Canadian Natural Resources Ltd Q3 FY2020 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Canadian Natural Resources Earnings Results Conference Call and Webcast. After the presentation, we will conduct a question-and-answer session and instructions will be given at that time. Please note that this call is being recorded today, November 5, 2020, at 9:00 a.m. Mountain Time. I would now like to turn the meeting over to your host for today's call. Corey Bieber, Executive Advisor. Please go ahead, Mr. Bieber.

Thank you, operator. Good morning, everyone, and thanks for joining our third quarter 2020 conference call. With me this morning is our President, Tim McKay; and Mark Stainthorpe, our Chief Financial Officer. Before we begin, I’d refer you to the special note regarding non-GAAP measures contained within our press release. These measures used to evaluate the company's performance should not be considered to be more meaningful than those determined in accordance with IFRS. I would also like to refer you to the comments regarding forward-looking statements 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 noted. With that, I'll now pass the call over to Tim.

Thank you, Corey. Good morning, everyone. Canadian Natural delivered top-tier operational results in the third quarter, with 79% of our liquids production coming from our high-quality, long-life, low-decline assets, which proved resilient in volatile pricing. As a result of our operational excellence, ability to enhance margin, and capital discipline, we delivered substantial cash flow in the quarter. The strengths of Canadian Natural's business model also contribute to environmental, social, and governance performance, providing industry-leading performance across the board, which is crucial for our long-term sustainability. Canadian Natural, along with the entire Canadian oil and gas sector, leads the world and has delivered game-changing environmental performance. In the third quarter, we published our 2019 stewardship report to stakeholders. Highlights from the report include a total recordable injury frequency at 0.28, down 51% since 2015; awarded approximately $550 million in contracts to 150 indigenous businesses; three out of eight of our independent directors are female; corporate GHG emissions decreased by 16% from 2015; and both science mining and in situ GHG intensity were down 36% since 2016. At Quest, our 70% owned carbon capture facility, we reached a milestone in the third quarter with 5 million tons of CO2 injected, equivalent to taking 1.25 million cars off the road annually. We are leading in carbon capture and sequestration in the oil and gas sector worldwide. These are just a few examples of our ESG excellence. In our oil sands operation, we aim to continue to develop technologies using Canadian ingenuity to get closer to Canadian Natural’s aspirational goal of reaching net-zero emissions. We have multiple pathways to achieve net zero with actions identified in the near, mid, and long-term. The strength of Canadian Natural's oil sands mining assets, with their long life and low decline, provides one of the clearest routes to net zero of any global oil asset. Operationally, Canadian Natural’s third-quarter results show production of 1.11 million BOEs, with natural gas production of 1.36 Bcf and liquids production of approximately 884,000 barrels a day, as we maximize production while optimizing curtailment strategy and efficiently conducted maintenance. Starting with natural gas, Q3 overall production was 1.36 Bcf, a decrease from Q2's 1.46 Bcf, with North America’s Q3 natural gas at 1.34, down from Q2's 1.43 Bcf. We continue to focus on operational excellence; our Q3 North American natural gas operating cost was strong at $14 per Mcf versus Q2's $11. We continue to add low-cost natural gas volumes, which allowed us to add approximately 58 million cubic feet per day at approximately $2,000 per BOE/d, much less than our target of $3,000 per BOE/d. We remain on track to add 35 million cubic feet per day of natural gas volumes annually. In Q3, Canadian Natural realized a North American natural gas price of $2.25 per Mcf, approximately 49% higher than Q3 2019. With strong natural gas pricing, the company has reallocated capital within its existing budget to both Septimus and Townsend areas, targeting approximately 95 million cubic feet of natural gas and 2,900 barrels of NGL for less than $5,000 per BOE. Our Q3 North American light oil and NGL production was 79,600 barrels, down by approximately 3% primarily due to natural declines and maintenance activities in the quarter. Q3 operating costs decreased to $14.13 per barrel versus Q2's $14.41 per barrel. Overall, our international assets produced 38,800 barrels per day in Q3, as expected. Offshore Africa production was 17,500 barrels, comparable to Q2's 17.4. Operating costs in Q3 were $12.32 U.S. per barrel versus Q2's $7.67 per barrel due to lifting schedules. In the North Sea, production averaged approximately 21,200 barrels a day in Q3, down from Q2's approximately 26.6, principally due to planned maintenance activities and natural field declines with operating costs around $42.10 per barrel. After the quarter-end, we announced that the operator of South African Block 11B/12B made a second significant gas condensate discovery. The exploration well encountered 73 meters of net pay and is currently being tested, with deliverability results aimed for by year-end 2020. Canadian Natural holds a 20% working interest and expects the costs of the wells to be fully carried based on the Farm Out Agreements. Heavy oil production in Q3 increased to approximately 71,000 barrels a day versus 62,500 in the second quarter, as we reinstated temporary curtailments related to low pricing. Q3 operating costs decreased to $15.96 per barrel from Q2's $17.97, reflecting our focus on cost control. A key component of our long-life, low-decline assets is the world-class Pelican Lake pool, where our leading-edge polymer flood continues to deliver significant value. Third-quarter production was approximately 56,400 barrels a day, up from the second quarter's 55,700, primarily from reinstating well servicing activities in the quarter, offsetting natural decline. Operating costs remain very strong at $5.76 per barrel versus Q2's $6.31 per barrel. At Pelican, our team continues to drive operational excellence, and with our low decline and very low operating costs, Pelican Lake continues to have excellent financial metrics. Our Thermal team achieved a great third quarter with thermal production records of 287,978 barrels a day, up from Q2's approximately 213,000 barrels a day. Operating costs in Q3 were near record lows at $7.85 per barrel, down 23% from Q2's operating costs of $10.13. Some of the highlights from the third quarter indicate that Kirby North production was very strong at 42,400 barrels above our nameplate capacity of 40,000. Jackfish set a record for Canadian Natural at 122,346 barrels a day. These are just a few examples of the great work done by our team. In our oil sands mining operations, Q3 production was approximately 350,600 barrels at planned maintenance. The strong operating costs were $23.81 per barrel of SCO, as our teams are very focused on driving operational excellence. As part of the company’s overall strategy to maximize value and enhance margins, we completed work at the Scotford upgrader, increasing its capacity to approximately 320,000 barrels a day. In late October, the Albian mine ran at rates of roughly 345,000 barrels a day of production, while Scotford processed approximately 323,000 barrels a day. Due to workforce curtailments, AOSP aims to resume full expanded capacity in December 2020. This additional capacity at AOSP will allow for increased margin enhancement in our oil sands mining upgrading segment, as well as substitute for the planned maintenance completed at Horizon, which is currently at 260,000 barrels a day. I will now turn it over to Mark for a financial review.

