Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Douglas Proll - Chief Financial Officer and Senior Vice President of Finance

Réal Doucet - Senior Vice President of Horizon Projects

Allan Markin - Chairman and Member of Safety, Health & Environmental Committee

Peter Janson - Senior Vice President of Horizon Operations

Steve Laut - Principal Executive Officer, President and Director

John Langille - Vice Chairman

Lyle Stevens - Senior Vice President of Exploitation

Analysts

Menno Hulshof - TD Securities

Mark Polak - Scotia Capital Inc.

George Toriola - UBS Investment Bank

Kam Sandhar - Peters & Co. Limited

John Herrlin - Societe Generale Cross Asset Research

Harry Mateer - Lehman Bothers

Garland Buchanan - Babson Capital

Canadian Natural Resources Limited (CNQ) Q4 2010 Earnings Call March 3, 2011 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2010 Fourth Quarter and Year-End Results Conference Call. I would now like to turn the meeting over to Mr. John Langille, Vice Chairman of Canadian Natural Resources. Please go ahead, Mr. Langille.

John Langille

Thank you, operator, and good morning, everyone. Thank you for attending this conference call where we will discuss our 2010 results and also update our 2011 plans. Participating with me today are Allan Markin, our Chairman; Steve Laut, our President; Lyle Stevens, our Senior Vice President Exploitation, to comment on our reserves; Réal Doucet and Peter Janson, our Senior Vice Presidents at our Horizon Oil Sands mining operations; and Doug Proll, our Chief Financial Officer.

Before we start, I would refer you to the comments regarding forward-looking information contained in our press release, and also note that all dollar amounts are in Canadian dollars and production reserves are both expressed as before royalties, unless otherwise stated. I'll just make some initial comments before I turn the call over to the other participants.

In reviewing our 2010 results, both operationally and financially, I think you can see we follow our successful principles and strategies to ensure we continue to create value for our shareholders. Some of these are cash flow increase to gain year-over-year, our replacement of reserves was excellent, both in terms of replacement rate and the overall cost of replacing those reserves. Our overall production increased 10% despite a 6% reduction in North American natural gas production. Natural gas production declined to about a third of our production mix that contributed only 15% of our gross revenue.

Just three years ago, natural gas represented closer to 50% of production, reflecting our reallocation of capital towards higher return oil projects. Our oil production mix was fairly evenly distributed between light, medium, primary, heavy oil, heavy oil recovered using steam and synthetic oil for mining operations. And as Steve will show you, we have projects ongoing which will result in increases overtime for all of these categories of oil production.

Our operating costs continued to be effectively controlled and our balanced portfolio of assets is positioned to provide growth opportunities in the short-term frame as well as the longer term. And even as we deal with restoration of production at our oil sands mining operations, our strong cash flow and financial position allows us to maintain our planned capital programs and also effect an increase of 20% in our dividend rate.

Over the last two years, our dividend rate per share has been increased 70%, reflecting the increased sustainability of our cash flow and our strong financial position.

Before we turn the call over to Steve, I would ask Allan for his comments. Allan?

Allan Markin

Thank you, John. Good morning. Canadian Natural completed another solid year, benchmarked by an overall record annual production level of over 632,000 barrels per day of oil equivalent. As well, our reserve additions and replacement in 2010 reflect the strength of our asset base and the value of the company as we go forward. The company increased total proved and probable BOEs by 9% to almost 7 billion barrels, replacing 341% of our 2010 production.

Our total proved replacement value reserve replacement ratio on a BOE basis is 246%, which are excellent results and showed the dedication of our people to work to create value for our shareholders and provide choices for effective capital allocation.

As John discussed, we continue to provide short-, mid- and long-term growth. In 2010, a record heavy crude oil drilling program, the sanction of Kirby Phase 1, the next stage in our thermal heavy crude oil growth plan, the continued development of our world-class Pelican Lake crude oil pool, completing the first phase of our Septimus Montney shale gas play in Northeast British Columbia and the announcement of plans for expansion at Horizon are many examples of these.

Our commitment to safety and environment is at the forefront of how we operate and is a big part of doing it right in our mission statement. These core values are reflected throughout the organization and have been a big contributor to our success. For example, on the natural gas side, as a result of our continual focus on effective and efficient operations, we demonstrated strong operating expense performance. In particular, North American natural gas operating cost in 2010 actually decreased from 2009 despite lower production volumes and after acquiring higher cost properties within core areas. We do have a strong natural gas asset base.

Turning to Horizon, which we'll be discussing throughout this conference call, we will and are of course working prudently and safely to get operations back to plant capacity as soon as possible following the fire in January. Our success in 2010 showed a ramp up of synthetic crude oil production, and we were able to fine-tune our winter operating procedures and preventative maintenance activities.

At the same time, production volumes did progress to capacity levels. Canadian Natural's growth plan continues to deliver value to our shareholders, and it is anchored by our disciplined approach towards operational and financial strength. I am confident in the company's ability to remain disciplined, and we will persist in our commitment to effective and efficient operations. Steve?

Steve Laut

Thanks, Al, and good morning, everyone. As both John and Al said, the fourth quarter and overall year in 2010 were strong. Oil production was up 20% year-over-year as a result of a very effective capital program and $1.9 billion in opportunistic property acquisitions. This strong production performance generated significant free cash flow. As a result, we reduced our debt by $1.2 billion and increased our dividends by 43% in 2010.

Canadian Natural is a strong, well-balanced company with diversified assets which holds significant upside. Our assets are accompanied by a strong and experienced technical, operational and financial teams, who working together, have consistently delivered effective and efficient operations that are safe, minimize our environmental footprint and are low cost.

