MEG Energy's (MEGEF) CEO William McCaffrey on Q1 2016 Results - Earnings Call Transcript

| About: Meg Energy (MEGEF)

Meg Energy Corp. (OTCPK:MEGEF) Q1 2016 Earnings Conference Call April 28, 2016 11:00 AM ET

Executives

John Rogers - VP, IR

William McCaffrey - President & CEO

Eric Toews - CFO

Analysts

Greg Pardy - RBC Capital Markets

Joe Gemino - Morningstar

Gary Stromberg - Barclays

Brian Bagnell - Macquarie Capital Markets

Nick Lupick - AltaCorp Capital

Menno Hulshof - TD Securities

Blake McWherter - PineBridge Investments

Operator

All participants please standby, your conference is ready to begin. Good morning ladies and gentlemen. Welcome to MEG Energy Corp's First Quarter Results Conference Call. Please be advised that this call is being recorded. I would now like to turn the meeting over to John Rogers, VP Investor Relations and External Communications. Please go ahead, Mr. Rogers.

John Rogers

Thank you, Mary, and good morning everyone and welcome to our first quarter conference call. For our conference conversation today we have with us our CEO, Bill McCaffrey, and our CFO, Eric Toews. To start off Eric will focus on our results during Q1 and Bill will then take over and have a look forward and see in terms of how we see the balance of the year and forward

I will remind you today's call does include forward-looking information. Please refer to our quarterly reports and all other documents at SEDAR in our website for further information.

And with that I will turn it over to Eric. Eric?

Eric Toews

Thanks, John and good morning everyone. As John indicated, I'll start with our operating and financial performance over the past quarter. Production for the first quarter came in at 76,640 barrels per day, which was in line with our projection taking into account our planned maintenance of Phase 2B during the quarter. The turnaround was completed on April 17 and production has returned to full volumes.

During the quarter, we experienced a small fire at our sulphur plant. The cause of the fire was determined to be a heater in one of the tanks in the sulphur unit. Our team quickly identified the source of the fire and extinguished it with assistance of our neighboring communities and operators. There were no injuries, and because the incident coincided with reduced production rates during our plan turnaround disruptions to operations were minor. The extent of the fire was limited to the tank and its ancillary connections. We anticipate the cost of the repair to be largely covered by our insurance. And as a result of the fire we have made modifications to the heating system to prevent future incidents of this nature. Repairs have already been completed and the sulphur recovery unit has been restarted.

Supported by strong production rates in January and February prior to the turnaround, we remained on target for our annual productions on energy off running cost guidance for the year. Looking at our realized pricing during the quarter, we saw WTI: WCS differentials of $14.24 per barrel which an absolute dollar terms have remained relatively stable over the last 12 months. However the significant fall in WTI in the quarter which averaged $33.45, resulted in a historic high differential and percentage terms of 43%. This contributed to the reduction in our revenues. Additionally the following WTI during the period from Q4 to Q1 have the effective increase in our realized diluent cost on a relative basis. We purchased diluent a month or so in advance of its usage. Combined lower realized pricing and higher relative diluent cost drove betterment [ph] realizations to $11.43 per barrel which resulted in cash used in operations of $131 million or $0.58 per share in the first quarter.

Looking ahead we expect this to be the most challenging quarter in 2016. This current benchmark prices are significantly above Q1 levels, heavy differentials on a percentage basis are narrowing, and the relative impact of diluent cost per barrel are dropping. At the current strip which is close to $15 a barrel higher than what we realized in the first quarter and with WCS differentials having narrowed to about 30%, we expect to generate positive cash operating net backs for the balance of the year.

Let me take a moment now to talk about mixed financial position. At the end of the first quarter with $125 million of cash from our balance sheet, and the current strip prices we anticipate our U.S. $2.5 billion revolver will be undrawn at the end of 2016, make strong financial liquidity along with its well-structured debt in its ability to maintain operations with a very low capital investment continue to be a defining attribute of the company.

On that note, I'll pass it over to Bill.

