 billion available at the end of 2016. This CAD 3.5 billion liquidity figure excludes many other financial levers available to the company. Based upon lower current strip pricing and after accommodating for Horizon downtime in Q3 for turnaround and Phase 3 tie-ins, we would still expect our turnarounds before the AOSP acquisition to continue generating free cash flow and debt repayment, exiting the year in that range of 2 times debt to EBITDA and debt to book capital of 34% to 36%. We remain on track for Horizon Phase 3 completion in Q4, when we would target a further increase in production and available cash flow and the culmination of major project capital expenditures, again free cash flow additive. Our robust cash flows and available liquidity provide us additional flexibility in our approach for the financing of the Athabasca Oil Sands Project, where we have a range for CAD 3 billion three-year term loan, and up to CAD 6 billion in potential bond issuances in the U.S. and Canadian debt capital markets. In coming weeks, we will determine targeted tenders, currencies and amounts to optimize this acquisition requirement. As always, we will be mindful of ensuring that our financing plans afford the flexibility to repay debt or refinancing as each maturity comes due. Delivery of the defined plan continues and our teams remain focused on growing value for our shareholders. With that, I hand it back to you Steve for your closing comments.

[Steve W. Laut:]

Thanks, Corey. As you've heard this morning, Canadian Natural has a unique combination of asset base strength, diversity and balance, combined with our strategy and competitive advantages, effective capital allocation and management teams that align with shareholders more than any of our peers allows us to deliver the best of all worlds in long-life, low decline capital exposure assets. Canadian Natural may be the only company in our peer group, as I said earlier, that has quality of both these asset types, the technical and operational expertise to execute in both types and deliver effective and efficient operations, and importantly, the discipline to effectively allocate capital to grow production and maximize cash flow. The strength, size and power of both asset types combined with effective capital allocation makes Canadian Natural very robust and maximize cash flow. We strive to balance and optimize the four pillars of cash flow allocation to maximize shareholder value; balance sheet strength, return to shareholders, resource development, and opportunistic acquisitions. With free cash flow increasing, we're effectively balancing the four pillars to maximize shareholder value. In the first quarter, we increased dividends for the 17th consecutive year. The 70% acquisition of the Albian Oil Sands strengthens Canadian Natural as free cash flow has increased significantly. As a result, the balance sheet strengthens quickly and we target debt to EBITDA to be in that 1.8 to 2.2 range by the end of 2018. Again, as Corey pointed out, debt reduction was CAD 500 million in Q1. Our disciplined capital allocation allows us to grow production organically in that 68% CAGR range. With the Albian acquisition that increases to 15%. As you can see, we're balancing the four pillars of cash flow allocation to maximize value for shareholders. Canadian Natural is in a great position and is now more robust and sustainable and the future looks even more robust and sustainable. With that, we'd be now happy to open up the line for questions.

[Operator:]

Thank you. Your first question comes from the line of Roger Read with Wells Fargo. Your line is open.

[Roger D. Read:]

Sorry. I didn't turn off the mute. Good morning there.

[Steve W. Laut:]

Good morning.

[Tim S. McKay:]

Good morning.

[Roger D. Read:]

I guess, kind of big question I really have. Some third-party issues here obviously impacting you on the gas side. Seems like most of what you've got internally is working properly, but what seems to be – I guess, the easiest way to say is, the governor on production here in the near-term?

[Steve W. Laut:]

I'm not sure what you mean by governor? What do you think is going to limit our growth or...?

[Roger D. Read:]

Yeah. Well, I guess, the third-party issues. Are we pretty well – other than what's highlighted, are we pretty well beyond that? I mean, is it, we should be focusing on the completion of the projects in the third quarter, early fourth quarter? And it's what we think it should be on growth? Are we still going to be dealing with the occasional stumbling block here?

[Steve W. Laut:]

I would say internally in terms of all our execution and our projects, we're on track. There's no issues. You can see, we are very frustrated with the third-party facility and their ability to operate and stay on stream. Reliability wise, they're now targeting beyond and June 1st. We have some concerns that they will be able to lever based on their track record, that's reflected in our production guidance. But internally everything that we control, we're executing on. I'm very confident, we're going to deliver.

[Roger D. Read:]

Okay. Thanks. That's helpful. And then, as a general question about CapEx, the relatively modest decline rates and obviously crude being a generally better margin opportunity than gas. Why not reduce the spending on the gas side overall, and I'm just thinking of a mix of cash margin. Kind of what's the bigger driver on wanting to put the effort you are putting into the natural gas side?

[Steve W. Laut:]

I think, the way you got to look at it Roger is that, every project, I think, Canadian Natural has to compete for capital. And we do the highest return on capital projects. So those gas projects, we're drilling. It's not a lot. We could drill a lot more than we are, compete with many of our light oil, heavy oil projects in our portfolio. And as Tim pointed out those are very high rate wells with lots of liquids. So they compete and that's why those wells get drilled.

