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Executives

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

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

John G. Langille - Vice Chairman

Steve W. Laut - Principal Executive Officer, President and Director

Analysts

Barbara Betanski - Addenda Capital Inc.

John P. Herrlin - Societe Generale Cross Asset Research

Greg M. Pardy - RBC Capital Markets, LLC, Research Division

Andrew Potter - CIBC World Markets Inc., Research Division

George Toriola - UBS Investment Bank, Research Division

Mark Polak - Scotia Capital Inc., Research Division

Canadian Natural Resources Limited (CNQ) Q3 2011 Earnings Call November 3, 2011 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2011 Third Quarter Results Conference Call. Slides for this conference call are available to view with the webcast and in PDF format at www.cnrl.com. 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 G. Langille

Thank you, operator, and good morning, everyone. Thank you for attending this conference call where we will discuss our third quarter 2011 results and review our planned budget for 2012, which was included in our quarterly press release issued earlier today.

Participating with me today are Allan Markin, our Chairman; Steve Laut, our President; and Doug Proll, our Chief Financial Officer. In discussing our 2012 budget, Steve will be referring to certain information contained on slides, which as the operator indicated, can be accessed through our website at www.cnrl.com.

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 and reserves are both expressed as before royalties, unless otherwise stated. I'll make some initial comments before I turn the call over to the other participants.

The third quarter has again shown that our overall strategies and principles and the business plan that CNQ follows is sound, tested and successful, just as it has been for the past 20-plus years. Our production continues to grow in an orderly fashion, but only if allocation of capital to particular areas makes economic sense. And as Steve will show, this will continue in 2012 and the years thereafter. Our 2011 third quarter cash flow amounted to almost $1.8 billion, which is 15% higher than that achieved in the second quarter of this year and the third quarter of 2010. This cash flow exceeded the total CapEx expended in the third quarter, and again, Steve will show that this trend continues into 2012. We are one of the few independent oil and natural gas exploration companies in the world that can achieve that on an ongoing basis and also have production increases.

Commodity prices continue to be volatile, but our balanced production base mitigates the volatility to some extent, as we have exposure to several different pricing platforms, such as West Texas or Brent, Canadian heavy or SCO. With pipeline and refinery constraints in the third quarter, the discount applied to Canadian non-upgraded heavy oil increased to 20% off West Texas. But so far, in the fourth quarter, this discount has reduced to closer to 10% to 12% off West Texas pricing, as these pipeline constraints were fixed. This of course, is positive for the price we received for all of our un-upgraded heavy oil. Before we turn the call over to Steve for an in-depth review of our operations and our 2012 plans, I would ask Allan to make some comments. Allan?

Allan P. Markin

Good morning. As John said, Q3 '11 was a quarter of strong cash flow generation and operational performance across the entire asset base. We are back on track. At Horizon, we safely resumed full production in the quarter. We leverage the lessons learned from this event, and are moving forward more disciplined and more effective as an operator. We remain committed to creating value for our shareholders by doing it right together.

Turning to the North American E&P side of the business, our primary heavy oil operations achieved record production for the third consecutive quarter. We achieved these results through effectively executing a significant drilling program. Our thermal in situ operations also achieved record production for the quarter, reaching 110,000 barrels a day. Development on Kirby South Phase 1 continues to move forward on budget and on schedule as we unlock value in our top-quality thermal in situ assets.

Looking ahead to 2012, we target production growth of 17% and including 24% crude oil and NGL growth. This reflects our strong primary heavy and light oil drilling programs. Expansion of our liquid rich Septimus Montney shale gas play, additional pad developments at Primrose and solid performance from Horizon. The 2012 budget reflects our continued commitment to disciplined capital allocation and our defined plan to transition the company toward a longer life, sustainable reserve asset base. Steve?

Steve W. Laut

Thanks, Al, and good morning, everyone. This morning I will focus most of my comments on the 2012 budget. If you're looking at the slides on our website, I'll start off briefly talking about how we have and continue to build sustainable value on Slide 2.

Canadian Natural executes our strategy by effectively driving our capital allocation model, which maximizes our return on capital, generates significant free cash flow, maintains our strong balance sheet through those price cycles and continues to transition our asset base to a more sustainable, long-term asset base, providing us the ability to increase dividends on a consistent basis.

To effectively execute this model and deliver sustainable value, Slide 3, we maintain a strong, balanced asset base that has significant upside in each component of our business. It is essential to have a well-balanced, diverse asset base to ensure critical or effective capital allocation that maximizes return on capital over the long run and through the commodity price cycles. Today, with strong oil prices and low gas prices, Canadian Natural continues to allocate capital disproportionately to oil projects. In our light oil portfolio, we are growing light oil and NGL in Canada significantly, 17% in 2012, as well as progressing the development programs in offshore Africa. We're unlocking huge value in our heavy oil portfolio, our plan will see thermal or in situ heavy oil production capacity grow from just under 100,000 barrels a day in 2011, to 480,000 barrels a day of low cost, high value heavy oil production. In addition, we'll grow primary heavy oil production by 16% in 2012. Primary heavy oil provides us the highest return on capital in our portfolio.

