Cenovus Energy Inc. Q1 FY2020 Earnings Call

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy's First Quarter Results. As a reminder, today's call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Please be advised that this conference call may not be recorded or rebroadcast without the express consent of Cenovus Energy. I would now like to turn the conference call over to Ms. Sherry Wendt, Director Investor Relations. Please go ahead Ms. Wendt.

Thank you, operator and welcome everyone to our first quarter 2020 results conference call. Today's call is a slight departure for us. Since we've all been working remotely for the last several weeks due to COVID-19, we are coming to you today not from our conference room downtown, but via cellphone from the respective home offices. If we have any technical issues, we hope you'll bear with us. To keep it simple and limit background noise, we have our President and Chief Executive Officer, Alex Pourbaix, our Chief Financial Officer, Jon McKenzie, our Executive Vice President Upstream Nori Ramsey; and our Executive Vice President Downstream Keith Chiasson on the call to answer your questions. The rest of our leadership team is in listen-only mode today. I refer you to the advisories located at the end of today's news release. These advisories describe the forward-looking information non-GAAP measures and oil and gas terms referred to today and outline the risk factors and assumptions relevant to this discussion. Additional information is available in our annual MD&A and our most recent annual information Form M and Form 40 F. The quarterly results have been presented in Canadian dollars and on and before royalties basis. We have also posted our results on our website at cenovus.com. Alex will provide brief comments, and then we will turn to the Q&A portion of the call with Cenovus' leadership team. We would ask analysts to hold off on any detailed modeling questions and follow-up directly with our Investor Relations team after the call. We would also ask that you keep to one question with a maximum of one follow-up question and then rejoin the queue for any other questions. Please go ahead Alex.

