Canadian Natural Resources Limited (CNQ) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2012 Second Quarter Conference Call. I would now like to turn the meeting over to Mr. John Langille, Vice-Chairman of Canadian Natural Resources. Please go ahead, Mr. Langille.

Thank you, operator and good morning everyone. Thank you for attending this conference call where we will discuss our second quarter results and review our planned activities for the balance of 2012 and in some cases beyond that. Participating with me today are Steve Laut, our President, and Doug Proll, our Chief Financial Officer. Before we start, I would refer you to the comments regarding forward-looking information contained in our press release, and also note that all dollar amounts are in Canadian dollars and production and reserves are both expressed as before royalties unless otherwise stated. I’d like to make some initial comments before I turn the call over to Steve and Doug for their in-depth discussion. The second quarter saw us meet our production guidance and achieve record production. Crude oil production grew to over 470,000 barrels per day from the 395,000 barrels per day in the first quarter, and natural gas production remained at over 1.2 bcf per day. This growth was driven by firstly, the best quarterly production of SCO ever from Horizon, our oil mining project. Quarterly production averaged over 115,000 barrels per day as the completion of a third ore preparation plant greatly enhanced reliability. Secondly, we have continued strong production from our primary heavy oil areas, which averaged over 122,000 barrels per day. And thirdly, production response of our thermal in situ project at Primrose returned to a production cycle from a steaming cycle. Daily average production from this project grew to 94,000 barrels from the first quarter average of 80,000 barrels. This strong production together with emphasis on cost control and reduction of cost contributed to the growth in our quarterly earnings and cash flow. Cash flow amounted to $1.75 billion, up from $1.28 billion in the first quarter of this year. The…

Thanks, John and good morning, everyone. As you can see in the second quarter our balanced and diverse assets, proven and effective strategy, executed by our strong teams delivered a very strong quarter. Production was up and operating costs were down across the board in North America. In addition, we’ve been nimble, effectively optimizing our capital allocation in the quarter in response to market conditions. We’ve reduced our capital spending in 2012 by roughly $700 million, a 10% reduction, and at the same time slightly increased our overall production guidance for 2012. Canadian Natural’s ability to quickly and effectively reallocate capital and at the same time increase production, confirms the strength of Canadian Natural’s assets, our capital flexibility, the effectiveness of our strategies and the ability of our teams to effectively execute. Few, if any, companies in our peer group can effectively reduce capital spending and deliver a production increase. I’ll briefly comment on each of our areas, starting with gas. As you know, we’ve been bearish on gas prices and that’s not changed. In Q2, we proactively reduced our gas drilling program for the year by half, from 71 wells to 35 wells. As well, we deferred the well completions on our Septimus program and as a result we’ve deferred $110 million of gas capital out of the 2012 plan. This deferral of capital impacts gas and NGL production exit rates, since all these wells, especially at Septimus, were liquids-rich wells. We’ve also proactively shut in 20 million cubic feet of gas in 2012. Canadian Natural has very strong gas assets and with this significant capital reallocation and gas shut-ins, we still remain within gas production guidance and our operating costs are down 15% as expected in Q2. Even in this very low price environment, our average wellhead net-backs…

Thank you, Steve and good morning. I would like to briefly summarize a few financial highlights for Canadian Natural in the second quarter and first half of 2012. In the second quarter we generated $1.75 billion of cash flow from operations and incurred $1.3 billion of capital expenditures. This resulted in first half cash flow from operations of $3 billion and capital expenditures of $2.9 billion. After taking into consideration our dividend program and the purchase of common shares under our Normal Course Issuer Bid, long-term debt at June 30, 2012 was $8.5 billion, roughly in-line with our year-end long-term debt of $8.6 billion. Our balance sheet metrics remained very strong, with debt-to-book capitalization of 26% and debt-to-EBITDA of one times, considerably below our internal targets. We focused our attention on liquid resources and long-term debt maturity schedule in the second quarter. In June, we extended our $1.5 billion revolving bank facility to June 2016, and issued $500 million of seven-year Canadian medium-term notes with a coupon rate of 3.05%. At June 30, our available unused bank lines amounted to $4.4 billion, which allow for the retirement of the roughly $1 billion of debt maturing in October of this year and January and February of 2013. In addition, we can prepare our 2013 capital budget knowing that available resources are available to back-stop commodity price volatility and to continue to manage our day-to-day business. In a constantly changing environment for commodity prices and ongoing economic news impacting North America and European economies, liquid resources are a must. Our commodity-hedging program continues to be actively managed. Currently we have Brent Collars for 150,000 barrels per day with a floor of US$80 for the remainder of 2012. This reduces to 50,000 barrels per day for the first half of 2013. In addition, we have US$80 puts in place for 100,000 barrels a day for the remainder of this year. In conclusion, I believe we are very well positioned to continue to develop our diverse asset base, including strategic projects at Horizon and Kirby. Our strong cash flow, balance sheet strength and adequate liquid resources ensure that we are able to complete our business plans. This financial strength complements our management strategies and the company’s disciplined approach to project execution and operational excellence. Thank you. And I will return you to John, for some closing comments.

