Cenovus Energy Inc. (CVE) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy's Third Quarter 2017 Financial and Operating Results. As a reminder, today's call is being recorded. [Operator Instructions]. Please be advised that this conference call may not be recorded or rebroadcast without the expressed consent of Cenovus Energy. I would now like to turn the call over to Mr. Kam Sandhar, Vice President, Investor Relations and Corporate Development. Please go ahead, Mr. Sandhar.

Thank you, operator, and welcome, everyone, to our third quarter 2017 results conference call. I would like to 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 Q3 MD&A and our most recent annual information form and Form 40-F. The quarterly results have been presented in Canadian dollars and on a before-royalties basis. We've also posted our quarterly results on our website at cenovous.com. Brian Ferguson, our President and CEO, will provide brief comments. And then we will turn to Q&A portion of the call with the Cenovus leadership team. Please go ahead, Brian.

Thanks, Kam. Good morning. Our third quarter results highlight our continued progress in executing on a strategy we set out earlier this year. This quarter, we benefited from a full 3 months of ownership in the assets that we acquired in May as well as a solid contribution from our downstream business. During the quarter, we generated $544 million of free funds flow and delivered another strong operational quarter. With total production up 116% compared with the third quarter of last year, we remain on track to announce $4 billion to $5 billion in cumulative asset sale agreements by year-end and are very satisfied with the 3 sale agreements we've reached over the past few months. We are doing what we said we would do and, I think, today's results are a clear reflection of our dedication to executing on our plan. Oil sands production rose to over 360,000 barrels per day in the third quarter, an increase of 136% from last year, as we benefited from the full ownership of our oil sands assets and the ramp-up of Foster Creek phase G and Christina Lake phase F, both of which were brought on in the second quarter of 2016. Christina Lake continues to be an industry leading with average production of 208,000 barrels per day, an esteemed oil ratio of 1.8 in the quarter. Phase G construction resumed in the first quarter of this year, and activity ramped up through the third quarter. We remain on track to deliver first oil in the second half of 2019. Foster Creek production averaged 154,000 barrels per day in the quarter with August volumes impacted by temporary treating issues, which are routinely encountered with the startup of new sustaining pads. Volumes recovered through September, and we remain on track to meet our production guidance for the year. The integration of a Deep Basin asset has gone extremely well. Production from the Deep Basin averaged more than 115,000 barrels of oil equivalent per day in the quarter. We are pleased with the execution of the capital program to date and are continuing our disciplined approach to development, which is focused on the drilling and completion of horizontal production wells targeting liquids-rich gas within the Deep Basin corridor. We are on track with our plan to peak at 7 rigs and drill 28 wells across the Deep Basin by year-end. The refining and marketing segment generated $211 million in operating margin in the third quarter of 2017 compared with an operating margin of $68 million in the third quarter of last year. Higher average market crack spreads due to weather-related events that impacted the U.S. Gulf Coast refineries were partly offset by narrower light-heavy differentials as well as a stronger Canadian dollar in the quarter. We continue to benefit from our integrated portfolio and view the refining and marketing segment as a core component of our strategy to help protect against periods of wider light-heavy differentials and to help maximize the margin on the barrels that we produce. As you've seen over the past couple of months, we are on track with our asset divestiture program. We are very pleased with the completed Pelican Lake sale and have sale agreements in place for both Suffield and Palliser. And we remain confident we'll have a sale agreement for Weburn before the end of the year. We are also in the final stages of analysis on the Deep Basin assets with a view to identifying non-core properties for potential sale. Our prime focus remains on reducing near-term leverage. Net proceeds from these divestitures will be used to pay down the asset sale bridge facility, which was put in place to help finance the acquisition. With the closing of the Pelican Lake sale on September 29, we have fully retired the first tranche and a portion of the second tranche of our $3.6 billion asset sale bridge facility. We will also apply the net proceeds from the sales of Suffield and Palliser to further reduce the bridge facility when those transactions close in the fourth quarter. Concurrent with our sales processes and to further support our financial resilience, while the balance of the asset sale bridge loan remains outstanding, we have accelerated our hedging program and have hedged a greater percentage of our forecast liquids and natural gas volumes. Our 2018 activity is weighted towards the first half of the year and focus on providing downside price production. You should expect us to get back to a more normalized hedging levels subsequent to the completion of our asset sale program. To reflect the additional capital cuts that we've made and cost improvements that we have achieved, we are updating our 2017 capital expenditure guidance by lowering the midpoint of our guidance by $100 million. The majority of the reduced capital spending relates to continued improvements in drilling performance, development planning and optimized scheduling of well start-ups at our oil sands operations. Our production outlook for our core areas in the oil sands and Deep Basin this year remains unchanged. Looking ahead, our 2018 budget process is now underway, and we will be able to share more details about our plans later this year. We intend to keep capital discipline top of mind, as we focus on near-term debt reduction and generating increased free funds flow over production growth. We expect our 2018 budget will reflect this. Before I turn it over to Q&A portion, I'd like to take this opportunity to congratulate and welcome Alex Pourbaix as my successor to the Cenovus team. Alex brings a tremendous amount of experience and knowledge to the table. And I know the board has full confidence in his ability to lead Cenovus through what, I believe, will be an exciting time for the company. I will be staying on in an advisory role reporting to the Board Chair until March 31, 2018, to help facilitate an orderly transition. I have confidence in the management team, our business plan and the people at Cenovus who are dedicated to executing on this plan. It's been a great honor and privilege for me to lead this company since its launch. And I am proud of what we've accomplished together. I remain fully committed to doing whatever I can to ensure a seamless transition over the coming months. And I'm excited to see Cenovus continue to deliver. With that, the Cenovus leadership team and I are ready to take questions now.

