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

Executives

John G. Langille - Vice Chairman

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

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

Analysts

George Toriola - UBS Investment Bank, Research Division

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

John P. Herrlin - Societe Generale Cross Asset Research

Dan Geary

Barbara Betanski - Addenda Capital Inc.

Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division

Harry Mateer - Barclays Capital, Research Division

Canadian Natural Resources Limited (CNQ) Q3 2012 Earnings Call November 8, 2012 11:00 AM ET

Operator

Good morning, ladies and gentlemen. Welcome to the Canadian Natural Resources 2012 Third Quarter Conference Call. I would now like to turn the meeting over to Mr. John Langille, Vice Chairman of Canadian Natural Resources. Please go ahead, Mr. Langille.

John G. Langille

Thank you very much, Operator, and good morning, everyone. Thank you for attending this conference call where we will discuss our third quarter results and review our planned activities for the balance of this year and, in some cases, beyond that.

Participating with me today are Steve Laut, our President; and Doug Proll, our Chief Financial Officer. Before we start, I would refer you to the comments regarding forward-looking information contained in our press release and also note that all dollar amounts are in Canadian dollars and production and reserves are both expressed as before royalties unless otherwise stated.

I'd like to make some initial comments before I turn the call over to Steve and Doug for their in-depth discussion. Our proven business principles and strategies are long-standing and they work. They continue to build a powerful business model that is geared to creating long-term shareholder value. Our production is balanced, and our resource base is one of the best in the E&P space. This base will add to the balance production as known resources are developed through the appropriate allocation of capital using diligence and discipline. We can use a lot of flexibility when setting our CapEx programs, and we are prepared to reallocate capital, if any project is not making our economic hurdles.

We are good at evaluating opportunities to acquire and consolidate assets that will add value to our portfolio. A great example of that is at our Kirby in situ development, where we expanded our initial plans from around 40,000 barrels per day to north of 120,000 barrels per day through an acquisition a couple of years ago. And this year we further expanded our position by completing several acquisitions to acquire contiguous lands. This new larger land position will set us up for many years of development, leveraging the resources and synergies available from this dominating position.

We have built an industry-leading portfolio of properties that will provide plenty of long-term growth opportunities, from large resources located in such shale plays as the Montney and the Duvernay in Western Alberta and Northeast BC to oil mining assets that provide sustainable cash flow for decades and to our large land holdings in the main fairway of in situ resources. All of these assets will be developed over time using our patient, disciplined approach to allocation of available capital to generate returns.

And in the shorter term, our heavy oil properties continue to grow. Our leading edge polymer flood at the Pelican Lake oilfield will result in higher production and recoveries of reserves, and our natural-gas-producing properties at our international oil properties generate free cash flow.

Our current production generates sufficient cash flow to effectively develop our growing resources, including current production increases and expenditures on longer-term production increases. We pay a sustained increasing dividend, up 17% from last year, and from time to time we buy back our common stock. Year-to-date we have acquired over 7.8 million shares, certainly one of the highest levels among North American independent E&P companies.

With that, I will turn the call over to Steve for a detailed review of our properties and prospects. Steve?

Steve W. Laut

Thanks, John, and good morning, everyone. This morning, I'll make a few comments on Q3, as well as our view on the oil markets going forward. As you know and as John talked about, Canadian Natural is in a strong position. Our assets deliver free cash flow and still grow near-term production. As a result, we're able to deliver sustainable free cash flow, which allows us to allocate capital to our large, long-life, low-decline resource base, driving continued free cash flow growth and sustainability. In addition, we've been able to return cash to shareholders through increasing dividends and share buybacks. Our balance sheet is strong, with the capacity to capture opportunities and weather any commodity price volatility we might encounter. This strong position is a direct result of our ability to effectively execute our strategies.

In the third quarter, Canadian Natural had solid results in our conventional business, and we took significant proactive steps at Horizon to deliver improved performance and reliability going forward. We've also reduced capital spending for the year by an additional $230 million, taking the total capital spending reductions for 2012 to $910 million, with only a slight change to midpoint of production guidance, mostly due to the more proactive steps at Horizon to improve long-term reliability. This reflects the strength of our assets and our capital flexibility.

So turning to our assets, and starting with gas. With low gas prices in 2012, our capital allocation to gas has been very limited, with only 35 wells to be drilled in 2012. We've also shut in 20 million cubic feet a day of gas on top of the 20 million we shut in late 2011 for a total of 40 million cubic feet a day. Gas operating costs were up in Q3, primarily as a result of our decision to allocate capital away from gas. As a result production declines and with a portion of cost being fixed off costs have increased. In addition, we continue to see increasing property tax and lease rentals, which contributed to the higher costs.

Canadian Natural is the second largest natural gas producer in Canada, with a very large land base and effective and efficient operations, allowing us to continue to be one of the lowest-cost operators in the industry despite declining gas production.