[Roger D. Read:]

All right. Well, that's it from me. Thank you.

[Operator:]

Your next question comes from the line of Benny Wong with Morgan Stanley. Your line is open.

[Benny Wong:]

Good morning, guys. I'm just looking at what crude price is doing today? And I know you have CAD 900 million in CapEx flexibility, and I think CAD 800 million in financial levers. Can you give us an idea of what points and with the different options in those buckets, how do you think about the orders, the order of the levers you would pull and what objectives or targets you would look to maintain in that process?

[Steve W. Laut:]

I think, Benny, what we do is we look at the overall situation we're in and what the outlook looks like. I don't think we will react on a sort of daily or weekly basis based on the crude price or the natural gas price. And it all depends on the market what kind of lever we'll pull or when we'll pull it. So, I don't think I can actually give you a priority ranking or anything like that. It's just all market driven and we're focused on maximizing value for shareholders.

[Benny Wong:]

Got it. Okay. Thanks, Steve. And I was hoping to get an update on how you guys are thinking about the acquisition market out there today or assets? I know you guys have a strong portfolio in oil and gas (26

[Steve W. Laut:]

I think what we do – it's probably the same answer you get – we give every time is that, all the assets that go through our core areas, we'll look at. We look at every one of them when we evaluate them. We bid on a few, and we get even less. So it's very much a high-grade process. Clearly, we got the Albian closing in front of us, and that's what we're focused on right now, and so we've got lots on our plate. But that won't stop us from evaluating everything that goes through our core area.

[Benny Wong:]

Great. Thanks for the color.

[Operator:]

Your next question comes from the line of Neil Mehta with Goldman Sachs. Your line is open.

[Neil Mehta:]

Good morning, team. Wanted to take a moment to ask you guys about the Athabasca transaction. Since the last time you spoke, and you've had some time to look at this asset and further kick the tires. What have you learned since that time that you can provide to the market, in terms of the outlook for production here, cost, or the quality of the asset?

[Steve W. Laut:]

I think, Neil, what our big focus has been here since our last announcement is, getting the deal closed. We're focused on integrating the Shell people, all our systems and processes that go with that, getting all the regulatory approval that are necessary. So, I don't think we have any more color that we can provide other than we did at the last conference call. Nothing has changed. We're still very positive on the whole transaction and what we talked about in the last quarter, nothing has changed from that outlook at all.

[Neil Mehta:]

All right. And Horizon, it looks like production is surprising to the upside relative to nameplate capacity. Can you talk about whether this is sustainable, and what you're watching on that front? And then also, can you talk about the debottleneck here, and the milestones you guys are tracking to figure out whether that makes sense?

[Steve W. Laut:]

Okay. So, as Tim pointed out, we're doing 205,000 barrels a day today. I think that's probably unrealistic to expect that to run at that rate for long periods of time. That's sort of a no downtime or unplanned downtime factor number. And you have to account for that. If you look at all big plants, refineries across the board, there's average about 6% downtime. We target to be less than that, unplanned downtime. So you've got to factor that into it. As far as debottleneck goes, I guess Tim can give you more detailed information, but the clear overriding principle here is, we do seem to be doing more capacity than we expected at the Horizon 2B, similar to what we've seen in Horizon 2A, by the way. And what we're doing now, as you can imagine, the overall design was for 250,000 barrels a day. We have 80,000 barrels a day coming on in Phase 3. So there is, I would say, a very detailed and comprehensive evaluation that Tim talked about, the engineering evaluation, to ensure that all the product splits are correct. And we know what the value of the products splits are, where we have vessel constraints, where we have pump constraints, and all the flow dynamics Did I get that right, Tim, or is there more details that you should give?

[Tim S. McKay:]

Yeah. No. (30

[Steve W. Laut:]

Just to be clear though, this is a good problem to have.

[Neil Mehta:]

All right. Thanks. And then, last question from me. There's been a lot of ink that's been spilled about Canadian oil differentials, recognizing that Trans Mountain and Line 3 will be coming online towards the end of the decade. But investor concern is there around 2018, WCS difference. Could you just talk about how you guys are thinking about the intermediate differential potential? And then also, the impact of the Syncrude outage more near term, how that could be affecting price realizations at Syncrude, which could be beneficial?

[Steve W. Laut:]

Yeah. We'll start with the last one first, on the Syncrude. That's probably just temporary. It's a slight supply/demand dynamic. When you're short of some synthetic oil, the premiums for synthetic increased about $3 to $5 a barrel WTI (31

[Neil Mehta:]

All right. Thanks, guys.

[Operator:]

Your next question comes from the line of Greg Pardy with RBC Capital Markets. Your line is open.

