Canadian Natural Resources Limited (CNQ) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2012 Third 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 very much, Operator, and good morning, everyone. Thank you for attending this conference call where we will discuss our third quarter results and review our planned activities for the balance of this year 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. Our proven business principles and strategies are long-standing and they work. They continue to build a powerful business model that is geared to creating long-term shareholder value. Our production is balanced, and our resource base is one of the best in the E&P space. This base will add to the balance production as known resources are developed through the appropriate allocation of capital using diligence and discipline. We can use a lot of flexibility when setting our CapEx programs, and we are prepared to reallocate capital, if any project is not making our economic hurdles. We are good at evaluating opportunities to acquire and consolidate assets that will add value to our portfolio. A great example of that is at our Kirby in situ development, where we expanded our initial plans from around 40,000 barrels per day to north of 120,000 barrels per day through an acquisition a couple of years ago. And this year we further expanded our position by completing several acquisitions to acquire contiguous lands. This new larger land position will set us up for many years…

Thanks, John, and good morning, everyone. This morning, I'll make a few comments on Q3, as well as our view on the oil markets going forward. As you know and as John talked about, Canadian Natural is in a strong position. Our assets deliver free cash flow and still grow near-term production. As a result, we're able to deliver sustainable free cash flow, which allows us to allocate capital to our large, long-life, low-decline resource base, driving continued free cash flow growth and sustainability. In addition, we've been able to return cash to shareholders through increasing dividends and share buybacks. Our balance sheet is strong, with the capacity to capture opportunities and weather any commodity price volatility we might encounter. This strong position is a direct result of our ability to effectively execute our strategies. In the third quarter, Canadian Natural had solid results in our conventional business, and we took significant proactive steps at Horizon to deliver improved performance and reliability going forward. We've also reduced capital spending for the year by an additional $230 million, taking the total capital spending reductions for 2012 to $910 million, with only a slight change to midpoint of production guidance, mostly due to the more proactive steps at Horizon to improve long-term reliability. This reflects the strength of our assets and our capital flexibility. So turning to our assets, and starting with gas. With low gas prices in 2012, our capital allocation to gas has been very limited, with only 35 wells to be drilled in 2012. We've also shut in 20 million cubic feet a day of gas on top of the 20 million we shut in late 2011 for a total of 40 million cubic feet a day. Gas operating costs were up in Q3, primarily as a result of…

Thank you, Steve, and good morning. As Steve mentioned, the third quarter of 2012 was a solid operating quarter. I would like to briefly summarize a few financial matters for Canadian Natural arising in the third quarter. In the third quarter, we generated $1.43 billion of cash flow from operations and $4.47 billion for the 9 months of 2012. Third quarter of cash flow is lower than the second quarter, and the reduction is largely attributable to lower volumes from Horizon SCO and international, partially offset by conventional volumes in Canada. Lower conventional crude oil and natural gas prices realized product netbacks, realized management activities, largely attributable to foreign currency contracts. The foreign currency program relates primarily to cash management positions, which settle monthly and are dependent upon the foreign exchange rate for the Canadian and US dollars. As you will see from past quarter, this reported activity fluctuates as the Canadian dollar strengthens or weakens against its U.S. dollar counterpart, and lower current income tax reflecting these noted changes. Capital expenditures for the 9 months amounted to $4.5 billion, funded by cash flow from operations for the same period. Our dividend program amounts to an annual return to shareholders of $0.42 per share, paid $0.105 quarterly. In 2012, we have purchased 7.8 million shares for cancellation under our Normal Course Issuer Bid. After taking into consideration the dividend program and the purchase of shares, long-term debt at September 30 was $8.4 billion, slightly less than the $8.6 billion outstanding at December 31, 2011, and roughly the same amount at June 30, 2012, and as adjusted, on a mark-to-mark basis for our U.S. dollar debt outstanding. Our balance sheet metrics remain very strong with debt to book capitalization at 26% and debt to EBITDA of 1.1x, reflecting management's focus on financial strength and flexibility. Our liquid resources remain very strong with $4.3 billion of unused bank lines. Our commodity hedging program continues to be actively managed as we have 150,000 barrels per day hedged for the first half of 2013 and 100,000 barrels per day for the second half of 2013, all with a floor of USD 80. In conclusion, we are very well positioned financially as we move to complete our 2013 capital budget. Our strong cash flow, actively managed commodity hedge program, balance sheet strength and adequate liquid resources ensure that we are able to complete our short-, mid- and long-term business plans. Thank you. And I will return you to John for some closing comments.