Within our large land base, we have a dominant Montney land position, with over 1 million net acres -- largest in the industry. As well our Duvernay land position is significant at 500,000 net acres. When gas prices strengthen, Canadian Natural is in great shape. Our vast asset base in conventional and unconventional gas and our dominant infrastructure position allows us to maximize the benefits of higher gas prices and if we choose, quickly and efficiently increase gas drilling and production at very effective cost. At current gas production rates, $1 increase in AECO pricing generates $280 million of additional cash flow, giving Canadian Natural a valuable option on increasing gas prices.

Our light oil and NGL assets in Canada are strong, and light oil and NGL volumes will grow at 14% in 2012 to 64,000 barrels a day at midpoint of guidance. Very strong growth and reflects the strength of our light oil asset base as we progress water floods, EOR developments and horizontal multi-fracs across our large asset base.

As we reported in our last conference call, our international light oil production volumes were impacted by Q3 -- in Q3 by turnarounds at Ninian North and Central and a smaller turnaround at Tiffany in the North Sea, as well as a third-party outage at the Ninian pipeline system -- it took longer than expected.

A turnaround at Baobab was also completed in our Offshore African operations. In Offshore Africa, we're still on track for the start-up of the Espoir in-field program in Q4 2012. And this program will begin to deliver production in Q2 2013 and ramp up to 6,500 BOEs a day at a cost of 24,000 per flowing BOE.

In South Africa, we're tracking to plan in our process to bring in a partner for our Big E exploration project. As a reminder, this development has up to 3 significant structures on our lands, billion barrel-type structures that we currently own 100%. We're seeing strong interest from a select group of potential partners, and a likely earliest date to drill South Africa would be early -- or late 2013 or early 2014.

Turning to primary heavy oil, where we dominate the land base and the infrastructure and are the largest heavy oil producer in Canada, with over 8,000 locations in inventory. Due in part to this dominance, we have excellent capital efficiencies and low operating cost, making primary heavy oil the highest return on capital projects in our portfolio. Primary heavy oil production continues to exceed expectations, with production now expected to grow 22% in 2012, up 5% from our forecast last quarter, to 125,000 barrels a day at midpoint of guidance. Driven by strong results from our drilling program, particularly at Woodenhouse, this is the seventh consecutive quarter of record heavy oil production and reflects the depth and strength of our heavy oil inventory.

At our world-class Pelican Lake pool, our leading-edge polymer flood is driving significant reserves and value growth. And we have over 550 million barrels to develop under polymer flood. We are continuing to see solid response in the polymer flood, with production increases from 37,300 barrels a day in Q2 to 40,500 barrels a day in Q3, and exit rate is expected at 43,000 barrels a day, a 15% increase from Q2 production rates, setting ourselves up for a very strong 2013.

Our thermal operations at Primrose and Kirby are strong. At Primrose, we continue to effectively deliver production volumes. Primrose pad adds are some of the lowest cost production capacity additions in the industry at $13,000 a flowing barrel, as are Canadian Natural's operating costs, which are targeted to come in at $9.50 a barrel in 2012, making Canadian Natural's thermal in situ heavy oil production very profitable, if not the most profitable in Canada.

At Kirby, we remain on track. The Kirby South development is on an overall basis, 67% complete, 2% ahead of plan, with module assembly 96% complete and construction 58% complete. Overall, drilling completions are 73% complete, with the rig now on the fifth pad, and the sales pipeline is now under construction with completion targeted for Q2 2013.

Most importantly, we have seen no reservoir surprises and have been able to [indiscernible] the SAGD wells where we want them. Kirby South is targeted to add 40,000 barrels a day of SAGD production, with facility room to go to 45,000 barrels a day at a cost of $32,000 per flowing barrel. First steam is scheduled for November 2013.

As you know, Canadian Natural has always had a strategy of dominating land base and infrastructure to optimize capital efficiency and maximize value. In addition, when it comes to thermal operation, scale does matter, as scale drives higher returns on capital. We have in 2012 effectively used this strategy at Kirby. We made 3 tuck-in acquisitions from smaller land holders in the Kirby area, who on their own do not have a scale for a commercial project. These lands are contiguous with Kirby.

Canadian Natural leverage our infrastructure to capture these [indiscernible] reserves, as well as achieve operating and capital cost synergies. These lands have 340 million barrels of contingent resource. The development of these resources will leverage our existing Kirby development and with the enhanced scale, be very economic. We'll also improve the overall economics of the entire Kirby development -- another clear example of how Canadian Natural leverages our infrastructure and land base to maximize value. The current overall Kirby development will see Kirby South capacity increase to 60,000 barrels a day, and Kirby North develop to 80,000 barrels a day in 2 phases, for a total capacity of 140,000 barrels a day. However, with these recent additions, we are evaluating the potential to increase the overall productive capacity of the Greater Kirby area.

At Kirby North, EDS is complete and we're now completing the detailed design as per schedule. The regular process remains on schedule with the application submitted in Q4 2011. Clearing of the central plant site is complete, and we have ordered the evaporators and steam generators. First steam in for Kirby North is targeted for early 2016.