Thanks, Tim. The third quarter was strong both operationally and financially, as we delivered significant free cash flow of approximately CAD 1 billion after capital expenditures and approximately CAD 470 million after capital and dividends, with adjusted funds flow of CAD 1.74 billion. These results reflect high planned maintenance and turnaround activity at both Horizon and Scotford during the quarter. Net earnings in the quarter were also strong at CAD 408 million. This clearly demonstrates the advantages of having a low-cost structure with breakeven prices, including maintenance capital and the dividend at US$30 to US$31 WTI. We have a unique portfolio of assets with low declines supported by zero decline production for mining assets, providing high quality, premium value synthetic crude oil production. Our balanced and diverse product mix limits our exposure to any single product, with fourth quarter production targeting approximately 45% high-value light crude oil, synthetic crude oil, and NGLs, approximately a third heavy thermal crude oil, and approximately a quarter of natural gas in total. Importantly, around 80% of our liquids production comes from long-life, low-decline assets, which require less maintenance capital, ensuring sustainability through volatile prices. In the fourth quarter, we are targeting over 1.6 Bcf a day of natural gas production, including our recent acquisition. Based on the current Q4 strip pricing, our natural gas assets are forecast to generate approximately CAD 1.2 billion in annual operating cash flow. The operating flexibility of our asset base and the ability of our teams to execute the plans were evident during the quarter, as we balanced production within our asset base to increase funds flow and maximize value. Our flexible capital allocation ensures long-term free cash flow generation and continued balance sheet strength. Net debt decreased by CAD 1.1 billion compared to Q2 2020 levels, as free cash flow contributed to debt repayment in the quarter. Liquidity remained strong at the end of Q3, with total availability of CAD 4.2 billion, including cash and short-term investments. We also retired a CAD 1 billion bond at maturity in August. Our long-life, low-decline assets and our effective and efficient operations afford us the ability to sustain returns to shareholders over the long term. This is demonstrated by our 20 consecutive years of dividend increases, reflecting our culture of continuous improvement, our effective and efficient operations, and our relentless focus on cost control at Canadian Natural. All these factors contributed to significant free cash flow generation and strong financial results in the quarter. With that, I'll turn it back to you, Tim.