[Greg Pardy:]

Thanks. Steve, maybe just to come back to the heavy oil program, you were quite active drilling wise in the first quarter. Could you just frame it up for us for the balance of the year? What is going to look like just in terms of activity levels and perhaps the impact on production?

[Steve W. Laut:]

I think what we're going to see here, Greg is, activity obviously and breakup a slowdown, and we'll keep probably about the same rig count going forward here into Q3 and Q4. So you'll see Q3 and Q4 fuel accounts being similar to Q1.

[Greg Pardy:]

Okay. And what would the rig count have been in the first quarter?

[Steve W. Laut:]

I think we had about 6 rigs going. Tim?

[Tim S. McKay:]

Yes.

[Greg Pardy:]

Okay. Second question is just around hedging. How are you thinking now about your hedging policy? And how does the AOSP deal affect that thinking at all?

[Steve W. Laut:]

Yeah. We look at hedging every week and look at the market conditions and where we are with our cash flows and our balance sheet. We have done more hedging in the first quarter. It's not a lot. We've got 67,000 barrels a day between CAD 50 and CAD 60 WTI. We'd look to add more, but not at these price levels.

[Greg Pardy:]

Okay. Great. Thanks very much, guys.

[Operator:]

Your next question comes from the line of Phil Gresh with JPMorgan. Your line is open.

[Philip M. Gresh:]

Yes. Hi, good morning. I just had a one clarification question for Corey. I think, Corey, you said the leverage target at the end of this year is 2 times. I want to clarify if that was standalone or if that was a pro forma target because when I look at your slide-deck from April, post deal, the actual was 1.8 and the pro forma is around 2.2.

[Corey B. Bieber:]

Yeah. So that is without AOSP at current price decks, so in that 2 range, 1.9 to 2.1.

[Philip M. Gresh:]

Got you. So you're thinking it's up a bit from what you had previously thought?

[Steve W. Laut:]

Yeah. And that's predominantly due to the lower commodity prices.

[Philip M. Gresh:]

Yeah. Okay. Got it. And do you have a pro forma target for the end of this year, than just add 40 bps to that maybe?

[Corey B. Bieber:]

I don't have a pro forma target, Phil. Sorry.

[Philip M. Gresh:]

Okay. All right. Thank you.

[Operator:]

And your next question comes from the line of Chris Cox with Raymond James. Your line is open.

[Chris Cox:]

Hi, guys. Just a couple of quick questions from me here. The first, I guess, would be on some of the results that you had spoke about on your North American portfolio and especially those wells at Gold Creek looked pretty impressive. And I'm just kind of curious how those results just start to ramp up activity in your conventional portfolio? How they're kind of comparing against what you are expecting? And then especially in some of that liquids activity in the Gold Creek or (36

[Tim S. McKay:]

So, Tim McKay here. So the Gold Creek wells are very similar to what we had predicted for the outcomes there. Right now, we're just going to evaluate and make sure that they are as good as we believe they are. And we have additional lands that we would schedule to drill Q3, Q4 of this year. But the facility constraints will be there. Obviously, we'll have to pace our development there, but it is going to our own plant. And so it will be, we can accommodate it over time.

[Chris Cox:]

And would that plan – assuming we are correct, there was an expansion underway there. Can you just maybe remind me how much was being added at Gold Creek?

[Tim S. McKay:]

Yeah. We're looking to expand it to approximately I think, 70 million cubic feet per day. And obviously in that area there's lots of other parties that are interested in coming to Gold Creek and we're just matching the facilities to add some capacity.

[Chris Cox:]

All right. Thanks. And then just kind of a quick one here on Horizon, just with the debottleneck project, guidance was kind of 5,000 barrels a days to 15,000 barrels a day is potential kind of upside. As you started – are you just starting to do some of the work on kind of felt like (37

[Steve W. Laut:]

Chris, I don't think that number is going to change much. But we're still right in the flow dynamic. So I wouldn't expect to see that go up at all.

[Chris Cox:]

Okay. That's it from me. Thanks guys.

[Operator:]

And there are no further questions at this time. Mr. Stainthorpe, I'll turn the call back over to you.

[Mark A. Stainthorpe:]

Thank you, Sally. And thank you everyone, for attending our conference call today. 2017 is a very important year for Canadian Natural. The completion of Horizon Phase 2b in late 2016 and Phase 3 later this year, along with the integration of the acquired assets at Albian, Canadian Natural begins to generate significant free funds flow. This leads to a strengthening balance sheet, while increasing liquidity and flexibility moving forward. This also provides the opportunity to effectively allocate capital in a disciplined manner to our four pillars, which are designed to maximize long-term shareholder value. If you have any further questions, please give us a call. Thank you again and we look forward to our Q2 2017 conference call in August.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.