William McCaffrey

Thanks, Eric. As Eric mentioned in his remarks, the successful completion of the turnaround now behind us and with oil prices beginning to firm up as reflected in the forward curve, we feel well-positioned as we move through the rest of 2016. And while we have made many improvements over the course of the year, we feel there are still additional measures we can and will deploy to help us preserve our liquidity.

First, we're looking additional opportunities to reduced our 2016 capital expenditure requirement. The capital budget was recently reduced from $328 million to $170 million, which is down 33% from last year. As we continue to capture efficiency gains, we see flexibility to reduce our capital even further without impacting production.

Second, we have been very successful at lowering our operating and G&A cost. Our per barrel non-energy off cost and G&A are down 15% and 12% respectively from this time last year. Despite the impact that the scheduled turn around had on reducing production volumes during the first quarter of 2016.

And while we've made great progress at finding ways to sustainably reduce cost in all areas, we continue to look for other opportunities to further reduce our cost. These efforts aligned with our continued focus of protecting the balance sheet and position us well to be able to grow in low-priced environment.

Third, to reduce the corporation's exposures to volatility of global crude oil market, we're implementing a hedging program. Today, the objective of this program is to help protect our liquidity against down-sized risk. In the longer term, the objective of the program will be to provide cash flow stability to support our capital programs. The company has recently entered into WCS and colored contracts on the portion of our blend sales to protect our revenue. To-date, we have contracts in place for about 10% of our blend sales through the end of Q3 and are continuing to look for opportunities as they arrive to further protect our cash position in 2016. We're also protecting our cost by entering into fixed-differential contracts for our diluent. To-date we have hedged approximately a quarter of our remaining 2016 [ph] safety and roughly 40% for 2017. This aligns a significant portion of our diluent cost with the WTI pricing looks to majority of our blend barrels for price battle.

And lastly, we continue to make progress on the divestiture of the access pipeline. At the moment, we're in discussion with counterparties regarding possible transactions, so I've got to be careful of what I can say in this call. Given the volatility of the volatile markets that we've been in, they're taking a very disciplined approach and weighing the tradeoffs between the potential proceeds and structure of any transaction versus the associated long-term cash cost. We're going to continue to work hard to get the right deal for the business and our shareholders. Potential proceeds will be directed to our deleveraging our balance sheet and strengthening our financial liquidity.

I believe the business is well-positioned. We've reduced our capital demand and we've reduced our operating cost and we're going to continue to look for opportunities to reduce them further. And with the implementation of a hedging program, we continue to work to protect the business from downside risk and at the same time we have lost sight of the fact that the lower oil prices experience in the first quarter are unsustainable over the longer term.

With that in mind, we've again fight our next phases of growth. We've had the potential to add almost 50% to our production levels once completed. While we remain cautious in the short term, we're very excited about the future.

And with that I'm going to turn it back to John.

John Rogers

Great. Thank you, Bill and Eric for your remarks. We'll now open the lines for questions. Probably don't need to remind you, but if we could keep the questions at the strategic level, Helen and I will be around later to answer your detailed modeling questions and more appropriate on one on one basis. So Mary, why don't we open the lines for questions?

Question-and-Answer Session

Operator

Thank you. [Operator Instructions] The first question is from Greg Pardy from RBC Capital Markets. Please go ahead.

Greg Pardy

Yes, thanks, good morning. Bill, I just wanted to follow up on a couple of things that you said. First, just on the spending, the $170 million potentially trending lower. I'm just wondering if you could give us orders of magnitude and what the timing might be when that would be unveiled. I think I missed that. And then secondly, just with respect to the hedging, are you hedging predominantly spreads or would you also be looking at just hedging absolute WTI prices, either through fixed or colors? Thanks very much.

