Cenovus Energy Inc. (CVE) Q3 2019 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy’s Third Quarter 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 conference call over to Ms. Sherry Wendt, Director of Investor Relations. Please go ahead, Ms. Wendt.

Thank you, operator, and welcome, everyone, to our third quarter 2019 results conference call. I refer you to the advisories located at the end of today’s news release. These advisories describe the forward-looking information, non-GAAP measures and oil and gas terms referred to today and outline the risk factors and assumptions relevant to this discussion. Additional information is available in our annual MD&A and our most recent annual information form and Form 40-F. The quarterly results have been presented in Canadian dollars and on a before royalties basis. We have also posted our results on our website at cenovus.com. Alex Pourbaix, our President and Chief Executive Officer, will provide brief comments, and then we will turn to Q&A portion of the call with Cenovus’ leadership team. We would ask analysts to hold off on any detailed modeling questions and follow-up directly with our Investor Relations team following the call. [Operator Instructions] Please go ahead, Alex.

Thanks, Sherry, and good morning, everyone. As I’ve done over the past couple of quarters, I’m going to keep my prepared remarks short and to the point this morning. I’m sure everyone has already seen our third quarter financial and operating results that we released a few hours ago, so I’m not going to go into detail on the numbers. And most of you will have already seen our presentation from earlier this month at our Investor Day in Toronto, where we spoke at length about our updated business plan through 2024. We highlighted the tremendous progress we’ve made over the past couple of years in delivering safe and reliable operations, maintaining capital discipline and industry-leading costs, strengthening our balance sheet and improving our market access position. Based on these achievements, we’ve built a business that we believe is resilient and sustainable even at bottom-of-the-cycle commodity prices around $45 WTI. And our business plan includes significant capacity to generate free funds flow across the cycle while also increasing returns to shareholders. I’m extremely excited about the future prospects for our company. We’re doing everything we said we would do, and in the third quarter, we continued to build on our excellent financial and operating results for the first half of the year while demonstrating best-in-class safety performance. And I want to touch on safety for a minute. Safety is core to our business, and I’m happy to report that we’ve achieved more than a 40% reduction in our significant incident frequency in the first nine months of 2019 as compared with the same period in 2018. And I want to send my thanks to our team for this very important commitment. Another core element of our business that I’d like to draw your attention to is our cost structure. Even at constrained production levels due to the Government of Alberta’s mandatory curtailment program, we’ve kept our per barrel operating and sustaining capital costs low. I’m really proud of the work our staff have done to achieve this. For example, at $0.90 per barrel, our third quarter oil sands operating costs were 21% and 24% lower, respectively, than in the second and first quarters of 2019. And even with the decrease in production at our Deep Basin operations, per barrel operating costs were down 9% and 11%, respectively, from the second and first quarters. We’ve also got a good story to tell when it comes to our G&A costs, and we were – significantly reduced our financing costs through our ongoing debt reduction activity. And we’re confident the great majority of our cost improvements over the last few years are structural in nature and are sustainable. To keep our costs low, we are focused on maintaining the reliability of our facilities, and we have defined plans to measure and improve each of our cost drivers through our supply chain channels, materials and demand management and through technology improvements. As a result of our low-cost structure and our focus on maintaining capital discipline and balance sheet strength, we continue to demonstrate strong financial performance in the third quarter. Cenovus generated free funds flow of more than $620 million in the quarter, bringing total free funds