Thanks, Sherry and good morning everyone. I hope that all of you, your friends, and your families are staying safe and healthy during this challenging time. Before I get to our quarterly results, I wanted to briefly touch on the steps we've taken in response to the COVID-19 pandemic to protect the health and safety of our staff and service providers and the continuity of our business. Virtually, all of our office staff and some of our field staff who don't need to be on site for our operations to continue running safely and smoothly have been directed to work from home. At our field operations, we've reduced the number of staff on site, established extensive physical distancing measures, stepped up cleaning procedures, implemented active screening for people traveling to site, brought in mandatory self-isolation policies, and we've restricted business travel. To date, we have not had a confirmed case of COVID-19 at Cenovus, and we're doing everything we can to reduce the risk of that happening. Turning to our first quarter operating and financial results, I expect you've all seen our news release this morning, so I'm not going to spend a lot of time walking through the numbers. I do want to provide you with some insight into what's behind the financial results we reported this morning and how Cenovus is positioned to navigate through the rest of this current downturn. These are obviously unprecedented times for our industry. During the first quarter, the combination of a global pandemic that sharply reduced demand for oil and a supply dispute between two of the world's largest producers, Saudi Arabia and Russia, resulted in a significant drop in benchmark prices for oil and refined products. While we expect the supply-demand imbalance to be relatively short-term in nature, it has led to a rapid decline in share valuations for global energy companies, including Cenovus, and has temporarily impacted financial results for our industry and for our company. The balance sheet has always been a top priority for us, and in this economic environment, that is more true than ever. Over the last few years, we've been relentlessly focused on paying down debt, reducing costs, and maintaining capital discipline. As a result, we came into this downturn with a relatively strong balance sheet. We also have ample liquidity in place to see us through this downturn. Right now, our number one priority is protecting the health of our staff. After that, our focus remains on preserving our balance sheet, maintaining liquidity, and continuing to manage our business to drive our cash flow breakevens as low as we can. During the first quarter, the combination of the sharp decline in benchmark oil prices and widening light-heavy differentials in Alberta contributed to a more than 50% drop in realized pricing for our barrels compared to the first quarter of 2019. It has also resulted in a number of temporary impacts to our financial results. For example, the condensate we used to blend with our heavy oil was purchased a few months ago when prices were higher, which negatively impacted our upstream results. The same principle applies to refinery feedstock, which negatively impacted our refining and marketing results. Additionally, due to the rapid decline in oil prices during the quarter, we recorded significant non-cash inventory write-downs and asset impairments which combined with the non-operating foreign exchange loss contributed to the operating and net losses we reported this morning. We know this pandemic will pass, and the markets will recover. As benchmark prices begin to return to more normalized levels, we expect to see these price-driven impacts to our business begin to reverse themselves. I fully believe we'll see share prices for our industry recover as well, but it's not clear how long that's going to take. While we can't influence the macroeconomic environment, there's plenty we can do to protect our balance sheet during this challenging period, and that's exactly what we've been doing. We were in a strong financial position coming into 2020. We had net debt of $6.5 billion, down almost $2 billion from a year prior. We had and continue to have among the lowest cost structures in the industry. In 2019, we demonstrated that in a West Texas Intermediate environment of $45 or more, we have significant cash-generating potential. In 2019, we delivered $2.5 billion in free funds flow, which reflects the true underlying strength of our assets, our financial position, and our business plan. We are not in a $45 WTI world at the moment, so we've taken decisive steps to improve the resilience of our business and protect our balance sheet for the duration of this downturn. On March 9th and again on April 2nd, we took advantage of the flexibility in our business to make significant adjustments to our 2020 budget and business plan. We reduced our planned production volumes for the year and are actively managing production levels as market conditions change to optimize the value we receive for our products. We cut planned capital spending by $600 million and revised our forecast operating results for this year by about $100 million. We trimmed our planned G&A costs for the year by about $50 million, which includes pay reductions for me, our Board, and our executives and to a lesser degree our staff. We deferred final investment decisions on growth projects and have now essentially ramped down our crude-by-rail program. We suspended our dividend, which we've always said would be sustainable at a West Texas Intermediate price of $45 or more. We also worked to improve our already strong liquidity position, adding another $1.1 billion of committed capacity with some of our lenders this month. Together with our largely undrawn existing committed credit facilities and uncommitted bilateral credit lines, we have liquidity to sustain operations through an extended period of low oil prices. To sum up, we've been proactive about protecting our balance sheet and enhancing our liquidity and I believe we are in a relatively strong position to navigate the current commodity price environment. While the significant changes in the macroeconomic and business environment over the last couple of months have impacted our recent financial results, the underlying strength and value of our business has not changed. And with that, let's get straight to your questions. What I'm going to do is probably do a little quarter backing and either take the call or direct who I think should answer just to try to make things a little bit easier. So, with that, let's open it up for questions.

First question comes from Greg Pardy with RBC Capital Markets.

Thanks. Good morning Alex, and Jon and others. A couple of quick ones for you. I guess just with respect to the 60,000 that you've got shut in right now. I'm just wondering if you could provide just more background around that. Is that all at Christina Lake, is this the implementation of dynamic storage that you've used successfully in the past? And is that number kind of climbing as we speak or is it relatively stable?

Hey Greg, it's Alex. Why don't I have Norrie respond to that and then I might give a little bit of color at the back.

Sure. Hi, it's Norrie Ramsay here. Just a bit of context, we have taken about 60,000 barrels a day down from Christina Lake, that's correct. A lot of it is driven by our mandatory production curtailment cap that we actually have in Calgary.

Okay. And is this dynamic storage? In other words, are you still injecting steam in the system or is this more akin to shut-in?

Yes, I mean we've just tailed back some production. So, we have very low OpEx and very low cost per barrel. What we're doing just now is really optimizing value rather than volume. At this stage, we're not putting it into storage, but we have that flexible ability to do that if required.