William McCaffrey

Sure, thanks Greg for the question there. First one on the cap - on the reduction beyond the $170. We're looking at it right now but, so I don't have an absolute number today but what I'll tell you is that you've seen tremendous efficiency gain, continued gains in the EM SAGP process and it's allowing us to find ways to free up more steam which means we need less capital. So you can see from the first quarter that we invested almost $35 million on capital, so we would be already off-pace for the $170 million in terms of lighter in that area. And I think it's going to be something that as we continue to make advances in the EM SAGP part of it and see the successes that we have been seeing that we're just going to continue to progress that way. So we see it more along the lines of that continuing throughout the year. Once we get a better handle we'll certainly give that information. We just want to see it in play a little bit more as we go through the year.

Greg Pardy

Okay, right.

William McCaffrey

Thanks. And then on the second part on the hedging part of it, let me take a moment and why don't we just talk about our thought process here. Obviously I mentioned in the call that we want to protect downside risks, so first thing we had done is put some swaps into place just to protect ourselves in the inventory in the possibility the prices in reverse single back down. As we've seen the price strengthen, we've gone more to colors with the idea that the floor of the color itself is positioned to cover our in a general sense our cash clause. And then we're trying to allow that color to widen as we go forward in time as we layer in and more of them so that we can capture the upside as well in this. So it is a layering effect, almost a day by day assessment of it as to where we're going and where we see the prices going and then when we can try and straight that balance to protecting the downside risk while still having the upside opportunity to the pricing.

Greg Pardy

Great, thanks very much.

William McCaffrey

Yes, you're welcome.

Operator

Thank you. [Operator Instructions] The next question is from Joe Gemino from Morningstar. Please go ahead.

Joe Gemino

Hi, thank you. Can you provide some light into transportation expense? I've noticed that it increased per barrel basis from last quarter. Can you talk about how you see that going forward? Does have to do with higher expenses shipping down to the gulf? Thank you.

William McCaffrey

Sure. Yes, since Q4 we've gone into next chapter where plan again is now - we have 50,000 barrels a day at go-to-plan again versus 25,000 barrels in Q4. And what that does for us is it opens up additional market opportunity. So you do see traditionally for our business, our business would have sold the pad too and it would have sold out of Edmonton and the price of transportation would have been within the price of our crude. As you go to pad 3 you tend to sell at the plant gate, that's how that market is done. And so then your transportation cost becomes more transparent than it would have in the more traditional sense. That's the case for our entire industry really.

Joe Gemino

Great, thank you.

William McCaffrey

Yes, you're welcome.

Operator

Thank you. The following question is from Ashok Duga [ph]. Please go ahead.

Unidentified Analyst

Good morning. Bill, you just mentioned about you being cautiously optimistic about the next phases of growth. The next phases would be bite sized proceeds that's been talked about earlier by you guys?

William McCaffrey

Yes, that's correct. Let me spend a minute on that as well. What we've been doing is we have mentioned over the last year to that, one of the plants was designed for 60,000 barrels a day. We tested it to far greater levels anywhere from 110, 115, 120; we don't know the absolute limit, we haven't bumped up against it but we have tapped [ph]. And so with that meant is we didn't have to put a lot of capital into the processing side of the facility and our focus would be on adding steam in that going forward, so on the steam and water treating side. But what we've seen in the last year or so, as I say is we continue to make advances on the EM SAGP Technology and free up steam that can be redeployed to new wells. That is pushing back our need ultimately for facilities in the water treating and steam at least for the next series of expansions. So that means our expansions become focused more on drilling of wells which is really exciting because right away that takes it and makes it a very versatile business that can be done in bite-size pieces but you can do as many or as few as you need to, so it ideally positions us to grow at little oil prices.

Unidentified Analyst

Okay. And at what price, ballpark or a range would you signal growth?

William McCaffrey

We believe recovering our cash cost now, a few more dollars we'll cover our sustaining cost as well and even though those are very, very low end indicated in the last quarter, its $4 to $5 dollars right now, and we think that will be low for the next few years as well. The oil can vary anywhere from $4 to $8 or something in that neighborhood, depending on what we're doing. But we obviously are getting our balance sheet into good position first, but then we do have the ability to start growing after that. So if you think where oil prices are today and as they improve, they are certainly working in the direction that is helping us progress right now.