Thank you, Mark. Canadian Natural’s ability to deliver significant and sustainable cash flow is driven by our effective and efficient operations and our ongoing drive for continuous improvement. For 2020, we are on track for targeted savings of approximately CAD 745 million. As an example, in Q3 2020, North American E&P liquids operating costs were down 17% versus Q3 2019, resulting from our effective and efficient operations and the high quality of our assets. We maintain a low free cash breakeven, including capital expenditures plus current and dividend at approximately US$30 to US$31 per barrel. Canadian Natural continues to take proactive and effective steps to ensure the health and safety of our workforce, and we continue to enhance our COVID-19 program across the company. We are on track to achieve our environmental targets and will continue to lower our intensity as we work towards our aspirational goal of net zero for the Oil Sands. In Q4, we are targeting over 1.6 Bcf of natural gas production, including our recent acquisition. Based on the current natural gas strip pricing, including the value of liquids, our natural gas assets could generate approximately CAD 1.2 billion on an annualized basis. In summary, we continue to focus on safe, reliable operations, reducing our GHG intensity, and enhancing our top-tier operations. Our high-quality, diverse assets deliver strong cash flow generation. We are unique, sustainable, and robust, clearly demonstrating our ability to deliver returns to shareholders by balancing our four pillars. That concludes our Q3 call. I will now open the line for questions.

Your first question comes from Greg Pardy from RBC Capital Markets. Your line is open.

Thanks. Good morning. A couple of questions for you. Tim, maybe just to revisit the capacity growth at Scotford, and let's also weave in Horizon. Do you see further low-cost bottlenecks and capacity increases that you could achieve here in either 2021 or 2022? Is there still much room for you to go after?

At Scotford, there is still some capacity available. However, that won't happen until 2022, as we're working through those plans with our partner. As for Horizon, yes, there are opportunities to enhance production there as well. We are proceeding with some work into 2021, and again in 2022. There is value to be realized as we continue to operate these facilities, and we are always looking for opportunities to enhance production and reduce our costs.

Okay, terrific. Regarding the Scotford, I mean, could you give a rough order of magnitude? Is it similar to what you've just done, around 20,000, or is that too early to determine?

It's too early to say.

Okay. Understood. Moving back to the last conference call, this is pre-Painted Pony. Mark, I think your thinking at that time was that our net debt should be relatively flat year-over-year, excluding Painted Pony. How do you see that shaping up through the balance of the year? You've obviously made good progress this quarter.

Certainly, the commodity prices are ever-changing. That was based on an August pricing strip. However, if you exclude the acquisition, we are going to generate strong free cash flow in the quarter. If you exclude that acquisition, we'll drive toward those levels. The free cash flow we saw in Q3 will be going toward debt repayment, and we expect strong cash flow with the current pricing in Q4.

Okay, terrific. Thanks, guys.

Thank you.

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

Hey, guys, congrats on a good quarter here. The first question I had was regarding your natural gas business. Can you talk about how you see it fitting strategically in the context of CNQ's portfolio? Do you want to grow gas as a percentage of your mix over time? You mentioned strip pricing translating into a $1.2 billion cash flow business. Could you clarify what you think the free cash flow will be? Help us understand the CapEx associated with funding that cash flow?