As we enter the next step in the evolution and growth of the company, we are generating substantial cash flow so the focus becomes on ensuring effective allocation of our cash flow to maximize returns. With a major spend of Horizon Phase I behind us and we return to stable operations after the fire repairs are completed, our ability to take a more mid- and long-term projects leverage our expertise and technology across our vast asset base is significantly enhanced.

Canadian Natural is poised not only in 2011 but for many years to come to unlock significant value and generate more sustainable returns for shareholders on a consistent basis year after year. Going forward, we'll continue to focus on oil development in the near and midterm with a greater portion of our capital being allocated to the mid- and long-term projects in thermal, light oil EOR and Horizon, which generates superior and more sustainable long-term returns on capital.

We will also preserve our strong gas asset base for the recovering gas prices, a recovery which in our view could be some distance in the future. As always, we continue to focus on execution excellence and preserve our capital allocation flexibility by maintaining a strong balance sheet and the generation of significant free cash flow. We'll deploy our free cash flow in the following priorities: opportunistic acquisitions; increased dividends; share buybacks, but on a small scale; debt repayment is the last priority.

Canadian Natural is in a very strong position and we'll maintain our 2011 capital program despite the Horizon incident. In 2011, we will see significant production growth for primary heavy oil, light oil and Pelican oil. Not only are we delivering growth on the oil portion of our asset base, even more impressively, is a roughly 40% of our 2011 capital budget does not have production in 2011.

Clearly, the Horizon fire will result in a temporary hit to our 2011 production and cash flow. However, it is also very clear that our assets are strong and generating significant free cash flow, allowing Canadian Natural to not only deliver the value growth from our assets in the near term but ensure we keep our mid- and long-term capital projects on track and do not compromise the future.

Few, if any, companies in our peer group have the assets, the balance sheet and the people to effectively execute our defined-yet-flexible plan, which delivers not only production growth but generates substantial free cash flow and as well sustain in the events such as the Horizon fire.

I will now quickly highlight each of our areas, but before I do, I want to highlight four key numbers to watch for as I go through the areas. They are 11%, 11%, 12% and 17%.

Let me turn to the first of the two 11% numbers. In 2011, our primary heavy oil production has started to grow by 11% to a midpoint guidance rate of roughly 103,000 barrels a day. Within our primary heavy oil assets, we have a dominant land and infrastructure position with 9,000 wells in inventory. As a result, Canadian Natural's operations in heavy oil are very effective. And with current oil prices and heavy oil differentials, our heavy oil projects generate some of the highest return projects in our portfolio.

In 2011, Canadian Natural drilled 790 wells, up 22% over 2010 and delivered 11% production growth over 2010. With similar drilling programs in 2012 and beyond, you can expect to see production growth of roughly 10% to 11% per year going forward, as we have inventory to maintain this program for many years as long as commodity prices remain favorable and is very high-value portion of Canadian Natural's portfolio.

The second 11%, light oil production in Canada is also targeted to grow 11% in 2011, as we will drill 138 wells, up 18% from 2010. Canadian Natural has a large light oil land base in Canada. As you know, the light oil base in Canada is a mature basin. However, with the investment in technology and higher oil prices, we're able to implement this technology to increase recovery and production over the mid and long term, creating significant value for shareholders. This includes CO2 flooding, alkaline surfactant polymer flooding, waterflooding, and utilization of multi-frac horizontal wells in 15 different pools across Western Canada.

Our oil production is targeted in 2011 to grow 11%. And going forward, production growth will be a bit lumpy as EOR projects kick in. As a result, we'll target 7% growth in 2012 and target an average of 67% growth, thereafter, substantial light oil growth.

12%. In 2012, we target production growth of 12% for our vast thermal heavy oil asset base, an asset base where we have a dominant land position with over 1.1 million acres of high-quality undeveloped land. Canadian Natural's thermal heavy oil assets contain over 34 billion barrels of bitumen in place in over 6 billion barrels recoverable, very comparable to the 6 billion barrels we have in our world-class Horizon asset. Canadian Natural's taking a very disciplined, stepwise and cost-effective plan to develop these resources with production steps of between 30,000 and 50,000 barrels a day every two to three years, ultimately taking production to over 445,000 barrels a day.

Kirby is our next step in Canadian Natural's defined plan to add that 445,000 barrels a day, and we will develop Kirby in two phases as well as debottleneck opportunities for Phase I down the road. We have over 1.5 billion barrels of petroleum initially in place and 500 million barrels to recover in the Kirby development. As you know, Phase I was sanctioned in November 2010 and is expected to peak at 40,000 barrels a day. In 2011, we will also submit the regulatory application for Kirby Phase II to take Kirby to between 70,000 and 100,000 barrels a day.

The Kirby Phase 1 plan is to build a processing plant capable of processing 118,000 barrels a day of water, generate 118,000 barrels a day of steam and treat 40,000 barrels a day of oil. The initial development will include 47 SAGD well pairs, 16 of which will be drilled in 2011, seven surface pads and 5.2 kilometers of pipe. The capital cost will be about $1.2 billion or $31,250 per equivalent barrel. We anticipate we'll be able to leverage this initial infrastructure for future bases, bringing down the capital cost for foreign barrel, assuming of course cost inflation remains in check.

We are on track at Kirby, all major equipment has been ordered, with 95% of all equipment already ordered. We are currently constructing the general utilities and infrastructure for the plant and have 200 people on site, which will ramp up to 850 people by late 2012. We are to bid for significant construction contracts, and we'll gear up for full construction this summer. The mechanical completion of the plant and pad facilities is targeted for August 2013, with first steam in December 2013 and first oil out February 2014.