flow year-to-date to nearly $2.2 billion. And notably, we achieved operating earnings from continuing operations of over $280 million compared with an operating loss in the third quarter of 2018. Continued strong performance at our upstream operations contributed to our financial results for the quarter. This was offset somewhat by lower crude oil runs and refined product output year-over-year at our jointly owned U.S. refineries, where we have some planned turnaround activities and unplanned downtime. We’ve continued to use our capacity to generate strong free funds flow to further reduce debt. At the end of the third quarter, our net debt was $6.8 billion, down from $7.1 billion at the end of the second quarter. And our net debt-to-adjusted EBITDA ratio was 1.9 times, down from 2.4 times at the end of the second quarter. We remain firmly focused on achieving our long-term net debt target of no more than $5 billion. At that level, we anticipate being in a position to achieve and maintain a target ratio of less than 2 times net debt-to-adjusted EBITDA at bottom-of-the-cycle commodity prices. We also remain firmly committed to maintaining our three existing investment-grade credit ratings. And as a result of our continued success in improving our balance sheet, I’m happy to say that we’ve made progress towards reestablishing the investment-grade credit rating with Moody’s Investors Service. Last week, Moody’s affirmed Cenovus’ Ba1 credit rating and improved its outlook for Cenovus from stable to positive. In the third quarter, we also demonstrated continued progress in ramping up our oil-by-rail capacity. In September, we reached an average of more than 80,000 barrels per day of oil transported by rail for delivery to U.S. destinations where we continue to increase our exposure to global pricing for our products. We are well down the path to reaching our target of approximately 100,000 barrels per day of rail loading capacity, which we continue to expect to achieve by year-end. This leaves us very well positioned to benefit from the Government of Alberta’s mandatory curtailment program announced this morning, which will allow producers to ship barrels in excess of mandated curtailment levels if those barrels are transported by rail. As you know, we’ve been proponents of this measure for some time now. We think it’s a great way to incent further rail takeaway capacity out of Alberta, and we applaud the government for moving forward with this initiative. While we’re on the subject of market access, I want to take this opportunity to highlight that we remain at a critical juncture for getting new pipelines built in this industry. It is crucial that the federal government follow through on its commitment to get the Trans Mountain expansion project built without further delay. Allowing this project to languish further would be a national tragedy. As we have always done, we will continue to work with the government to press for reasonable Canadian energy policy. We believe the best path forward to improve global emissions and environmental performance is to support a vibrant Canadian energy sector that can invest in emissions-reducing technologies while continuing to make a strong contribution to the national economy, create jobs, invest in local communities and support indigenous business and employment. At Cenovus, we’re committed to continuing to deliver leading environmental, social and governance performance. This includes ongoing work to identify meaningful practical targets and plans to achieve them for our four ESG focus areas; climate and GHG emissions; indigenous engagement; land and wildlife; and water stewardship. It also means we will remain focused on delivering excellent safety performance and maintaining healthy and safe work sites for our staff as part of our ongoing commitment to responsible development. In closing, I’d like to leave you with this. I think of our third quarter performance as yet another chapter in a turnaround story that has been a couple of years in the making but one that really started to take hold at the beginning of 2019 when our cost discipline and historically strong operational performance started to provide strong financial performance. You can expect us to continue to deliver on the commitments we’ve made to our shareholders, and I believe we are on the right path to create significant additional value in the months ahead. So with that, why don’t we get to everyone’s questions?