Unidentified Analyst

Okay. Thank you very much.

William McCaffrey

Yes.

Operator

Thank you. The next question is from Kelly Burn from Voya [ph]. Please go ahead.

Unidentified Analyst

Hey, guys. Thanks for the call. I know that you've said that you're talking to a number of people about the sale of a pipeline. Can you give us a little bit more granularity in terms of how many counterparties are looking at the asset and how many you're in conversation with them?

William McCaffrey

Yes, I can say it's more than one, but I can't give you any more detail on it. It's just a very sensitive time in the negotiations and everything, I apologize for that. But we have to exceptionally careful at what we can say at this phase.

Unidentified Analyst

Okay, and then in terms of the hedging I appreciate the little bit more color on the strategy. The only question that I would have is when you think about the percentage of production that you ultimately hedge, have you guys given any thought around that? Is there a targeted level where you say we feel like we're fully hedge at this percent of the production?

William McCaffrey

I think depends on the task that turns off the hedges that we're able to put in relative to our cash cost, relative to our needs to grow. If it's on the condensate side it's related to the opportunities that exist, maybe I can say a little bit on that too that the we - on the condensate side, we get about half of our condensate from the Gulf Coast. And so - and that typically can be - the pricing of that can be off of a different market, so we are trying to increase our condensate hedging to a point that it protects the fact that your pricing is off of a little different market than where WTI is. So we're doing hedges that link condensate to WTI which we think helps reduce the variability of it. So it is more driven, valued in a number per se, it's more driven about cost the alignment that happens with our business. And in the case of condensates, it's easier when you say because that's like half of our condensate comes out of that Gulf Coast and we're trying to align protection in that area.

Unidentified Analyst

Okay. And then expectations in terms of how far out you're willing to hedge.

William McCaffrey

Well hedging on time is a tool too, obviously. Right now our priority is to protect this time over the next three to six months here. And - but we are looking at opportunities further, so its opportunity driven. So in the case of condensate, as I mentioned we have hedged 40% out through 2017 because in that pricing we actually think that it's favorable pricing to what we've seen. As a percentage of WTI over a large number of years, that vary price range is. So if we think it aligns to protect our business and if we think that it is favorable, we tend to go more, let's say we're at 40% on the 2017 number now on condensate.

Unidentified Analyst

Okay, that's it for me, guys. Thanks.

William McCaffrey

Thank you.

Operator

Thank you. The next question is from Gary Stromberg from Barclays. Please go ahead.

Gary Stromberg

Hi, good morning.

William McCaffrey

Good morning.

Gary Stromberg

Probably a question for Eric; cash was down about $285 million from the quarter, CapEx as you said was $35 million. I know some coupons are paid in the quarter but still left a pretty hefty cash burn. Was there something else going down in the quarter, maybe a swinging working capital that can explain the cash burn?

Eric Toews

Yes, thanks Gary. Obviously we had a 3, 345, we had a negative cash flow about $25 million, and as you point out we had a, our payments for our bonds in term loan are in Q1 and Q3, they're basically equal over those two periods, and so there was a $125 million payment on the bonds in the quarter, and then we had a one-time smaller charge, one time charge on some transportation items in the quarter that affect the working capital. So I think the reconciliation is primarily inside the working capital changes that were negative in the quarter.

Gary Stromberg

Okay, that's helpful. And do you see some benefit over the rest of the year from working capital or do you expect a pretty flat?

Eric Toews

We expect it to work itself back up to neutral through the rest of the year.

Gary Stromberg

Okay, so it could be some positive cash flow from working capital?

Eric Toews

Yes.

Gary Stromberg

Okay, and then just second question. Potential cash uses, if you do monetize your interest in access, is there a requirement to take certain debt out like the term loan or can you use the proceeds to buying bonds as well?

Eric Toews

We're working through the strategy, Gary, and once - if there is a deal to do on aqueous then we'll promote a strategy on that.