Our thermal heavy oil assets are very strong and will deliver value growth for many years to come. Canadian Natural's program targets production growth of 12% in 2011 and for 2012, production is targeted in 105,000 to 115,000 barrel a day range, up about 10%. In 2013, we target production decrease roughly 15% to 125,000 to 130,000 barrels a day range and in 2014, with Kirby coming on stream, we target growth over 20% in 150,000 to 160,000 barrel a day range. Solid production growth from our thermal assets, which are key drivers of our overall corporate near-, mid- and long-term production growth profile.

17%. Pelican Lake production is targeted to grow 17% in 2011, with targeted higher growth in 2012 roughly 25% to the 50,000 to 60,000 barrels a day range and roughly 30,000 in 2013 to 75,000 to 80,000 barrels a day. Pelican Lake is a world-class oil pool with 4.1 billion barrels of oil in place and 550 billion barrels recoverable, about 17% recovery is expected at Pelican Lake.

We continue to roll out the highly successful polymer flood that will ultimately take production to the 80,0000 barrel a day level. We have had great success at Pelican Lake, however, we are still in the steep part of the learning curve, and we believe there is significant room to optimize performance and costs. For example, in the southern portion of pool, we are seeing a production response which is approaching the other edge of our expected response time range. This is a strong indication that better overall oil recovery may be achievable. This would also affect the overall shape of the pool production profile, however, it's too early to say if higher oil recovery is achievable in the southern portion of pool.

Our plan is to convert Pelican over to polymer flood in a stage manner with 54% of the pool converted by the end of 2011 and reaching 71% by 2013. We'll also expand the facilities in stages. Capacity was increased to 52,500 from 2010 and we'll go to 68,500 in 2011 and then to 106,500 by 2012 as we prepare for that wall of polymer-driven production in the next few years. Production growth targets are 17% in 2011, 25% and 30% in both 2012 and 2013, when we reach the targeted plateau rates of 80,000 barrels a day.

As you know, Canadian Natural is the largest heavy oil cruiser in Canada. And with our growth targets in Primary, Thermal and Pelican Lake are set to unlock significant value for shareholders. As part of that value creation chain, it is important that additional upgrading capacity gets built to process the significant volumes of heavy oil expected from Alberta. To facilitate additional heavy oil processing capacity to accommodate expected volume increases and to dampen somewhat the volatility of heavy oil differentials, Canadian Natural has entered into partnership with North West Upgrading to build a 50,000-barrel a day upgrader/refiner in Edmonton. And together, we've entered into an agreement with the Alberta government to approach that process on a toll basis the Alberta Bitumen Royalty In Kind volumes. We are progressing the engineering as we speak to prepare for the project sanction and have allocated $340 million in our 2011 capital budget for the Redwater project.

Turning to our international operations. Our strategy is to maintain our existing operations to convert our undeveloped resources as slots become available on the platforms. We'll also progress pool development in Cote d'Ivoire and progress a Big E exploration prospect in South Africa. It's important to point out that the international operations are a major driver of free cash flow generation for Canadian Natural. Our international operation is generating significant free cash flow. Although international accounts were only 10% of our production, it generates 25% of the company's free cash flow.

In Offshore West Africa, capital spending is down 48% as we lined up to development in the Olowi Field. As you know, Olowi has been a very disappointing development for Canadian Natural. Performance has not been near expectations, and we have taken the decision not to drill off the fourth and final platform, Platform B. With only three platforms on stream and disappointing performance, we now expect Olowi to produce between 5,000 and 6,000 barrels a day in 2011.

As a result, we have written down the Olowi assets in the fourth quarter, clearly, a result we're not happy with. The reservoir and geological risk at Olowi were much higher than anticipated when the project was sanctioned. In fact, all the key reservoir and geological parameters came in, in the low end of our ranges, and in some cases, below the bottom of the ranges.

As a result of failure in Olowi, Canadian Natural's undergone an extensive review over the last year and a half of how we evaluate and execute international projects and have made significant changes to our structure, our processes and various roles within the structure to ensure we do not have any more Olowis in our future.

That being said, it's important to note that Offshore West Africa has some of the highest return on capital projects in our portfolio and generate significant free cash flow for Canadian Natural. And with the changes we have made and the increased rigor that will be delivered through these processes, we are very confident we'll be able to add value going forward.

Turning to gas in Canada. As you know, our look for natural gas in North America has been very bearish. We believe shale gas production is real, shale gas reserves look real and shale gas full-cycle economics at $4 AECO prices are not certain. It likely works for the sweet spots and some, but not all, liquid-rich shales, but overall, it's too early to tell.

The LNG supply threats do exist and we'll provide a cap on gas prices. As a result, we anticipate the gas markets in North America to be oversupplied for two to seven years. Therefore, in this environment it is paramount to be the most effective and efficient gas producer, and Canadian Natural is an effective and efficient producer. Our overall strategy for gas is to leverage our dominant infrastructure and land base, maintain our position as the most effective producer and continue to strengthen our unconventional and tight gas asset base. We'll do that by delineating new and emerging plays, leveraging new technology to open additional resources, lower costs and openly position ourselves for strengthening of gas prices when they arrive.

Septimus is a good example of this strategy. Our Montney Play at Septimus looks very good as we're running our production at 60 million of cubic feet a day and 1,800 barrels a day of liquids, well above our 50 million a day design capacity of the plant. Septimus is in the early stages, looks very strong, and we we'll be able to expand the plant to 200 million a day and 6,000 barrels a day of liquids, if we choose to allocate the capital to Septimus.

