Canadian Natural Resources Ltd Q2 FY2021 Earnings Call

Good morning. We would like to welcome everyone to the Canadian Natural Resources 2021 Second Quarter Earnings Conference Call and Webcast. After the presentation, we will conduct a question-and-answer session. Instructions will be given at that time. Please note that this call is being recorded today, August 5, 2021 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, sir.

Thank you, operator, and good morning, everyone, and welcome to Canadian Natural’s Second Quarter 2021 Corporate Update Conference Call. Canadian Natural had another strong quarter financially and operationally. As I mentioned before, I believe our asset base is unique amongst our peer group, underpinned by long-life, low-decline assets, and complemented by our conventional assets that allow significant flexibility, all of which can generate significant free cash flow. Beyond our robust asset base, there is a corporate strategy that focuses on generating real returns for shareholders, along with a driven management team and a corporate culture that prioritizes effectiveness and efficiency. Over the years, Canadian Natural has clearly demonstrated its robustness, sustainability, and the strength of its business plan. For 2021 and beyond, I believe we are among only a few companies capable of delivering meaningful economic growth, increasing returns to shareholders, and reducing absolute debt in a responsible manner. As both Tim and Mark will discuss, we’re pleased to provide further clarity on how our substantial future free cash flows will be disbursed among our four pillars. For today’s call, Tim McKay, our President, will first provide a corporate update, followed by Mark Stainthorpe, our Chief Financial Officer, who will provide an update on our 2021 financial outlook as well as our strong financial position. Tim will then provide a summary prior to opening up for questions. Before we kick off, I’d like to remind you of our forward-looking statements of note. In our reporting disclosures, everything will be denominated in Canadian dollars unless otherwise stated, and we report our reserves and production before royalties. I would also suggest reviewing our comments on non-GAAP disclosures. So with that, I’ll turn it over to you, Tim.

Thank you, Corey. Good morning, everyone. Canadian Natural delivered strong operational results in the second quarter, as we achieved quarterly production of approximately 1.142 million BOEs per day. As a result of our long-life, robust, low-decline assets and operational excellence, combined with our capital discipline, we generated significant free cash flow. We balance free cash flow towards our four pillars of capital allocation, maximizing value for our shareholders. In the first two quarters of 2021, we have reduced net debt by $3.1 billion and returned approximately $1.3 billion to our shareholders through dividends and share repurchases while maintaining capital discipline and executing on opportunistic transactions, which will add long-term value. The strengths of Canadian Natural’s business model also apply to environmental, social, and governance objectives, delivering industry-leading performance across the board – a significant factor in our long-term sustainability. From 2016 to 2020 in our oil sands operation, our GHG intensity is down 38%. North American E&P methane emissions are down 28%. Over that timeframe, we have effectively taken the equivalent of over one million cars off the road annually. Furthermore, we are the leading capture and storage of CO2 in the oil and gas sector worldwide. Our safety record is top tier as the corporate total recordable industry frequency improved to 0.21 in 2020, a reduction of 58% from 2016 levels. In June, we announced the Oil Sands Pathway to net zero initiative, an alliance of oil sands industry participants with the goal of achieving net zero emissions in oil sands operations by 2050. This is an important initiative for the industry that will enhance Canadian Natural's leading ESG performance while delivering meaningful emission reductions and balancing sustainable economic development. This will require collaboration with the federal and Alberta governments, allowing us to contribute towards Canada’s climate goals. With a positive outlook for commodity prices for 2021, we have increased our annual capital budget by $275 million. The breakdown is as follows: our conventional and unconventional budget has increased by $120 million, primarily for additional drilling of 78 wells and development activities with a targeted capital efficiency of approximately $8,400 per flowing BOE, resulting in a 2021 exit rate of approximately 14,000 BOEs per day. Additionally, $110 million is related to our long-life, low-decline assets, of which $75 million primarily pertains to the additional scope and extended turnaround time to complete the Horizon overhaul in Q2. $35 million of the $110 million is earmarked for the construction of three pads at Primrose, two at Kirby North, and two at Kirby South to support production additions in 2022 and beyond. Our area-based abandonment programs have proven to be highly cost-effective, and as a result, we have added an additional $45 million to our 2021 capital budget, targeting an additional 800 well abandonments as we continue to prudently manage our liabilities and environmental footprint. All of these additional expenditures will generate an estimated increase of 1,500 jobs across Alberta, British Columbia, and Saskatchewan. Moving to our natural gas assets, Q2 production was 1.614 Bcf per day, an increase from 1.598 Bcf per day in Q1. North American Q2 natural gas production was 1.591 Bcf, up from Q1's 1.5815 Bcf, despite Pine River's decline of approximately 100 million during the full quarter. As of July 24, the plant resumed operation and is currently producing approximately 100 million a day. We remain focused on operational excellence, and in Q2, our North American natural gas operating costs were a strong $1.15 versus Q1's $1.24 per Mcf. At Septimus, a five net well pad came on stream in June as budgeted, with total current rates limited to approximately 30 million a day of natural gas, achieving a strong capital efficiency of approximately $5,000 per flowing BOE. Septimus is not yet at full capacity, which is approximately 150 million a day of natural gas and 9,000 barrels a day of liquids, and is targeted to remain at full capacity for the remainder of 2021. At Townsend, a six well pad started operations in June on time and on budget, with total rates of approximately 55 million cubic feet of natural gas for strong capital efficiencies of approximately $4,000 per flowing BOE. Production at Townsend reached approximately 265 million cubic feet of natural gas in Q2 and is on track to exit 2021 at a production rate of approximately 340 million cubic feet per day. Looking towards the second half of 2021, AECO strip prices remain strong at over $3.50 per GJ, improving the economics of our natural gas projects and adding more value to our natural gas production. We have revised our natural gas guidance up to a range of 1.68 Bcf per day to 1.72 Bcf, targeting an exit above 1.8 Bcf per day for 2021. Our Q2 North American light oil and NGL production stood at 98,559 barrels per day, up 6% from Q1 2021, primarily driven by the company’s drilling and development activities. Q2 operating costs decreased to $14.39 per barrel compared to $16.07 per barrel in Q1. The company is advancing its high-value Montney light crude oil development at Wembley, where 13 net wells have been drilled to date, ahead of schedule, and under budget in relation to the targeted 18 net wells slated to be operational in 2021. Cost efficiencies on the Wembley drilling program are realized, with targeted costs being 12% lower than budgeted levels, resulting in a strong capital efficiency of approximately $8,300 per flowing BOE once on stream. The construction of the new crude oil battery and gathering system has top-tier status and is approximately 45 days ahead of schedule, now targeted to be online in mid-August, with costs expected to be under budget by 11%. This project is projected to exit 2021 with total production rates of approximately 8,500 barrels per day of liquids and 30 million cubic feet of natural gas. The International E&P crude oil production averaged 32,697 barrels per day in Q2 2021, a decrease of 26% from Q2 2020 levels, but a 3% increase from Q1 2021 levels. The changes in production from prior periods result primarily from planned maintenance activities, natural field declines, and the permanent shut-in of the Banff and Kyle fields in 2020. Crude oil operating costs increased from prior periods mainly due to lower volumes and planned maintenance activities in the North Sea and Offshore Africa as well as increased GHG and energy costs in the North Sea. Q2 heavy oil production increased to approximately 66,000 barrels a day compared to about 62,700 barrels per day in Q1, primarily due to the company’s drilling and, to a lesser extent, increased development activities linked to higher prices in the quarter. Q2 operating costs rose to $19.32 per barrel, compared to $18.89 per barrel in Q1. At the company’s Clearwater play at Smith, all six net horizontal multilaterals are now operational, with current production from these wells totaling approximately 2,200 barrels per day, exceeding budgeted rates by 600 barrels per day. As part of our additional capital efforts, the company aims to drill an additional 70 heavy oil wells, including another pad of six net horizontal multi-flow laterals at Smith, which will be drilled and come on-stream in Q4. This pad is also targeting strong productive rates of approximately 2,000 barrels a day. A key component of our long-life, low-decline assets is our world-class Pelican pool, where leading-edge polymer flood continues to deliver significant value. Second quarter production was 55,212 barrels per day, comparable to the first quarter's approximately 57,500, primarily due to well drilling program activities offset by natural field declines. Operating costs have remained strong at $6.90 per barrel compared to $7.38 per barrel in Q1. During the quarter, the company brought on stream 10 net wells, which currently have a production capacity of approximately 1,300 barrels per day at low capital efficiencies of $9,900 per flowing BOE. Our Pelican team continues to drive operational excellence, and with our low decline and very low operating costs, Pelican continues to provide excellent netbacks. Our second quarter Thermal production reached 258,551 barrels per day, down 3% from Q1. Operating costs in Q2 were 3% higher at $11.78 per barrel compared to Q1 operating costs of $11.40 per barrel, primarily due to lower volumes in the quarter. At Primrose, the steam flood area, a solvent injection pilot is on track to commence in Q4 2021, similar to the first pilot at Kirby South, which is also set to operate for a two-year period. In our Oil Sands Mining operations, we reported a strong second quarter with production of 361,707 barrels per day, including maintenance at Horizon and Scotford during the quarter, at strong operating costs of $25.46 per barrel of SCO. Our teams continue to leverage technical expertise between the two sites and drive our costs down consistently. The company’s continuous improvement initiatives have led to high utilization and reliability at the Oil Sands Mining and Upgrading assets. As a result, we achieved a record monthly SCO production of approximately 495,100 barrels per day in June 2021, an increase from the previous record of approximately 490,800 barrels per day of SCO in December 2020. I will now turn it over to Mark for the financial review.