At Horizon, our expansion plans to increase synthetic light oil production to 250,000 barrels a day are underway, and we're on initial planning stages to expand to 500,000 barrels a day or 0.5 million barrels a day of light, sweet 34-degree API crude. We also have vast natural gas assets, which, when gas prices strengthen, will provide the opportunity to unlock significant value for shareholders. Having a well-balanced asset base with significant upside is critical, it is just as important that these assets be focused in core areas, where Canadian Natural dominates the land base and infrastructure, ensuring we are the most effective and efficient operator, a key factor in Canadian Natural's ability to generate significant free cash flow.

Canadian Natural has a strong team with a depth and breadth of experience as shown on Slide 4, to effectively execute in each of our areas to deliver value growth. As a result, as an on Slide 5, Canadian Natural generates significant free cash flow, between $1.1 billion and $1.5 billion in 2012; delivers production growth of 10%, Q4 '12 over Q4 '11; and importantly, oil production growth of 17% Q4 over Q4. Strong growth, considering 53% of the 2012 capital program is allocated to future value growth as we transition to a more sustainable and longer life asset mix. This enhances our ability to increase dividends, dividends that have increased for the last 11 consecutive years. Our balance sheet remain strong, and we are poised for additional acquisition opportunities should they be available [indiscernible], and add value.

Canadian Natural's ability to generate free cash flow on a per share basis sets us apart from our peer group. Slide 6. It is comparable to the super majors. This gives Canadian Natural the opportunity to utilize our free cash flow to maximize value for shareholders.

Slide 7 shows our target 10-year organic group production growth profile, which targets delivering significant production growth, growth that is entirely oil. In 2012, this growth comes from Horizon recovery, heavy oil, both primary and thermal in situ and Canadian light oil. In the midterm, this growth again comes from heavy oil, Pelican, Kirby, and to a lesser extent, Horizon. In the longer term, Horizon and our well-defined thermal in situ development plans delivers significant production growth. In addition, we have the ability to grow our gas volumes significantly, if gas prices strengthen in the future. At current pricing, free cash flow over and above the capital required to deliver this growth profile will be in excess of $13 billion, reflecting the strength of our assets and the soundness of our strategy.

Also during this period, Slide 8, we are transforming our asset base to a longer life, more sustainable asset mix as we grow from 35% long life oil assets in 2012, to 55% by 2018, as well as increase our relative light oil production waiting.

In 2012, Slide 9, we are delivering significant oil production growth. Total oil production growth is 24%, driven by a full year of Horizon production; Canadian light oil growth of 17%; primary heavy oil growth of 16%; and thermal heavy crude oil growth of 10%. Gas growth is 2.5% year-over-year, but will decline entry to exit, as we continue to allocate additional capital to oil projects. Overall, we are targeting to deliver 10% COE growth Q4 2011 over Q4 2012.

Capital expenditures for 2012, Slide 10, will be $7.2 billion, up 18% from 2011. Roughly 90% of our capital program, $6.4 billion, is allocated to oil. We're increasing capital spending, as driven by the Horizon expansion capital at $1.95 billion, up $1.4 billion from 2011. And thermal in situ expansion capital at $1.4 billion, up $170 million from 2011. Primary heavy oil capital is just under $1 billion; light oil, with Canada and International combined, is just over $1 billion; with Pelican at $470 million; and gas at $850 million.

Our targeted cash flow for 2012, Slide 11, is $8.2 billion to $8.6 billion at the strip, and will generate free cash flow of between $1.1 billion and $1.5 billion. Our production growth, as I said earlier, Q4-over-Q4 is 10%, a significant growth. We consider that $3.8 billion, or 53% of our capital program does not deliver production in 2012. We also have tremendous capital flexibility in 2012, with the ability to curtail 42%, or $3 billion of our spending if we choose. In these volatile economic times, it is important to have this high level of capital flexibility. Our already strong balance sheet will strengthen in 2012, debt is reduced by $1.2 billion, and our debt to book is strengthened by 22%, at the midpoint of guidance. These are very solid numbers, reflecting the strength of our assets, the robustness of our strategy and our ability to execute. Very few, if any companies in our peer group, can deliver 10% production growth, all oil growth by spending only 47% of the capital program on current year production, generate significant free cash flow, pay down debt, increase dividends as we have for the last 11 years, and at the same time, transfer on the asset base to a more sustainable longer life production mix, allowing Canadian Natural to generate high returns on capital and enhance our capacity to increase dividends on a sustainable basis.