For the remainder of 2011, we will monitor Septimus closely to ensure we get a good hard [ph] handle on the ultimate reserves recoverable, something I'm not sure all shale gas producers have the luxury of doing. As is always the case, we remain very selective on the acquisition front. However, if opportunistic acquisitions are available and we can see the value can be added, we will, as we have in 2010, capture those opportunities.

Turning to Horizon. Let me summarize where we are and where the plant is going forward in general terms. Both Peter and Réal are here to provide a bit more detail. As you know, the fire occurred on January 6 in the midst of a very cold weather, minus 35 degree to 40 degrees C. We successfully controlled the fire and minimized damage to our equipment given the seriousness of the event. All people were successfully moved from the situation, and the people injured are all making good recoveries. It is clear, our merchant response plans and teams worked very effectively during this event. The cold weather and icing situations, as you know, make completing the investigation and saving the plant difficult. The de-icing and saving is now behind us, unfortunately the cold weather is not.

Regardless, we are fully into the rebuild of the derrick and repair of collateral damage due to freezing and emergency shutdown of the coker unit. We continue day by day to complete further assessments of the plant and any collateral damage that may have resulted because of the fire. We are making good progress on the rebuild, the collateral damage and acceleration of future turnaround work in this period of shutdown. We believe we will be able to bring up two of the Coke Drums in Q2 and the second set in Q3. The cost estimates for the rebuild and repair of the collateral damage is in the $300 million to $400 million range. The critical path at this time is the repair of the coker furnished tubes, which sustained freeze damage in the days after the fire. Canadian Natural carries insurance to cover the cost of these repairs, as well as business interruption insurance after 90 days to cover operating costs up to $30 a barrel.

To give you more detail, I will turn it over to Réal and Peter, who will update you on the rebuild, the collateral damage and the acceleration of turnarounds.

Réal Doucet

Thank you, Steve. I will start with the business recovery, effort that we have done since the incident. First, we have made a plan to retrieve, which is coker plant safe, accessing and inspecting the coker structure and the equipment, conducting the incident investigation and managing the regulatory interfaces, assessing collateral damage due to freezing and other damages, mobilizing the team for coker structure and equipment demolitions and rebuild and also initiating opportune maintenance, withstanding capital work and accelerating the 2011 and 2012, some turnaround work, as Peter will talk about it here in a minute, managing also the insurance interfaces and the documentation of this.

The major activities that are underway right way now is we have developed the plan for operating the Drum 2A and 2B prior to having Drum 1A and 1B fully recovered. The engineering services and the procurement has been awarded to Technip, who was, by the way, the engineer of design of the plant to start with. The contractors also have been mobilized since the 9th of February here.

On the mechanical side, we have PCL, who were the major constructor of the coker as well. On the electrical and instrumentation, we have DCM, and on the insulation, contractors and de-icing panels and pipe. So right now, the area has been hand over to the rebuild team on the 17th of February following the investigation and the safeing of the plant. The derrick demolitions and the construction's activity have started since, so we have also raised preliminary EFE and contract for this undertaking. We have also undertaken on the Canadian Natural side the critical long lead direct procurement. We have made agreement also with other coker operators to get their spare coking cutting equipment since some of them are quite long delivery. We are also looking at the modifications of those equipment to make sure that they fit the design criteria that we have on our plant. We have also put some critical purchase order to Rur pumping [ph], who are the coke-cutting equipment manufacturer, Waiward Steel for the structural beams and so on and DeltaGuard for the valves for the decoking equipment. We are also doing some market survey right now for the fittings, small consumables and cables, which we are right now looking at who has those kind of equipment and goodies on stock.

The other demolition and rebuild, the critical path for us right now for half the plant operation is on the hydraulic pump unit. This is a system that's providing a hydraulic fluid for the hoist on the decoking equipment. The number two coke-cutting control shelter as well, which was slightly damaged, actually, not much, but we do have to do some full inspections in there and really testing all the E&I equipment in there. The DeltaGuard valves, which are the decoking valves located on top of the Coke Drum, also have to be inspected, evaluated and some of them have to be changed. And the Number 2A, which is the coke equipment that has less damage coke-cutting equipment, which is the rotary drive motor, the cutting deck, the drill stem and those kind of equipment that help decoking the coke. On a critical path, also on a collateral damage right now, like Steve says, the coke furnace tube replacement and the air coolers fin-fan replacement. So with this, I'll pass it on to Peter for the collateral damage and the rest of the information.

Peter Janson

Thank you, Réal, and good morning, everyone. Plant 33, our delayed coking unit that did experience considerable damage associated with the emergency shutdown and subsequent freezing immediately following the incident. Steam, normally used in the process aided in the extinguishing of the fire but also introduced much more water into the system. Purging and draining of the unit was very limited due to access restrictions associated with the hazards of the damaged derrick and the stop-work order that was in effect at the time. With the extreme cold temperatures experienced in those days following the incident, water and liquids remaining in the process froze, causing damage to the equipment and piping systems. This freeze damage we're referring to as the collateral damage is isolated to the delayed coking unit only, as all other units were shut down in a deliberate and controlled fashion.

Lockdowns and visual inspections on all of the equipment in the delayed coking unit have been completed. To date, significant freeze damage has been found inside the fired heaters, heat exchangers, pumps and piping systems. We have also found some externalized damage to building walls and cable trays. Test packages and integrity testing programs are in the development today to verify that the equipment will be ready for start up. And we expect these assessments will be completed by the end of March. Repair scopes for the work have been prepared. Resources are mobilized and material requirements have been expedited for the collateral damage. And as Réal had mentioned, the critical duration items affecting the recovery of the unit for a single-trained coker operation is specific to one coker heater and a bank of 10 air-cooled heat exchangers.