Yes. And Greg, it's Alex. Just to add to Norrie's comments, we are continuing to steam the reservoirs. So, this really falls within that dynamic storage process that we've discussed before. One of the benefits of our business is our very low variable cost of production. We're always going to do the right thing. As long as we are covering our variable costs and making a contribution to the fixed costs, we would generally look to keep that production going, but we will be very thoughtful in looking at the overall situation.

Okay. Terrific. Last one for me, maybe for Jon. You've got a lot of liquidity in place. It looks like it's certainly very large in relation to your cash burn this year, but just any color around that would be great as to how you see the year unfolding with obviously a lot of moving pieces right now?

Yeah. Thanks, Greg. It's very difficult to understand how the year is going to unfold because you're right. There are so many moving pieces and they're all moving with a velocity that we haven't really seen before. So what we've done, consistent with our management philosophy, is we have been very conservative in the way that we've positioned our balance sheet, positioned our liquidity, and cut costs to make sure that we're sustainable regardless of what happens through the end of the year. On the liquidity side, we've added a $1.1 billion revolver to our portfolio just to increase that liquidity over time. We've also got $4.5 billion in our syndicated facilities. We've got a $1.2 billion facility that matures on November 22 and $3.3 billion that matures on November 23rd. All together, we're up to $5.6 billion in banking facilities today. On top of that, we also have some bilaterals. We've got $1.6 billion of uncommitted bilaterals. So all-in, it's about $6.7 billion. We think that will be adequate to get us through anything that the year is going to throw at us and certainly well into 2021. We feel very good about that. In terms of our cash burn and profile, it's really difficult today to get a firm handle on it because things are moving around. But the way we look at it is through a breakeven analysis. We've cut capital, the dividend, and taken prudent steps to reduce our all-in cash breakeven to about $38 WTI. And from that, we see the cash burn measure based on how we recalculate it with underlying assumptions. That's how we think about it and how you can best model it, understanding the sensitivities around that.

Sure. There's been significant discussion with both the Alberta government and the federal government about the need for incremental liquidity support. There are relatively few companies like Cenovus and several of the bigger companies that have been able to put significant liquidity in place to support their business during this downturn. However, this does not apply to the entire industry. There's an essential need for the government to provide immediate liquidity support to the industry. We've been hearing for weeks that support is coming. However, weeks have passed, and the industry is still waiting. We're gathering significant deficits as a result of this crisis. Once the current situation passes, we're going to need a rapid injection of revenue to support Canadian economic recovery. The energy industry is the largest contributor to Canadian GDP. In 2008, 2009, the energy industry actually led the recovery. With adequate liquidity support from the government, I truly believe the industry can do that again. The industry does not ask for handouts; it is looking for a temporary safety net. I also want to give appreciation to the Canadian banks that I have engaged with. They see the importance of this industry and have been very supportive in providing liquidity.

Yeah. No, thanks guys. Great answers.

Next question comes from Emily Chieng with Goldman Sachs.

Hi. Good morning. Just a follow-up from one of Greg's questions if I may. I remember in November 2018, production across Foster Creek and Christina Lake was taken down by about 100,000 barrels per day. How should we think about the 60,000 barrels that you're mentioning today? Is that a matter of taking the time to safely reduce production further? Should we expect to see more production cuts in the near term, or is there something else that we're not considering here?

Thanks for the question, Emily. As I mentioned earlier, our decisions in the field are based on daily analyses, covering our variable costs and making a contribution to fixed costs. The cuts we've made today are in line with that analysis, and we do this every day. Back in the fourth quarter of 2018, we took production down significantly. We have the capability to continue that for quite a while and we are comfortable making deeper production cuts if necessary.

Got it. That's helpful. My follow-up is around the CapEx profile for the remainder of the year, given the full-year guidance midpoint of around $800 million. This would imply about $170 million going forward on a quarterly basis. What does this mean for operations? What types of activities make the cut and what doesn't?

Norrie, do you want to take that?

At Christina Lake, we've retained a number of pads that are ready to start-up. We've just left them off right now since we don't need the production. We're only spending money on the lowest-cost netback activities, balancing the ability to retain our low production while having the opportunity to ramp up in the future as oil prices improve.