Thanks, Tim, and good morning everyone. The second quarter was strong operationally and financially, delivering net earnings of $1.55 billion, significant adjusted funds flow of $3.05 billion, and free cash flow of approximately $1.5 billion after capital and dividends in the quarter, excluding acquisitions. As a result of this significant free cash flow generation, our net debt balance at Q2 2021 of $18.2 billion is down $3.1 billion from the end of 2020. The net debt reduction from Q1 2021 was approximately $1.7 billion. This debt reduction includes the full repayment and cancellation of our Devon acquisition term facility of $2.125 billion during the quarter. We’ve also exercised the par call option on our bonds due in November to repay early in August, leading to interest cost savings and further absolute debt reduction. Additionally, up until August 4, we have returned over $1.5 billion to shareholders in 2021 through our dividend that was increased in Q1 and share repurchases. Our long-life, low-decline assets support a sustainable, growing, and predictable dividend. This was evident through the period of challenging commodity prices in 2020, where we increased and maintained our dividend with another increase in March 2021, marking the 21st year of consecutive dividend increases. We continue to maintain significant liquidity, with revolving bank facilities, cash, and short-term investments. Liquidity at Q2 2021 was approximately $5.6 billion. We had approximately $680 million in commercial paper, which we reserved capacity under revolving facilities. Free cash flow generation in 2021, defined as adjusted funds flow less budgeted capital and dividends, is targeted to be substantial. Using an annual average WTI of approximately US$66 a barrel, free cash flow is targeted to range between $7.2 billion to $7.7 billion. As a result of this strong free cash flow and increasing balance sheet strength through 2021, the Board of Directors has revised our share repurchase policy effective July 1, 2021, authorizing management to increase returns to shareholders through incremental share repurchases of approximately 1% of shares outstanding, or approximately 11 million shares per quarter. Additionally, the new policy specifies that once the company reaches an absolute debt level of $15 billion, currently targeted for Q4 of 2021, 50% of free cash flow will be allocated to share repurchases, with the remaining 50% focused on further strengthening the company’s balance sheet. This provides balance to our four pillars of capital allocation, increasing returns to shareholders, further debt reductions, economic resource development, and opportunistic acquisitions. This clearly demonstrates the sustainability of our business model and the capability of our unique long-life, low-decline asset base with low maintenance capital requirements and effective, efficient operations to generate significant free cash flow. With that, I’ll turn it back to you, Tim.

Thank you, Mark. Canadian Natural’s ability to deliver significant sustainable cash flow is driven by our effective and efficient operations, our high quality, long-life, low-decline assets, which have low maintenance capital and significant reserves. Canadian Natural’s advantage lies in our capacity to effectively allocate cash flow to our four pillars. In Q2 2021, we balanced our commodities with approximately 43% of our BOEs from light crude oil, 34% from SCO, 34% heavy oil, and 23% natural gas, which gives us exposure to all improving commodity prices. We have raised our annual production guidance to a range of 1.220 million BOEs to 1.267 million BOEs per day. We will continue to allocate cash flow to our four pillars in a disciplined manner, maximizing value for our shareholders, all driven by effective capital allocation, efficient operations, and our teams who deliver top-tier results. In March, our dividend was increased by 11%. We have maintained 21 years of consecutive dividend increases with a CAGR of 20% during that time. Effective July 1, 2020, the Board authorized management to repurchase 1% of the common outstanding shares per quarter, and once net debt falls below $15 billion, we will allocate free cash flow—defined as adjusted funds flow minus budgeted capital and dividends—50% to repurchasing shares and 50% to strengthening our balance sheet. As we achieve our interim environmental targets, we will set new ones. By 2030, we aim to reduce methane emissions by 50% from our 2016 baseline, and by 2026, we want to decrease freshwater usage intensity in situ and mining by 40% from our 2017 baseline. Through our Oil Sands Pathway to net zero initiative, we will collaborate with our industry partners to advance key milestones as we work towards our goal of net zero in oil sands by 2050. In summary, we continue to focus on safe, reliable operations, reducing our environmental footprint and enhancing our top-tier operations. Canadian Natural is generating top-tier cash flow. We are unique, sustainable, robust, and we clearly demonstrate the ability to deliver returns to our shareholders by balancing our four pillars. That concludes our Q2 call. I will now open the line for questions.

Your first question is from Greg Pardy with RBC Capital Markets.

Thanks. Good morning, and thanks for the rundown, guys. A couple of questions for you. The first one is just on Horizon, AOSP, and I’m just wondering how anomalous the 495,000 barrels a day in June is and if that’s something that is setting up more of an achievable number on a sustained basis?

Yes, that’s exactly what it’s doing for us, Greg. Over the last six months, you've seen continuous improvement from roughly 491,000 to 495,000. That’s precisely what it’s all about. It’s about the little increments we are making on site at both locations to improve reliability and enhance predictability in our production. Therefore, the goal is to get closer and closer to those numbers on a sustainable basis over time.

Okay. And does that have much impact on your operating costs? Or will it allow you to absorb either higher gas prices or higher power prices?

Yes, operationally, those incremental barrels are very low in terms of cost efficiencies. So yes, it will help absorb some costs related to fuel and some of the commodity inflation we’re seeing, including labor and steel, et cetera. So yes, it helps mitigate that and continues to drive those costs down in the oil sands.

Okay, terrific. And last one for me is, you made changes with the North West Upgrader. We understand the financial implications, but what’s happening operationally? Are you guys becoming more operationally involved at the North West Upgrader?

Yes, that’s correct. We’ve appointed one of our operational personnel from Horizon, who has a strong capability to help that operation become more reliable and achieve higher utilization. This process will take some time, but yes, we have onboarded a Canadian Natural person into that role to assist in improving operations, which we expect will generate some cash over time.

Okay, traffic. Thanks very much.

Thanks, Greg.

Your next question is from Neil Mehta with Goldman Sachs.

Good morning, guys. A lot of cash in the guidance here this morning; good to see. So, a couple questions related to that. The first one is about capital spending. You’ve picked up that level this year on the back of financing that came through. Any early insights around 2022? Should we be thinking in the $3.5 billion to $4 billion range? Or do you see upside or downside to that number? And then I have a follow-up question around the dividend?

It’s too early; we traditionally prepare our capital budget in the fall, where we re-evaluate the different commodities and look at prices at that time to be prudent with our capital budget. So, it's too early to say. If you look back in time, when we built the capital budget for 2021, it was based on $45 WTI and $2.50. So, the increase in capital spending is just an opportunistic move to efficiently keep some of the activities we're managing well progressing.

And your view on sustaining CapEx? Just remind us, Tim, where do you think that level would be to keep production flat?

It’s generally in the $3 billion to $3.5 billion range. It always depends on the types of activities we perform, and this year it was $3 billion. So, in summary, it’s usually in that range.

Okay. The follow-up is just around the dividend. As you said, you have a long track record of increasing it. Any thoughts, given the amount of cash in the model, on doing another dividend raise later this year? And what’s your view on the dividend growth profile going forward?