For full production, rate capability, the second coker heater repair will be required. Also, recommendations coming forth from the investigation team's efforts will be reviewed for hazard and operability, and they'll be incorporated into the rebuild and business restoration. Full pre-start-up safety reviews, instrument and control checks and a review of all our operating and emergency response procedures will be completed prior to start-up. The estimated time to complete the repairs is within the second quarter timeframe for the first coker train and third quarter for both coker trains.

I'll now provide an update on the turnaround and opportunity work that has been brought forward from previously scheduled outages in 2011 and 2012. In the mine, staff and contractor workforce are jointly moving overburden, building dike for our tailings pond and managing our basal water program. The workforce there is constant.

Bitumen production. We brought forward previously planned reliability work, sustaining capital projects and 2012 turnaround work scopes that are specific to enhancing reliability and operational improvements necessary for sustained production. This work is being completed through their base maintenance crew and will be completed in time for start-up.

In upgrading and utilities, they've similarly brought forward previously planned reliability work based upon the previously discovered corrosion areas as well sustaining capital projects. The catalyst changes that originally planned for this year have been deferred but the reformer PSA catalyst bids are being changed out during this outage. Most significantly, however, is that about a quarter of the 2012 turnaround scope has been brought forward. And we're currently assessing the possibility of deferring the balance of the 2012 turnaround scope into 2013, which would coincide with a catalyst change-out in that year. The turnaround scope brought forward represents regulatory inspections of pressure vessels and pressure release systems. And this scope includes about 77 pressure vessels, 167 pressure release valves that need to be tested, and all of that accumulates to about 208,000 field man hours of effort. And to date, we have completed approximately 42% of that man-hour effort. Despite extreme cold weather, ice hazards and frozen equipment, the safety performance has been good. Extra efforts have been made towards managing safety risks through job hazard assessments and added safety presence. Back to you, Steve.

Steve Laut

Thanks, Peter and Real. The events at Horizon, although not a usual for coker operations in the industry worldwide, have been a significant lesson for Canadian Natural. We believe that our operations are safe and our procedures are solid. That being said, we will, as a result of this incident, not only increase our focus on safe and effective operations at Horizon but across all operations. As a result, I firmly believe that Canadian Natural came out of this incident a much stronger and effective company than before the incident.

Consistent with the other areas in the company, we have not lost focus on the value creation of future expansions. We expect in Q2 to have a completed and more detailed cost assessment for the Horizon expansions. As we discussed in the last conference call, we'll break the expansions into five major components. The first component, reliability, has been previously approved and is well underway and will add about 5,000 barrels a day.

The second component is what we have named Directive 74. This involves all equipment and tailings processes to meet the new regulatory standards mandated by the ERCB by 2015. Our current cost assessment for this work is roughly $900 million.

The third component is Phase IIa, which is essentially an upgrading debottlenecking project and the acceleration of the coker expansion that will provide initial 10,000 barrels a day of SCO capacity.

The fourth component, Phase IIb includes, as major components, a fourth OPP, an initial froth-treatment plant, vacuum distillation and a gas oil hydro treater providing an additional 45,000 barrels a day of SCO capacity, as well as set the stage for Phase III work. The fifth component or Phase III increases capacity by 80,000 barrels a day and includes a fifth OPP to third and fourth extraction trains and a combined hydro treater and additional sulfur recovery.

To deliver these projects and ensure greater degree of cost certainty and cost control, we refined our execution strategy based on our lessons learned and our view of the market going forward.

Going forward, debottlenecking expansion will be combined and the expansion will be broken into the five major components described, which will be further broken into 46 individual projects that Canadian Natural can, at our discretion, start or stop depending on marketing conditions.

On top of this, the 46 individual projects will be broken into engineering, procurement and construction, giving us even greater flexibility to control the project and keep costs under control. Construction will only be awarded when E&P is at required levels and the market can absorb more construction. We will also extend engineering beyond the 8,100 rule, which we utilized very successfully for the most part in Phase I. We will use lump sum for E&P or construction when possible. The use of the combined EPC lump sum contracts are possible but expected to be rare. We'll also cap the construction labor force at 5,500 people compared to peak of 10,000 on Phase I. We'll also cap the yearly capital exposure at the $2 billion and $2.5 billion range.

Horizon is a world-class asset. We have over 16 billion barrels on our lease with 6 billion barrels recoverable. Our design capacity is currently 110,000 barrels a day, and our plan is to take a staged approach to expand to the first 250,000 barrels a day and then ultimately to just under 500,000 barrels a day or half a million barrels a day of light sweet 34-degree API crude for 40 years, no declines.

Horizon is a world-class asset and we'll continue to generate significant free cash flow for decades. Therefore, it is very important that we get our expansion right and we effectively execute our expansion plans and strategies. It goes without saying that no future expansions will be proceeding if the economics do not meet our thresholds.

Now let me turn you over to Lyle, who will provide an update on our year-end reserves and our outstanding 2010 performance.

Lyle Stevens

Good morning, ladies and gentlemen. To start our reserves a discussion, I'd like to point out that as in previous years, 100% of our reserves are externally evaluated and reviewed by Independent Qualified Reserves Evaluators. Our 2010 reserves disclosure is presented in accordance with Canadian reporting requirements using forecast prices and escalated costs. The Canadian standards also require the disclosure of reserves on a gross basis before royalties and also on a net basis after royalties.