In terms of our natural gas volumes, our target is to add long-term value. We are looking to maximize value across the asset base, whether it is gas or oil. This year, we started off with a budget of $4.1 billion, which aligned more with oil pricing and value. As natural gas prices strengthened, we reallocating capital within our $2.7 billion budget toward natural gas because it presented better value, especially in Septimus and Townsend. So, there is no intent to grow a single product over another; we continuously modify our plan to maximize value. Regarding free cash flow, it is difficult to quantify a specific number without a major program at Septimus and Townsend in Q4. It's primarily free cash flow generation from our operations.

Understood. The follow-up is about capital spending. Are you still planning on hosting an open house later this year? I assume it would be virtual. Will that be when we get a sense of the 2021 spending? I know you've mentioned some release in December, and any early thoughts on how it could look relative to the $2.7 billion this year?

Hi, Neil, this is Mark. We are still finalizing our plans and do intend to announce or release details in December regarding the 2021 budget. We're still working out how that will be communicated, whether it'll be a full-blown presentation or not, but we are going through it now. It’s too early to indicate direction; we need to finalize the last details first.

Okay, all right. Thanks, guys. Looking forward to it.

Thank you.

Your next question comes from Asit Sen from Bank of America. Your line is open.

Thanks. Good morning. Tim, we've started to see some M&A activity both in the U.S. and Canada. What do you think is triggering this wave? You've mentioned no holes in the portfolio. From a broader industry standpoint in North America, do you anticipate more consolidation? What do you see as the main impediments to consolidation?

Yes, I believe we are in a time of consolidation. There are some very healthy companies and others that are struggling. Consolidation presents opportunities for companies to improve their operations in terms of capital allocation and general administrative (G&A) costs. I think there will be continued consolidation over the next year; it's part of the cycle in the industry.

Great. On your international asset portfolio, you have some solid cash-flow-generating assets in the North Sea and offshore Africa. How do you assess that portfolio? Is there room for deepening or rationalizing it? What are your thoughts?

We are pleased with our internal assets. They generate free cash flow, and we've earned billions from those assets over the years. We're satisfied with them and will continue to invest prudently to generate free cash flow.

Thanks.

You're welcome.

Your next question comes from Menno Hulshof from TD Securities. Your line is open.

Good morning, everyone. I have a question about your In-Pit Extraction Process (IPEP) due to its potential for significant reductions in emissions. You mentioned in the press release that pilot work was slowed down due to COVID. Can you provide an update on the data and your best guess on where things currently stand in terms of the timeline to commercialization if everything goes according to plan? Additionally, how significant is this work in relation to your net-zero aspirational target?

IPEP is an excellent project. We want to pilot it further this year to refine the process. From a sediment stacking perspective, it has worked well, but we needed to achieve higher stackability and recoveries on the higher-refine materials, which were not satisfactory. We aimed to refine these areas, which was to occur this year. However, due to COVID, we have shifted towards commercial engineering alongside the IPEP team to keep that project progressing. As for commercial viability, we are looking at a converted implementation starting around 2026. The transition process will be methodical, with projected commercialization set for that time frame.

So the 2026 timeline still seems achievable?

I believe so. We would like to conduct final testing on the high-refine material to ensure confidence in its performance. So yes, that remains the plan.

And in terms of conversions, are you thinking a timeline of about 3 to 5 years, or is it a bit longer?

Yes, 3 to 5 years is about right.

Your next question comes from Manav Gupta from Credit Suisse. Your line is open.

Hey guys, I think on the last earnings call, Tim, you specifically stated that you would flex your total muscle in Q3, and I think it was underappreciated how strong that muscle was, given the volumes and costs. So congratulations on that. My question here is: as we consider Thermal In Situ production for Q4, we thought as Horizon goes up, Thermal In Situ might come down due to production curtailments. However, since the curtailments are gone, will Thermal In Situ production decrease to around 230, or might it run at a higher rate given that the curtailments have been lifted?