I'll now walk through each of the assets, starting with gas on Slide 13. Our outlook gas pricing has been bearish, and that has not changed. We now expect gas prices to be low for the next 5 to 10 years. Therefore, it is fortunate that we were able to leverage our dominant land base and infrastructure to maintain our position as the most effective and efficient producer, which allows Canadian Natural to generate free cash flow of 350 AECO. During a period of low prices, Canadian Natural continued to strengthen our unconventional and tight gas asset base and delineate new and emerging plays with the application of new technology. Our focus will be on liquids-rich developments. We'll also make opportunistic acquisitions if they're available and add value.

Canadian Natural has one of the largest land bases in Western Canada at 11.1 million acres, Slide 14. Within that land base, we have very strong positions in the emerging shale plays. Canadian Natural has 385,000 acres on the Duvernay play and 766,000 acres of Montney lands. All acquired over time and at relatively low cost compared to land prices seen in the last 2 to 3 years.

Canadian Natural's Montney land position is one of the largest positions in Canada. As you can see on Slide 15 we have the second largest land base in the Montney.

Our gas plan for 2012, Slide 16, targets production to increase by 3% in 2012, even though we're drilling 9 fewer wells, and is driven mostly by gas acquisitions made in 2011. Capital is up roughly $100 million, as we perceive the expansions of our liquids-rich Septimus Montney gas development, where we will drill 17 wells and expand the plan from 60 million to 120 million cubic feet a day. Set up in the Septimus plan is expected November 2012, that's the increase, even with low gas prices, our liquids-rich Septimus development competes for capital with oil. Later this month, we'll connect Septimus to a deep cut facility, which will take liquids recovery to 45 barrels 1 million of condensate mix, plus an additional 45 barrels 1 million of ethane. Although low gas prices are challenging for our gas assets, they make our returns on our thermal heavy oil assets even greater.

As you can see on Slide 17, Canadian Natural has a dominant land position in the high-quality fairway for thermal in situ development.

These lands have 78 billion barrels in place, Slide 18. And we expect to recover 8.5 billion barrels from our vast thermal heavy oil resources. Canadian Natural's executing a disciplined, stepwise plan, Slide 19, to unlock the huge value of this asset base by bringing on 40,000 to 60,000 barrels a day every 2 to 3 years, taking production facility capacity to 480,000 barrels a day, which we own 100% and operate.

Our 2012 plans, Slide 20, targets production growth of 10%, or 107,000 barrels a day at the midpoint, as additional Primrose development comes on stream. Capital spending is targeted at $1.42 billion, up from 2011, and reflects the expected increase in spending at the Kirby development unfold, and increase strats well drilling to progress future developments.

Our strategy at Primrose, Slide 21, is to continue developing pad adds in the Primrose area, optimizing our steaming techniques to enhance oil recovery and lower cost. There is potential to expand the Primrose/Wolf Lake facilities to accommodate future development at the McMurray and Grand Rapids zones that are not in our current development plan. In addition, we'll continue to undertake the development of follow-up processes and leverage technology to increase recovery and lower costs.

In 2012, the Primrose plan, Slide 22, is to progress the development of 5 pads at Primrose East, that will add 20,000 barrels a day in 2012 and ramp up to 30,000 barrels a day in 2013, at a cost of just under $13,000 a flowing barrel. At Primrose South, we'll progress the development of 3 pads that will add 15,000 barrels a day in 2012 and ramp up to 20,000 barrels a day in 2013 for a cost of $13,000 a flowing barrel. Primrose pads are some of the lowest cost production capacity additions in the industry, as are Canadian Natural's operating costs, which are targeted to come in under $9 a barrel in 2012, even lower than our benchmark operating costs in 2011, making Canadian Natural's Thermal Institute heavy oil production very profitable, if not the most profitable, in Canada.

At Kirby, Slide 23. The Kirby South development is on schedule and on budget. In 2012, we'll progress the construction of the facilities and drill 24 well pairs for steam in November 2013. Kirby South is targeted at 40,000 barrels a day of SAGD production, plus facility room to grow up to 45,000 barrels a day, at a cost of $32,000 a flowing barrel.

In summary, Slide 24, we'll continue to progress the full development of Primrose with further pad adds. And we will add roughly 50 more pads adds in inventory throughout Kirby South Phases 1 and 2, as well as Kirby North Phases 1 and 2, which will bring Kirby productive capacity to 140,000 barrels a day of high-quality, low cost production. At Grouse, the regulatory application for 40,000 barrels a day of capacity will be submitted in Q1 2012. At Birch Mountain, we'll submit the application in Q3 2012, for 60,000 barrels a day. And additional progressive technical work at Gregoire and Germain for future development.

