MEG Energy's CEO Discusses Q2 2013 Results - Earnings Call Transcript

Jul.30.13 | About: Meg Energy (MEGEF)

MEG Energy Corp (OTCPK:MEGEF) Q2 2013 Results - Earnings Call Transcript July 30, 2013 9:30 AM ET

Executives

Bill McCaffrey - President & Chief Executive Officer

Dale Hohm - Chief Financial Officer

Don Moe - Vice President of Marketing

Helen Kelly - Director of Investor Relations

John Rogers - Vice President, Investor Relations

Analysts

Mark Friesen - RBC Capital Markets

Mark Polak - Scotiabank

Hubert van der Heijden - Tudor, Pickering, Holt

David Nicol - Morningstar

Mike Dunn - FirstEnergy

Menno Hulshof - TD Securities

Operator

Good morning. My name is Steve and I will be your conference operator today. At this time I would like to welcome everyone to the MEG Energy Corporation, second quarter financial results conference call.

All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)

I will now turn it over to John Rogers, Vice President, Investor Relations . Please go ahead sir.

John Rogers

Great, thank you, Steve and thanks everyone for listening in to our second quarter conference call. In the room here with us today we have Bill McCaffrey, our President and CEO; Don Moe, our VP of Marketing; and Dale Hohm, our CFO who are in the room here, we are all very sad to state this will be Dale's last conference call with us. as of tomorrow he'll be retiring from MEG and we're all very sad as that's happening.

Bill McCaffrey

Everybody is agree with that, John.

John Rogers

Well on that note, I know we have Helen Kelly and myself from the investor relations department. We'll have Dale say a few things little later, but Bill why don't you kick it off with your comments on the quarter.

Bill McCaffrey

Well, good morning and thanks for joining us. I trust you all have had a chance to review the results so I'll just start it off with a recap of the highlights. Looking first at Q2 operating results, we achieved top-tier performance in both our steam-oil ratios with a SOR of 2.3 and our net operating costs of just $8.85 thereof.

Production volumes represented Meg's highest [non-flush] production quarter-to-date averaging 32,100 barrels a day and we're within 400 barrels a day of setting another overall record. These are statistics that we'd be proud of in any quarter but we're especially proud to have hit these highs during a planned maintenance quarter, but reduced production and added operating costs over the course of a two week period at the end of May.

A big part of reaching those exciting highs was the success of the RISER initiative in adding significant volumes. The other reason we achieved these results was that we were able to continue to produce at reduced rates during the maintenance period rather than undergo a complete shutdown. This added flexibility was possible because of the success of our reliability programs in maintaining the equipment as validated during prior turnaround and because of cross connections put in place between the phase 1 and phase 2 plans in prior years.

Along this theme, we have interconnected Phase 2B to Phase 1 and 2 in a similar manner. With these enhancements, we believe we are now capable of significantly mitigating production losses associated with future planned turnarounds.

Returning briefly to the Q2 operating performance for a combination of structural changes that are beginning to occur in the marketplace today, which I'll spend a few minutes talking about in a few minutes, and strong operating results led to another top tier outcome. With Q2 cash operating netbacks that close to $42 a barrel and quarterly cash flows of nearly $80 million. With higher production, lower operating cost and improved market dynamics firmly taking hold in the second quarter, we're on plan for what we see as a truly transformational year.

I'd like to just take a few minutes now, and update you on our growth plans. In addition to the maintenance work conducted in May, we also took the opportunity to complete one of two debottlenecking projects better part of the RISER initiative, once the second debottleneck projects complete in October, we expect to reach production capacities of 35,000 to 40,000 barrels per day from Phase 1 and Phase 2 combined and just as a reminder at 40,000 this is equivalent to 140% of the initial design, so that's really great.

On the reservoir side at RISER, we're ahead schedule for Phase 2 deployment of eMSAGP. In Q2, we completed drilling the remainder of our 37 Phase 2 in-fill wells and have begun the tie-in process, ramp-up of in-fill wells and the early stages steam displacement with non-condensable gas has also begun and we'll continue through the remainder of 2013 and into 2014.