Yes. Thank you for your comments on the Thermal side. For November, Thermal production will be curtailed along with ASOP and other properties. When we reach December, we will start to increase production. We will evaluate how much we want to increase our thermal production based on pricing, being flexible with the cyclic steam side. We may decide it is better to delay a cycle and shift it to next year. We are always analyzing our options to maximize value, so production in December will increase.

For my follow-up, could you elaborate on Enbridge Line 3? What are the next important milestones or data points we can track? In your opinion, could we see a startup for Enbridge Line 3 in 2021?

I understand there is some information expected next week from the courts, which will provide a step forward for the completion of Line 3. Hopefully, it can proceed, targeting mid-2021 for startup. However, for precise information, you may want to speak directly with Enbridge.

Thank you for answering my question.

You're welcome.

Your next question comes from Matt Murphy from Tudor, Pickering, Holt. Your line is open.

Thanks. Good morning. I would like a follow-up about IPEP and how you manage capital associated with achieving net-zero ambitions over time. How do you think about investment in emissions reduction technologies? In the broader capital allocation process, is it a matter of returns versus returns and competing for capital, or is there additional consideration for environmental impact?

We strive to balance both return on investment and environmental considerations. For instance, with IPEP, one motivating factor is that it significantly reduces GHG emissions. Additionally, it eliminates our tailings pond liability, which is a major reclamation issue. We seek projects that complement our operations, provide long-term value, and simultaneously reduce our environmental footprint. Our teams excel at generating innovative ideas to minimize environmental impact while delivering economic returns.

Thanks, Tim. A quick follow-up for Mark regarding the comments on maintaining a largely flat net debt year-over-year. One key moving piece discussed previously was working capital movements in the second half of the year. Could you remind us of your thinking regarding the progression of cash flow from that component in Q4?

It's always challenging to predict changes in working capital, as it depends a bit on pricing as we go through December. In Q3, we did not see the anticipated pickup, but we expected it to contribute to debt repayment along with the free cash flow generated. Predicting changes is challenging, but we expect the ability of our assets to generate free cash flow in Q4 will be evident, even at lower commodity prices.

Thanks, guys.

Your next question comes from Roger Reed from Wells Fargo. Your line is open.

Thank you. Good morning. I would like to understand the dynamics of increasing crude production in December. We've seen rather tight WCS to WTI differentials. As you consider your $31 breakeven and the potential for wider differentials, do you think your tolerance for a wider WCS differential might limit production, particularly as we head into early 2021?

If you reflect on what has transpired over the last year or two, significant production increases have not occurred, particularly on the heavy oil thermal side. From March through November, there was a notable decline in oil storage in Alberta, dropping close to 20 million barrels. As curtailment measures ease along with completed maintenance in our operations, production will increase during winter months. However, I don't foresee significant production additions; operations generally aim for maximum capacity during these months, making it essential that our pipelines operate safely. There have been no notable increases to production capacity, and therefore it depends on how companies choose to run under winter conditions.

That makes sense. Should we consider it a short-term adjustment where you respond to market demands rather than stressing about a specific differential? Given the collapse in the market that initially prompted curtailments, do you think that if we exceed $15, producers will be cautious, or will the market drive everyone to push production out until we're forced to pull back?

Absolutely, fluctuations are a natural part of the cycle. Nonetheless, as production rises, we don't see significant new capacity coming online. The focus will be on maximizing production during the winter months, and we must ensure our pipelines operate effectively and reliably.

Thank you. I appreciate your insights.

You're welcome.

There are no further questions at this time. I'll turn the call back over to the presenters.

Thank you, operator, and thank you, everyone, for attending our conference call this morning. Canadian Natural's large, diverse asset base continues to drive substantial shareholder value. Our teams' capability to deliver effective and efficient operations with top-tier performance contributes to significant and sustainable free cash flow. This, combined with effective capital allocation, supports our goal of maximizing shareholder value. If you have any further questions, please don't hesitate to reach out to us. Thank you, and goodbye.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.