[Operator Instructions]. Your next question comes from the line of Paul Cheng with Barclays.

First, Brian, that wish you the best of luck in your retirement and have a lot of fun.

Thanks, Paul. That's going to be #1 on the list.

Yes, I'm sure that you will have a lot of fun on that, so best wishes. Several question. First, just want to clarify that $4 to $5 billion on the asset sales target for the end of the year, that's not including any sale -- potential sale in the basin, right?

No. We are assuming that -- so the 4 sales that have previously announced of the legacy assets get us substantially to the bottom of that range of $4 billion. And we are targeting and including some sale of non-core Deep Basin assets to get us into that $4 billion to $5 billion range.

Okay. And on the Deep Basin, in this guidance, it look like you have reduced comparing to the last guidance on the royalty by 3%. Is that just simply a timing and/or noises? Or that this is something fundamental and we should use it for the future modeling?

Yes, it's a sustainable increase. It's related to price royalties or price-sensitive number.

No. You actually reduced it comparing to the last guidance. Last guidance is 10% to 12% on the royalty in Deep Basin. And now that you're talking about 7% to 9%. So you have 7% to 9% just the fee -- is a good baseline to use into the future. So that means that is actually lower than previously we thought.

Yes, subject to what prices do.

Okay. And the final question for me. Once that your -- the net debt ratio bring you a net debt down to about 2x on your cash bowl, what will be the priority? How they stack up between return cash to investor and the organic growth projects?

So as you correctly point out, the #1 priority is reducing our near-term leverage back into our long-term managed ranges. Once we've accomplished that, then the first thing that we'll be assessing is how much capital are returned to our shareholders, first and foremost.

The next question comes from the line of Joe Gemino with Morningstar.

Can you touch a little more on your SAP technology and how you plan to incorporate it on your existing production through your maintenance activities within the next couple of years?

Sure. I'll ask Harbir Chhina to respond to that question.

Joe, first of all, we've been testing solvents for quite a few years, so we believe that they're going to have a lot of value and improve our value of all of these assets. So we're doing a number of tests. We're not doing them to figure out whether it's economical or not. We already know these solvents are economical. The test that we're doing over the next year, as we've tested butane at the 10- to 15-weight-percent-injection, now we're going to test it at lower as well as extremely high-weight percent. So up -- so we want to figure out how these solvents are behaving in terms of SOR and oil rate from any reference 0 to as high as 80%. So that's what these tests are focused on. And the other one is to test our propane because propane is relatively cheap. And we feel that it's going to be more accretive to value than butane given today's commodity prices. But we are set up to go with either one of those solvents.