Turning to primary heavy oil, Slide 25. Canadian Natural has a dominant land and infrastructure position, with over 8,000 drilling locations in inventory. As a result, our operations are very effective and efficient. And we are the low-cost producer. With current pricing, heavy oil generates the highest returns on capital in our portfolio.

In 2012, Slide 26, heavy oil production will grow by 16% year-over-year with a drilling of 808 wells and a capital program of $990 million. In 2011, we'll grow heavy oil production 10% with our large inventory of wells, that's 10% in '11, 16% in 2012, and we expect to continue to grow production in the 8% range for the next 3 to 4 years. At our world class Pelican Lake oil pool, Slide 27, Canadian Natural's leading-edge polar flood, has been very successful and has significantly increased oil recoveries. We believe the Pelican Lake polymer flood will ultimately recover 536 million barrels of oil.

As you've heard me discuss in previous conference calls, Slide 28, we have been seeing slower response in the south part of the pool. These slower response times are attributable to a number of factors: oil fat, oil viscosity, varying water and gas saturations in the reservoir and where the reservoir was previously water flood before the polymer flood was initiated and a number of other factors. The combination of these various factors have caused response time to be slower in the south part of the pool and has affected our production profile. It has also provided us with significant learnings on how we can further optimize the polymer flood to maximize oil recoveries. It is our belief that this slower response, although damping the ramp up of oil pool production, it has however, ultimate oil recovery will be higher. In 2011, we have deferred our drilling program for start up in September. Until at the earliest, after breakup 2012 to confirm the learnings we have treat in 2011, ensure we have the right drilling configuration and optimize the execution of polymer flood conversions to maximize capital efficiency going forward.

As a result, in 2012, Slide 29, we'll drill 63 injectors and 13 producers, with only modest 4% midpoint production growth. Capital spending is $470 million as we complete this program, and battery expansions to handle increased production, we expect this portion of the pool, converted to polymer flood in the last 2 years, begin to ramp up, a ramp up that we're already seeing in somewhere else in the south. But this ramp up is stronger than expected. We have the option to increase our drilling program in 2012. And polymer conversion, we can maximize polymer flood conversion practice.

Canadian Natural's light oil and NGL growth in Canada, Slide 30, has become significant, as we begin to reap the benefits of leveraging technology through water flooding, EOR and horizontal multi-fracs over our large light oil assets in Canada. In 2012, we'll also progress small pool developments on 9 new pools.

Production growth in light oil, Slide 30, is targeted to be 10% in 2011 and 17% in 2012, significant growth. In 2012, the capital program will be $550 million to continue development of our large light oil assets. We're targeting roughly this amount of capital for the next 5 years and deliver production growth in a 4% to 9% range post 2012.

Turning to Slide 32 and our international operations. Our strategy is to maintain our existing operations and convert our undeveloped resources as slots become available in our platforms, progress with Big E exploration in South Africa, monitor acquisition opportunities and generate free cash flow. As well in 2012, we will prepare for the abandonment of the Murchison platform.

In 2012, Slide 33, our plan in the North Sea is to continue with the required workovers and maintenance, as well as some subsea work at Lyell, injection wells in Ninian, and a production well at Tiffany. As a result of the tax changes in the U.K., we have curtailed much of the volume-adding investments that was in our long-range plans. As expected, production declines in the North Sea. In offshore x Africa, as expected, production is also declining, as we maximize the uses of our existing slots before we begin our infill drilling programs at Baobab and Espoir. The Espoir infill drilling program will begin in late 2012 when the tender in situ drilling rig becomes available. With production increases ramping up in 2013, and expected production increases of 6,500 barrels a day -- of BOEs a day at the completion of the drilling program with a total cost of $143 million, $75 million of which will be spent in 2012 for an overall cost of $24,000 a floor in BOE.

We're also making good progress in tying up all the regulatory requirements before drilling our South Africa exploration well, Slide 34. This series of very large prospects is at the ready-to-drill stage and has potential for 1 billion-barrel structures, with our best estimate in place of 3 billion barrels in place. We own this block 100%, which is in deep water, with challenging sea conditions. We will in 2012, begin the process of selecting a partner to drill the first exploration well in South Africa, likely in 2013, at the earliest.

Turning to Slide 35 and our world-class Horizon Oil Sands operations, where we have over 14 billion barrels in our lease and 6 billion barrels recoverable. Our capacity today is 110,000 barrels a day, and we are well underway in our staged cost discipline expansion to 250,000 barrels a day and then ultimately to 500,000 barrels a day or $0.5 million barrels a day of light, sweet 43-degree API crude, with no declines for 40 years and virtually no reserve replacement costs. Horizon is a world-class asset that will continue to bring sustainable and significant free cash flow for decades to come.

