Cenovus Energy Inc. (CVE) Q2 2015 Earnings Report, Transcript and Summary

Welcome to the Cenovus Energy's Second Quarter 2015 Financial and Operating Results. [Operator Instructions]. I would like to now turn the conference call over to Mr. Kam Sandhar, Director, Investor Relations. Please go ahead, Mr. Sandhar.

Thank you, Operator and welcome, everyone, to our second quarter 2015 result conference call. I would like to refer to you 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 most recent annual information form or Form 40F. The quarterly results have been presented in Canadian dollars and on a before-royalties basis. We have also posted a link to a supplemental slide deck for today's update on the front of our website at Cenovus.com. Brian Ferguson, President and Chief Executive Officer, will begin with a strategic update and then turn the call over to Ivor Ruste, Executive Vice President and Chief Financial Officer, who will discuss our financial performance. Following that, John Brannan, Executive Vice President and Chief Operating Officer, will provide an update of our operating performance. Brian will then provide closing comments before we begin the Q&A portion of the call. Please go ahead, Brian.

Thanks, Kam. Good morning. Today we're reporting that Cenovus has delivered on the commitments that we made to our shareholders over the last several months as we work to address the reality of a lower price commodity environment. Our plans for the current expansions, Christina Lake optimization and phase F, as well as Foster Creek phase G, are on track. These projects will add 50,000 barrels per day net capacity in 2016 which is approximately a 25% addition to our current oil volumes. We've reduced our operating costs. We've strengthened our balance sheet with the sale of our fee lands and royalty business and created greater financial resilience for our company. We've reduced the dividend by 40% to align with our expectations for commodity prices over the next three years. And we plan to adjust the pace of development for future capital investment in our oil sands assets. Companywide we're on track to achieve approximately CAD280 million in operating capital and G&A cost reductions this year. That's 40% greater than the savings we originally targeted earlier in the year. We expect about half of these cost savings to be sustainable at higher commodity prices. While we have achieved significant cost savings to date, we believe that we can achieve even more sustainable changes to our cost structure. This will reinforce our position as a low-cost SAGD oil sands leader ready to compete on a global scale. Part of our cost reduction effort has focused on workforce. In February we eliminated about 800 positions that were no longer needed due to project deferrals. It is always difficult when we have to let good staff members go and we take these decisions very seriously. Today, I can tell you that we've identified another 300 to 400 positions at our Calvary offices that will be cut before the end of this year. These workforce reductions are directly related to a more focused pace of work in response to the continued low price environment. The cost savings associated with these positions is expected to be at least another CAD100 million annually. These savings would be ? are in addition to the CAD280 million cost reduction target already established for this year. Developing our oil sands assets remains the focus of our strategy. The cost cutting measures we've undertaken and the financial strength positions us to be able to invest counter cyclically. This is important for Cenovus as we do not want short-term pricing to dictate our investments in long-life, high return oil sands projects. Our continued spending on Foster Creek phase G and Christina Lake phase F in 2015 and 2016 are examples of this. Cenovus is positioning itself to thrive in an environment with WTI prices of approximately CAD65 a barrel over a prolonged period. We stressed tested our financial strength at CAD50 WTI prices through 2017 and believe that we can internally fund our reduced dividend, as well as sustaining and growth capital investment at that price level without compromising our balance sheet strength. Our focused approach to oil sands development means limiting the number of projects that we will be undertaking at any given time and level loading our workforce to ensure the best productivity, utilizing our best and most experienced people. We are confident that this approach will deliver superior shareholder value. As we enter our 2016 budget process, our priorities for future capital allocation are as follows. Resuming Christina Lake phase G will be our first priority. We expect this project to benefit from excellent reservoir quality and significant scale. Our second priority will be to resume activity at Foster Creek phase H. We will first take the opportunity to utilize equipment that we already have in place. We will be investing a small amount of capital this year, that's CAD25 million to CAD30 million net, to give us the flexibility to restart these two projects in 2016. Our next priority will be resuming work at Narrows Lake phase A, as well as capital investment for the remainder of Foster Creek phase H. We are also resuming limited tight oil drilling in Southeast Alberta for the second half of this year, where we have had success over the last couple of years, as well as some incremental investment at Weyburn. These projects provide strong returns at current prices and have shorter cycle times and shorter payback periods. We've added about CAD70 million to our conventional program and are reactivating three rigs. We do not plan on allocating additional capital to Pelican Lake or other conventional projects this year. As part of our strategy to add shareholder value, we continue to monitor opportunities to crystallize additional value from our conventional portfolio for shareholders as we did with the sale of our royalty lands. We also do not expect to allocate capital to emerging resource plays in the near-term. Our focus for Telephone Lake in Grand Rapids is evaluating options for a step change reduction in capital costs. A detailed process is underway to review these assets, incorporating all of the latest process and design innovations that we've developed, as well as new technologies. I would also like to clarify our position with regard to downstream and marketing capital. Since 2010 we have accumulated over CAD2 billion in free cash flow from our refining assets. These assets have been instrumental in reducing volatility in our consolidated cash flow and importantly in obtaining access to global pricing. Going forward, we expect to continue to use a mix of tidewater pipeline, rail and refining capacity to maintain our exposure to global pricing and maximize the value of our resources. We have no pending plans to invest in additional downstream assets. We are always looking for opportunities to optimize our portfolio and maximize the margin on every barrel that we produce. The acquisition of the Bruderheim rail loading facility is a great example of the type of acquisitions that we might consider. Allocating significant capital to the downstream or marketing segments of our business would only be done on an opportunistic basis and would need to align with our oil sands growth plans and would need to deliver compelling value. We expect to provide details on our capital plans and timing, reactivation of the deferred projects in December of this year as part of our 2016 budget process. I'm now going to turn the call over to Ivor Ruste, our Chief Financial Officer, to provide more detail on that, as well as our recently completed sale of Heritage Royalty Partnership. He'll also give you an update on our balance sheet and some of the non-recurring tax items that we booked in Q2.