Great. And when do you plan to utilize these solvents on your current production?

So one of the pilot is eminently starting right now with propane. And so we'll see the results over the next 9 to 12 months. And then we will start to convert pads over to solvents starting in 2019.

Now we would like to invite the members of the media to ask questions. [Operator Instructions]. The first question comes from the line of Deborah Jaremko with Daily Oil.

So my question is about the potential sale of non-core Deep Basin assets. I was wondering if you could talk about the time line on that and also what the characteristics of those -- of assets might be in the Deep Basin that might be considered non-core.

So thank you for the question. We have continued to get a lot of inbound, unsolicited interest over the last 6 months. And we're in a process, as we indicated in the news release, of sort of finalizing our assessment. Not in a position today to get into specifics on the specific assets that we will be considering non-core at this time. Stay tuned and you'll hear more about that in December as part of our budget process.

Your next question comes from the line of Robert Tuttle with Bloomberg News.

I was wondering about the -- you'd mentioned Marten Hills with assets there are your wells. What's your plan with that? You've mentioned that as a possible divestiture.

So Marten Hills is -- we've got a large undeveloped land based there. One appraisal well into it and looking at a small additional appraisal program to really assess the potential -- you're quite right. It's been getting a lot of interest, both by industry and media, recently.

Is it a sale? You'd mentioned sale. Would that be a possible sale this year?

We've not made a decision on that as yet.

Your next question comes from the line of Jeff Lewis with The Global and Mail.

My question is about succession. Just wondering how are things going to change under the new CEO. And a follow-on, I mean, what do you think needs changing at the company?

I'm going to ask Al Reid to respond to that one.

Jeff, thanks very much for your question. So I think that in the short term, our strategy will be unchanged. The board approved our strategy prior to our investor day in June. And I've identified a candidate, through a very robust process, that is known for his ability to execute. So we'll continue to be focused on deleveraging our balance sheet through divestiture and generation of free funds flow from our 2 production platforms in the oil sands and the Deep Basin.

Do you think anything needs to change beyond that?

I think what we need to do is to continue to deliver on the plan that we outlined at investor day and even before that on March 29 when we announced the transaction. So what you've seen this morning is that the transaction is showing us adjusted funds flow that are -- that have increased -- free funds flow that have increased. We continue to find capital efficiencies that allow us to reduce our capital. We've reduced it again this quarter. And it's just a matter of continuing to deliver on the divestitures. So that we're going to continue to execute on the plan we put out.

Your next question comes from the line of Neil Mehta with Goldman Sachs.

This is Emily Chieng on behalf of Neil Metha. Just a quick question on -- I know this is outlook for the WTI, WCS crude differential going forward. As this got a number, new projects coming into service this quarter. How does the company think about impacts then?

I'm going to ask Bob Pease to respond to that question.

Thank you, Emily. We have seen some strength in WCS heavy crudes due to activity on a larger global scale. But we do also see that as production comes online, we can foresee the accretive time, whether it's not surplus pipe capacity likely to see an increase in the rail as a result of that. That should lead to a widening of the spread, certainly not like we'd seen in past periods of time. There is sufficient capacity. And Cenovus is very well positioned in the event that it does take longer than we would certainly like and the industry needs for pipelines to come on board. But yes, directionally, we see that additional capacity putting stress on the pipe capacity. So we do expect a widening of WTI, WCS over time until more pipe comes on.

And perhaps my second question. As you've had a full quarter of operatorship of 100% of FCCL, I guess, what kind of -- what levels of normalized OpEx can we expect to see longer term as Cenovus strips cost out? And I guess, what run rate of synergy captures can we expect to see from the Western Canada acquisition?

So I'll think ask Ivor Ruste to comment on that and maybe Kieron as well. We have given guidance, which you can refer to the guidance document that we have in place.

Thank you for the question. If I understood it correctly, you asked whether or not we see synergies arising from that acquisition of the other 50% of the oil sands business. And I think we continue to see great efforts in reducing our overall operating cost program. We have always been the operator there, so it's up to us. And we develop plans to take cost out of our operating cost. But we're getting down to pretty low levels there as well now. But certainly, the teams continue to be focused on that. With respect to the Deep Basin, I might ask Drew to speak to what we've seen in that area of operations.

Sure, Thanks, Ivor. Yes, thanks, Emily, for the questions. So if I was to look at OpEx as we've kind of now have the Deep Basin for the quarter, the assets continue to be run very well by the team that came with it. We do see some opportunity and some of the things that we discussed at Investor Day around plant utilization getting some more throughput through some of these facilities. But at the same time, we're looking at the operating structure of how we're running them, and we see some good opportunities. So I would expect that you would see us to start coming and bringing the OpEx guidance down in the Deep Basin. And obviously, we can probably share some more as we come into the budget release at the end of the year about how far and then what are the kind of the parameters around making us potentially continue to show better improving OpEx. But very impressed and very pleased with the performance over the quarter.

I would just add to that, that we have announced that we are targeting $1 billion in cumulative capital, operating cost and G&A savings over the next three years. And I think that we're well on our way to continue to deliver on that target.

Your next question comes from the line of Deborah Yedlin with Calgary Herald.

Brian, congratulations on a very strong career. And I'm just curious as to what quarter is the best for you in terms of being involved in the financial reporting since you started with AEC?

Thanks for the question, Deborah. It's my 100...

I have a few more, but I just wanted to start with that.

Sure. So this is my 121st reporting quarter.

That's quite an achievement. Just wanted to follow on that last comment you made about the $1 billion, the -- in savings over the next 3 years. What role -- can you talk about the progress you've made in terms of moving towards adopting more artificial intelligence, digitization and what role that's played to date and how that factors into that $100 million in decreased capital expenditures that you'd talked about for -- going forward in the short term?

So we have identified a number of opportunities in terms of data analytics, big data, digitization, where we see that as being a meaningful opportunity for us to continue to improve the overall efficiency of the organization. We haven't had actually yet publicly released the guidance on that, but we do see that being a very material opportunity for us. And so if you look at other businesses and industries, it is definitely something that will contribute very meaningfully towards that $1 billion opportunity. But I would say that the $1 billion brings into all aspects of technology as well as organizational efficiencies that will be related to not just digital, but many other things that we're working on.

And now just -- could you give us a sense of the level of interest that you have for the Weburn assets?

Yes. We've had, I would describe, a very competitive process. It's a very attractive asset. And all the parties that are in the process, I would characterize as substantive parties that are well financed.

Can you tell us how many parties?

Can't do that. There's CAs in place.

Right. And finally, have you had any recent conversations that are -- with the debt rating agencies regarding the debt position of the company?

Yes. So we have ongoing discussions with all 3 of the rating agencies. And I would say that they continue to provide us positive feedback in terms of the financing plans and deleveraging the balance sheet.

The next question comes from the line of Ethan Lou with Reuters.

Questions for Al to follow up on Jeff's question. Can you expound on what you mean by short term when you say in the short term, the company's strategy will not change?

Sure, Ethan. So I think we've been fairly clear on what our short-term priorities are. We've also been very clear on what our capital allocation will be in terms of our 2 production platforms. So I think you can continue to see us progressing down that path over the next 6 to 12 months. So that's really what I'm referring to as our short-term plan. And certainly, as we are working through our capital budget process, there will be more direction coming out on that when we release our budget later this year.

Your next question comes from Dan Healing with The Canadian Press.

And congratulations, Brian, on retirement. I just had a question about crude by real. Are you seeing an uptick in crude by rail? Are you expecting one? Are you increasing staffing and gearing up at your crude by rail terminal?

I'm going to ask Bob Pease to respond to that.

Yes. Thanks for the question, Dan. No, we haven't seen an uptick yet at the current differentials. We are moving volume out of Bruderheim terminal. And we are staffed for a fairly significant growth if we see a really robust opportunity. We also -- one of the good things about this facility is the ability to add additional capacity to meet that. We can turn that around in a reasonably short order. But at that this point, we haven't seen an uptick. There are still markets. Even at this differential, we reach well. But we do see that day coming.

Okay. And just had a follow-up on Deb's question about technology and using it to improve efficiencies. Is there a concern by the company about data breaches and such things given recent events that have occurred regarding other big companies with a lot of data?

Thanks for that follow-up question. We've got a very active cybersecurity program here at the company and don't -- it's one of those risks that all corporations and everybody as individuals on a personal basis need to continue to be vigilant about.

Your next question comes from the line of Arthur Grayfer with CIBC.

Just one quick question for me. You made a comment about prioritizing near-term debt reduction and also increasing free fund flow over production growth when you put out your '18 budget. I assume that refers to not commissioning or not sanctioning oil sands growth, but that also elude to, perhaps, slowing down the Deep Basin program that you laid out in the investor day. There is a multiyear plan. Is that -- would that suggest as well?

So you'll have to stay tuned for specifics with regard to the 2018 budget. I would say, as a fundamental strategic principle, as we've talked about, we believe that the Deep Basin and the oil sands will be free cash flow generators. So we are going to make sure that as we go forward that the Deep Basin is self-sustaining and self-funding on its own right.

And that's the plan that you laid out on the multiyear program.

Yes. And I would suggest to stay tuned for specifics on -- as it relates to 2018 budget. But yes, we -- subject to what pricing is. We've got a lot of flexibility. And that's one of the key attractions that we saw strategically is that the Deep Basin assets are short cycle, and we can be very flexible in terms of how we manage that program.

Your next question comes from the Fai Lee with Odlum Brown.

Brian, congratulations on your retirement and also on the asset sales. I think it's to say there was a fair amount of skepticism around them at first, but looks like you're mostly waiting through that. In terms of the -- my question, the Deep Basin, I was just wondering about the liquids cuts over time. Do you expect that to improve as you get more knowledge in the area? Or how do you see that turning over time?

I'm going to ask Drew to respond to that.

Yes. Thanks, Fai. You're right. I mean, over time, I guess, you'd have to put a time horizon around it, but that's the beauty of this portfolio is that it's got a lot of depth in the amount of resource that we've got now in the portfolio. So where we will focus and what we will be continuing to look at to get the best returns and the best ability to generate cash flow will be in a higher liquids content parts of the portfolio. So as you concentrate in that, knowing we've got a great kind of base level of production that has -- that affords us a really nice 16%, 17% decline, over time, you will -- we will be drilling more liquids yield content wells. So over time, you would see the liquids content on a ratio standpoint increase relative to the current base production. So that is just a matter of at what pace and how much. But you're right, it should continue to kind of more liquids production because that's really what's driving the economics.

Okay. And in terms of the identifying the non-core assets, like, what are the characteristics that you're looking in terms of diverse -- divesting? Is it basically liquids yield or infrastructure? Or what's the criteria on that?

Yes. So it's a long list, actually, Fai. So I mean, with 3 million net acres, I mean, there's a lot of -- these are all very good place. I mean, if you look what ConocoPhillips had done historically, as they continue to look at that portfolio, they continue to keep the best place. So I would argue that we essentially picked up the best of all the best that they had over the last number of decades. And with that came a lot of great infrastructures you alluded to. So we used a lot of different ways to analyze this. And we're getting near the end of that now. But depth of inventory, gas to liquids content and potential long-term yield, the depth of that material inventory and running room, we looked at OpEx, infrastructure options, short-, long-term competitiveness and our ability to keep evolving technology and the outright productivity and the ultimate enhancing the EOR. So there was a long list of filters that we kind of put for the entire asset base. But this is a very good fundamental portfolio that, ultimately, we probably won't have enough capital to fund the entire portfolio. So some of these great assets will just going to be worth a lot more to some other people. And so we are just getting close to the end of that analysis.

Okay. Fair enough. And the last question I had was in terms of the other assets that were identified previously in terms for sale, like the Deep Basin growth overriding royalties and undeveloped oil sands, et cetera, are they still in the mix? Or that it's just kind of with the noncore Deep Basin sales, like you should be able to just reach your target already by the end of the year?

So we're continuing to assess various alternatives that we have, Fai. And you should expect some more guidance on those things specifically when we come up with our budget in December.

This concludes the Q&A portion of today's program. I would now like to turn the call back over to President and CEO, Brian Ferguson.

Thank you for joining us today. That -- this concludes our call.