In Q3, Slide 36, we completed the rebuild, on cost, of $390 million to $400 million, except for time taken out because of the forest fires in the area, on schedule. Insurance will cover the cost of the rebuild, and business interrupt insurance covers operating cost up to $30 a barrel. During the rebuild, we completed significant opportune maintenance. As a result, the previously planned turnaround for 2012 has been rescheduled to 2013. We've also taken this time to ensure the operations discipline at Horizon is at the same high levels of excellence we have across the rest of our operations. We are confident that operation discipline is in place and also believe we could still continue to improve, not only at Horizon, but across our entire operations. The fire at Horizon has increased company-wide our focus on our already strong operations discipline. As a result, our start up in Q3 was very solid. With first production coming on line August 16 and delivering 44,600-barrel a day average for August, or a stream day rate of 86,400 barrels a day. September was steady at 108,200 barrels a day, and October is coming in at 105,650 barrels a day, even though rates were reduced to complete coker furnace digging. Our third oil preparation plant, OPP3, will be commissioned and turned over to operations for start up by the end of November. As a result of these improvements, we expect a solid, reliable run in 2012.

Our plan in 2012, Slide 37, is to deliver midpoint production guidance of 110,000 barrels a day, with operating cost all in, in the range of $30 to $36 a barrel, and sustaining capital of 230 billion barrels, which is roughly $5.70 a barrel. The project capital spend for expansion in 2011 is forecast at $540 million, down from the $888 million we originally forecast. This reduction in spending is due to 2 main factors: Firstly, we slowed down some activities at sites to ensure we had optimal focus on the rebuild and collateral damage repair; secondly, and probably most importantly, we took extra time to optimize the definition and breakdown of the projects underway and work awarded. As a result, we've been able to break the work scope into smaller, more focused pieces, allowing a wider range of bidders and bidders who are much more confident in their ability to deliver. In some cases, we have rebid work and reconfigured work packages. And this takes additional time, but is well worth it, as we achieve improved cost and project execution. In Q3, we have recently awarded lump-sum contracts for 2 major plants in our expansion, the Gas/Oil Hydrotreater and the Froth Treatment plant. We believe these lump-sum contracts are fair and will enhance our cost certainty and project execution going forward. In Phase 1, the plants were constructed under lump-sum bids had the best performance from a cost and execution perspective. Both these strategies line with our cost focused execution strategy and although it's early, we are seeing good results. The projects under construction today are on track and running at or below cost. In 2012, we're targeting a capital expenditure of $1.95 billion to progress the expansion of Horizon to 250,000 barrels a day, with work underway in all phases of expansion. We will, a we have in 2011, continue to execute the execution of our strategies going forward to ensure we deliver high levels of capital cost-effectiveness.

Highlighting our current activity, Slide 38. Reliability's on track and running below cost, with OPP3 turned over to operations for start up at the end of November. Directive 74 is on track, and our pilot studies have been positive. Our use of CO2 with polymer additions to ensure fine tailings has been successful. And though it's early, we may have the potential to reduce the capital required to meet Directive 74, as the sizing of physical equipment may not be as large as originally anticipated. Phase 2's schedule is set to bit, roughly 6 months due to the fires I mentioned earlier. And Phase 2B, we have awarded major lump sum contracts and work on Phase 3 extraction trains 3 and 4 is on track.

In summary, our production operations at Horizon are on track and have a very solid -- after a very solid start up. And we're looking to a -- forward to a consistent and reliable 2012. Our expansion strategy on Horizon is proving effective, and we believe we can deliver the expansions even more effectively than we delivered Phase 1. Even though industry activity is projected to be very high, in 2013 and '14 in particular, most of this increase is coming from the in situ side. With a multitude of players, many of them building for the first time, compared to the mining side which has seen consolidation. This time around, there's a smaller number, more disciplined and experienced group of operators will get through the past period of hyperinflation. As a result, we believe we can deliver a cost-effective expansion.

At a high level, our overall 2012 budget, Slide 39, there is cash flow of $8.2 billion to $8.6 billion at the strip. With a capital program of $7.2 billion, we generate significant free cash flow of between $1.1 billion and $1.5 billion. Our production growth is very solid at 10% Q4 over Q4, very impressive when you consider this growth is organic, and 53% of our capital program does not deliver production in 2012. Considering the volatility in the global economic -- economy today, it is important to point out that we have significant flexibility to reduce our capital program by up to $3 billion, or 42%, if a significant event were to occur, ensuring we preserve our strong balance sheet, which in 2012, will become even stronger with debt reduction of over $1 billion and debt to book shrinking to 22% at the midpoint of guidance. Canadian Natural is at a very strong position. With our effective capital allocation strategy, our balanced assets, which contain significant upside, we are delivering strong oil weighted production growth, investing significantly in future production growth, we are retaining capital flexibility, paying down debt and generating significant free cash flow of between $1.1 billion and $1.5 billion.