Emily, I would just add that we are confident we can maintain this level of capital expenditure for the balance of the year, and beyond if conditions continue to be challenging.

Next question comes from Manav Gupta with Credit Suisse.

Can you help us understand a little bit how the condensate price lag was a headwind in Q1, and as condensate prices have come down, how should we expect that to help you in terms of bitumen realizations going into Q2 and Q3?

I'll leave that to John or Keith to address.

Manav, we source condensate from two pools, from Western Canada and the U.S. from Mont Belvieu. The condensate travels from Mont Belvieu with a two- to three-month lag between procurement and delivery. We carry our inventory based on a weighted cost basis, meaning that the condensate lag seen in Q1 will continue through this month and by mid-May, we'll be into much cheaper condensate available today.

Thanks. A quick follow-up here is you have suspended rail contracts. I'm trying to understand if the transportation and blending cost at Foster is still higher relative to Christina? Is there a point when we start seeing the transportation costs come down as some of these rail contracts roll off?

Yes, in Q1 we moved more of the Foster Creek production through our rail connectivity to the Gulf Coast. We still moved about 100,000 barrels a day in Q1, which is ramped down as of today. You should see the impact of the reduced rail costs in transportation and blending, along with the reduced condensate costs in Q2.

Thank you, guys. Thank you for taking my question.

Next question comes from Phil Gresh with JPMorgan.

Hey. Good morning. My first question was a follow-up on transportation costs. You've said in the past that about a third of those costs are fixed. Could you elaborate on how that will influence Q2 and beyond in transportation costs and any flexibility around this?

If you look at our full rail costs on a fully loaded basis for one year, it's about $81 million. By ramping down these costs get to about $18 million a year. There's significant savings when moving from a fully loaded variable cost down to that level. It was the right decision to ramp down rail at this point based on where differentials have moved.

Yeah. Thanks, John. We ramped down at the end of April. We spent some capital back in 2019 building out storage capacity for cars at our Bruderheim facility, which is in place for storing cars or quickly ramping back up the program if needed. Fixed costs remain around 20% of where we were running when we had the full program.

Okay. Great. Thank you. Second question is a follow-up, John, regarding your comments around the breakeven, which were very helpful. Curious about the tax situation this year. Your guidance had indicated no cash taxes due to material pre-tax losses. Is all of that factored into the way you framed that breakeven?

Yes, Phil, we don't anticipate being cash taxable in Canada or the U.S. this year. Our add backs have been largely used up, so zero cash tax is what you should be modeling for 2020.

Next question comes from Asit Sen with Bank of America.

Thanks. Good morning. Alex, good morning. I wanted to follow up on the earlier question regarding dynamic storage. I see a number of factors to consider to avoid reservoir damage. Can you talk a bit about how you're managing this?

Sure. Norrie, do you want to address that?

We're slowing down our pumps to allow oil levels to rise in the reservoir and that allows us to store oil. We continue to inject steam into the pads to keep temperatures correct and maintain flow. We're confident we can maintain production without jeopardizing reservoir integrity.

Thanks for the color. Alex, a follow-up on the crude-by-rail program and thinking about the cost arbitrage of transportation. How do you think this balances with pipelines as we look longer term?

The key is to evaluate the market egress challenges getting out of Alberta. If there are economic arbitrages, we will consider rail contracts, but we've kept them to relatively short tenures to stay flexible in response to market conditions.

Next question comes from Benny Wong with Morgan Stanley.

Hey, guys. Good morning. Thank you for taking my question. I wanted to know about storage. Can you provide an update on storage or inventory levels in Alberta and what your marketing and storage capabilities are to navigate this situation?

Keith, why don’t you address that?

Currently, we see Alberta’s inventory levels flat at around 32 to 33 million barrels, and Cenovus has significant storage capacity exceeding over 10 million barrels, giving us flexibility to capture market opportunities.

One of the attractive features of our business is our very low variable cost of production, which allows contribution to fixed costs even at low prices. This positions us well during these circumstances.

Thank you very much, guys.

Next question comes from Joe Gemino with Morningstar. Please go ahead.

Thank you. How do you feel long-term about market access after supporting the Canadian Mainline push for take-or-pay contracts? Have your views changed given the current environment?

Keith, would you like to address that, and I may add some context?

Market access has been a big challenge over the past decade. We see some progress on a few growth projects like TMX and KXL, which is under construction now. We've been a supporter of Enbridge moving to a mainline, and while the process may drag out due to the COVID crisis, we remain committed.

Thank you.

Next question comes from Harry Mateer with Barclays.

Looking at your next bond maturity in the second half of 2022, are you preparing for that given your increased debt load? What liquidity or balance sheet levers might you consider?

Jon, would you take that?

We value our investment-grade ratings, and we believe in ensuring liquidity to facilitate a path towards our target owing debt. We are aware of the 2022 and 2023 maturities, and we will address them in the coming quarters, but we are currently focused on maintaining liquidity.

Thank you. I appreciate the details on your strategy.

Next question is from Fai Lee with Odlum Brown.

I was wondering how your reported net debt-to-capital ratio of 30% compares to your covenants? How do non-cash write-downs affect those calculations?

Jon, would you cover that?

The capital ratio of debt to consolidated capital is on a book capital basis. We would have liquidity long before approaching close to that 65% range for covenants, and the write-downs are minimal in impacting that covenant.

Okay, but those write-downs do affect covenant calculations?

Yes, they do.

Next question comes from an unidentified analyst with Wall Street Journal.

I wanted to see if recent volatility is prompting a rethink of your hedging strategy. Have your attitudes toward hedging changed?

I'll let John address that, then I may add my take.

Alex, Keith, and I agree that a bullet-proof balance sheet is the best hedging policy. Hedging becomes challenging with dirty hedges because we have no clean forward market for our product. Thus far, we're not inclined to lock in losses at this market stage, but we may explore hedging as commodity prices recover.

I agree with John; hedging decisions are more appealing as prices increase. Currently, locking in losses does not reflect a thoughtful strategy for hedging.

Next question comes from Chris Varcoe with Calgary Herald.

Alex, regarding liquidity measures, what additional support do you want to see from the federal government for the industry?

I am focusing on liquidity for the industry, which has suffered due to the pandemic and price war. Protecting the energy sector, a critical contributor to the economy, is essential for recovery. Therefore, immediate liquidity support needs to be ensured by federal and provincial governments. While discussions are ongoing, urgent action is required.

Does the industry still require further production cuts in your mind?

The market right now appears to be working. We have seen a significant reduction in production this month. I think we can continue to monitor storage levels, and should they begin to reach their limits, we may need to take further action.

Next question comes from Dan Healing with Canadian Press.

Has the shift to remote working created long-term savings for the company in terms of office space?

This is an important question, Dan. Our productivity seems to remain high, and we may find operational benefits with reduced face-to-face meetings. However, the long-term effects of extended remote work on productivity are still uncertain.

What about headcount changes compared to last year?

Certainly, we've made tough staffing decisions in the past that have led to a sustainable workforce. Presently, contractor headcount has reduced due to ramping down operations.

Next question comes from Kevin Orland with Bloomberg News.

How long do you expect it to take for oil demand to normalize in North America?

It's challenging to predict. We observe that demand in China is returning to pre-COVID levels. In North America, as states and provinces relax restrictions, upward demand trends are expected, specifically during the summer months. We will recover upstream production gradually as we work through current storage levels.

And at this time, I will turn the call back to the presenters.

I want to thank everyone for taking the time to hear our presentation and for the thoughtful questions. Please keep safe during these challenging times. Take care.

This concludes today's conference call. You may now disconnect.