From the eMSAGP patterns that are already in production, we're seeing steam oil ratios in the 1.5 to 2 range, which at this stage is consistent with or slightly ahead of our pad-A pilot and so obviously these results are very exciting as they help validate and repeatability at the eMSAGP technology.

Between the reservoir and [pads] where we've invested about $360 million in the RISER initiative in the first half of this year. That investment includes RISER implementation on Phase 1 and Phase 2, but it also includes work to make the Phase 2B plant RISER ready, and not just the plants but to be able to handle further interface production growth beyond 80,000 barrels a day, once Phase 2B well is matured to the point we can deploy eMSAGP.

And from the recent visit to the Phase 2B site I can tell you that a lot has changed over the past year. The plant looks ready to go and in fact it's not for off, the water treatment and steam generation side of the project is now mechanical complete. And we are now focusing on commissioning of those both facilities and finishing the remaining work on the oil treating side.

We expect the of commissioning phase to take a few months to work through and we're on schedule the first steam in late Q3, and initial oil production in the late Q4. From first oil, we expect the ramp up to designed capacity to take 9 to 11 months. With most civil work including some RISER pre-builds and most of the spending already behind us, we believe we'll pass the typical project risks zone for schedule and budget on 2B and we anticipate costs will continue to remain well within the budgeted range.

Let's turn our attention to marketing where there's a lot of value to be harnessed between the wellhead and the customer. Among this point, we are positioning ourselves to take advantage of infrastructure to get to markets and most importantly to have direct control our access to those markets. The goal is to participate in projects that will significantly reduce or eliminate exposure to North American differentials and help move our products towards world market pricing.

Along these lines, we're getting to benefit from both the structural changes in the larger markets, while at the same time advancing our own marketing strategies. We believe macro changes in the market are beginning to ship the overall pricing equation and that where the early stages of normalizing light heavy differentials.

From the heavy side of the equation, new conversion capacity this year at the BP Whiting refinery will increase demand for heavy in the pad 2 area and in fact with around 240,000 to 250,000 barrels a day at heavy capacity Whiting will more than absorb expected increases in the near term heavy supplies including the ramp up of Imperial's Kearl Project.

On the right side of the equation, the ramp up of the Permian and Longhorn pipelines, in addition to new takeaway capacity from Cushing via seaway to the Gulf Coast are helping release some of the congestion that drove the disconnect of WTIs for more pricing. We believe the combined effects of these changes is causing some of the current tightening of both WCS to WTI and WTI to Brent and it's helping strengthen Meg's netbacks.

Additional structural changes in the market will continue this year, with the completion of the Southern Lake of KXL between Cushing and the Gulf Coast and into next year with the launching of Flanagan/Seaway pipeline system in mid-2014, this latter system that will help provide an additional buffer against anticipated increases in heavy supply. And MEG is a founding shipper on this system which will solidify our access from the Chicago area to the U.S. Gulf Coast.

Because it's a hot topic I should restate that we are very supportive of the entire Keystone XL pipeline and although we are, we are not committed shippers on this line and it is not a significant component of our marketing strategy. Our choice was to secure pipeline space to US Gulf Coast markets on lines that do not hold the staying level of risk of regulatory delay.

Beyond the structural changes underway MEG's also making its own moves to secure higher price realizations and [debt] and market volatility through our hub and spoke marketing strategy. And this as just a reminder the first key piece of the strategy is makes proprietary interest in the Access Pipeline which delivers our product to the Edmonton area at a very low cost. And Access is being connected to MEG's 900,000 barrels Stonefell terminal which is on schedule for mechanical completion in Q3. Stonefell will access hub and launch point of many of our marketing initiatives.

Transportation spokes that branch up out from the hub to gain access to reliable long-term international pricing include not just pipeline connections like the Flanagan/Seaway but also other alternatives we can employ at our option. The first alternative spoke is barging via the US on the waterways system and that goes to high valued markets on the US Gulf Coast. And I am happy to report that MEG has now taken delivery of all of its 18 leased barges and that they are available as needed for use.