Canadian Natural will allocate the free cash flow in 2012, Slide 40, to opportunistic acquisitions, if they're available, add value and are able to compete for capital. We have increased dividends consecutively for the last 11 years, and we anticipate this going forward. We'll continue to pay down debt, and lastly, buy back shares.

And lastly, on Slide 41, it is clear that Canadian Natural is in great shape. Our management, business philosophies and practices work. We have a strong, well balanced and diverse asset base with vast opportunities. Our strategy is balanced, effective and proven. We have control over 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, effective operations and cost control, allows Canadian Natural to build an even stronger, more sustainable asset base, which will generate even significant -- more significant free cash flow in the future. With that, I'll turn over to Doug to talk about our strong financial position.

Douglas A. Proll

Thank you, Steve, and good morning. Steve has provided a comprehensive overview of our current operations and our capital expenditure plans for 2012. I would like to briefly provide you with some of the financial highlights for the third quarter of 2011 and to provide a few indicatives of our financial targets for 2012 to assure you that we continue to hold firm that the strength of our balance sheet is foremost on our minds as we continue to build value for our shareholders. The largest financial highlight for the third quarter of 2011 was of course, the return to production and delivery of synthetic crude oil to markets in August. This resulted in the return to positive cash flow from operations and positive free cash flow for the quarter for the Horizon operations.

In the third quarter, Canadian Natural generated almost $1.8 billion of cash flow from operations and incurred $1.4 billion of capital expenditures. For the 9 months ended September 30, we generated $4.4 billion of cash flow from operations and incurred $4.5 billion of capital expenditures, virtually a balanced budget, encompassing at an 8.5-month period where there was no production or sales from the Horizon operations. This is a testament to our operational and financial discipline and the adherence to balance sheet management. We exited the third quarter with $9.3 billion of long-term debt, an increase from the $8.6 billion at June 30. This increase resulted from the weakening of the Canadian dollar at September 30 as compared to June 30 with the mark-to-market unrealized foreign exchange loss applied to our U.S. debt.

At September 30, our debt-to-EBITDA was 1.2x. Debt to book capitalization was 30%, and our undrawn bank facilities amounted to almost $2.2 billion. Our financial strength and management discipline has been recognized by Standard & Poor's, who upgraded our debt rating to BBB+ with a stable outlook last week.

Turning to the 2012 budget, the financial, as well as the operational highlights were addressed by Steve. In summary, the budget targets, the generation of positive free cash flow in the range of $1.1 billion to $1.5 billion after budget capital expenditures of $7.2 billion, an overall reduction of long-term debt and a corresponding improvement in our balance sheet metrics of debt to EBITDA and debt to book capitalization. These targets are all summarized on Slides 11 and 39 of the conference call slide presentation. Now that the 2012 capital expenditure plans are clear, we will review our commodity hedging strategy for 2012 and 2013. Currently, no positions are in place for 2012, largely as a result of our balance sheet strength, our ample sources of liquid financial resources and as we do not have any significant near term maturities of long-term debt.

Our financial goals for 2012 are easily identified. During these continuing uncertain economic times, we continue to focus on the development of our significant and very diverse asset base, prudent spending within our financial means, maintaining and expanding our sources of financial liquidity and the continued focus on our balance sheet strength. Thank you. Now I'd like to turn you back to John for some closing comments.

John G. Langille

Thanks very much, guys. I think as everybody can see, CNQ continues to execute its sound business plan, which will always ensure that we create value for our shareholders. With that, operator, I would now like to open up the meeting to questions that people may have.

Question-and-Answer Session

Operator

[Operator Instructions] The first question is from Andrew Potter of CIBC.

Andrew Potter - CIBC World Markets Inc., Research Division

Just a question, first on Horizon. It wasn't clear what the 2012 OpEx guidance is for Horizon. I didn't see that actually in the guidance document. And then second, just looking for a little color on the Redwater upgrader and what sort of CapEx we could see in 2012 presuming that, that is sanctioned, maybe if you can give us this idea what kind of actual spending would go on the project, and then I guess, how much would actually cross your books if it is just project financed.

Steve W. Laut

Hey Andrew, Steve Laut here, thanks for the question. I did mention in the conference call, we didn't put in the guidance. Right now, we believe operating cost for 2012 will be between $30 and $36. That's a fairly wide range, we're just working get that range narrowed before we put in the guidance documents. So it's $30 to $36, all in, per barrel. At Redwater, we're progressing to get the sanction in 2012. There's enough funding in the partnership now that our capital spending, if we are sanctioned in 2012, will be negligible, if any, because we have enough money in there right now to progress it and there will be project financing upon sanction. So there'll be no capital at Canadian Natural going forward.