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

Hi. Thanks. Good morning. A couple of quick ones for you. The first is in terms of the ramp-up at Christina Lake. Typically, that’s done over 12 months, but you guys have been injecting steam for some time. So if you were permitted to ramp up as quickly as you could, what kind of a profile do you think we would see?

Hey, good morning, Greg. It’s Drew here. So for Christina Lake Phase G, we did have the facility early this year. We started utilizing the steam gens, and we continue to steam existing pads. And under curtailment, that still limited us from bringing any additional new pads on that would actually fill the Phase G kit. So your assumption is right. For us to still get full utilization of the Phase G facility, we still need that 6 to 12 months to fully ramp up. So we have been utilizing steam. We’ve continued to steam the existing reservoir to maintain its effectiveness. But in order to bring incremental new volume now with these rail announcements, we still need a 6- to 12-month window here in order to actually ramp up new pads with new incremental volume.

Okay, great. Thanks for that, Drew. And then the second one is just around the crude-by deal announced this morning. Could you just explain the mechanics in the context of 100,000 barrels a day of crude by rail that you’ve already contracted and that you’re ramping up on, how that will work?

Hey, Greg, it’s Alex. Why don’t I have Keith kind of walk everyone through that?

Thanks for the question, Greg. Obviously, industry has been working with the government over the past several months to come up with a workable compromise solution, and we do really see this as a win-win-win; win for industry to fully maximize the rail facilities in the province; a win for the province and the taxpayers of the province to generate more royalty revenue; and a win for the service providers, the railroads that will be able to fully utilize all the installed infrastructure. Specifically for Cenovus, the Q1 baseline would mean that we would have approximately an additional 85,000 barrels a day of dilbit capacity, which will fully allow us to ramp up our oil sands assets as well as Phase G.

Sure. Thanks very much.

Your next question comes from Emily Chieng with Goldman Sachs. Your line is open.

Thank you. My first question is just around operating costs. They were quite low this quarter, and I was just curious as to how sustainable this is going forward. And perhaps, can you discuss some of the operational changes driving this lower number?

Sure. Good morning, Emily, it’s Drew here. So in oil sands, I’ll just remind everyone, coming out of Q2, we had a major turnaround at Christina Lake. So for that quarter, we would have had some increased costs as part of that turnaround. But again, it just goes to show the teams both in oil sands and Deep Basin – and I’ll give you some Deep Basin context in a second. The teams just continue to operate very well, continuing to look at all of our cost drivers, continuing to increase the reliability of our assets. And even under curtailment and less production per barrel, the teams keep finding good ways to operate these facilities. And I’m still optimistic that the teams are going to continue to still find good cost structure changes and continue to make small improvements, so still excited about that. For the Deep Basin, very proud of that team. We – in the first half of this year, we took the opportunity to reset the Deep Basin’s entire operating model. Basically, the systems we use, how we operate internally to manage those assets, and we’re starting to see the fruits of some of that work that the team spent a lot of time to put a lot of effort in the first part of this year. As far as an absolute cost standpoint as we look forward, I think for the Deep Basin, we’re going to continue to find avenues to keep our absolute costs in check. But as you’ve seen from an investment standpoint in the Deep Basin, our volumes are going to be continuing to come down somewhat. But on an absolute cost basis, I still think the teams are finding good improvements in both oil sands and the Deep Basin.

Great. Thanks. And then just one follow-up, if I may, around project sanction, can you remind us what we need to see in terms of market egress to sanction Phase H of Foster Creek or Christina Lake given the rail above curtailment announcement this morning? Or is this still really a pipeline-dependent decision in conjunction with where the commodity price is tracking?

Emily, it’s Alex. I think the way to look at it and similar to how we discussed it at the Investor Day is, right now, those H phases are in our base five-year plan. But at the same time, we are going to be very thoughtful about this, and it would be not a very sensible decision to sanction those projects if we’re not confident that we have market access. So it’s hard to say what the bright line test for that would be, but I definitely know what it’s going to look like. We will sanction those projects if and when we have high level of confidence that we will have long-term market access to get those barrels to market. So that’s the question that we’ll consider over the next year as we bring those projects closer to an FID decision.

Great. Thank you.

Welcome.

Your next question comes from Manav Gupta with Credit Suisse. Your line is open.

Hey, guys. One quick question. First is you’re generating about $600 million of free cash even in this quarter. I’m trying to understand now that you have broken that $7 billion mark, should we assume almost all of free cash flow will still continue to just be just to lower leverage? Or is there a certain amount of cash you would like to hold on your balance sheet, Jon, just in case some other opportunities arise, including Conoco?

Yes. Hi, Manav, it’s Jon. What you should assume is the free cash flow that we produce on a go-forward basis is, by and large, going to the balance sheet. I think we laid out a pretty clear deleveraging plan in October. As far as other priorities, including COP, we’re pretty clear as well, I think of between $7 billion and $5 billion. If COP was to come to market with their shares, we would like to participate in one form or another, whether that be directly or indirectly. And the closer we are to $5 billion would really determine the order of magnitude that we’d be able to participate in that. But we are focused on $5 billion. And really, the COP block is outside of our control. But if and when they come to market, we will participate in one form or another.

Thanks. And a quick follow-up. We have got the rail over curtailment deal, but – maybe I missed it, but is there an update on what happened to the government-contracted railcars? Were they able to offload that to somebody?

Manav, it’s Alex. The government has not yet announced the disposition of those rail contracts. That process appears to be ongoing.

Thank you.

Your next question comes from Phil Gresh with JPMorgan. Your line is open.

Hi, good morning. I guess just a quick follow-up to Jon on Manav’s question there, maybe just worded differently. If we were to get to the $5 billion net debt target, how would you kind of assess the magnitude of your capability to participate given the size of – or the amount of shares that are owned by Conoco when we get to the target?

Yes. Phil, if you’re asking for an absolute number, I can’t give you one, and I wouldn’t be inclined to give you one. But what I would say, again, is the closer we get to $5 billion and then even going beyond $5 billion just gives us more flexibility in how we respond to that. So if you’re asking me what is the absolute amount that we’d be willing to allocate to that, I’m not really prepared to go there. But certainly, order of magnitude, you should be thinking about as being more participative as we get closer to $5 billion and more than that if we go below $5 billion.

Sure. Okay. Appreciate it. A difficult question. So I guess the second question just with this situation with the Keystone pipeline. I realize you guys don’t – as you disclosed in your Analyst Day, you don’t have any specific commitments on the pipeline. But I presume that Wood River indirectly does have access to that pipeline. So I guess could you confirm that? And is there any – if this were extended, would there be any kind of operational impact that we might want to be thinking about?

Phil, it’s Keith here. It’s early days. Obviously, the operator is responding to the event. We don’t have a lot of details on exactly the duration of the outage. What I would indicate is for Cenovus, obviously, with our rail program and ramping up to 100,000 barrels a day our pipeline access on pipelines other than this one, we also have almost 3 million barrels of cavern storage available to us. But I think it’s a clear indicator – it’s an unfortunate incident that happened, but a clear indicator of kind of the need for additional pipelines and the fact that the current Alberta government has a curtailment tool to ensure that differentials kind of stay narrow. With regards to our refinery, our partner operator is addressing that issue and watching it real time.

Okay. And just one final one on the refining. Operating cost guidance that you’ve given for the year has seemed to be tracking a bit above that. And so I just want to get some clarification on – perhaps maybe there are just some onetime factors this year that have driven that, but any additional color would help. Thank you.

Yes. Thanks, Phil. Basically, we’ve had some turnarounds happen early in the year and are currently actually in some turnaround activity as well at both of our refineries that are driving up some of those maintenance costs.

Okay. Thanks.

Your next question comes from Mike Dunn with GMP FirstEnergy. Your line is open.

Thanks. Good morning everyone. Apologies if this was answered earlier, but just curious as to whether or not you can peg a number or a rough number on how much your oil production has been curtailed this year relative to what it otherwise might have been I guess, if we – excluding Phase G Christina Lake. Just trying to get a sense of where to take our numbers as we think about the crude by rail above curtailment announcement this morning. Thanks.

Yes. Good morning, Mike, it’s Drew here. So you’ll recall here, the government has adjusted it here over the year. So our latest guidance here still has us probably – I guess, to your – I think what your question really is about is that as crude by rail comes into effect, what could you expect from us here from an initial production change. And we probably have about 10,000 to 20,000 barrels that could come on fairly quickly as we would apply for that crude-by-rail allowance that the government announced here this morning. And then as I reiterated earlier to Greg’s question, we’d still need to take about a six-month- to 12-month window here in order to bring on incremental production to that amount as Phase G was to ramp up. So we probably have about 10,000 to 20,000 that we can bring on fairly quickly, and then the incremental Phase G will be six months to 12 months following.

Sorry, Mike, it’s Alex. Just one thing. I mean our intention with this government announcement is we will begin to fully bring Christina G on now.

Great. Thanks. That’s all from me. That’s answer it perfectly.

And we would now take questions from the media. [Operator Instructions] Your first question comes from Joe Gemino with Morningstar. Your line is open.

Great. Thank you. Just wanted to point out I’m not a member of the media. I’m an analyst at Morningstar. But just a quick question. How have you thought about all the pushback on the Enbridge Mainline tolling? I know Cenovus has been reported to be reporter. Does that change – a supporter of it, excuse me. Does that change your overall thoughts for long-term growth? Or can you shed any light on that?

Sorry, Joe, was the question to describe why we support it? Or – I wasn’t quite sure where you were getting at.

Sorry. Yes, if you could shed some light as to do you continue to support it and why the pushback might be out there. And do you think that pushback may actually prevent it from moving to the contracts?

I have to say I’m somewhat surprised by the industry pushback. I think we tend to look at it in a very simple way. Just the way that Enbridge’s Mainline system has developed over the decades and with their requirement for downstream verification, for pretty much its entire history, that pipeline has largely been controlled by downstream refiners because of this downstream verification requirement. In order to ship on that pipeline, you have to be able to demonstrate that you have a home for the oil at the other end of it, either a refinery storage or a downstream pipeline. So just the effect of that is it has been controlled in large measure by refiners. And from – certainly, from my perspective, I think we have all seen that, that situation has very greatly benefited the refining industry and has very significantly impacted the upstream sector. My own personal view and very simply is that one of the biggest issues affecting our industry right now is people’s concern over market access. And I see – saw Enbridge’s proposal to convert to a contract carrier as an opportunity where a producer like Cenovus could actually, for the first time, be the master of its own future with respect to getting oil to market. And I – my own personal view was that this represented a really interesting opportunity for a company like ours and other companies in the upstream in Alberta to get firm access to the Chicago market and from there, get it to – get that oil to both to the Chicago markets and other markets and do that at what I view is a pretty reasonable price. I’m really happy to see that Enbridge is going to continue to make the application to Canada’s energy regulator. And I just – I think it’s a shame that we’re now going to face further delays while the regulator opines on the merits of the application. I think we could have got at this faster.

Great. I appreciate it.

Your next question comes from Fai Lee with Odlum Brown. Your line is open.

It’s Fai here. Now like your debt targets in Canadian dollars is $5 billion, but your debt’s denominated in U.S. dollars. And in a bottom-of-the-cycle scenario, it’s not unforeseeable to see the FX exchange weaken. I’m just wondering how do you think about that in the context of your debt target, where debt could possibly increase just because exchange rate weakens.

Fai, it’s Alex. I could answer that but I would just get corrected by my CFO, so why don’t I let him answer that for you?

Yes. Fai, you’re absolutely right. There does tend to be a correlation between oil prices and the Canadian dollar. So certainly, for – or by and large, you’re going to see that correlation. It hasn’t been as strong in recent years as it has been in the past. But if WTI were to weaken and we were to have a downtick, you would see our U.S. dollar-denominated debt grow in Canadian dollar terms. That all being said, the FX works both ways for us. It also increases our cash flow at the bottom of the cycle. So as the Canadian dollar weakens, you do tend to get the opposite effects. We’ve stress tested this across a number of different FX and WTI prices to ensure that the thesis still holds. And by and large, we’re still comfortable that getting our debt down to $5 billion is the right number, although you’re right, it’s – the long-term debt’s denominated in U.S. dollars.

Okay. So not – just a follow-up. And so if the debt goes up in U.S. dollar amount on the balance sheet, but then, in theory, you’ll have more – you’ll retain more cash to get you back to the $5 billion. Is that your thought process?

Yes. So what would happen is if – typically, again, as the economy weakens and the WTI price goes down, our U.S.-denominated debt would grow in Canadian dollar terms, but so would our cash flows in that your U.S. dollars converted back to Canada on cash flows increases. So there is a quid pro quo there in terms of how these things tend to move together.

Okay. Thanks.

Your next question comes from Chris Varcoe with The Calgary Herald. Your line is open.