Hi, Neil, it’s Mark. Thanks for the question. The dividend, as you noted, has increased for 21 straight years; it’s consistent and predictable. The board typically reviews it in the March timeframe, but given our free cash flows in 2021 and into 2022 being substantial, there will be opportunities for the board to consider continuing that growing dividend strategy. The free cash flow allocation policy was developed due to the accelerated repayment of debt in 2021, with the $15 billion target in Q4 approaching quickly. I believe that the ongoing returns to shareholders provide balance to the capital allocation across our four pillars for the remainder of the year. Thus, the dividend will be reassessed during our regular and predictable times.

Okay, perfect. Thanks, guys.

Your next question is from Manav Gupta with Credit Suisse.

Hey, guys, first of all, you always have a very informed view on apportionments, risk capacity as it relates to line three, where the inventories are, and what your near-term outlook for differentials is. Could you provide some of those details?

Sure. Currently, the apportionment is high, at record levels around 52% to 54%. There is some maintenance being performed on line three. However, all barrels are flowing, and inventory levels in Alberta have remained steady at around 35. The differentials have been extremely strong and are less than 20% of WTI. Looking ahead, we expect line three to come online in Q4, providing us with extra capacity as TMX progresses in 2023. Therefore, we remain quite optimistic that developments are progressing positively.

Okay. And a quick clarification regarding the revised guidance of discretionary cash flow post-dividend. It increased from 5.7 to 6.2 to 7.2 to 7.7 billion. Besides changes in the oil price deck, was there anything else that drove the increase in cash flow, or was it simply a matter of price changes?

No, most of the change was indeed due to the price deck as well as our continued reliable operations targeted for the rest of the year.

Thank you for the clarification, and thank you for taking my questions.

Thank you.

Your next question is from Roger Read with Wells Fargo.

Yes, good morning. I would like to follow up on some medium to long-term emissions reduction goals. When do you expect the CapEx to be allocated? Is it already happening, or will it be distributed on a regular basis to meet various annual targets? Furthermore, could you discuss some ancillary benefits in terms of improved operations, returns, and overall better cash flows? What are some of the upside opportunities besides regulatory incentives?

Yes, it's early to comment as we've only conducted high-level conceptual analysis on the trunk line and the sites involved. Our teams have been evaluating different technologies to ensure the most cost-efficient means of reducing CO2 on-site. It’s too soon to outline exact timelines for capital expenditure allocation. The ultimate benefit we aim for is net zero in oil sands by 2050. We’ll identify new milestones and develop clarity on costs and allocations as this process progresses.

I appreciate that context regarding oil sands. I was actually referring to the 2030 targets related to methane reduction and freshwater usage. I'm sure I won't be around to hold you accountable in 2050.

Yes, regarding methane reductions, our field operation teams have made significant strides in using the latest technologies to detect leaks and opportunities for reducing fugitive emissions. The economic benefit is clear since more natural gas will be sold. Additionally, some sites can consolidate operations at an economic advantage. The same applies to freshwater usage; increased water recycling lowers energy demands, improving efficiency in operations. Overall, these initiatives yield economic benefits and complement our operating costs.

Great, thank you.

Your next question is from Menno Hulshof with TD Securities.

Good morning, everyone. I just have one question regarding shareholder returns. You clearly prioritize a 50% free cash flow allocation towards buybacks once the $15 billion debt target is achieved. This precludes variable and special dividends, which have gained traction in the U.S. Can you remind us how you philosophically view different shareholder return mechanisms and whether variable or special dividends could ever be part of that conversation, or is that too far-fetched?

Yes, Menno, when we evaluate the asset base—its long-life, low-decline, and predictable cash flow—it supports a sustainable dividend that grows year after year. That's been our focus. Of course, dividends and allocations to shareholders are board decisions, but this approach aligns well with our asset base and provides opportunities for shareholder returns through buybacks as we generate increasing free cash flow.

Looking back to 2020, we were among the very few companies to grow our dividend while maintaining our balance sheet. Our assets lend themselves to a predictable and growing dividend strategy.

Perfect, thanks a lot.

There are no further questions. I will turn the call back to Mr. Bieber.

Thank you very much, Operator. Thank you to all who joined us today on the call. If you have any further questions, please don’t hesitate to follow up. Thank you, and goodbye.

That concludes today’s conference. You may now disconnect.