Moving on to our results. As Steve mentioned, in 2010, we had a great year, replacing 246% of our production on a proved basis, 277% for crude oil and NGLs and 179% for natural gas. On a proved-plus-probable basis, we replaced 341% of our production, 445% for crude oil and NGLs and 216% for natural gas. Total corporate proved reserves increased by 8% or 338 million BOEs to 4.5 billion BOEs. This consists of 4.3 Tcf of gross proved natural gas reserves and 3.8 billion barrels of gross proved crude oil and NGL reserves.

On a proved-plus-probable basis, reserves increased by 9% or 557 million BOEs to 6.9 billion BOEs. This is comprised of 5.8 Tcf of gross natural gas reserves and 5.9 billion barrels of crude oil and NGL reserves. The largest increases in reserves were in thermal bitumen, primary heavy oil and natural gas.

On a proved-plus-probable basis, thermal bitumen reserves increased by 375 million barrels, a 28% increase, primarily as a result of the acquisitions of oil sands leases adjacent to Phase I of our Kirby Project and also strong positive technical revisions from our Primrose South, North and East assets. Primary heavy oil proved-plus-probable reserves increased by 62 million barrels, a 40% increase from 2009. This was largely driven by the results of our record heavy oil drilling program.

On the natural gas side, proved-plus-probable reserves increased 525 Bcf, a 10% increase. This resulted from acquisitions coupled with the initial development of our Septimus Montney assets and the continued strong results from the deep basin of Alberta. Horizon proved-plus-probable reserves increased by 2% largely as a result of our 2010 operations achieving greater bitumen recovery than assumed in the 2009 reserves evaluation. Crude oil and NGLs now account for 84% of our proved reserves and 86% on a proved-plus-probable basis.

In summary, these excellent results reflect the strength and depth of our asset base. I'd now like to turn the call back to Steve.

Steve Laut

Thanks, Lyle. As you can see, our performance on reserve replacement has been outstanding in 2010. Canadian Natural is in a very strong position and we're able to maintain our capital program despite the Horizon incident. In fact, as I stated earlier, we'll see significant production growth for primary heavy oil, light oil, thermal heavy oil and Pelican oil in 2011. Not only delivering growth on the oil portion of our asset base, we are doing it with spending 40% of our 2011 capital program on projects that do not have production in 2011.

Clearly, the Horizon fire results in a temporary hit to our 2011 production and cash flow. However, it's also very clear that our assets are strong and generate significant free cash flow, allowing Canadian Natural to not only deliver the value growth from our assets near term but to ensure we keep our mid- and long-term capital projects on track and do not compromise the future.

Not many, if any, companies in our peer group have the assets, the balance sheet and the people to effectively execute our defined yet flexible plan, which delivers not only production growth but generates substantial free cash flow and sustaining events such as the Horizon fire. We are in great shape. Our management, business philosophies and practices work. We have a strong well balanced and diversified asset base with vast opportunities. Our strategy is balanced, effective and proven and we have control over our capital allocation and are nimble enough to capture opportunities.

Our strong assets, combined with our great teams of people and our culture which is focused on execution excellence and control of costs, continue to generate significant free cash flow. As we enter the next step in our evolution in the growth of the company, we are generating substantial cash flows but the focus again is ensuring effective allocation of our cash flow to maximize returns. And with the major spend of Horizon behind us, as said earlier, and we return to stable operations, our ability to take on more mid- and long-term projects, leverage our expertise and technology across our vast asset base is significantly enhanced. Canadian Natural is poised not only in 2011 but for many years to come to unlock significant value and generate more sustainable returns for shareholders.

With that, I'll turn it over to Doug to give you the update on our prudent financial management.

Douglas Proll

Thank you, Steve, and good morning. 2010 was another financial success for Canadian Natural. Net earnings for the year amounted to $1.7 billion or $1.56 per share, cash flow from operations was $6.3 billion or $5.81 per share. And we generated $800 million of free cash flow. We received the positive debt upgrade for Moody's Investors Services (sic) [Moody's Investors Service] to Baa1. We also received a trend change to BBB+ positive outlook from Standard & Poor's while maintaining our BBB high rating from DBRS. We reinstituted our Normal Course Issuer Bid where our 2 million shares were repurchased in Q3 2010. The significance is not the size of the repurchase, but we remain true to our principles of disciplined allocation of capital.

In 2010, we increased our annual dividend from $0.21 to $0.30, an increase of 43%. Today, we have announced a further increase of 20% to $0.36 per share. This is the 11th year of consecutive increases in the dividend payment to our shareholders. Our balance sheet was also strengthened through strong cash flow, the judicious allocation of capital and positive free cash flow from each of our operating divisions. Debt outstanding was reduced by $1.2 billion and our balance sheet metric of debt-to-book capitalization is now under 30%, again, focusing on the importance of balancing strength to weather uncertain times or unpredictable events.

In addition, at year end, we had $2.4 billion of available unused bank credit facilities. We believe that our liquid capital resources are sufficient to compensate for any short-term cash flow reductions arising from the stoppage of Horizon production. And accordingly, our targeted capital programs for 2011 remain unchanged. In addition, we implemented a two-for-one share split in May of 2010, the fourth split since 1989. This, we believe, further enhances shareholder value through the enhancement of the liquidity in our shares. I would also note that we continue to retire our debt as it matures and that we have not issued new debt since January 2008. Our commodity hedging practice program is active and closely managed albeit at lower volumes, which is the direct result of our balance sheet's strength.

For 2011, we have 50,000 barrels per day hedged with the floor of West Texas Intermediate USD $70. In addition, we have established puts on a 100,000 barrels per day with a strike price of USD $70. We are unhedged on our natural gas production as we see natural gas prices trading near their current levels through 2011. Details of all of our positions are available in the notes to the financial statements and are also available on our website.

As a final note, with the closure of 2010, we have now officially embarked into the brave new world of IFRS or International Financial Reporting Standards. We have completed our internal system changes, the documentation of policy changes and the analysis of the required accounting changes. Our external auditors are currently completing their required analysis. We are comfortable to estimate that shareholders' equity previously reported at January 1, 2010, will decrease by less than 4%. We expect that 2010 net earnings will decrease between $100 million and $200 million primarily due to a higher calculated depletion, depreciation and amortization of our fixed assets and certain other less significant line items. We do not anticipate any significant differences in reported cash flow from operations.

Thank you, and I will return you to John for some closing comments.

John Langille

Thank you, everyone for those summaries of our past year results and updates on our ongoing operations. As you can see, we are well positioned to continue growing our assets, our production base and ultimately our value for our shareholders.

With that, operator, I will open up the call to questions participants may have.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Mark Polak of Scotia Capital.

Mark Polak - Scotia Capital Inc.

First question, just in terms of the guidance, looking at it relative to what it come out in December, there's a bit of an increase to that property acquisitions and midstream component. Wondering if you could give any color on whether that's increased midstream spending or any smaller acquisitions that have popped up?

Steve Laut

Mark, Steve here. We felt it's prudent to increase the property acquisition budget mainly because we're starting to see more deal flow and more deal flow within our core areas where we can leverage our infrastructure and capture some synergies. So we see more opportunities, not to say that we have got them in the bag, but we think there'll be more opportunities so we increased the budget proactively.

Mark Polak - Scotia Capital Inc.

Just in terms of Northwest operator, it looks like it's an interesting opportunity. A modest return on a very modest investment for you guys, increasing demand for bitumen. I'm wondering, the offset perhaps being -- I think, that's been talked about, maybe 8,000 people working on that project, and how you sort of balance that off against your thermal growth plans and Horizon and sort of overall view on the labor market in Alberta.

Steve Laut

I think we got a concern there that is there. Obviously, another project adds more demand for labor. Throughout the Northwest or the Redwater project is a bit ahead of the other projects because the equipment spot engineering is close to being done. So we think we can be ahead of the big wave that's coming. I would say '13, '14 looks to be a very big demand year for labor. It's also in the Edmonton area, and we'll be using a high degree of marginalization to try to reduce the amount of labor on site. So we're taking steps to try to minimize the impact on labor and the effect. Most of the effect will be on our Horizon expansions because it's the same type of labor. The safety projects are smaller in scale, and we've been able to manage, particularly Primrose, during the last highly inflationary period very effectively. So we feel confident about doing that going forward.

Operator

The next question is from Mr. Harry Mateer from Barclays Capital.

Harry Mateer - Lehman Bothers

Doug, it's a question for you. You mentioned how you guys haven't been in the primary debt market in a while. Do you expect that to remain the case in 2011?

Douglas Proll

I think so, Harry. At this time, we don't have anything anticipated. Once we are back on stream at Horizon, we will be generating positive free cash flow in all of our divisions. And we see the Horizon rebuild as short term. And of course, we have adequate bank lines of credit available to ensure our liquidity through that piece.

Harry Mateer - Lehman Bothers

And in terms of the bank line, can you just give us a sense for how you see that, your utilization of that trending over the next few quarters. Obviously in, the first half of the year, I would expect to see some borrowings go up just ahead of Horizon coming back online. But if you can just give us a sense for how you see it trending, it would be helpful.

Douglas Proll

Yes. I think you will see an increase in our drawn bank lines in the first quarter without the Horizon cash flow and the continuing expenditures on our winter drilling programs. And then as Horizon comes back on stream, as we've outlined in our corporate guidance, you'll see the bank lines moderate and then start to reduce again in the second half of the year.

Harry Mateer - Lehman Bothers

And is there any guidance you can share with us at this point on where you think other gross debt or net debt is going to be at the end of 2011?

Douglas Proll

I think until we get some certainty on Horizon, being back on stream and of course the certainty of commodity prices, that would be a little difficult to get. But I think we exited the year at $8.5 billion, and I think that we could be not too far away from that number come year end.

Steve Laut

Higher obviously.

Operator

The next question is from Garland Buchanan of Babson Capital Management.

Garland Buchanan - Babson Capital

A quick follow-up to the last question. What kind of events would bring into the market to issue new debt?

Douglas Proll

Since we aren't anticipating any, I'm not sure what events would bring us to the market.

Garland Buchanan - Babson Capital

Increased M&A, for example?

Steve Laut

Yes. Obviously, if we had a larger acquisition, realizing of course that we did almost $1.9 billion worth of acquisitions in 2010, so it would have to be more significant than that. And certainly, to my knowledge, there's no acquisitions of that nature on the horizon this year.

Operator

The next question is from John Herrlin of Societe Generale.

John Herrlin - Societe Generale Cross Asset Research

Could you address your reserves at all on SEC standards? Is that possible, for the changes?

Steve Laut

I think, we'll get Lyle to answer to answer that question, John. We have -- the way that regulators work here in Canada, we are not allowed to disclose that one way or the other. Is that right, Lyle?

Lyle Stevens

Yes, that's right. We're bound by community regulations now. We lost our exemption last year to report SEC style. You will see a similar SEC type reconciliation table in our U.S. GAAP filing however.

John Herrlin - Societe Generale Cross Asset Research

Next one for me, business interruption insurance. You mentioned that you will recover the lost cost. What about the revenue side, maybe I missed that in your prior disclosures?

Steve Laut

No, we have insurance on business interruption after 90 days from the incident to recover only our operating costs up to $3 a barrel, so the revenue side is not insured.

John Herrlin - Societe Generale Cross Asset Research

Last one for me is on West Africa. You took off a fair amount of TV given the impairment but not as much on the reserve side. Obviously, you have Gabon and CI together. What's the split between Gabon and CI in terms of the reserves?

Steve Laut

On Gabon, actually wasn't carrying much reserves before and now the reserves on the Gabon, on a proved-plus-probable basis, are both 7.7 million barrels left.

Douglas Proll

Yes, Gabon carries 7.8.

Operator

Next question is from Menno Hulshof of TD Securities.

Menno Hulshof - TD Securities

The first relates to 2011 free cash flow. What are your revised expectations given the drop to production guidance and the increase in CapEx?

Steve Laut

Well, I think, as Doug said earlier, we're probably a little early because we don't know exactly what day we're going to get back on Horizon for the first set and the second set of Coke Drums. The way I look at it right now, with the strip, I would say we might, with that timing, we'd still have some positive free cash flow but the nature of that is up for a debate, depending on the timing of the start-up.

Menno Hulshof - TD Securities

And then the second question relates to the Heavy Differential. Given the uptick in the WCS Heavy Differential specifically, I'm just hoping to get your current thoughts on the outlook for the remainder of the year and then into 2012 as well?

Steve Laut

Our view on heavy oil differentials is that the long-term average will be in that 22% to 24% of WTI. Obviously, we're riding quite a bit higher in that right now. We believe that's mostly due to logistic issues on the pipelines, and that overtime, that will get resolved. To give you a feel for it, Mayan crude right now is trading about $2 off WTI and WCS is trading about $26 or $27 off WTI, so it's there's huge ARB there. Once we believe that some of the logistical issues of the pipeline gets resolved, we think differentials will come back down into that 22%, 24% range. But don't see it going down to the 10% to 15% range we had for most of 2010.

Menno Hulshof - TD Securities

And then one final question on your thermals, what sort of a contribution did you see from Primrose East during the quarter?

Steve Laut

As far as production goes?

Menno Hulshof - TD Securities

Yes.

Steve Laut

Primrose East production I believe was roughly around 100,000 barrel a day mark.

Menno Hulshof - TD Securities

Sorry, I was thinking for Primrose East.

Steve Laut

For Primrose East itself, that would've been about 26,000 barrels a day.

Menno Hulshof - TD Securities

And then in terms of the ramp up for design rates, are you expecting that to take place sometime between now and the end of the year, early 2012?

Steve Laut

Yes, I think, as we talked before, is that our design rate was to get 45,000 barrels at Primrose East. Obviously, with the issues we had there in the past and steaming in part cycles, I will probably not able to get to the high level of 45,000. But we think we'll get to 40,000, maybe towards the end of 2011 or in 2012, depending on the cycles we use here.

Operator

The next question is from George Toriola of UBS Canada.

George Toriola - UBS Investment Bank

The question is around Olowi. Two parts of the question, the first is just in terms of the poor performance you've seen here, if you could provide a little bit more context to that. Is that just reservoir performance? Is it reservoir definition? What is the context of that? And the second part of the question is, does your experience at Olowi change or in any way affect how you view international sort of opportunities, and would you be thinking differently when you look at us outside of North Americas?

Steve Laut

I think for us, the major rationale or the reason for the issue at Olowi is the oil water content and the reservoir dip and the amount of faulting and structural changes in the reservoir was quite a bit different than when we went in with. So the dip was steeper. This is an oil rim, so a steeper dip means less reserves. There was some faulting which changed the oil water context so it caused confusion, which we didn't realize in the oil water contact. And so the oil water contact was higher. So not only was the rim smaller and narrower extent but the contact was higher making less oil. Those are the two major drivers of Olowi. So going forward, does it change our view? I don't think it does change our view come actually. We feel strongly that we can execute in the international arena, probably more strongly now as we've plugged the gaps in our process and we have much more rigor. So going forward, maybe we'll be more cautious, but I don't think it changes our view.

Operator

[Operator Instructions] The next question is from Kam Sandhar from Peters & Co.

Kam Sandhar - Peters & Co. Limited

I have two questions. First of all, just wondering if you could give us a bit more break down on your thermal reserves as to how much of that would be Kirby versus Primrose? And then a second question is just around, I guess, given the amount of bookings for conventional heavy, I'm wondering if you could give us the total change in your future development capital over 2009?

Steve Laut

Kam, could you just repeat them again for us?

Kam Sandhar - Peters & Co. Limited

So the first question was just around your bitumen reserves or In Situ reserves and what the breakdown would be between Kirby and Primrose? And then the second question is just given the amount of, I guess, conventional heavy and bitumen reserve bookings, what's your total company-wide change in future development capital would be?

Steve Laut

So I'll get Lyle to answer those questions. Lyle?

Lyle Stevens

Sure. Kam, on the split between Kirby and Primrose, on Kirby, so that's the original CNR assets, we have proved reserves of 140 million barrels and proved-plus-probable reserves of 185 million barrels. On the assets that we acquired, we have proved reserves of 109 million barrels and proved-plus-probable of 272 million barrels. And the remainder of our thermal reserves, of course, is all at Primrose. As far as the future development capital, we'll be releasing in our AIF more detail on our future development capital.

Operator

There are no further questions registered at this time. I would like to return the meeting over to Mr. Langille.

John Langille

Thank you very much, operator, and thank you, everyone for attending our conference call. And as usual, any further questions, don't hesitate to call us. Thank you very much, and have a good day.

Operator

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

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Canadian Natural Resources Limited Management Discusses Q4 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts