Cenovus Energy, Inc. (NYSE:CVE)
Q2 2016 Earnings Conference Call
July 28, 2016 11:00 ET
Kam Sandhar - Vice President Investor Relations and Corporate Development
Brian Ferguson - President and Chief Executive Officer
Drew Zieglgansberger - Executive Vice President, Oil Sands Manufacturing
Ivor Ruste - Executive Vice President and Chief Financial Officer
Kieron McFadyen - Executive Vice President and President, Upstream Oil & Gas
Bob Pease - Executive Vice President, Corporate Strategy and President, Downstream
Phil Gresh - JPMorgan
Neil Mehta - Goldman Sachs
Paul Cheng - Barclays
Fernando Valle - Citi
Fai Lee - Odlum Brown
Good day, ladies and gentlemen and thank you for standing by. Welcome to Cenovus Energy’s Second Quarter 2016 Financial and Operating Results. As a reminder, today’s call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions]. Members of the investment community will have the opportunity to ask questions first. At the conclusion of that session, members of the media may then ask questions. Please be advised that this conference call may not be recorded or rebroadcast without the express consent of Cenovus Energy.
I’d now like to turn the conference call over to Mr. Kam Sandhar, Vice President Investor Relations and Corporate Development. Please go ahead, Mr. Sandhar.
Thank you, operator, and welcome everyone to our second quarter 2016 results conference call. I would like to refer to you to the advisories located at the end of today’s news release. These advisories describe the forward-looking information; non-GAAP measures; and oil and gas terms referred to today and outline the Risk Factors and assumptions relevant to this discussion. Additional information is available in our most recent annual information form or Form 40-F.
The quarterly results have been presented in Canadian dollars and on a before-royalties basis. We have also posted a link to our quarterly results including updated guidance on the home page of our website at cenovus.com. Brian Ferguson, our President and Chief Executive Officer will begin with some opening remarks and then turn the call over to Ivor Ruste, Executive Vice President and Chief Financial Officer, who will discuss our financial performance. Following that, Kieron McFadyen, Executive Vice President, and President, Upstream Oil & Gas will provide an update of our upstream operating performance. Bob Pease, Executive Vice President, Corporate Strategy and President of Downstream will then provide an update on our downstream results before turning the call back to Brian for some closing comments.
We will then begin the Q&A portion of the call. Please go ahead, Brian.
Thanks, Kam. Good morning. I am pleased to be reporting strong operating and improved financial results for our second quarter. Our focus on cost and production efficiency is paying off. Cenovus is benefiting from continued strong operational performance, sustained cost savings, operational efficiencies as well as improved commodity prices and seasonally stronger refining margins. We remain focused on the commitments we have made to our shareholders over the past 18 months to build a stronger company, one that is fit to withstand and to take advantage of the period of prolonged commodity price volatility that we are experiencing. We made some tough but necessary decisions with respect to capital, workforce reductions and dividends. We believe that these actions have positioned Cenovus to generate superior value for our shareholders over the long term.
Companywide, we remain on track to achieve up to $500 million in capital, operating and G&A cost reductions compared to our original 2016 budget. Of the cost reductions realized over the past 18 months, we expect about two thirds are sustainable over the longer term and in a higher commodity price environment. Continued improvements to our cost and operating structure will help reinforce our position as a cost leader able to compete globally. We have a strong portfolio of organic investment opportunities. Our upstream business continues to deliver strong operating performance. Our oil sands facilities continue to perform at high utilization levels and are demonstrating a steady ramp up with volumes averaging about 143,000 barrels per day net in the quarter primarily as a result of base production optimization and strong performance from new sustaining pads.
As of today, expansion facility at Foster Creek G is now producing oil. And Christina Lake F remains on track for first oil in the third quarter. These two phases are expected to add 40,000 barrels per day net increase in capacity to Cenovus which represents about a 25% increase to our current oil sands productive capacity. Our downstream integration continues to benefit Cenovus. Our refining business demonstrated excellent operational performance in the second quarter and benefitted from seasonally stronger crack spreads. I am excited to be part of a company that’s in a position of such strength. We have created a leaner organization with a strong balance sheet and a top tier portfolio of opportunities to invest in when the timing is right.
Given the strength of our balance sheet and financial position as well as our high level of confidence that the cost reductions we have achieved will be largely sustainable. I am optimistic about the potential to resume construction on some of our deferred projects. However, we still need additional clarity on federal, fiscal and regulatory policies that could impact our operating environment. We are spending a small amount of capital now to progress Christina Lake G where we are in the process of completing detailed engineering and rebidding work. We expect to provide specific timing and cost estimates on this project as well as our deferred projects as part of our 2017 budget announcement in December. I want to also take a minute to talk about the devastating forest fires that impacted the city of Fort McMurray and surrounding area during the quarter. Our hearts go out to the many families and businesses that were impacted by this tragedy.
I am proud of the way that Cenovus supported the diaster relief efforts and we will continue to offer our support to the community as the rebuilding continues. Cenovus was fortunate that these fires did not affect any infrastructure or operations as our Foster Creek or Christina Lake properties. Overall, I am pleased with our operational and financial performance during the quarter and I look forward to maintaining our momentum through the second half of 2016.
I am now going to turn the call over to our Chief Financial Officer, Ivor Ruste to provide more details on our financial performance during the quarter.
Thanks Brian. Good morning everyone. Strong operational performance combined with improved commodity prices allowed us to maintain our robust financial position. We exited the quarter with approximately $3.8 billion of cash on our balance sheet and $4 billion in unused credit capacity. Our good debt metrics at June 30, 2016 were 17% net debt to capitalization and 1.9 times net debt to adjusted EBITDA. Commodity prices remain volatile but WTI improved by over $12 per barrel from the first quarter of this year. The upturn in oil prices has benefited our total crude oil net back which increased by over $11 per barrel from the first quarter including hedges. Cenovus reported cash flow of $440 million in the quarter or $0.53 per fully diluted share. Improved cash flow during the quarter was primarily as a result of strong operations, improved oil prices, higher crack spreads and continued cost improvements across the organization.
We continue to evaluate market opportunities to execute on our hedging strategy of stabilizing cash flow to support financial resilience. Our 2017 hedge positions are weighted towards the first six months of the year as we expected seasonal commodity price weakness to occur during that period. Details of our hedging positions can be found in our corporate presentation hosted on our website. With today’s release, we have updated certain items in our 2016 guidance to reflect actual results to-date as well as our projection for the second half of the year. Oil sands capital is down reflecting continued improvements, and operating cost are expected to be lower across all areas.
Kieron will speak to these improvements shortly. G&A guidance has been increased to account for one time charges related to staff reductions including severance and lease cost totaling $50 million year-to-date 2016. Go forward, we expect run rate G&A to be in the $260 million to $280 million on an annualized basis. As Brian mentioned, we are building a stronger and more profitable organization. Our financial strategy remains unchanged. Our plan is to continue to maintain financial resilience to support our growth while ensuring safe operations and providing long-term value creation to our shareholders. I will now hand the call over to Kieron to discuss our upstream operations.
Thanks Ivor. Good morning everyone. Since joining in April this year, I had a good opportunity to engage with our staff and to view our operations. Overall, I am extremely impressed by the level of capability and talent across the organization. I am also very encouraged by the many technical and operational achievements made to-date. Building on this tight record, my aim is to continue to focus Cenovus as a top tier operator and the cost leader in industry. A cost leader that continually demonstrates operational excellence, enabled by safety, innovation and of course technology.
Once again, this quarter we have demonstrated strong operational performance. Plant obtains have been high and we continue to improve both unit operating cost and unit development costs. For the second quarter, total upstream operating costs were under $9 a barrel per oil equivalent. That is down 12% from the previous quarter is also down 25% since October 4, fourth quarter 2014. These improvements are largely as a result better supply rates, workforce reductions, lower fuel costs, the continued optimization efforts. Once again, Christina Lake continues to demonstrate top tier performance with an average SOR of 1.8 in the quarter and with a plant running near capacity of 80,000 barrel a day net. Foster Creek also continues to perform well and in line with our expectations with fuel volumes ramping off as new sustaining pads are brought on.
Production at Foster Creek averaged 65,000 barrels a day net during the second quarter. In the month of June, the field also averaged 69,000 barrels a day net. So overall, we remain on track to exit the year producing in excess of 70,000 barrels a day net from Foster Creek. Foster Creek Phase G and Christina Lake phase F expansions are on track and are expected to add incremental volumes, oil volumes in the third quarter. We expect these phases to ramp up over a 12 to 18 month period bringing the total production capacity 195,000 barrels a day on a net basis. The conventional oil and gas business continues to perform well generating $166 million of free cash flow in the first six months. This part of our portfolio remains highly profitable and generates stable cash flows. As Brian indicated, we are currently reviewing our capital opportunities across the entire portfolio and we plan to provide more details in clarity over the coming months.
So in summary, in the near term our focus is to deliver upon operational commitments, and at the same time position for future phases of profitable growth. With safety top in mind, we continue to seek further opportunities to sustain operational excellence and of course leadership across the asset base. So the measures we have taken and our continued focus will help us remain competitive in this current volatile price environment. And over to Bob to review the existing performance.
Thanks Kieron. Our refining and marketing business rebounded from a challenging start to 2016. As expected, we are finding margins were positively impacted by higher average crack spreads on increased seasonal demand. The Chicago 3-2-1 crack spread averaged approximately $17.15 per barrel in the second quarter up over $7.5 per barrel from the first quarter of the year. Operationally both Wood River and Borger had very strong performance during the quarter with average utilization of 100%. The Wood River de-bottleneck project remains on track for start up in the third quarter of this year. This light-ins processing project is expected to add 18,000 barrels per day of gross crude capacity with added flexibility to process more light or dilbit heavy type crudes. Operating cash flow from refining and marketing in the quarter was $193 million. Using the LIFO inventory method as is done in the U.S. our operating cash flow would have been $107 million lower.
As expected overall bitumen realizations improved substantially in the second quarter as we benefited from blending less expensive condensate purchased in prior periods and sold in a rising price environment. Realized bitumen field price during the second quarter averaged about $30 per barrel compared with $10 per barrel in the first quarter of this year. The revenue uplift achieved in the quarter covered incremental oil sands transportation costs resulting from higher rail and pipeline volumes to the United States. Our marketing and transportation strategy remains focused on maximizing the margin of every barrel we produce.
I will now pass the call back to Brian for some closing comments.
Thanks Bob. Cenovus is in a strong position both financial and operational as we enter the second half of 2016. I expect continued volatility in commodity prices and believe that we are well prepared to deliver value to shareholders in this new reality. I have confidence in our assets, our people and our track record. 2015 and 2016 have seen a significant transition in Cenovus’s operating model. We been playing defense for the past 18 months and we are now well positioned to resume value-added growth in the months ahead. With that the Cenovus team is now ready to respond to your questions.
[Operator Instructions] Your first question is from Phil Gresh from JPMorgan.
Hi good morning and nice quarter. Right, my first question is on the kind of return of capital policy, you obviously cut the dividend twice, and I guess as you look forward, how do you think about that structurally with respect to you know target as a percent of cash from operations. I think in the past you have given a range of what you thought there and as we look out, it looks like there might be an opportunity to maybe kind of grow again from these levels. Just any thoughts you could share on that?
Sure, thanks for the question Phil. So we very much believe and I am a big fan of
total shareholder return including the discipline of paying a dividend. As you pointed out, we had to make a difficult decision given the substantial change structurally in our business to adjust our dividend to a level that we felt was sustainable. And just to remind you, we stress tested our current capital program and dividend and can fully fund all of those obligations including the dividend if prices were to for example remain as long as 40 bucks WTI for an extended period of time. The sustainability dividend obviously is important. I think as we go forward and we get into a more normalized price environment, and we will absolutely be assessing how to allocate capital between the sustaining capital that we need to sustain our operations, cash flow and earnings, how much to return to the shareholders through the income stream of a dividend and then we would assess beyond that our capacity to fund growth capital beyond that.
So is it fair to say that you still think about this 20% to 25% of CFO payout ratio that you have discussed on past calls?
We are reassessing that and have not yet been made a decision. I would expect it will, we’ll have that kind of a conversation with our board of directors probably in about a year's time as we have a discussion around strategy and how we return capital to the shareholder. I don't expect a change – I don't expect a change in the dividend policy for the balance of this year.
Right okay, fair enough and then just second question obviously, you know now we have seen a pullback in oil prices and so but you are still sounding reasonably upbeat about spending a little bit of capital here and potentially then moving forward with Christina G.
So I guess is there any sensitivity to the oil price with this project? Obviously, you spent some money already so it probably has a decent forward-looking IRR but any thoughts on maybe how to think about that or how we should calibrate that?
So just a reminder, we did revise downward in our guidance our expected spend on capital for the balance of this year and that’s maintaining the same scope of operations and maintaining the same production guidance. So we are seeing ongoing cost and productivity efficiencies throughout our portfolio. My view is that this is the time to be countercyclical in terms of investing in our organic projects. They have got strong IRR as you point out and the reason to defer these projects and I will use Christina Lake G as an example when we decided to suspend that project last year, it was entirely around cash conservation, had nothing to do with the actual economics of the project and the other projects that we have in the portfolio.
So what we are focusing on now is a very measured disciplined pace of reactivation that balances you know the needed financial strength in our balance sheet. As I mentioned, we mentioned in the news release and I mentioned here – earlier in the call notes, I have got a very high confidence level in the sustainability of the cost structure improvements that we've seen. And you know so we are now in the position where as I said Cenovus has been playing defense for last 18 months. We are in a position now where given the structural changes in our cost that are sustainable where I want to take advantage of you know low industry activity and a better cost environment to now start redeploying some of that cash we got on the balance sheet into very measured and disciplined growth as we go forward.
Okay so it sounds like even in this price environment, with the pullback that the project would work from an IRR standpoint.
Correct, yes saying it – I expect we are going to see volatility in prices seasonally, you know there are certainly indications that we are seeing supply-side response to the weak environment that we’ve seen but we’re not relying on where prices may or may not go here. You know this is about how do we create long-term value? These are 30, 40, 50 year life projects and to be able to bring them on to actually bring them on – do the construction bring them on in a low price environment when you're looking at a 30,40, 50 year life is a good opportunity for us.
Okay, understood, thank you.
Your next question is from Neil Mehta from Goldman Sachs.
Good morning, guys. So just wanted to follow up on the details here on Christina Lake Phase G. So can you give us a little sense of when you are thinking about making a decision around FID [ph], what are the gaiting factors in terms of the decision and then refresh us in terms of the incremental production and potential CapEx associated with the project?
Sure, I will ask Drew to respond to that.
Yes, thanks Neil. So the current state of Christina Lake Phase G, we do have a little bit of detailed engineering that we need to complete which is some of the work we will continue to do here in the second half of this year. Just to remind everyone, we had a substantial number of pieces, the equipment already procured on Christina G and then have about 10% of the field construction actually initiated when we did suspend the project. So really the focus for the teams right now is to rebid some of the work, we've asked them to spend some time you know reevaluating exactly how will execute the construction. And the teams have been doing a lot of work on the field development side of the pads and obviously the drilling and sustaining cost. So that’s the focus here for the second half of this year and we will give everyone an update on the actual costs and our execution strategy for that – that phase here likely in the December budget call. Just as your question that phase is a 50,000 barrel a day gross expansion, 25,000 barrels net to Cenovus is the plant capacity of that facility expansion.
That's very helpful, thank you. And then just if you – any comments on the M&A environment as it stands right now. Last time we spoke it sounded like the bid asked were still relatively wide, you do have a very strong balance sheet right now. Do you see opportunities that are out there for assets or something larger than that and then on the other side of it how are you seeing the divestment side, are there non-core assets in the portfolio that you look to monetize as the commodity price or evaluation environment warrants?
Thanks for the question. So our prime focus is on this great organic portfolio that we got, you know that’s the first call on capital. As you point out, we certainly do have a very strong balance sheet and if there were an opportunity on a very select basis to enhance that portfolio, we would certainly consider that but the prime focus continues to be on the organic portfolio. With regards to divestitures, you are correct, we got two non-core conventional packages that are data room ready. Don't think the market is yet settled enough but we do want to part with those assets in this environment. So we are waiting to see some continued improvement. I have always believed that having an ongoing divestiture program is real healthy form of capital discipline in an organization and where you can realize proceeds, redeploy them back into higher return growth opportunities and portfolio, I think that you should do that. So, we’re certainly prepared to do that but I don't see that happening here in the near-term.
And last question for me is around the reduction in capital spending guidance, congratulations on that. Can you just walk us through what ultimately drove the reduction there and how much of it do you see as moving forward post 2016?
So we will continue to be relentless in terms of our pursuit of cost and productivity improvements as a general mindset and attitude. I think, I will ask Kieron, if he wanted to give some overall color on the reductions on the capital in the oil sands.
So it comes from many things, I think the main thing that I would want to highlight is excellent project management and the project team is up solely focused on many things, focused on safety and focused on cost. Not schedule driven. And I think that’s driving pretty clear productivity improvements to the extent that for the same scope we’re getting you know higher, higher capital efficiency. So really that's another…
Alright, thanks guys for the comments.
The next question is from Paul Cheng from Barclays.
Hi guys, good morning. Brian, I think Christina Lake pad, the development cost is about $32,000 to $35,000 per daily barrel, do you have a rough estimate what G may be looking like?
We don’t have one as of yet. As we mentioned, we are rebidding the project or components of the project right now. And do expect that costs will be down but I can’t give you a specific number yet. We will provide that specific guidance as part of our December budget announcement.
Then you do believe that it is going to be lower than the phase F?
Okay and do you have any discrepancy in terms of the timeline to pursuit the growth with your partners, I mean given the balance sheet position you know that maybe somewhat different, so are we, we in sync or there is some discrepancy?
We have – had an excellent operating relationship with our partner, we continue to be very strategically aligned. They have approved the budget for 2016. You know their expectation of us is the same as my expectation of us and that's that we be a very good operator and what we have generally been trying to do is to manage – to balance cash inflow, cash outflow and that continues to be our focus and we continue to be aligned on that.
If there is a dispute, how is the process to resolve it? Is there a mechanism saying that as an operator that you have to define those thing or how does that work?
So, we haven’t had a dispute since the partnership was put in place in 2007. We’ve had a very good working relationship. There is a good healthy challenge between the two organizations and that that has worked well for us, I believe for the nine years now that we have, we have been partners and I don't see that changing.
And after Christina Lake Phase G, what is the next project will be. Now you said going to be Foster Creek on the Phase H or that you will start looking at no [indiscernible] when you refile?
So as you pointed out, we got a good portfolio, good inventory of regulatory approved projects that we can choose how we apply capital to. We are doing – continuing to do work and try to take advantage of this industry slowdown where we’re relooking at all aspects of our – those future phases. We have not yet made a decision with regard to specific capital allocation or timing of those additional projects but will be giving specific guidance on that as part of our December budget release.
Final one for me, given your strong balance sheet today and look like oil price may have already bottomed and is probably going to be higher over the next 12 to 18 months, will the company revisit whether that we may need for the hedging?
We will continue to have a very consistent and disciplined hedging policy and hedging practice and execution. Our objective is to have certainty around a proportion of our forecast, cash flow and cash outflows so that we can make sure that we have the financial capacity and stability to continue to move forward our projects and our sustaining capital.
[Operator Instructions] And at this time, we will also open the call to members of the media. And the next question is from Fernando Valle from Citi.
Hi guys, good morning, thanks for taking my question. I guess following up on the last question on investments, when you are considering your budgetary decisions, what's, where is the threshold for you to sanction a new phase, what indicators are you looking that will give you confidence in sanctioning next phase of FCCL or a Narrows Lake and how do you weight that versus increasing the dividend back to higher level on a long-term sustaining basis?
Thanks for the question around capital allocution. You know as we said historically and we continue to have the same view, the first call on capital allocation goes to the capital required to sustain our production so that safety regulatory maintenance capital. And the run rate on that is round numbers as a corporation about $1 billion. Dividend and total shareholder return as I mentioned earlier on the call is a very important aspect from my perspective as CEO in terms of returning an income stream to the to the shareholder. Any income stream and any increase in the dividend, I want to make sure is sustainable. As I mentioned earlier, we made some very difficult decisions around capital reductions, workforce reductions and dividend reduction earlier on. So to look at dividend increase, I want to ensure that it is sustainable as we go forward and we are looking at a combination of how do we return capital to shareholder through the income stream and how can we create value for shareholders with additional growth investment, so that we’ve got that balance.
Great, just on the growth itself, is there, you’ve talked about deflation but is there a target where you're saying this is where we need to be in order to sanction for example do you need to see a breakeven of below a certain oil price where you'd feel comfortable. Are you – is that how you are looking at or is it more on a return basis or a payback basis. How are you thinking about capital allocation considering the volatility in oil prices going forward?
So we are focused on ensuring that we’ve got a robust business model and a $55 WTI environment. You know we are not, we are doing things on flat prices. I want to make sure that, I got 3700 staff that are focused on cost and productivity, I don't want other than about a handful of people thinking about what the price of oil might or might not be. So we are using a flat price deck as I mentioned. We are testing our economics against that, and all the various economic thresholds internal rates return, payback supply cost all those things are things that we consider. In addition, we look at the overall umbrella of our capital structure because we want to in turn continue to manage our company as an investment grade organization.
Okay, thank you very much.
The next question is from Fai Lee from Odlum Brown.
Thank you, hi Brian. I am just wondering you mentioned supply cost in your last response, can you and given the current cost environment, can you possibly give us a sense of where the support cost might be fore Foster Creek, Christina Lake and I guess even Narrows Lake?
We will be – obviously one of the key things there is the capital cost. As we mentioned, we’re rebidding projects at Christina Lake G right now. I would say that the ongoing sustaining All that we would have our base operations is that very will supply cost associated capital that we would have on our base operations has got very low supply cost associated with that ongoing sustaining capital and that would be in the mid $30 WTI range. As it relates to specific projects, we would reactivate that's going to obviously be influenced by the – our current assessment and the rebidding process we are doing. So I can't give you a specific number on that as this point. But it – as I said we are going to make sure that we’ve got a robust business model at $55 WTI. So supply costs need to be less than that.
Okay, thank you.
There are no further questions. I will turn the call over to you Brian Ferguson for closing comments.
Thank you for joining us today. The call is now complete.
This concludes today's conference call, you may now disconnect.
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