Thanks for taking my question. Alex, we’ve seen a number of drilling companies move their rigs south recently. We – today, we saw Encana say it’s going to move its base to the United States and become an American-domiciled company. I guess I’m just wondering, in your opinion, what signal or message should Canadians and governments take away from these trends

Chris, it’s Alex. Thanks for the question. I don’t think there’s any other way to describe it. I think this is a tragedy for Canada. I could focus on the energy industry, and goodness knows we’ve seen the vast majority of international companies that were investing billions of dollars in this country have exited. But I think there’s a more fundamental issue going on, and that is, over the past five or six years, we have generally seen an exodus of investment both by international companies and frankly, Canadian companies into this country. And it’s an element of our competitiveness, our regulatory – the regulatory world that we’re in right now. I look at – you look at Encana, I think it’s a great example. Not too many years ago, that company was, by market cap, the largest company in Canada, and obviously, it was a predecessor company to Cenovus at one time. And to see a company of that importance of Canada – to Canada now exit its head office from the country, I think it’s a tough day for Canada, and we got to remain very, very focused on how competitive conditions are for our industries.

And just to follow up on a slightly different topic, talking about the crude by rail. Obviously, the government is going to provide some details later on this morning about the plan. But is there any concerns or are there any challenges in your mind to what this plan might mean for oil price differentials increasing again?

Chris, I guess I’d say a couple of things on it. And first, I kind of want to reiterate a comment that Keith made. I – this was a proposal that was created by industry. I think it was a great example of industry collaborating on something that we really see as a benefit for all concerned. From the perspective of what it will do to differentials, I actually think you’re going to see almost two markets develop. I think you’re going to see – I would hope or I expect we will see crude by rail ramp up probably to or close to the full capacity of the existing rail loading facilities in the province. And the producers that take advantage of that are going to pay the rail cost to get that to market and get a netback commensurate with that. And then we still have all of the other barrels in the province. And with the government’s mandated curtailment, I think we would probably expect to – probably – I think we’re probably going to see different netbacks for those two pools of production, if you will.

Thank you.

Your last question comes from Dan Healing with The Canadian Press. Your line is open.

Good morning. Thanks for taking my question. I just had a – looking for some more color on the crude by rail. You mentioned that you’d be able to bring on 10,000 barrels to 20,000 barrels a day right away and that the Christina Lake Phase G would be able to go ahead within six to 12 months. Can you describe where the 10,000 to 20,000 comes from? And would that be all of the curtailed barrels you have at the moment?

Yes. Thanks, Dan. It’s Alex. The 10,000 barrels to 20,000 barrels really come from a strategic and operating decision that we made when curtailment was first announced. We made a decision at that time to largely continue to make full use of our steam-generating capability up in our oil sands. So we were continuing to apply for more or less maximum steam to our reservoirs, and all we did is we dialed back the production. So right now, at both of our oil sands sites, we have significant amounts of oil that is mobilized, liquid in the reservoir. And as Drew mentioned, we will be able to ramp that up very, very quickly. And that accounts for the 10,000 to 20,000. And then the remainder of the Christina G, we’re just going through the standard process we would go through when we commission a new oil sands phase. And as Drew said, typically, we – that occur – you’ll see that production ramping over a six-month to 12-month period.

Okay. And how much are you shipping by rail right now?

Probably around 80 – probably about 85,000 barrels a day. Given the government – and this is a point worth noting, but given the government’s announcement that the baseline for rail above curtailment is Q1 of this year, at that time, we were moving about 15,000 barrels a day. So under that scenario, we have approximately – we will have relief from curtailment as long as that oil moves by rail of about 85,000 barrels a day of our 100,000 barrel-a-day rail commitments. So we have ample rail capacity both to undo the impacts of curtailment on our existing facilities and to allow the full production from Christina G now to come on to market.

Okay. Great. Thanks.

That concludes the Q&A session. I would now like to turn the call back over to Mr. Pourbaix for final remarks.

Well, not much more to say. I just want to thank everybody for joining us today. And with that, we’ll sign off. Thanks, everyone.

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