Thanks, Doug and Steve, for your comprehensive reviews of our assets and finances. We are very well positioned to continue to apply our sound business principles and strategies and create value for our shareholders. Now with that, Operator, I would now like to open the call to questions that participants may have.

[Operator Instructions] We have a question from George Toriola from UBS.

I've got 3 questions. The first is where do you think, I guess -- no, I'll rephrase that. Maybe this is for John, what do you think the market is currently missing with the way your stock price is currently performing?

George, I think there's a couple of things. I think there's confusion and maybe volatility in establishing longer-term oil prices and where they're going in heavy oil and where its market can get to, et cetera. I think that weighs on our stock probably a lot more than it does on several others simply because we are the largest producer. However, I think as Steve very adequately put it, I think that's a problem that's going to solve itself in sort of mid-term here as additional capacities get built to accommodate -- or to get to additional refining capacities and as some additional refining capacities get built. I think the other thing is, I think our natural gas assets although very, very strong, because of the ability of us to allocate capital to our very stronger oil projects, sometimes, I think, the fact that we have a strong base of natural gas assets gets lost in the shuffle, as we really are not -- have not been spending a lot of money on them, even though they are very strong assets in terms of future potential when the economics of natural gas recover. And we're not in a position that we're forced to drill things to save land to a great degree. So we don't really -- we have not been allocating a lot of dollars to that situation. And thirdly, I think we have to get some credibility back on running our Horizon, our mining project. And I think as Steve very adequately set out, we have a very good process in place to get there. And I think, again, we're dealing with an asset that's going to last us 40-plus years, and we have to make sure that we do it right to make it last that long. Hopefully that answers your question, George.

Okay. It does. And it leads me to the next question here, which is -- I mean, this is a hypothetical, but assuming that as you continue to sort of demonstrate some of the things you talked about, and the market fails to realize or to attribute the value that you think the assets have, would you potentially think of splitting up the company to -- I mean, because when I look at companies that are pure heavy oil companies or pure natural gas or pure international assets, some of the parts here is very different from what we've seen in your company. Is that something you would even consider?

I think George, at this point in time we're not considering that, and it's something that we have always believed that having a balanced and a diversified portfolio is best in the long term. Certainly, you get periods where you get little hiccups happening, heavy oil differentials, heavy oil marketplaces. Natural gas prices may or may not result in some difference in one part of your business. However, we think on the long term, it's better to have a diversified portfolio, and we will use our business model to develop that portfolio over time and ultimately, return a much larger return to shareholders. That's our personal opinion.

Got it. So it's a more balanced flexibility that comes with the balanced portfolio. I guess the last question is around reliability and operating capacity at Horizon. When we look at the current capacity, what is a realistic -- sort of when we look ahead into the future, what is a realistic production level that we can expect out of Horizon? Is it 95,000? Is it 100,000? Is it 115,000? Where is that number?

George, I think, Steve is the best one to answer that, so I'll pass it over to Steve.

Okay. So, George, clearly, we've had some issues here at Horizon, but I think what you're seeing here, particularly in Q3 and Q4, is a result of our different philosophy and our conservative approach. And maybe you can say it's too conservative, but our operating capacity, we believe, is between 110,000 and 115,000 barrels a day on an average quarterly basis. Now what we've done here recently, as I said, is probably maybe been more conservative than we might have in the past by restricting rates to ensure that we don't damage our catalyst. There are some who believe that we probably could have made it through the turnaround, we should have ran at higher rates. But we're more conservative, and you can see here with the sort of minor hiccups we had in starting back up after the outage, we've taken a very conservative approach. And obviously, we're going to make sure that we run this thing at a steady reliable rate and not go for the quick production and take risks. So that's what we see going forward. We believe that we can run this thing at a steady rate and reliable rate between 110,000 and 115,000 barrels a day. And we're well on our way to doing that.

The next question is from Greg Pardy from RBC Capital Markets.

So just a few nitty questions. Steve, what's CNQ's equity stake then in Redwater?

Our equity stake, we have 50% of it, and it's about $340 million we've so far committed to Redwater.

Okay. So I know you're -- so you are 50%, but there's a bunch of project financing, right? So the -- will this be back-stopped then with a fair bit of debt versus capital that you're going to put into it, or how will that work?

This will basically be funded by project financing and debt, so our equity contribution will probably be very limited. I think we might get up to about $400 million roughly for the whole project.

Okay. And then you're going to earn, I think you mentioned about 10%. So it would be 10% on the 50% of the project or 10% on the 400 do you think you'll earn?

On the 50% of project. And also I got to remind you, if you look at the agreement, the partnership, which we own 50% of, gets all creek [ph] capacity to its own account and we believe that will help us generate a stronger return on capital going forward.

Okay. What's the duration of the May turnaround at Horizon next year?

Most of that -- it's 18 days and most of that is to replace the catalyst. That's the critical path to the long -- or critical path of the project turnaround.

Okay. When we dug through the numbers, it looks as though there's still -- there's upward pressure on your OpEx, at least versus what we'd expected in guidance and so on. But it looks as though you've made a fair bit of improvement on the oil side in Canada. So it is some of the other areas that are standing out. But what is your sense just directionally then for Canadian oil liquid OpEx as you go through the balance of the year and into next year? And I think we've talked before about kind of getting into the mid-30s in terms of OpEx at Horizon. Is that -- do you think that's still realistic in 2013, just given the more conservative approach you're taking now?

I think that's -- we're still working through the budget, but I think that's reasonable that we could be there at Horizon. Obviously, we have taken a conservative approach, and so we probably are spending more on maintenance and being -- carrying more people than we really likely need once we get lined out, but we're very being conservative. So going forward at Horizon, I think $35 is a pretty good target. It might take us a little while to get there. We're still working through it. But as I said before, we want to be on the conservative side of everything. That we are doing everything on that way now going forward on Horizon. So we'll probably be more conservative in our approach and in our estimates and how we approach the amount of people and the amount of maintenance and the proactive work we do with Horizon.

Okay. And then maybe just the last question for me. I think it's like 32 net wells or something you drilled this year and yet, your volumes have stood up extremely well. So have you been just doing a lot of countercyclical tuck-in acquisitions and stuff on the gas side?

On the gas side, we haven't really spent a lot on acquisitions this year. We have some last year that sort of carried us through this year. So we are seeing declines through the year, but it's just -- Septimus has come on last year and helped us out, but it just really just the strength of the asset base. As you get longer-than-life declines actually start to slow down for you.

The next question is from John Herrlin from Société Générale.

Just 2 quick ones for me. Not to beat a dead horse with Horizon, but do you think at the end of the day, given the variety of problems that you have that or have experienced that you had kind of basic engineering issues, or these are just all one-offs?

Okay, so and that's a good question, John, and obviously, I don't believe that we've had any major basic engineering issues or design issues. There's been a few design things that we've been working on, but they're mostly around materials where we get extra corrosion and erosion in certain wear components -- and that's probably standard for a new plant. So most of it is not design. I'd say most of it has been in just getting to know the plant and getting the operating experience. And quite frankly, taking this more conservative approach, more operating discipline has made a tremendous difference. And I know from The Street, you don't see that with Q3 and Q4 production volumes, but that is really a reflection of a more steady and reliable plant that we're running here. We're taking a different attack, and we are willing to sacrifice production to ensure reliability in the long run. So we're taking a hit here in Q3 and Q4, but I expect 2013 to be very strong because of it.

Okay. That's fine. Next one for me is, again, kind of a shareholder-oriented question. You did part of your Normal Course Issuer Bid. Why not do a tender? I mean, you're growing, but clearly, your stock is not being rewarded for the growth and investors are not being rewarded -- you are almost at 2009-type price level. Why not do a larger tender? You have got the balance sheet capacity. Why not really buy back a lot of stock?

I think I'll let Doug add to this comment but really, when you look at our portfolio, John, we have significant resources to develop and we see we can get a better return doing that. We have bought more shares back and Doug will talk about that. And also we see better returns is going through dividends. But Doug, do you want to add to that?

No, I don't think so, Steve. I think that our share buyback program is there in place to counter out balance of the effect of exercising stock options as we move through, which is a major component of our compensation and also as a mark that we can have against dedicating future projects and dedicating capital to those. And so I don't think that allocating a whole bunch of resources to a tender offer would be in the company's plans for the foreseeable future. I think that we're very happy with the Normal Course Issuer Bid in returning capital to share -- or returning funds to shareholders also with our dividend program and then developing our assets. And I think that's where management's focus is.

The next question is from Dan Geary from Wintergreen Advisers.

Just sort of emphasizing what the previous question went to about the buyback. We think you guys generally do a great job operationally, but at the same time, it's frustrating to look at the valuation of your stock on both an absolute and relative basis, as John acknowledged a few minutes ago. So our question is why not take a more significant portion of your discretionary cash flow and buy back a more meaningful amount of shares rather than just offsetting dilution? It seems, if my math is right, you still have a few billion dollars after accounting for maintenance CapEx in cash flow on an annual basis, and we'd really to like see you utilize more of that towards a buyback.

Well, I think the answer to that question is pretty much the same as we just gave to the previous question. Again, we think we have a pretty solid asset base here. We prefer to return cash to the shareholders through the dividends. And as John said, we've increased dividends probably at 17% CAGR, and we don't see that changing. I think we continue to increase dividends but they have to be sustainable. We are building a larger more sustainable free cash flow machine here at Canadian Natural, and I think as you go forward, you'll see us have more and more discretionary free cash flow to allocate back to dividends or share buybacks as we go forward.

The next question is from Barbara Betanski from Addenda Capital.

Steve, thanks very much for the breakdown sort of month by month in terms of the price differentials on WCS versus the volumes that you're shipping down to the Gulf. And so I just was wondering if you could just talk a little bit about the additional transportation costs that you incur in order to ship down to the Gulf? So how much of that spread are you actually capturing in terms of upside?

Yes, so it depends on how you get there, Barb. But if you go there by pipeline, you're in that $8 barrel range. If you go there by rail, you're probably in that $12 range. So most of our oil that we get to the Gulf, about 20,000 of [ph] 30,000 is through pipelines, the other 10,000 is by rail.

So that would be the incremental costs that you're incurring?

That's not...

Or is that the total?

That's not the total incremental cost. That's the total of cost from Hardisty to the Gulf. Obviously most of our oil goes to Chicago anyway. So you probably got $5 extra to get from Chicago down to the Gulf.

Okay. And just -- so you did say you're shipping about 30,000 now. Would you have any sort of an estimate in terms of how those volumes to the Gulf might increase? Like what volumes increase over the next couple of years?

For us right now, I think we'll probably wait for pipeline capacity, which the first one would be Flanagan in 2014. But I think, Barb, what I would want to point out is, with the extra 310,000 barrels a day of capacity in PADD II or the Midwest, we probably don't have the capacity and supply in Canada to get too much more heavy oil to the Gulf Coast because we'll need to fill that 310,000 barrels a day of extra capacity coming on.

Right, okay. And just a final thing. If you could just mention your base case assumptions for the WCS differential for next year.

We're still working that through, but we think we're probably in that 18% to 22% range right now -- above [ph] WTI.

The next question is from Kate Minyard from JPMorgan. Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division: Just a couple of quick questions on the comments around taking crude to the U.S. Gulf Coast. You have talked about 30,000 barrels a day. Can you talk about whether that's to one particular refiner or multiple refiners and whether it's contracted volumes or whether it's just on spot? And are you just testing the market, or do you have kind of a firm long-term commitment at those volume levels?

We don't have any firm long-term commitments, Kate, but we have been shipping 20,000 barrels a day via pipeline to the Gulf Coast for probably 3 to 4 years, and we have very good relationships with a number of refineries on the Gulf Coast, and we have no problems clearing that Canadian crude. It actually trades depending on what month it is, either a slight premium to Mayan or a slight discount to Mayan. So quality-wise, it's pretty much the same as a Mayan crude. Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division: Okay, sure. And then when you talk about the refiners potentially blending heavies with light crudes to create sort of a proxy for a medium blend. How long do you think it would -- what's your sense as to how long it might take refiners to sort of test that type of blend and become comfortable with that means of getting a heavy -- or excuse me, a medium as opposed to taking an actual medium crude grade?

I think it all depends on the refiner and what their appetite is for it. We've seen in the past where we've blended SCO with bitumen in the Midwest. The refiners like to run small batches to see what kind of products they get. And after a couple of months, if they feel comfortable, they start to take larger and larger batches of that type of crude. So I would guess it would probably be the same type of timing. But I think going for a medium crude look-alike in the Gulf Coast would happen after all the foreign light oil barrels are pushed out, and then you go start pushing out medium crudes. Obviously, you want to take a bit of discount to do that on light pricing. Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division: Okay. All right. And then just finally on your comments about just moving barrels to the West and East Coast via pipeline for Canadian crudes of all grades. Can you talk about whether you are participating in any discussions or whether any are underway in terms of volume commitment? So I would assume with your position, your production position in Canada, you'd be a potentially attractive client to kind of anchor some of those shipments. Can you give us any insight into what sort of discussions might be going on, or whether you've been able to make any commitments yet?

We haven't made any commitments yet. We're a strong supporter of Gateway. We'd like to see TMX helping as well off the West Coast, and we're talking to all these guys, we're also talking to TCL [ph] about the East Coast option to Montréal. But we've made no commitments at this point.

[Operator Instructions] The next question is from Harry Mateer from Barclays.

Just a quick question, I guess, for Doug. You do have a couple of maturities coming up early in 1Q. Can you give us a sense for how you're approaching that? It sounds like you have a decent amount of balance sheet capacity, so I wouldn't expect you to delever, but can you just confirm whether those are something you'd pay down with cash or look to refine and extend?

Thanks, Harry. Yes, as we mentioned, we have the $4.3 billion of unused lines at the end of September. We think that, that's fairly substantial. We did have $1.1 billion worth of debt maturing in the third quarter, which we -- or fourth quarter, which we paid on October 1. We got 2 more in the first couple of months of 2013, and we'll be using our bank lines to repay those. And as we said, our 2013 budget, we'll make sure that we got adequate lines going forward. In my view, I think that we do have adequate lines. I think that the funding process for 2013 is complete and then when we get into after the budget is set, we'll look to funding requirements going forward after 2013.

We have no further questions registered at this time. I'd like to turn the meeting back over to Mr. Langille.

Thank you very much, Operator, and thank you, ladies and gentlemen, for listening in on our call today. And as usual, if you have any further questions, please do not hesitate to contact us. Good day, and have a good day, and we'll see you later. Bye-bye.

Thank you. The conference has now ended. Please disconnect your lines at this time. And we thank you for your participation.