Operator

The next question is from George Toriola of UBS.

George Toriola - UBS Investment Bank, Research Division

The question is around your heavy oil growth. And this year, we are seeing 10% growth, next year you're looking at 16% growth. I wonder if you can speak to what it is in that business that is driving the growth. Is it a function of the commodity price environment? Is it recovery factors that you're seeing? Is it down spacing? What is it exactly, or technology? What is it exactly that's behind that growth?

Steve W. Laut

That growth is mainly driven -- obviously commodity prices make heavy oil the most profitable part of our portfolio, the primary heavy oil. And we have as you know, a very large land-base, we dominate the area. We dominate the infrastructure, so we can do it at a very low cost, and we have 8,000 wells and locations. So essentially what we're doing is -- or in inventory. So really what we're doing is just drawing down our inventory and drilling primary heavy oil wells, keeping our facilities full and expanding some of our facilities, which we'll be doing here in late 2011 and 2012, to give us more production growth. So really, it's just an effective cost execution drawing down our inventory in a very large land-base and a very dominant infrastructure that allows us to deliver this growth. We can do that probably for 2 to 3 more years at these kind of rates, and then I think, you'll start to see the -- because the heavy oil declines fairly quickly, you'll get to a sort of peak and it'll be very tough to keep that growth up. We'll probably plateau after that.

George Toriola - UBS Investment Bank, Research Division

Okay, so just to follow-up, I assume that your 8,000 wells all generate 2 -- recycle ratios of at least 2. Would it be sufficient to then say that part of what the growth driver is here is that you're probably able to go after wells that would have F&D costs in the mid-20s, something like that?

Steve W. Laut

Yes, I think a lot -- most of our F&D cost average probably in that $15 to $16 range, a some would be up higher that range, but as you know, we have a large inventory, so we are able to high grade and do -- only do the best that gives us highest return on capital as we go forward. That's the advantage of having a very large inventory.

Operator

The next question is from Greg Pardy of RBC Capital Markets.

Greg M. Pardy - RBC Capital Markets, LLC, Research Division

Steve, could you drill down maybe a little bit on the plans for the Duvernay. Obviously, a number of companies now that will be drilling pilot wells, there, here. But in addition to that, how are you thinking about gas growth at Septimus as you go into next year?

Steve W. Laut

So I'll talk about Septimus first, and then Duvernay. So Septimus, our plan is to take the plant, which we're doing about 60 million a day right now, through up to 120 million a day. We're in the process of tying into a deep cut facility at the younger plant, which will take liquid recoveries to 90 barrels 1 million, although 45 of that is ethane, and so we'll go to 120 million next year. That'll come on late next year. So we'll make sure we have the wells to fill it. As far as the Duvernay, our plans go, we'll likely drill one well, to sort of prove up some of our lands. But we are, as you know, fairly bearish on gas, we have large inventories on oil sites, so it's not like we have to drill up our gas prospects or liquids-rich gas prospects. So we're probably going to be, I would say, someone who watches what's going on and take the advantage of being a second mover.

Operator

The next question is from Mark Polak of Scotia Capital.

Mark Polak - Scotia Capital Inc., Research Division

In the budget slides, you touched on $3 billion of flexibility to the downside. If prices are above the $88 using your cash flow guidance, I'm just curious, how much flexibility there would be to increase that, or is that tougher on a shorter notice and that any incremental free cash flow is likely to go into acquisitions and debt reduction?

Steve W. Laut

I would say, Mark, you probably got it right. I think our first choice of incremental free cash flow would be to debt reduction, and we could increase capital spending, probably in the order of $200 million to $500 million, but to go beyond that on short notice means you're going to lose capital efficiencies because you don't have your rigs lined up. We tend to have a steady fleet of rigs and service rigs and service providers that give us capital efficiencies over time. So to increase that, they're probably bringing in less capital-efficient equipment. So we wouldn't do that.

Mark Polak - Scotia Capital Inc., Research Division

Okay. And on Pelican Lake, I think you mentioned after Q2, that you're expecting some data to come in on September to assuage the concerns that regulators have on the cap rock issues, any update on that?

Steve W. Laut

Thanks Mark, I forgot that in the conference call. We did get the data to the regulators. The regulators came back. They're happy with the data, and all those issues that required to move forward have now been addressed and we are moving forward. So there's no regulatory hurdles in front of us. So really what we're doing here at Pelican Lake, because we have such a large portfolio and we're able to allocate capital to get high returns, we are not driven. Many other companies would want to drive forward and continue at a fast pace of polymer conversion. We had the luxury to sort of watch and optimize all the things so that we can go forward to get even better capital efficiencies going forward, probably later in 2012, and for sure in 2013.