Thanks, Doug and Steve. As you can see, we are very well positioned to weather all the cycles that occur in this business. And we are able to drive our own agenda with the added amount of flexibility to ensure that we can control costs in an environment that often-times creates its own inflation. We will ensure that we continue to create value for our shareholders. With that, operator, I would like to open up the call to the questions that participants may have.

Certainly, sir. Ladies and gentlemen, we will now take questions from the telephone lines. (Operator Instructions) And the first question is from David McColl at morning – I beg your pardon – George Toriola at UBS, please go ahead. Your line is now open. George Toriola – UBS: Thanks, and good morning. I have a couple of questions, three questions. Just quickly, we’ve seen some industry players go away from CHOPS development to smaller scale thermal projects. Could you sort of address the way you look at your primary heavily oil growth and what you see along those lines as compared to what some of the other industry players are doing? That’s the first question. Secondly, you’ve talked about growth for this year 21%, could you provide an outlook over the next three years, what type of growth rates you would expect from primary heavy oil production if crude oil prices stay where they are at right now? And then lastly, on the CapEx reduction as far as the Horizon is concerned, is that due to cost inflation or some other thing? If you could do that, that would be helpful. Thanks.

Okay. Thanks, George. Steve, here. Could you maybe – I’m not sure what the first question really was about, smaller thermal projects and the primary heavy oil growth versus bigger projects. Is that what you’re asking or? George Toriola – UBS: Okay. So the first question was around we’ve seen some – on your primary heavy oil, we’ve seen some industry players say that CHOPS production does not really serve well if you look at it from reserve recoveries and that standpoint. Could you address that? You guys obviously – you probably see it differently so that would be helpful to understand how you look at heavy oil development versus other techniques that you might be able to use?

Well, good. Thanks, for that clarification because that’s a very important question and, as you know, Canadian Natural has a very large heavy oil asset base and we cover the whole range. So, you have to utilize the most effective technology that generates the greatest return on capital for each individual reservoir and type of reservoir. So, on our primary heavy oil production, we are targeting essentially thin sands that are unconsolidated and why the recoveries in primary heavy oil production work so well, is that the sand is actually mobilized and produced, that’s what the CHOPS production is, and you get very good recovery rate in terms of production rate. The actual recovery of oil out of the reservoir is probably in that 10% to 15% of original oil in place with that method. However, any other technique for that type of reservoir, if you use a thermal process it’s too thin, and also the sand production is huge, it’d be very difficult to run a thermal process. So you use the best technology there. On thicker, more cleaner sands, you’ll either look at the SAGD process and/or the cyclic process if there’s gas entrapped in the reservoir and oil. So cyclic is much more robust, so it may handle dirtier sand. SAGD needs to be thicker and cleaner and it can work with less gas, so there’s a trade-off there. And for us, we optimize based on the reservoir in our asset base the effective recovery. So the big thing here is, if we can find a way, and we’re working on the technology, we have found nothing yet, but we’re working on a few things, to improve that recovery on CHOPS production. If we could find a secondary recovery process, we have another 8 billion barrels roughly…

It’s not. Part of it is deferred into future years and part of its cost savings. George Toriola – UBS: Okay. And then maybe...

About 30% is cost savings. The rest is pushed out into future years as we re-bid the packages and get better costs with that. George Toriola – UBS: Okay. Thanks. And maybe you can just talk about – I mean you’ve talked about sort of the capital efficiencies you need to generate the rates of returns that you require, could you broadly talk about – based on the capital efficiencies you’ve talked about before, is there a percentage cost savings overall that you’ve seen to date? Are you able to provide that type of insight?