At Grouse, the regulatory application for 40,000 barrels a day of capacity has been submitted. Grouse engineering is on track with first steam targeted for late 2017. Overall, thermal in situ development program is on track and set to unlock significant value for shareholders.

Turning to our Horizon operations. We have, over the course of 2012, made significant improvements in our operations philosophy, taking more disciplined and conservative approach. We believe this approach has increased our operating reliability and will, as we go forward, further increase our reliability. Part of this philosophy means taking more proactive approach to maintenance. As you will recall, we discussed on the last conference call our plans to take a proactive outage in Q3 to repair exchanger leaks and repairs to a couple of mechanical seals on rotating equipment, driving increased reliability going forward. In the planning of this outage, we decided take additional proactive steps to not only address these immediate issues but also address a number of other pieces of equipment and components that could potentially be at risk or failure before the May 2013 turnaround.

We have the capacity in the schedule and did not need to increase the outage time to address these potential risks. By taking this approach, we have a decreased likelihood that any of these potential risks will result in an unplanned interruption, particularly during the winter months. To take advantage of this opportunity meant that we had to reschedule the outage for early October to ensure that we're well planned and the materials and skilled trades were lined up for an effective outage.

During Q3, we took a more conservative approach in how we ran the plant. Production was held back as the DRU heat exchanger leaks -- exchangers we replaced in October -- cost [indiscernible] losses and potentially adversely impacted the longevity of the hydrotreater catalyst. Eroding the life of the catalyst is not an acceptable outcome, as our catalysts are near life end and will be replaced in the May 2013 turnaround. As a result of the holdbacks in production, Q3 came in just under 100,000 barrels a day at 99,205 barrels a day, down from our strong Q2 at 115,000 barrels a day. Although this hurt Q3 production volumes, it was the right decision to ensure reliability going forward and safe, steady, reliable operations. We believe over the long run this will result in overall higher production volumes at Horizon.

Our outage to make these repairs was effectively executed on cost and on schedule -- actually ahead of schedule in the operating portion of the work. A good job by the Horizon teams. As reported in October, we came back on stream, and we're running at 115,000 barrels a day. However, shortly thereafter, we ran into a series of minor, non-related issues in the oil [ph] prep and extraction plants. That, in a normal operating state, would not have impacted SCO production, as we're able utilize froth and deal-bit tank volumes to -- upstream of the coker to maintain continuous feed to the upgrading complex. However, coming out of the outage, the tanks were not at optimal levels, and as a result we had to slow down the upgrader and for a period of time place the upgrader on circulation while we built tank levels. Normally, this is not an issue as the upstream can outpace the upgrader and tank volumes can be built. Because of these issues, we have taken a very conservative approach and downgraded our production guidance for Q4 to 85,000 to 92,000 barrels per day. However, I expect we'll most likely end up near the high end of this guidance or the low end of our previous guidance. This change, of course, impacts full year guidance. Again, although these actions have impacted production in Q3 and Q4, it is the right decision to make, as it increases our reliability going forward, especially as we head into the winter months and will result in greater yearly production volumes as we go forward. We expect steady state production to be in 110,000 to 115,000 barrel a day range as we move forward. Today, we're doing about 110,000 barrels a day.

Off-costs at Horizon are high in Q3, due to lower production volumes as most of the costs are fixed and onetime costs for shovel maintenance and drill stem repairs increase costs. If you normalize for these onetime events and the lower production, our costs would be in the $35 barrel range, a number we believe over the course of 2013 we will be able to improve on.

Phase 2/3 expansion at Horizon is going very well and we continue to track just below cost on an overall basis. Our strategy of breaking the project into individual pieces with the ability to slow down or stop if market conditions are not favorable has been very effective.

Capital spending in 2012 is now targeted at just over $1.35 billion, roughly $550 million below budget, as we continue to see cost savings and more importantly take extra time to properly split out bid packages to achieve better costs and execution certainty. Expansion will have a significant impact on our operating costs. With the exception of mining and natural gas costs, our operating costs are largely fixed, with the biggest component being labor. Mining costs are roughly $8.50 a barrel at the current time, and with expansion, we should see small efficiency gains. Natural gas costs are roughly $2.50 a barrel, assuming a $3.50 natural gas price. As a reminder, Horizon was designed [ph] for optimal operating performance at the completion of Phase 3. Therefore, expansion economics look very favorable as operating cost for the entire production stream are reduced significantly and in a $5 gas world, we'd expect operating cost to be in the $22 to $28 a barrel range. This reduction in operating costs, plus increased reliability, which not only provides more stable revenue, but in itself reduces operating costs on a per unit basis, making a significant contribution to the return on capital for Horizon expansions.

As a reminder, we have roughly 6 billion barrels to recover at Horizon, and we will ultimately expand to 500,000 barrels a day with a reserve life of 40 years with no decline. And although we've had some issues here in the early years, we are confident in our ability to deliver safe, steady and reliable operations over the next 50 years for this truly world-class asset. Clearly, Canadian Natural is in great shape with significant production growth and value to unlock in our oil assets.

And before I turn the call over to Doug, I'll make a few comments on oil pricing in North America. There is, in our view, some confusion on The Street about what is going on with oil prices in North America. And with the volatility we've seen in 2012, that's understandable. However, we believe this near-term volatility has unduly impacted the near-, mid- and long-term view on oil pricing. So starting with heavy oil and the recent heavy oil dips [ph] for Western -- WCS, or Western Canadian Select and Mayan crude. As a point of reference, today we ship roughly 30,000 barrels a day of heavy oil to the Gulf Coast, which clears the market at Mayan base pricing.

In September, the WCS differential was $16.39 off WTI, Mayan was a $6.04 premium to WTI, a $22.43 difference. In October, WCS differential was $9.69 off WTI, and Mayan was a $6.60 premium, a $16.35 difference. In November, WCS was $14.27 off WTI, and Mayan is expected to be about a $6 premium to WTI, a $20.27 difference. In December, WCS is indicating $30 off WTI, and Mayan should stay in that $6 premium range, a $36 difference. There are 2 main reasons that drive these recent volatility events for WCS pricing when compared to Mayan crude.

First, it's a short-term concern. The relative refinery supply demand balance in PADD II is currently tight. So what we have seen in 2012 and we're now seeing again here in December is the impact of unplanned and planned refinery outages now occurring in PADD II have on WCS differentials. Add on top of this, the drive by refiners to reduce year-end crude inventories, and you'll get what we're seeing in December, a dramatic widening in the WCS heavy oil differential. Second, a more mid-term concern is driven by the limited pipeline access and the bottlenecks at Cushing, making it difficult for Canadian heavy oil to reach the Gulf Coast, which is short of heavy oil.

Regarding the first concern, the PADD II supply demand balance is about to change dramatically. With some additional capacity now on, but still working out some minor infrastructure issues, a new capacity coming on by Q2 2013, we will see an additional 310,000 barrels a day of heavy oil conversion capacity come onstream. The existing market for Canadian heavy oil is 1.5 million barrels a day, adding 310,000 barrels a day will add 20% more heavy oil capacity for Canadian heavy oil. And although Canadian heavy oil production is increasing, it will take us some time to add an incremental 310,000 barrels a day of production. Bottom line, the heavy differential volatility is very likely to dissipate into 2013.

Regarding the second concern, in the mid- to long-term, we expect to gain access to U.S. Gulf Coast heavy oil refinery complex with increased pipeline access to the Gulf Coast. This access will come from the Flanagan South expansion for 585,000 barrels a day, which is slated to come on stream Q2 2014. It does not require a presidential permit and has the required producer and refiner support to proceed. It will also come from the Keystone XL project, which needs a presidential permit. It's slated to add 830,000 barrels a day of capacity in Q1 2014, if approved. Once we get to the Gulf Coast, the demand for Canadian heavy oil is very strong.

The optimum feedstock mix for Gulf Coast refineries requires approximately 3.4 million barrels a day of heavy oil. Today, U.S. Gulf Coast refiners are importing 2.4 million barrels a day of heavy. So once connected, we have 1 million barrels a day of heavy oil demand that today is not satisfied. In addition, over time -- and it will take some time for Canadian heavy to fill that million barrels a day of heavy -- of Gulf Coast demand. We'll also be able to push out the foreign heavy oil [ph] imports onto the Gulf Coast.

In addition, you will see in the Canadian Natural and its partners sanction the Redwater refinery to be built in Edmonton. This complex will process 50,000 a day of heavy crude and produce refined products, mostly ultra low sulfur diesel, scheduled for mid-2016 start-up. Canadian Natural has a 50% ownership in the Redwater partnership who will build and operate the facility, which can be expanded in stages to 150,000 barrels a day. The Redwater refinery not only provides a reasonable return but will help reduce the volatility on pricing for Canadian heavy oil.

In our view, heavy oil pricing looks strong in the near, mid-, and long-term with the addition of 20% or 310,000 barrels a day of heavy oil conversion capacity coming on stream in the near-term and additional pipeline capacity to Gulf coast, as well as the Redwater refinery covers off the mid- to long-term.

WTI or light oil pricing has been under pressure relative to Brent and LLS due to the pipeline bottlenecks at Cushing and the rapidly growing light oil production in the U.S. and, to a lesser degree, in Canada. The Cushing bottlenecks are well on the way to being removed. C will be expanded to 400,000 barrels a day of takeaway capacity in Q1 2013 and 850,000 barrels a day in Q2 2014. Plus, the Keystone Cushing market link will add 700,000 barrels a day of capacity by Q3 2013. As a result, we expect to see WTI to LLS differentials narrow to essentially a transportation cost between Cushing and the Gulf -- about $5 a barrel.