Thanks, Brian. And good morning, everyone. As you're all aware, we recently announced the sale of our royalty and fee lands business for gross cash proceeds of CAD3.3 billion. I'm pleased to announce the deal has now closed with the cash added to our account. This concludes a lengthy process that began in 2014 to maximize the value of these fee lands and royalty interests, given market valuations of similar assets. Although we did consider an initial public offering process, we believe that alternative would have introduced market and timing risk. With commodity prices strengthening through the second quarter, the timing was right for this transaction. Pro forma June 30 cash on the balance sheet with these gross proceeds is approximately CAD4.9 billion. Our pro forma net debt metrics at June 30, 2015, including the proceeds of the divestiture, would have been 7% net debt to capitalization and 0.3 times net debt to adjusted EBITDA. With no debt maturities until 2019 and favorable rates on outstanding debt issues, we do not have plans to retire debt in the near-term. Maintaining balance sheet strength is a top priority, along with continued investment in our core oil sands assets, as Brian discussed. In this challenging business environment, it is absolutely critical that we maintain capital discipline. The board has approved a third quarter dividend of CAD0.16 per share, a 40% reduction from second quarter levels. And the temporary discount under the company's dividend reinvestment program has been discontinued. Our investment decision-making process has not changed. We evaluate projects based on risk, financial returns and our ability to fund. We will only sanction projects with an expected internal rate of return of 15% or more, taking into account the risk factors and other strategic considerations. We continue to have multiple projects to select from in excess of our 15% hurdle rate. Our focus remains on reducing our costs and maintaining financial resilience while funding our sustaining and growth capital and revised dividend, even in the current price environment. Turning to the quarter, we reported cash flow per share of CAD0.58. Excluding the one-time cash tax charge in response to the Alberta corporate tax rate increase, cash flow per share would have been CAD0.89 per share. I'd like to provide some color on this. You will note we report a Q2 cash tax number of CAD315 million. This includes a reversal of the recovery reported in Q1. Tax planning put in place in Q1 to preserve cash by deferring income to the next year, was no longer effective, given the increased Alberta corporate tax rates. We believe this shift saved us approximately CAD30 million in cash taxes overall, but resulted in the CAD260 million or CAD0.31 per share of incremental cash tax in the second quarter. With today's release, we've updated our guidance for the year. Production levels continue to be strong, reflecting good operational execution. At the midpoint, our oil sands non-fuel unit operating cost guidance is down about 20% from our January 2015 guidance. Our updated guidance also takes into account the closing of the royalty business divestiture, including the third-party royalty production sold and higher royalty rates and gross overriding royalties going forward. Despite the production impact from the forest fire at Foster Creek in Q2 and the divestiture of the royalty business, our production forecast remains unchanged for 2015, due to strong production to date. While we can't control commodity prices, we're extremely focused on the cost side of our business. Reducing our cost structures will help ensure our competitive position and enhance the profitability of every barrel we produce. I will now hand the call over to John Brannan, our Chief Operating Officer, to discuss our focus on costs.

Thanks, Ivor. Our oil sands operating costs per barrel are down 30% compared with the same period last year. These improvements include cost savings realized from service provider reductions, rate negotiations and optimization efforts. We have also delivered on the six point plan we laid out in early 2014, resulting in a reduced steam to oil ratio and optimized production volumes. I'm also proud of the way our team performed during the quarter when forest fires in Alberta affected the areas in which we operate. As a precaution, we safely evacuated 1,800 people from our Foster Creek site prior to the forest fires on the Cold Lake Air Weapons Range closing the only access road into the project. Our plant was shut down for 11 full days in late May and early June, but with the hard work from the team, we were back producing 90% of our pre-fire volumes within a few days of getting back to site. Production has since returned to higher than normal levels due to some flush production associated with volumes lost during the shutdown. Despite an approximately 2,600 net barrels per day impact for the year, we have reiterated our previous guidance of 62,000 to 68,000 barrels per day at Foster Creek for the full year. Once again, Christina Lake continues to demonstrate top tier performance, averaging a steam to oil ratio of 1.7 in the quarter and continuing to run above nameplate capacity. Our optimization work continues as scheduled with our two additional blow down blowers expected to add steam capacity in the fourth quarter of this year. We expect the optimization project to ramp up over the next 12-month period and take Christina Lake's production capacity to 160,000 barrels per day gross. Both of these oil sands operations are running very well right now, producing about 300,000 barrels per day gross, combined in July, boosted by the flush production at Foster Creek after the fire. We continue to seek further opportunities to make sustainable and substantial cost reductions in our business going forward. We continue to foster a culture focused on returns in value rather than ones solely focused on achieving growth. This will help ensure our business remains competitive regardless of commodity prices. I will now pass the call back to Brian for some closing comments.

Thanks, John and Ivor. Cenovus is in a strong position as we enter the second half of 2015. We anticipate a continued lower oil price environment and we're well prepared to deliver consistent value to shareholders in that new price reality. To reiterate, we're targeting CAD280 million in cost savings for 2015. Additional planned workforce reductions this year are expected to add even more to those savings. The royalty and fee lands transaction increased the strength of our balance sheet even more and we will continue to be disciplined with our capital allocation, redeploying capital with a focus on value into the areas where we have had the most success as a company and that's our oil sands. Foster Creek and Christina Lake remain our top capital priorities. Last, but certainly not least, I'd like to take a minute to recognize the efforts of our executives who will be retiring over the course of the next few quarters. John Brannan, Kerry Dyte, Shelia McIntosh and Hayward Walls have exhibited integrity, dedication and passion throughout their entire careers and that's what's driven them as they have served on the Cenovus leadership team since the company's inception. Their contributions which have been significant, have been instrumental in making Cenovus what it is today. Thank you. We continue to make a smooth transition to the incoming leaders and in our organizational move to a functional model. I've directed the team to complete the move to the functional model by the end of 2015. Being organized functionally will result in efficiencies across our company which are expected to provide additional reductions in our overall cost structure. With those comments, the Cenovus team is now ready to respond to your questions.

[Operator Instructions]. Your first question comes from the line of Greg Pardy with RBC. Your line is open.

Brian, just based upon what you'd said about the oil prices, is it fair to say then that you're essentially going to leave cash on the balance sheet until such time as you're ready to resume growth in the oil sands? Is that the right way to think about it?

So we continue to take a three-year view of the world and a three-year business plan. I'm now of the opinion that we could well experience some pretty low and volatile prices through 2017. With that view of the world, I think we're better off to take a more cautious approach with regard to the strength of our balance sheet and continue to preserve some of the cash on hand. But I would emphasize that even if prices stay in the CAD50 to CAD55 WTI range, that we can self-fund the projects and the expansions that we have identified and that we've mentioned today at Foster Creek, Christina Lake over the 2017 period. And what that does basically is the capital investment in Foster Creek, Christina Lake over the next three-year period really positions us for five years of growing production, starting with an incremental 50,000 barrels a day next year in 2016.

And it is a good lead-in just in terms of the ordering then of the projects that have been deferred. And I guess the question would be specifically as just putting Christina Lake G which is obviously pretty big in front of Foster Creek H. And I just wonder a little bit about that given that H is I think 50% complete, but more importantly it's still standing in the way of the debottlenecking which presumably will be pretty cheap barrels. I'm just wondering how to think about those two in the ordering.

Maybe I'll just briefly comment and then I'll ask Harbir to comment specifically with regard to the two projects. But really what we're focusing on is a more moderated pace of growth, level loading our workforce level and optimizing overall corporate cost structure. Over to Harbir for more color on that.

So the first thing is we're not looking at this project independently, we're looking at Christina G and Foster H and Narrows to level load like Brian is saying. And so we're staggering the projects. One reason Christina is ahead is because that project is not going to change, it's going to proceed as designed. Whereas Foster Creek H, we're trying to take advantage of the equipment that's already there, like the boilers and get some production going earlier with small dollars and then finish the project. So we're staggering that project into two units and that's ? but really we're trying to level load all three projects and that's why we give a priority. And the other thing is we're still seeing cost reductions coming down and we think waiting another 3 to 6 months is actually going to lead a different cost structure and lower cost coming in on these projects.

And Harbir, when you say that, that's even on phases that are partially complete now that you've just put to the side for a while. You still think you can reduce the costs on those through the balance.

Yes, we're seeing costs coming down, especially on the sustaining side when we're putting the sustaining pads on the pipelining work, the mechanical work. We have seen some [indiscernible] up to 30% reduction and we think we can even get more on some of these projects. So waiting a little bit is actually a good thing.

I would just add that in this price environment if, for example, we see CAD50 to CAD55 as we go forward, then it's going to be a great time for us to able to invest counter cyclically now when the costs are lower and be well positioned to have more production coming on as prices recover later on.

Your next question comes from the line of Chris Cox with Raymond James. Your line is open.

I've got a few questions here just on the conventional side of the portfolio actually. And first I guess just kind of curious a bit on how you're thinking about Pelican Lake now and how that might sit within your portfolio [indiscernible]. It's become less of a focus in terms of growth capital the last few years and with spending being directed to some other conventional properties outside of Pelican Lake, is that now becoming almost non-core?

No, I wouldn't describe Pelican as non-core. We obviously had some disappointing performance in 2013 and we reassessed and slowed down development on that. There's still 3 billion barrels of oil in place there and we're taking the time to make sure that we really understand well a reservoir and what's the best recovery scheme there. In the meantime, it is and has been since last year generating free cash flow even at these prices, so it looks after itself, contributes free cash flow and we're taking this opportunity in the downturn to just reassess the overall development and capital allocation there. But as you correctly point out, we're not planning on allocating any additional capital there until we have a higher level of confidence in the returns that we would generate.

And then I mean you did sort of mention in the ? I think both prepared remarks, but also the press release this morning about maybe looking at some other non-core asset sales. And I guess I'm just curious are there any restrictions on divesting of properties that have a royalty including the recent sale to Heritage Royalty?

No, there's no restrictions.

Your next question comes from the line of Fernando Vali with Citi. Your line is open.

My main question is when you consider the dividend being sustainable at CAD50 WTI, do you already factor in any deflation on your sustaining capital? And how much growth outside of Christina phase F and Foster Creek phase G do you bake in to that sustaining CAD50?

We're positioning ourselves at CAD65 WTI, but we have stress tested as low as CAD50 WTI. And in that stress test case, so if we did have CAD50 for the next three years, then at the revised level of the dividend, we can internally fund the projects that we have described here, including reactivation of these other phases at Christina and Foster and still have a very strong balance sheet and a lot of cash on hand at the end of 2017. But it does include the cost savings that we have demonstrated and achieved so far in 2015, but nothing beyond that.

And then my second question was on the rail acquisition, the CAD75 million rail acquisition. Just wanted to understand a little bit of the rationale. Is that towards growth volumes? Why did you move at this stage to acquire that crude rail?

The rail has been identified as an important part of our strategy to be able to achieve global pricing and get our crudes to various markets. Our choice on timing was this was an acquisition at quite frankly a very good price for the amount and quality of assets available to us. The timing was good to step in. We're already seeing a significant interest, both in our ability to move our own barrels. We have contracts for third party barrels. We've seen a number of other parties that have approached us to move additional barrels and to partner with us on different activity. So we see a lot of opportunities to strategically grow this. Our principle use is to be able to maximize the value out of our oil sands production and reduce the total cost of getting to market. But it adds a lot of flexibility and was acquired at an excellent time from the cycle in the market.

[Operator Instructions]. Your next question comes from the line of Fai Lee with Odlum Brown. Your line is open.

Brian, you talked about investing counter cyclically and I'm just wondering for a pricing assumption, a planning assumption, are you basing that off of a CAD65 WTI that you talked about or some higher assumption?

CAD65 WTI flat.

And in terms of your target's capital structure over the long term, is there some of sort metric that you have in mind or I'm just wondering how you're thinking about that over, I guess, beyond the next few years.

Yes, we have not changed our financial strategy. We continue to target strong investment grade credit rating. And over the long run, 30% to 40% debt to cap and 1 to 2 times debt to EBITDA, we're clearly well below that today with the strength of the proceeds from the royalty lands disposition. And as I mentioned earlier, this is the kind of a pricing environment where, as I said, we've stress tested at CAD50 for the next three years. So want to make sure we're taking a little more cautious approach with regard to the balance sheet, given the uncertainty that we see in the macro-environment.

I think that makes a lot of sense, given this environment. You didn't mention a ? I don't know I might have missed it, but in terms of share buybacks, does that fit in the equation anywhere near capital allocation strategy?

Did have a discussion with that with our Board of Directors earlier this week. And we will be reassessing and revisiting share buyback as a use of capital when we're looking at our 2016 budget.

And there are no further questions at this time. I will now turn the call back over to the presenters.

Thank you for joining us today. That completes our call.