I think what we’re seeing right now – I think we’re hesitant to predict the future because we’re pretty early on and we know there’s going to be cost pressures. But at Horizon, we believe we need to be below $100,000 a flowing barrel, which we are. And so that’ll give us our strong returns on capital. On thermal projects, we probably need to be below $35,000 to $36,000 a flowing barrel. And we’re about $32,000 at Kirby so we feel pretty comfortable there. The expansion should be better. So right now I’d say in situ looks slightly better than mining and the economics. One of the things on mining you’ve got to remember is, we do reap a huge operating cost benefit with expansion at Horizon. George Toriola – UBS: Thank you very much.

Thank you. The next question is from David McColl at Morningstar. Please go ahead. Your line is now open. David McColl – Morningstar: Thank you, and good morning, guys. So as George mentioned, there’s the issue with the lower cost for Horizon. So I just want to build-off that a little bit. Guidance is showing higher costs for Kirby South and Primrose, relative to the previous guidance. So I’m trying to just get a handle on what’s kind of driving this? Are we seeing higher costs for in situ on the inflation side or are you guys trying to escalate a few things to as alluded to kind of get ahead of the curve for higher costs coming forward? Thank you.

I think, David, what you’re seeing here is a little difference in what – how we’re managing the project. Obviously to build Kirby is a smaller project than Horizon and quite frankly it’s less complex. So if you heard me talk this morning, Kirby’s ahead of schedule. We’re about 2% ahead of plan, so you expect the costs to be ahead of schedule as well. So we’re actually moving costs from probably 2013 into 2012 so that’s why the costs have gone up, capital cost have gone up on Kirby, because we’re actually able to execute at a faster rate. And that’s mainly because it’s a smaller project and we’re doing civil and structural mechanical work in 2012 that we’ve been able to accelerate and we’ll do more of the smaller piping and electrical instrumentation later in 2012 and 2013 and that’s where we use a lot of labor. So we’ll see how that works but we’re very confident we’re going to do well on Kirby cost. At Horizon it’s a case of – it’s more of a mega project, a bigger project, more complex, so we’ve taken our time. You’ve seen these four lump-sum bids. It’s taken us longer to get those contracts executed as we take the time to make sure we have the scope totally defined, the engineering complete, so that the lump-sum bids we get are very good, and they are good bids. That takes more time. And of course time to get the contract before they execute in the field and so the cost spend is lower mainly because they haven’t got to the field as soon as we had in the original schedule. Which all in all, is actually a good thing to get the better cost, and to let the schedule slip because we have float in the schedule at Horizon. And you can see here we’re driven in all cases to cost, not schedule. David McColl – Morningstar: So is there any thought just to follow up then on looking at Grouse and the other in situ projects to maybe try to pull up the schedule a little bit on those again to try to avoid some higher costs down the road?

Our view on cost is that you need to ensure you have your engineering complete and have – particularly in situ. And this is a mistake a lot of players have made in the past is they don’t get the engineering up front done. They don’t have enough geological definition and their modeling done before they start because it’s very easy on a SAGD project to get your wells placed in the wrong position, and for us we do not want to have to re-drill the wells as many of operators have, even the operators that have – are widely recognized as being very good SAGD operators, have had to re-drill wells. So it’s easy to do. So to accelerate is actually not a good thing. It’s probably going to be – destroy capital efficiency by trying to accelerate, so we’re being very disciplined, keeping to our schedule, making sure we got all the right data, collected data, and have the engineering complete before we start, so you won’t see us accelerate. David McColl – Morningstar: That’s great. Thank you.

Thank you. The next question is from Greg Pardy at RBC Capital Markets. Please go ahead. Your line is now open. Greg Pardy – RBC Capital Markets: Hi. Thanks. Good morning, Steve. Just a couple things; I want to come back to Horizon. Just looking at the OpEx in the quarter, which just surprised me, it seemed a little bit higher just given where the run rates were. But the absolute number looked bigger, and I’m curious as to whether any additional costs are being loaded into that number? And the same question would almost hold true on the depletion side for Horizon, just to get our numbers right? And then the more strategic question, obviously there’s lots of talk now with LNG and so forth, and you guys have vast resources, the Montney and the Duvernay, just curious as to what your plans are for that acreage? Is this effectively the stuff you’re going to leave as an option when prices move higher or could you see yourself doing something sooner? Thanks very much.

Thanks, Greg. So the higher operating costs in Horizon I think are a little higher than we would like. They’re good, but they’re not great, and I think it’s a case of we are totally focused here in 2012 on operating discipline and safe, steady, realizable operations. And in effect what we’ve done here is not focused so much on operating costs, but focused on reliability and steadiness in the operation. We believe with time, as we become more focused on reliability and the discipline that goes with it, you will see operating costs come down. But I think it’s maybe a case of conservatism; we made sure we had extra maintenance and probably loaded up on maintenance costs that in hindsight probably was not as necessary as we thought. But we believe that there’s a lot of room to grow on operating costs yet. So still our guidance is good, but I think over the long run you’ll our see operating costs come down. So I don’t know if I answered your question? But that’s really the operating costs. DD&A has basically determined how much we would pull out of the mine. As far as LNG and the Montney and the Duvernay, obviously we do have a huge gas asset base. Our review right now is we’re just going to use it as an option. We are not looking at LNG, however it’s something that we won’t rule out, but at this time, we’re not looking at it. But we are obviously strong cheerleaders for everyone who is building an LNG plant. Greg Pardy – RBC Capital Markets: Okay. So I appreciate what you’re saying in terms of the steadiness and the reliability. So 2Q probably not a bad idea as a run rate for the balance of the year, given sort of 110,000, 115,000?

I would say it’s probably – I think Q3 might be bit higher than that. Clearly we’ve got some maintenance we’re going to do here, and the rates are going to be down because of that. So you might see a little bit of a bump in Q3. Greg Pardy – RBC Capital Markets: Okay. Thanks a lot, Steve.

Thank you. (Operator Instructions) And the next question is from John Herrlin at Societe Generale. Please go ahead. Your line is now open. John Herrlin – Societe Generale: Yeah, hi. Thank you. With Horizon now being back to its normal operational status and more free cash flow being generated, will you consider having stock buybacks a more active part of your capital management program given the fact that your balance sheet isn’t over-levered?

I think I’ll maybe get Doug to answer more fully this question, but I think right now we’re happy with the way we’re doing our stock purchase bid and I don’t think we’re considering to do anything more substantial than we have in our plans right now. Doug, you want to add to that?

I think, Steve, I think it’s a – the stock buybacks are a function of making sure that we have the right use of capital across the company, as well as taking care of dilution. Year-to-date, we’ve actually bought back more shares than have been exercised under the stock option program, so we’re ahead of schedule on that plan. And going forward, it’s a function of the use of the availability of cash to initiate that program. I think that you can expect to see increased dividends going forward because that’s part of our plan. We have increased dividends for the last 11 years and the stock buyback program is a basic part of our financial plan.

So to add to that, John, our main uses for free cash flow on a priority are acquisitions if they’re there, and we haven’t seen anything that meets our criteria, increased dividends, which is probably where we’re more focused on and stock buybacks would be the third, but we have been doing that as well. So... John Herrlin – Societe Generale: That leads me to my next question, M&A, during down pricing periods, you tend to be more aggressive, you just haven’t, as you’ve just said, nothing has met your criteria?

That’s right. We don’t see anything at this point in time. We look at a lot of properties and nothing has really met our criteria in this environment, or at least what we’re willing to pay, I would say. John Herrlin – Societe Generale: Okay. Last two from me, quickly, services costs, you are getting more active in heavy activities, are you seeing any real changes at all?

I would say the service costs are sort of tale of two cities. On the heavy oil side, and primary heavy oil in particular, we’re starting to see pressure there, sort of continue in trucking costs and some of these service costs. On the gas side, we’re seeing obviously fracking costs are coming down and gas drilling rigs, which tend to be the deeper rigs, we’re seeing rates come down on the softness there. In Horizon and some of the major projects there, we are starting to see some pressure in some components, but interestingly, there’s – it’s sort of a mixed response; sum is nothing yet. John Herrlin – Societe Generale: Okay. Last one for me is just housekeeping with Doug, some of the companies in the U.K. are announcing third quarter or fourth quarter P&A deferred tax charges. Do you have any sense of what yours may be?

Yeah. I think we mentioned in our notes but it’s looking like it’ll be about $58 million. John Herrlin – Societe Generale: Okay. Thanks. I missed that. Thank you.

Thank you. There are no further questions. I would like to turn the conference back over to you, Mr. Langille.

Thank you very much, operator, and thank you, everyone, for attending our call. As usual, if you have further questions with us, do not hesitate to contact our Investor Relations department and have a very good day. Thank you.

Thank you. Ladies and gentlemen, your conference has now ended. All callers are asked to hang up their lines at this time and thank you, for your participation.