The second alternative spoke is rail delivery. As with barging, we've already tested new refining markets with rail shipments and we will have the option at our discretion to move significant volumes by rail with the completion of the initial phase of the [Connexus] loading facilities later this year.

Now both barge and rail can be independently wrapped up or down depending on whether they are accretive to the market price we can achieve using other alternatives. So when combined with their pipeline options, we expect to have the flexibility to optimize market aspects throughout North America and maximize our net effects and that flexibility is really what our hub and spoke strategy is all about.

So in summary, I believe all the pieces are coming together in 2013. We're showing great progress towards increasing production by the lower operating and capital cost and we have a great new opportunity to realize higher prices as we see improvements in the larger markets and take our own steps to realize the best margins within those markets.

Together, if these strategic initiatives are expected to result in a dramatic increase in our cash flow. If we look at the consensus at analyst, there is an expectation that makes cash flows roughly double in 2014 up from 2015 levels and triple in 2015 from ‘13 models and this will have the effect of rapidly closing the gap between cash flow and capital spending. And as we move to close that gap, we remain very comfortable with our financial foundation, our debt is extremely well structured, is covenant like and there are no maturities until 2020.

Although, we can never rule out equity, our plan is to finance growth beyond their 2015 80,000 barrel per day target with cash flow and debt. Financially, we are taking a conservative philosophy of pre-funding projects and generating related cash flows as a building block for growth, and we remain very confident in our financial position going forward.

And in closing, I want to take a moment to acknowledge that a big part of our strong financial position today is thanks to MEG's retiring CFO, Dale Hohm. And from our quarterly conference call point of view, I guess that's 12 quarters since we became publicly traded. But sales contributions go back much further than that, and for those of you who are regulars on our conference call, you understand my singing ability is not that key criteria for Dale's replacement.

I really do want to thank Dale for all these work over the year. Dale is a very important part of MEG Energy and has contributed a lot. Thanks, and with that I'd like to turn it back to John to open up lines for questions.

John Rogers

Great, Bill. Thanks for your comment. Steve, why don't we open up the lines for questions, and I do want to reminder the questioners that Helen and I will be around after the conference call for your detailed modeling questions. So you can keep the questions in the interest of everybody's time and if you could keep the questions at specific level, we will be most appreciative.

So Steve, why don't we go ahead?

Question-And-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Mark Friesen from RBC Capital Markets. Your line is open.

Mark Friesen - RBC Capital Markets

Just few questions here if you would. First of all, if you could expand the comments about the turnaround that happened in this quarter, how long did that turn take say relative to the previous turnarounds and what would you expect for, to invest in future turnarounds?

Bill McCaffrey

Thanks, Mark. In terms of the turning around, it was about 14 days, two weeks between on ramping down and doing the work and then starting to ramp up on it, and what we are doing is we are trying to find ways to utilize some of the equipment and take advantage of some of the interconnections that we have put in place over the last few years, so that we can mitigate that volume reduction that needs to occur typically when you do a turnaround. So we can never rule our total plant shutdowns but we do have alternate during turnarounds but we do have a lot of plans to try and mitigate the volume last during those periods.

Mark Friesen - RBC Capital Markets

Okay, and could you just confirm to that you prepare for your Phase 2B tier ends during this past turnaround that there won't be any need for a shutdown in Q3?

Bill McCaffrey

Yes, we have got the 2B tier and all done, we do have one piece of equipment to add as part of a debottlenecking on to the, but right now we think we are going to be able to manage that without any kind of shutdown impact in Q3.

Mark Friesen - RBC Capital Markets

Okay and what do you expect in terms of timing for timing of the current spending for wells and what you might expect for the rates coming off those wells?

Bill McCaffrey

We've across 13 of them tied-in right now. They are on temporary and we're just converting them over to permanent tie ends, but we do anticipate continuing to do those throughout this year and into the early parts of the, early first half I guess of next year. So it will be steady as she goes of it.

Mark Friesen - RBC Capital Markets

Okay. And then you're commenting on your expectations for rates coming in from?

Bill McCaffrey

I think they will be similar to what we have seen so far. We are very pleased with the results, we are getting tremendous repeatability of the whole eMSAGP process and I think that's very exciting, it's great to see it on the first phase, Phase A but it is also great to see it's repeating itself with additional patterns.

And the ramp up on the non-condensable part, we take a cautious approach and we're just continuing to do that slowly. So that will also phase in later this year and into 2014

Mark Friesen - RBC Capital Markets

Okay. With production currently had a I guess it's 135% of design capacity, are you fine with the plans on 1A and 2A it's getting stressed at all or is it able to handle continued volume additions from RISER or you get a rely on interconnects to use the plan that 2B discontinued the process RISER volumes?

Bill McCaffrey

Good question. We did their work in May; we actually found that we are able to make to reduce some of the pressure builds up on some of the lines between the vessels and so that's been very successful. So operating at the level that you mentioned is, it seems to be quiet comfortable flat right now, we don't feel like we are overstressing it. And we do have as I said one more piece of equipment to do, so that we feel comfortable between 35,000 and 40,000 barrels a day, that's in October as I mentioned, but we are now at these levels, but doing very well with it.

Mark Friesen - RBC Capital Markets

Okay. And the interconnections that you talked about before, are you able to move volumes between 2A and 2Bb?

Bill McCaffrey

Yes, we are and we think that's going to be quite a strategic advantage not only turnarounds, but as we learn more about where future bottlenecks could be that would limit us from future increases. So I think it's just very good work, good housekeeping to have that type of interconnect take place.

Mark Friesen - RBC Capital Markets

Changing gears quickly, you talked about marketing and potentially rail and barge, when heavy oil price differential, would you stop using rail stock, using barge in differentials narrow up here and just kind of wondering if that would be a type of environment where you would change the strategy?

Bill McCaffrey

Our strategy is one of creating flexibility so we are very focused on getting best value, maximum value for our product and so we will continually look for opportunities to enhance that value and having the barges operational now and the rail shortly really goes a long way to helping us to maximize that value and we are really focused on significantly mitigating the effects of differentials and reducing volatility. And so I think what you will see is the strengthening in cash flows as we go and I mean this is a good quarter on cash flows on its own. I think you will see that we are able to mitigate volatility in a meaningful way by having these tools in place and we treat them like they are tools. We can turn them on or off as needed and they will contribute to our overall cash flows in various markets.

Mark Friesen - RBC Capital Markets

Can you give a little more specific Bill and what kind of differentials you stopped using rail at?

Bill McCaffrey

No, we don't want to do that at this stage as we don't want to tip our head to some of on the marketing side where we sell our barrels. So we got to be very careful there. So I apologize for that part, but it is important for shareholder value that we maintain that quite in terms of displaying those numbers.

Mark Friesen - RBC Capital Markets

Okay. Any critical past issues for the rest of ramp up Phase 2B completion?

Bill McCaffrey

No, I think we're really excited to be directly complete on the steam and the water treating side of it and so we're in the commissioning phase out 2B right now for that portion of the plant. It is the biggest part of the plan. It seems to be going very well. You want to be careful with those comments as you are turning on a lot of equipment, new equipment and you just got to see that all works fine in order to whatever budget you have, but right now I am feeling now quite comfortable on that.

Mark Friesen - RBC Capital Markets

Okay. And just one final question for me. Can you maybe articulate what's your plans are for Phase 3A in terms of spending in the near-term and timing of that project?

Bill McCaffrey

Yes, sure. On 3A, right now, as I mentioned in our last quarterly call, we're comfortable with being patient on the timing of it. What we are really focused on is receiving some tremendous results out (inaudible) on Phase 1 and 2. (inaudible) part of that came on 2B and we're seeing some exciting possibilities in Phase 2B going forward and we want to make sure we understand all of those before we go through fast with 3A and so 3A is on track and everything, but we are going to focus on ramping up Phase 2B end RISER and also explore some possibilities of additional throughput through Phase 2B.

I don't want to comment too far on them right now, but I am just saying that we are seeing some interesting possibilities and those are very, very economic attractive projects that we want to make sure we explore. At the same time 3A is moving forward with the engineering and the long lease time equipment, the site has been prepared and so we are doing all of the initial work on it, but there will be work as mentioned before to link it in with 3B was just directly connected to it and to incorporate some of these other initiatives. So again not in a hurry on it, it's a great project, we are really excited about it, but we have some exciting things ahead of it right now.

Operator

Your next question comes from Mark Polak from Scotiabank. Your line is open.

Mark Polak - Scotiabank

Actually I think Mark asked some questions on CapEx.

Bill McCaffrey

Yeah, Mark, the other Mark did ask a quite flurry of questions, so hopefully there is some left.

Mark Polak - Scotiabank

Okay. Thank you.

Operator

Your next question comes from Hubert van der Heijden from Tudor, Pickering, Holt. Your line is open.

Hubert van der Heijden - Tudor, Pickering, Holt

Just one quick follow-up on the rail and in terms of the switching around between different browse to market, can you give any color around, I guess the cost of not using the (inaudible) that you have built out?

Bill McCaffrey

Sure. What we have done is, we spread up as a largely an optional approach to both the barge and the rail. The barge is of course on their own, and the go up and down in the specific, so we have the ability to use those or move them around. We have firm control of the leasing of those barges so we can't move those around. As far as the rail side goes, it's next option to move barrels by rail or not, and that is our [total column]. We don't have take our case exposure on that part, but we do have good access to doing it. So it's structured, it's is well structured to manage volatility where you may want to use it times and may not want to use at other times and we thought that was important because again our main theme here is to mitigate volatility and we want to be able to move in and out of these things at our rail when we want to based on maximizing the price.

Hubert van der Heijden - Tudor, Pickering, Holt

Okay. So for both the barge and the rail, it is just the lease thing that you have done on the equipment and nothing on the variable side that you (inaudible)?

Bill McCaffrey

We do have leases on the barges but we can manage those leases to our use or other use. On the rail, we are more open on the parts and can use it or not use it without fee.

Operator

Your next question comes from the line of David Nicol from Morningstar. Your line is open.

David Nicol - Morningstar

Just I guess a simple question really. I'm just trying to clarify the capacity on the barges where this is both kind of 10,000 to 30,000 barrel barges and just kind of building off the barge question, I'm guessing maybe you could price and (inaudible) how long does it take kind of round trip to move on these barges down to the Gulf Coast and is there any concern about congestional some of the inland waterways starting to develop over the next year?

Bill McCaffrey

Sure. So each barge is capable of about 20,000 to 30,000 barrels and there are six barges per toe, so you would move six barges at a time. So that's 120,000 to 180,000 per toe and then there are three toes that are possible. And the distance is a factor in the answer to how to long it takes. I believe it seven days one way to get around to the Gulf Coast and that's all we seeking this tend on field waters and everything. But there are destinations along the way that you can also do and obviously you would take the shortest destination and then you could move more barrels per month by doing shorter halts more often.

And what was the last part of your question.

David Nicol - Morningstar

I was just kind of wondering, if you might be (inaudible) any congestion developing on the Inland Waterways looking forward?

Bill McCaffrey

No, it's the regulated Waterways, they are built, there is over the course of the that part of the country and they are well structured and [late] set up to be able to move large [amounts] of barges up and down the Mississippi and our barges on a relative stands close to numbers of barges out there are quite small. All barges down move the ordinary thing but in terms of total barges and the capacity of the system it's quite capable of handling this.

Operator

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

Mike Dunn - FirstEnergy

Just following up on Mark Friesen's questions on Phase 3A and your taking on that, are you folks worried at all or how does it enter into the decision on that project as to whether if it's delayed too much to I guess after Phase 2B is completed, are you worried about losing labor if there's a gap there or do you anticipate you alternately have enough work for them to do with let's say RISER initiatives on Phase 2 etcetera? Thank you.

Bill McCaffrey

Yeah, thank you, Mike. No what we do is on our core people we do have enough work, a lot of work to do. We are not taking hirers per se on advancing things; we just see some exciting possibilities on RISER. On the general construction work force, the large, large numbers of people that are typically on those projects, it's very normal to turn those numbers up and down as need be. So it's a key guys that control projects and manage the projects we do have a lot of work for them. So we will maintain that skill set

John Rogers

Thanks Mike.

Operator

Your next question comes from the line of Mike (inaudible) from Barclays. Your line is open.

Unidentified Analyst

I am just wondering, given Phase 1 and Phase 2 and starting with Phase 2B, I am wondering whether you contemplated a higher production levels from Phases 1 and 2 in the design of Phase 2B and then I have a follow-up question. Thanks.

Bill McCaffrey

Sure. Well Phase 1 and Phase 2, obviously, we're running about 135% of the design capacity right now and so what we think we do there is that we will continue to test the capabilities of Phase 1 and Phase 2 with additional production for that phase and we will take a similar approach on Phase 2B. So design to be 35,000 at a 2.8 TMR ratio as we reduce that will increase those numbers. That's largely focused on additional wells to come into add to those volumes as the opportunity to further fill that plant once we round it up, presents itself.

But we do have our operating flexibility to move it around. I think that's important, I mentioned it earlier that it allows you to make sure your plant is getting best capital use. So if you had two plants and they were far apart of Phase 1 and Phase 2 and Phase 2B are not but if they were, you might find that you are full on one plant and resource short on the other plant. So the key is to integrate those plants don't have enough barrels around there to make sure you can best use to your capital. So Phase 1 and 2 and 2B are perfectly capable once we turn on and finish 2B off here to be able to move volumes around.

Unidentified Analyst

Thanks. And then just on the capital program, obviously, I guess you are about two-thirds (inaudible) plan CapEx for the year, can you just give a sense further and profile over the balance of the year?

Bill McCaffrey

Sure. Well, it's certainly front-end loaded for MEG this year. If you think about it, we thought our 2B on the water treating and the steam side largely complete, it's able to mechanically configure and we are just doing commissioning. And on the oil side, it's made tremendous progress as well. So it's reasonable with 2B, and Stonefell as well, which is now just finishing off mechanical completion and also with the drilling complete on the RISER initiative. We could see that we are very front-end loaded for the year which is all good, it allows us to bring on things faster in that approach. So you will see a decline as we go forward into the second half for the year especially that fourth quarter.

Operator

Your next question comes from line of Menno Hulshof from TD. Your line is open.

Menno Hulshof - TD Securities

I just have one quick question. You mentioned, I think it's nine to 11 months ramp-up for Phase 2B, and I was just wondering does that reflect the use of accelerated startup protocols like [Cenovis] did at its recent expansion or is it going to be a fairly standard startup?

Bill McCaffrey

That would be a standard startup. The approach we take is to see and bring on the production afterwards. And we want to make sure that we can anticipate any potential items that could occur during start up. We do turn on a lot of equipments so we are trying to make sure we allow time for ramp up in that manner.

Menno Hulshof - TD Securities

Should you be expecting any sort of the contribution in Q4 then, or is it more of a Q1 event?

Bill McCaffrey

We think we have the plants operational in Q4 and it depends on how successful that commissioning part of it is. Everything is on track for the mechanical completion on the oil side of it. And as I said the water and steam gen are already, steam capacity is already mechanically complete. So for able to get that up and steaming in the latter part of the third quarter and if we don't see too much, the challenge was startup of the oil side of it which typically is not an issue but that that one I rule it out, then we could see some volumes in that fourth quarter.

Operator

I am showing there are no further questions. So I will turn it back for any closing comments.

John Rogers

Great, thank you, Steve. And once again thanks everyone for listening into our second quarter conference call. Once again Helen and myself will be available right after the call for any of your detailed modeling questions. Thank you for not asking modeling questions on the call.

Once again thank you Dale for your final conference call. And everyone hopefully have a good day and we will talk to you soon, thanks.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

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