Gary Stromberg

Okay, that's all I have. Thank you.

Operator

Thank you. The following question is from Brian Bagnell from Macquarie Capital. Please go ahead.

Brian Bagnell

Good morning, guys. Thanks. Most of my questions have been already. But the last one is just on maintenance CapEx and you've noted that it's trending down. I'm wondering how repeatable you think that is going to be in 2017 based on kind of what you see today where prices are trending and the prices of service and what have you. Thanks.

William McCaffrey

Sure. As far as sustaining CapEx goes, I think that's what you're referring to, right?

Brian Bagnell

Pretty sure.

William McCaffrey

Yes, so we haven't done our numbers for 2017 yet. So I have to be a little careful about that but what I would say is that it's driven based off of our source of replacement of our barrels. So if we are in EM SAGP implementation mode, it tends to be lower for reaching out for new wells, it would move it up a bit, and so that $4 to $8 range is probably a good range. Next year we are heading into EM SAGP for Phase 2B because we'll have sufficient heat in them so that we can start to utilize that process which would tend to have it on the lower end of that range. But this is a qualifier, we don't having run the numbers I don't want to pin one or two parties when I give you some thought on it.

Brian Bagnell

Okay, great. Thanks.

William McCaffrey

You're welcome.

Operator

Thank you. Your following question comes from Nick Lupick from AltaCorp Capital. Please go ahead.

Nick Lupick

Yes, thanks guys, good morning, two quick ones for me. The first one is on the transportation expense, obviously there was a big increase in your available volumes that can go down on flank and sell it down to the Gulf Coast as you were saying. I was wondering when you have a plan to see the next step change in those volumes going up towards the 100,000 barrels per day range.

William McCaffrey

Yes, it's towards the end of the decade on that so it's not in the immediate future. It works well for us too, we think we've got the right balance going right now.

Nick Lupick

Perfect, thank you. The second question I had was just on the pipeline sale process. Would you describe this more as an open-ended process or is there a certain timeline that you have in place where eventually if amicable terms can't be agreed upon that you'll look at other, keeping the pipeline and look at other asset sales?

William McCaffrey

Well we see it as something we're very focused on right now, and as the environment improves, volatility changes, we do see interest on this and we are focused on deleveraging. So we're not seeing at is by this date, such and such, or anything like that. We're continuing to work to make sure we hit the right deal for our shareholders, and then we just have to be very disciplined about that.

Nick Lupick

Okay, that's it for me. Thank you.

Operator

Thank you. The following question is from Menno Hulshof from TD Securities. Please go ahead.

Menno Hulshof

Yes, good morning. I just have one quick follow up question on access. Is there less urgency to monetize that asset at $45 WTI relative to, just say a few months ago when oil was closer to $30, or is this completely independent of what oil prices do over the course of next couple of quarters.

William McCaffrey

I think oil prices helped in the monetization but we have not lost our focus or slowed down or anything in that area. We're being disciplined and calculated, but as I said earlier we do need to make sure we get that right balance because whatever we do today affects the future, and so we are being very disciplined on how we do it, but we haven't been slowing down.

Menno Hulshof

Okay, thank you.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting - I do apologize, we do have a question that just queued up from Blake McWherter from PineBridge Investments. Please go ahead.

Blake McWherter

Hi, I have a shocking one more question on access to follow up with Gary's question. As things stand out for the credit agreement, what are the required use of any proceeds from the sale as it stands now?

William McCaffrey

Yes, the credit agreement's not a public document, so we prefer not to talk about that in the call.

Blake McWherter

All right, fair enough.

Operator

Thank you. There are no further questions registered at this time. I would now like to turn the meeting back over to Mr. Rogers.

John Rogers

Great. Thank you, Mary, and thanks everyone for listening in and for those of you who asked questions, Helen and I of course will be around right after this call to answer any of your detailed questions. So thanks again and we'll talk to everybody soon. Bye now.

Operator

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

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