Mark Polak - Scotia Capital Inc., Research Division

That's great. And last one for me, just curious at your perspective on the strengthened synthetic pricing and your outlook for that going forward.

Steve W. Laut

So the strength on synthetic pricing, we actually look at it and think it's probably about the right price, because if you look at synthetic versus brand pricing, it's about the same discount as it normally would be, same as Louisiana sweet or LLS crude. And so really, where you've got the problems in WTI and probably heavy oil that's trapped somewhat in Canada and the northern portion of the U.S. until Keystone gets on. That being said, our heavy oil pricings are very, very strong, and we still generate the highest returns on capital in heavy oil.

Operator

The next question is from John Herrlin of Société Générale.

John P. Herrlin - Societe Generale Cross Asset Research

Just some quick ones for me. Regarding expansions on Horizon, what are you seeing on the cost inflation front and construction, things like that?

Steve W. Laut

So on Horizon, I mentioned to it or alluded to it in the conference call. On the construction we have going on right now, we're actually seeing cost coming in. We're actually under what we had budgeted for. So we're not seeing any inflation in 2011. 2012, we feel confident that we can hold the line. Our bigger concern is in 2013 and '14, if all these projects that people say they're going to do go ahead, we could see contractors and engineering firms stretched, and we're starting to see engineering firms already being very tight. So we anticipate that it'll be more difficult to keep costs in line in '13 and '14, and that's why, as you see, we're taking a very cost effective approach breaking these packages down, and if we don't like the cost, we're not going to award the work.

John P. Herrlin - Societe Generale Cross Asset Research

I was concerned about the long term, I was wondering if you were try to lock in anything, but that's fine.

Steve W. Laut

We haven't locked anything yet.

John P. Herrlin - Societe Generale Cross Asset Research

Okay, regarding the U.K., you're abandoning Murchison. You've got mature properties. Is it time to monetize them and redeploy more aggressively into your North American assets, your heavy oil assets?

Steve W. Laut

I don't think it is, John. We get asked this question quite often. And reality, we believe that if we had to sell the assets, we would get more value just producing oil [ph] because we think we're a pretty effective operator there. So there's more value by pushing them out. We also do not want to lose our technical and operational capacity to execute in offshore waters, and the North Sea does that for us. We have that capacity in the office there, and we believe there will be opportunities for us as we move forward. And as you know, we are generating significant free cash flow. So we would look to expand our offshore operations if that opportunity was there.

John P. Herrlin - Societe Generale Cross Asset Research

Okay, last one for me, on a flowing barrel basis, you seem to be undervalued versus your peers. Have you ever thought about that? Do you think there's a heavy oil bias by investors, or is it, maybe a concern about Horizon's reliability? More of a rhetorical question, I guess.

Steve W. Laut

Yes. Are we concerned about it? I suppose we are concerned about it. We always think we're undervalued. But reality and suspecting -- we have to live with the reality, as Horizon has been out for 8 months. So I think it's going to take the Street some time to see us demonstrate that we can run Horizon at high levels of reliability and at low cost, which we think we are well on our way to doing, but that'll take time.

Operator

[Operator Instructions] The next question is from Barbara Betanski of Addenda Capital.

Barbara Betanski - Addenda Capital Inc.

I just wanted to ask you if I could about marketing strategy, basically for access to North American oil markets. So if you could comment at all in terms of your positioning with respect to Keystone XL and what you think sort of the impact of pipeline capacity on the North American oil markets looks like going forward.

Steve W. Laut

So on Keystone, we obviously are a big supporter of the Keystone pipeline. We have 120,000 barrels a day of transportation locked up on Keystone for 20 years. We have 100,000 barrels a day of market locked up with a major refinery on the Gulf Coast to balance that off. We believe that Keystone will go ahead, ultimately. Although obviously, it's running in some choppy waters here, but we believe that's -- will happen. So that is our plan for marketing. If it does not happen, I think you will see the industry in Canada, which as you know, is very resilient and very innovative, move very quickly to find other outlets to get our heavy oil production and our synthetic oil production likely off the West Coast and into Asian markets. Because it's pretty clear, if Keystone doesn't go ahead, that U.S. markets are not in favor of having Canadian oil.

Operator

There are no further questions registered at this time. I'd like to turn the meeting back to Mr. Langille.

John G. Langille

Thank you very much, operator, and thank you, everyone, for attending our call. As usual, if you have any further follow-up questions, do not hesitate to get a hold of us. Thank you, and have a very good day.

Operator

Thank you. The conference has now ended. Please disconnect your lines at this time, and we thank you for your participation.

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