Currently, there's about 500,000 barrels a day of imported light into the Gulf, and there are some concern that North American light oil production will continue to grow to the point that it pushes all these foreign barrels out, causing the WTI to Brent differential to again widen. However, we need to remember that light can be blended with heavy to produce a medium crude look-alike and compete for the medium crude oil refining capacity on the Gulf Coast. And today the Gulf imports about 1.5 million barrels a day of medium crude. There's also 2 million barrels of light oil refinery capacity on the East Coast of Canada and the U.S. Today, there are significant real infrastructure being built to displace these 2 million barrels a day of foreign imports with North American light oil. And longer term, there's likely going to be a pipeline access for Canadian heavy oil -- or Canadian oil -- light oil and heavy off both the West and East Coast. However, they face their own regulatory and stakeholders challenges.

In summary, we are bullish on heavy oil pricing in the near-, mid- and long-term. Light oil pricing will face some headwinds, however we expect that with the new transportation infrastructure, displacing of foreign light oil imports, North American light oil will continue to be very economic as we work on export opportunities on both East and West Coast. Canadian Natural is in an enviable position. Our assets are very strong and delivering free cash flow to not only unlock our huge long-life, low-decline resources but also increasing returns to cash to shareholders, as well as ensure our balance sheet remains strong, which Doug will comment on. Doug?

Douglas A. Proll

Thank you, Steve, and good morning. As Steve mentioned, the third quarter of 2012 was a solid operating quarter. I would like to briefly summarize a few financial matters for Canadian Natural arising in the third quarter.

In the third quarter, we generated $1.43 billion of cash flow from operations and $4.47 billion for the 9 months of 2012. Third quarter of cash flow is lower than the second quarter, and the reduction is largely attributable to lower volumes from Horizon SCO and international, partially offset by conventional volumes in Canada. Lower conventional crude oil and natural gas prices realized product netbacks, realized management activities, largely attributable to foreign currency contracts. The foreign currency program relates primarily to cash management positions, which settle monthly and are dependent upon the foreign exchange rate for the Canadian and US dollars. As you will see from past quarter, this reported activity fluctuates as the Canadian dollar strengthens or weakens against its U.S. dollar counterpart, and lower current income tax reflecting these noted changes.

Capital expenditures for the 9 months amounted to $4.5 billion, funded by cash flow from operations for the same period. Our dividend program amounts to an annual return to shareholders of $0.42 per share, paid $0.105 quarterly. In 2012, we have purchased 7.8 million shares for cancellation under our Normal Course Issuer Bid. After taking into consideration the dividend program and the purchase of shares, long-term debt at September 30 was $8.4 billion, slightly less than the $8.6 billion outstanding at December 31, 2011, and roughly the same amount at June 30, 2012, and as adjusted, on a mark-to-mark basis for our U.S. dollar debt outstanding. Our balance sheet metrics remain very strong with debt to book capitalization at 26% and debt to EBITDA of 1.1x, reflecting management's focus on financial strength and flexibility.

Our liquid resources remain very strong with $4.3 billion of unused bank lines. Our commodity hedging program continues to be actively managed as we have 150,000 barrels per day hedged for the first half of 2013 and 100,000 barrels per day for the second half of 2013, all with a floor of USD 80.

In conclusion, we are very well positioned financially as we move to complete our 2013 capital budget. Our strong cash flow, actively managed commodity hedge program, balance sheet strength and adequate liquid resources ensure that we are able to complete our short-, mid- and long-term business plans. Thank you.

And I will return you to John for some closing comments.

John G. Langille

Thanks, Doug and Steve, for your comprehensive reviews of our assets and finances. We are very well positioned to continue to apply our sound business principles and strategies and create value for our shareholders. Now with that, Operator, I would now like to open the call to questions that participants may have.

Question-and-Answer Session

Operator

[Operator Instructions] We have a question from George Toriola from UBS.

George Toriola - UBS Investment Bank, Research Division

I've got 3 questions. The first is where do you think, I guess -- no, I'll rephrase that. Maybe this is for John, what do you think the market is currently missing with the way your stock price is currently performing?

John G. Langille

George, I think there's a couple of things. I think there's confusion and maybe volatility in establishing longer-term oil prices and where they're going in heavy oil and where its market can get to, et cetera. I think that weighs on our stock probably a lot more than it does on several others simply because we are the largest producer. However, I think as Steve very adequately put it, I think that's a problem that's going to solve itself in sort of mid-term here as additional capacities get built to accommodate -- or to get to additional refining capacities and as some additional refining capacities get built. I think the other thing is, I think our natural gas assets although very, very strong, because of the ability of us to allocate capital to our very stronger oil projects, sometimes, I think, the fact that we have a strong base of natural gas assets gets lost in the shuffle, as we really are not -- have not been spending a lot of money on them, even though they are very strong assets in terms of future potential when the economics of natural gas recover. And we're not in a position that we're forced to drill things to save land to a great degree. So we don't really -- we have not been allocating a lot of dollars to that situation. And thirdly, I think we have to get some credibility back on running our Horizon, our mining project. And I think as Steve very adequately set out, we have a very good process in place to get there. And I think, again, we're dealing with an asset that's going to last us 40-plus years, and we have to make sure that we do it right to make it last that long. Hopefully that answers your question, George.

George Toriola - UBS Investment Bank, Research Division

Okay. It does. And it leads me to the next question here, which is -- I mean, this is a hypothetical, but assuming that as you continue to sort of demonstrate some of the things you talked about, and the market fails to realize or to attribute the value that you think the assets have, would you potentially think of splitting up the company to -- I mean, because when I look at companies that are pure heavy oil companies or pure natural gas or pure international assets, some of the parts here is very different from what we've seen in your company. Is that something you would even consider?

John G. Langille

I think George, at this point in time we're not considering that, and it's something that we have always believed that having a balanced and a diversified portfolio is best in the long term. Certainly, you get periods where you get little hiccups happening, heavy oil differentials, heavy oil marketplaces. Natural gas prices may or may not result in some difference in one part of your business. However, we think on the long term, it's better to have a diversified portfolio, and we will use our business model to develop that portfolio over time and ultimately, return a much larger return to shareholders. That's our personal opinion.

George Toriola - UBS Investment Bank, Research Division

Got it. So it's a more balanced flexibility that comes with the balanced portfolio. I guess the last question is around reliability and operating capacity at Horizon. When we look at the current capacity, what is a realistic -- sort of when we look ahead into the future, what is a realistic production level that we can expect out of Horizon? Is it 95,000? Is it 100,000? Is it 115,000? Where is that number?

John G. Langille

George, I think, Steve is the best one to answer that, so I'll pass it over to Steve.

Steve W. Laut

Okay. So, George, clearly, we've had some issues here at Horizon, but I think what you're seeing here, particularly in Q3 and Q4, is a result of our different philosophy and our conservative approach. And maybe you can say it's too conservative, but our operating capacity, we believe, is between 110,000 and 115,000 barrels a day on an average quarterly basis. Now what we've done here recently, as I said, is probably maybe been more conservative than we might have in the past by restricting rates to ensure that we don't damage our catalyst. There are some who believe that we probably could have made it through the turnaround, we should have ran at higher rates. But we're more conservative, and you can see here with the sort of minor hiccups we had in starting back up after the outage, we've taken a very conservative approach. And obviously, we're going to make sure that we run this thing at a steady reliable rate and not go for the quick production and take risks. So that's what we see going forward. We believe that we can run this thing at a steady rate and reliable rate between 110,000 and 115,000 barrels a day. And we're well on our way to doing that.

Operator

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

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

So just a few nitty questions. Steve, what's CNQ's equity stake then in Redwater?

Steve W. Laut

Our equity stake, we have 50% of it, and it's about $340 million we've so far committed to Redwater.

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

Okay. So I know you're -- so you are 50%, but there's a bunch of project financing, right? So the -- will this be back-stopped then with a fair bit of debt versus capital that you're going to put into it, or how will that work?

Steve W. Laut

This will basically be funded by project financing and debt, so our equity contribution will probably be very limited. I think we might get up to about $400 million roughly for the whole project.

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

Okay. And then you're going to earn, I think you mentioned about 10%. So it would be 10% on the 50% of the project or 10% on the 400 do you think you'll earn?

Steve W. Laut

On the 50% of project. And also I got to remind you, if you look at the agreement, the partnership, which we own 50% of, gets all creek [ph] capacity to its own account and we believe that will help us generate a stronger return on capital going forward.

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

Okay. What's the duration of the May turnaround at Horizon next year?

Steve W. Laut

Most of that -- it's 18 days and most of that is to replace the catalyst. That's the critical path to the long -- or critical path of the project turnaround.

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

Okay. When we dug through the numbers, it looks as though there's still -- there's upward pressure on your OpEx, at least versus what we'd expected in guidance and so on. But it looks as though you've made a fair bit of improvement on the oil side in Canada. So it is some of the other areas that are standing out. But what is your sense just directionally then for Canadian oil liquid OpEx as you go through the balance of the year and into next year? And I think we've talked before about kind of getting into the mid-30s in terms of OpEx at Horizon. Is that -- do you think that's still realistic in 2013, just given the more conservative approach you're taking now?

Steve W. Laut

I think that's -- we're still working through the budget, but I think that's reasonable that we could be there at Horizon. Obviously, we have taken a conservative approach, and so we probably are spending more on maintenance and being -- carrying more people than we really likely need once we get lined out, but we're very being conservative. So going forward at Horizon, I think $35 is a pretty good target. It might take us a little while to get there. We're still working through it. But as I said before, we want to be on the conservative side of everything. That we are doing everything on that way now going forward on Horizon. So we'll probably be more conservative in our approach and in our estimates and how we approach the amount of people and the amount of maintenance and the proactive work we do with Horizon.

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

Okay. And then maybe just the last question for me. I think it's like 32 net wells or something you drilled this year and yet, your volumes have stood up extremely well. So have you been just doing a lot of countercyclical tuck-in acquisitions and stuff on the gas side?

Steve W. Laut

On the gas side, we haven't really spent a lot on acquisitions this year. We have some last year that sort of carried us through this year. So we are seeing declines through the year, but it's just -- Septimus has come on last year and helped us out, but it just really just the strength of the asset base. As you get longer-than-life declines actually start to slow down for you.

Operator

The next question is from John Herrlin from Société Générale.

John P. Herrlin - Societe Generale Cross Asset Research

Just 2 quick ones for me. Not to beat a dead horse with Horizon, but do you think at the end of the day, given the variety of problems that you have that or have experienced that you had kind of basic engineering issues, or these are just all one-offs?

Steve W. Laut

Okay, so and that's a good question, John, and obviously, I don't believe that we've had any major basic engineering issues or design issues. There's been a few design things that we've been working on, but they're mostly around materials where we get extra corrosion and erosion in certain wear components -- and that's probably standard for a new plant. So most of it is not design. I'd say most of it has been in just getting to know the plant and getting the operating experience. And quite frankly, taking this more conservative approach, more operating discipline has made a tremendous difference. And I know from The Street, you don't see that with Q3 and Q4 production volumes, but that is really a reflection of a more steady and reliable plant that we're running here. We're taking a different attack, and we are willing to sacrifice production to ensure reliability in the long run. So we're taking a hit here in Q3 and Q4, but I expect 2013 to be very strong because of it.

John P. Herrlin - Societe Generale Cross Asset Research

Okay. That's fine. Next one for me is, again, kind of a shareholder-oriented question. You did part of your Normal Course Issuer Bid. Why not do a tender? I mean, you're growing, but clearly, your stock is not being rewarded for the growth and investors are not being rewarded -- you are almost at 2009-type price level. Why not do a larger tender? You have got the balance sheet capacity. Why not really buy back a lot of stock?

Steve W. Laut

I think I'll let Doug add to this comment but really, when you look at our portfolio, John, we have significant resources to develop and we see we can get a better return doing that. We have bought more shares back and Doug will talk about that. And also we see better returns is going through dividends. But Doug, do you want to add to that?

Douglas A. Proll

No, I don't think so, Steve. I think that our share buyback program is there in place to counter out balance of the effect of exercising stock options as we move through, which is a major component of our compensation and also as a mark that we can have against dedicating future projects and dedicating capital to those. And so I don't think that allocating a whole bunch of resources to a tender offer would be in the company's plans for the foreseeable future. I think that we're very happy with the Normal Course Issuer Bid in returning capital to share -- or returning funds to shareholders also with our dividend program and then developing our assets. And I think that's where management's focus is.

Operator

The next question is from Dan Geary from Wintergreen Advisers.

Dan Geary

Just sort of emphasizing what the previous question went to about the buyback. We think you guys generally do a great job operationally, but at the same time, it's frustrating to look at the valuation of your stock on both an absolute and relative basis, as John acknowledged a few minutes ago. So our question is why not take a more significant portion of your discretionary cash flow and buy back a more meaningful amount of shares rather than just offsetting dilution? It seems, if my math is right, you still have a few billion dollars after accounting for maintenance CapEx in cash flow on an annual basis, and we'd really to like see you utilize more of that towards a buyback.

Steve W. Laut

Well, I think the answer to that question is pretty much the same as we just gave to the previous question. Again, we think we have a pretty solid asset base here. We prefer to return cash to the shareholders through the dividends. And as John said, we've increased dividends probably at 17% CAGR, and we don't see that changing. I think we continue to increase dividends but they have to be sustainable. We are building a larger more sustainable free cash flow machine here at Canadian Natural, and I think as you go forward, you'll see us have more and more discretionary free cash flow to allocate back to dividends or share buybacks as we go forward.

Operator

The next question is from Barbara Betanski from Addenda Capital.

Barbara Betanski - Addenda Capital Inc.

Steve, thanks very much for the breakdown sort of month by month in terms of the price differentials on WCS versus the volumes that you're shipping down to the Gulf. And so I just was wondering if you could just talk a little bit about the additional transportation costs that you incur in order to ship down to the Gulf? So how much of that spread are you actually capturing in terms of upside?

Steve W. Laut

Yes, so it depends on how you get there, Barb. But if you go there by pipeline, you're in that $8 barrel range. If you go there by rail, you're probably in that $12 range. So most of our oil that we get to the Gulf, about 20,000 of [ph] 30,000 is through pipelines, the other 10,000 is by rail.

Barbara Betanski - Addenda Capital Inc.

So that would be the incremental costs that you're incurring?

Steve W. Laut

That's not...

Barbara Betanski - Addenda Capital Inc.

Or is that the total?

Steve W. Laut

That's not the total incremental cost. That's the total of cost from Hardisty to the Gulf. Obviously most of our oil goes to Chicago anyway. So you probably got $5 extra to get from Chicago down to the Gulf.

Barbara Betanski - Addenda Capital Inc.

Okay. And just -- so you did say you're shipping about 30,000 now. Would you have any sort of an estimate in terms of how those volumes to the Gulf might increase? Like what volumes increase over the next couple of years?

Steve W. Laut

For us right now, I think we'll probably wait for pipeline capacity, which the first one would be Flanagan in 2014. But I think, Barb, what I would want to point out is, with the extra 310,000 barrels a day of capacity in PADD II or the Midwest, we probably don't have the capacity and supply in Canada to get too much more heavy oil to the Gulf Coast because we'll need to fill that 310,000 barrels a day of extra capacity coming on.

Barbara Betanski - Addenda Capital Inc.

Right, okay. And just a final thing. If you could just mention your base case assumptions for the WCS differential for next year.

Steve W. Laut

We're still working that through, but we think we're probably in that 18% to 22% range right now -- above [ph] WTI.

Operator

The next question is from Kate Minyard from JPMorgan.

Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division

Just a couple of quick questions on the comments around taking crude to the U.S. Gulf Coast. You have talked about 30,000 barrels a day. Can you talk about whether that's to one particular refiner or multiple refiners and whether it's contracted volumes or whether it's just on spot? And are you just testing the market, or do you have kind of a firm long-term commitment at those volume levels?

Steve W. Laut

We don't have any firm long-term commitments, Kate, but we have been shipping 20,000 barrels a day via pipeline to the Gulf Coast for probably 3 to 4 years, and we have very good relationships with a number of refineries on the Gulf Coast, and we have no problems clearing that Canadian crude. It actually trades depending on what month it is, either a slight premium to Mayan or a slight discount to Mayan. So quality-wise, it's pretty much the same as a Mayan crude.

Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division

Okay, sure. And then when you talk about the refiners potentially blending heavies with light crudes to create sort of a proxy for a medium blend. How long do you think it would -- what's your sense as to how long it might take refiners to sort of test that type of blend and become comfortable with that means of getting a heavy -- or excuse me, a medium as opposed to taking an actual medium crude grade?

Steve W. Laut

I think it all depends on the refiner and what their appetite is for it. We've seen in the past where we've blended SCO with bitumen in the Midwest. The refiners like to run small batches to see what kind of products they get. And after a couple of months, if they feel comfortable, they start to take larger and larger batches of that type of crude. So I would guess it would probably be the same type of timing. But I think going for a medium crude look-alike in the Gulf Coast would happen after all the foreign light oil barrels are pushed out, and then you go start pushing out medium crudes. Obviously, you want to take a bit of discount to do that on light pricing.

Katherine Lucas Minyard - JP Morgan Chase & Co, Research Division

Okay. All right. And then just finally on your comments about just moving barrels to the West and East Coast via pipeline for Canadian crudes of all grades. Can you talk about whether you are participating in any discussions or whether any are underway in terms of volume commitment? So I would assume with your position, your production position in Canada, you'd be a potentially attractive client to kind of anchor some of those shipments. Can you give us any insight into what sort of discussions might be going on, or whether you've been able to make any commitments yet?

John G. Langille

We haven't made any commitments yet. We're a strong supporter of Gateway. We'd like to see TMX helping as well off the West Coast, and we're talking to all these guys, we're also talking to TCL [ph] about the East Coast option to Montréal. But we've made no commitments at this point.

Operator

[Operator Instructions] The next question is from Harry Mateer from Barclays.

Harry Mateer - Barclays Capital, Research Division

Just a quick question, I guess, for Doug. You do have a couple of maturities coming up early in 1Q. Can you give us a sense for how you're approaching that? It sounds like you have a decent amount of balance sheet capacity, so I wouldn't expect you to delever, but can you just confirm whether those are something you'd pay down with cash or look to refine and extend?

Douglas A. Proll

Thanks, Harry. Yes, as we mentioned, we have the $4.3 billion of unused lines at the end of September. We think that, that's fairly substantial. We did have $1.1 billion worth of debt maturing in the third quarter, which we -- or fourth quarter, which we paid on October 1. We got 2 more in the first couple of months of 2013, and we'll be using our bank lines to repay those. And as we said, our 2013 budget, we'll make sure that we got adequate lines going forward. In my view, I think that we do have adequate lines. I think that the funding process for 2013 is complete and then when we get into after the budget is set, we'll look to funding requirements going forward after 2013.

Operator

We have no further questions registered at this time. I'd like to turn the meeting back over to Mr. Langille.

John G. Langille

Thank you very much, Operator, and thank you, ladies and gentlemen, for listening in on our call today. And as usual, if you have any further questions, please do not hesitate to contact us. Good day, and have a good day, and we'll see you later. Bye-bye.

Operator

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

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

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

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

Source: Canadian Natural Resources Limited Management Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts