MEG Energy's (MEGEF) CEO William McCaffrey on Q4 2016 Results - Earnings Call Transcript

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MEG Energy Corp. (OTCPK:MEGEF) Q4 2016 Earnings Conference Call February 9, 2017 10:30 AM ET

Executives

John Rogers - VP, IR and External Communications

William McCaffrey - President and CEO

Eric Toews - CFO

Analysts

Joe Gemino - Morningstar

Unidentified Analyst -

Benny Wong - Morgan Stanley

Greg Pardy - RBC Capital Markets

Unidentified Analyst - Linden Advisors

Arthur Grayfer - CIBC Capital Markets

Mia Williams - Reuters

Operator

Good morning, ladies and gentlemen. Welcome to MEG Energy Corp Fourth 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

Great, thank you Mary and good morning everyone and welcome to our fourth quarter conference call. For our conversation today we have with us our CEO, Bill McCaffrey, and our CFO, Eric Toews. To start off, Bill will discuss our vision and plans to deal with company initiate production growth through 2019 supported by the financial transactions we announced in January. Eric will review our results for the fourth quarter and for the full year of 2016.

I will remind you that today’s call does contain forward-looking information. Please refer to our quarterly reports and other documents on SEDAR and our website for further information. And with that, I will turn it over to Mr. McCaffrey. Bill?

William McCaffrey

Thanks John and good morning everyone. Over the last few months MEG has undertaken a number of transformational steps expected to increase production, decrease per barrel cash cost, and further the sustainability of the company's balance sheet. I would like to begin by discussing the importance as it relates to our vision for the future which entails the implementation of a series of highly economic, brownfield expansions like Christina Lake. Our goal is to ultimately take production to the regulatory approved limit of 210,000 barrels a day while driving down our per barrel cash cost with each incremental expansion.

On January 27th we closed four transactions which will underpin our vision for the future by enabling us to significantly derisk the company. They include an extension of the maturity date of our covenant like revolver to November 2021 which represents a five year of maturity profile. The refinancing of our U.S. $1.2 billion term loan to December 2023, a redemption of our U.S. $750 million notes with the proceeds from the issuance of new secondary notes due January 2025, and a successful equity issuance of $518 million which will substantially fund our 2017 capital program.

Now these transactions provide us with a five year window to grow production, reduce costs, and strengthen our balance sheet with essentially no change to our interest costs. The fact that we were able to materially extend our maturities with very little incremental cost indicates just how supportive our bank group and credit markets are of the quality of most assets, our execution track record, and the overall direction of the company.

Now we're really pleased with the equity raise -- that the equity raise went so well and was so supported by the marketplace. This opens the door for us to return to growth and begin implementing eMSAGP at Phase 2B immediately. In 2017 we will direct approximately $320 million towards the initiative out of our -- towards this initiative out of our capital budget of 590 million.

This initial phase of the eMSAGP growth offers some of the highest economic returns that the company has seen to date. We're able to grow the company at approximately half the cost we used to be able to. At current share prices the eMSAGP project is anticipated to deliver over a 50% IRR and add approximately 20,000 barrels a day of production once it's fully ramped up in early 2019.

When fully implemented this first in a series of expansions is anticipated to bring MEG's total production to approximately 100,000 barrels a day significantly improving the sustainability and profitability of the business by driving down cash costs about $4 to $5 a barrel. These savings contribute directly to our bottom line.

Now we're quite excited about the implementation of the eMSAGP on Phase 2B. Over the past six years we have proven and commercially applied eMSAGP on our Phase 1 and 2 assets which accounts for approximately 25% of our total worldwide production. When implemented the eMSAGP process has reduced the steam oil ratio by 50% to a range of 1.0 to 1.25. As we apply eMSAGP to the other 75% of our assets, we believe the value of this technology is going to become very apparent.

The work during 2017 will consist primarily of drilling infill and SAGD wells with minor [indiscernible] to central plant. Production in the first quarter of the year is expected to be 77,000 to 79,000 barrels a day as a result of the preparatory work we're doing for the eMSAGP. After the turnaround that we planned for the second quarter we expect production to begin ramping up and exit the year at 86,000 to 89,000 barrels a day with further production increases through 2018 and into 2019.

Assuming a similar operating and price environment to what we are seeing currently we estimate our second project the Phase 2B brownfield expansion could proceed sometime in the middle to latter part of next year. This extension will add a further 13,000 barrels a day and can be done concurrently with the implementation of eMSAGP. Once it's completed it will drop our cash cost by an incremental $2 a barrel in addition to the $4 to $5 a barrel savings we anticipate seeing once our eMSAGP growth is complete.

Overall we expect the implementation of the eMSAGP and the brownfield expansion to bring production to approximately 113,000 and reduce our cash cost by $6 to $7 per barrel. Further using strip prices we believe we can reach a net debt to EBITDA ratio of 3 to 4 once these projects are completed. We anticipate there will be further improvements to our debt metric as subsequent projects are developed. In addition the refinancing transactions we recently completed give us the added flexibility to pursue additional deleveraging alternatives which would improve our debt metrics even further.

Post completion of these two projects we will continue with our efforts to incrementally grow production to 210,000 at Christina Lake. We anticipate that we will do this by advancing a series of 10,000 to 20,000 barrel a day projects with capital cost intensities in the range of 20,000 to 30,000 flowing barrel. Now obviously the actual intensity of each project will be specific to the scope of work required.

Growing the business using a combination of the eMSAGP and brownfield expansions make so much sense. As we increase our production we can continue to improve our capital efficiencies and spread our fixed non-energy operating costs, G&A and interest over more barrels. With these lower cash costs we will be an even better position when it is time to advance our next phase which will in turn spread our fixed costs over even more barrels and lower cash costs with more increment.

As we mentioned earlier this is the path we plan to follow all the way up to 210,000 of the regulatory approval projects for Christina Lake. And because each added project requires significantly less capital than might have been the case before, we're comfortable we can speed up or slow down depending on market conditions. I will now pass it over to Eric to discuss our fourth quarter 2016 and full year results.

A - Eric Toews

Thanks Bill. With strong results over the full year we achieved record annual production volumes of 81,245 barrels per day which was in line with the 2016 guidance. This production increase was achieved despite the fact we reduced our overall 2016 capital budget by 47%. The original 2016 capital budget was $328 million dollars. With the continued focus on sustaining production and capturing efficiency gains through the eMSAGP process we invested only $137 million in 2016 primarily focused on sustaining a maintenance capital.

Our cost reductions are a good example of the impact our patented technology has on capital cost efficiencies. The less capital required, we've been able to reduce our G&A cost per barrel by 44% since 2011. Because these cost reductions are based primarily upon efficiency gains and the successful application of new technology we believe that they are largely sustainable.

A combination of technological advancements and an absolute focus on cost control has also enabled us to reduce our per barrel non-energy operating costs by 45% since 2011 and 30% since 2014 to a record low of $4.99 per barrel in the fourth quarter. We also achieved a record low net operating cost of $8.24 per barrel in Q4. In addition our yearly non-energy operating costs were $5.62 per barrel which was significantly below guidance and almost 15% lower than the previous year. This contributed to a record low annual net operating cost of $7.99 per barrel for 2016. The WTI prices averaging $49.29 per barrel we are able to generate cash flow from operations of $40 million in the fourth quarter.

Let me take a moment to talk about MEG's financial position. The company undertook capital investment of $63 million during the fourth quarter of 2016. Our year-end cash balance together with the net proceeds from generous equity financing that Bill spoke of and 2017 cash flow is expected to fully fund for 2017 capital budget of $590 million. Our U.S. $1.4 billion five year covenant rate revolver remains undrawn.

We continue to apply our hedging strategy which is focused on protecting our capital program against downward oil price movements. As of February 7th, we have hedges in place for roughly 47% of our blend sales in the first half of 2017 and had hedged the WTI component of our pricing for roughly 40% in the second half of the year. We've also hedged more than 40% of our condensate purchases through to the end of December 2017. With that I will pass it back to Bill.

William McCaffrey

Thanks Eric. Our success in 2016 business positions us very well. MEG has been able to rely on the strength of its reservoir and maintain its production through the recent downturn. The low level of decline enables us to dedicate a higher portion of our available cash flow to growth than others would be able to but the smaller portion than being needed to stay in the business. We believe this is one of the reasons that make it such an attractive investment opportunity in current price environment.

We certainly believe our reservoir and our technology put us in good shape but nobody stands still in this business. We will continue to work to improve our technology and reduce our cost to stay competitive with others in the industry who are working along similar lines.

On a macro basis we're encouraged that as OPEC focuses on strengthening oil prices it's doing so by reducing its supply of heavy barrels first. We think this will tighten supplies at the Gulf Coast, the world's largest market for heavy oil. When you add the declines in heavy production from Venezuela and Mexico plus the reductions from the Saudis, we believe that Canadian heavy will be in high demand on the Gulf Coast. With these factors in mind I think it's fair to say our Access to the Gulf through the Flanagan Seaway pipeline system combined with our use of rail gives us a competitive advantage to gaining Access to that market.

As we look ahead over the next few years MEG will have implemented the first two of many high return projects which have increased production by over 40%, decreased our cash cost by $6 to $7 per barrel, and positioned our balance sheet and business in a sustainable and profitable way going forward. In addition we plan to follow the path to 210,000 barrels a day with additional high return short cycle brownfield development projects each in the range of 10,000 to 20,000 barrels a day.

This is a very exciting time for MEG’s employees, management and shareholders. The recent transactions have offered us three separate benefits. They derisk the company going forward by moving the debt maturities out, we have extended the runway of our revolver and outstanding debt and thus enabling us to expand production, decrease per barrel cash cost, and improve profitability and improve our debt metrics.

By raising more than 500 million in equity we have enabled the company to fully fund its highly economic growth. This contributes significantly to normalizing our balance sheet. The transactions have also given the corporation more flexibility to undertake further actions to reduce our overall amount of debt.

To conclude the company has put in place a very solid foundation to move forward with its plans. This growth can be accomplished at current strip prices and does not rely on higher prices. Our focus now turns to the successful execution of those plans. And with that I’m going to turn it back to John.

John Rogers

Great, thank you Bill and thank you Eric. As a reminder to our audience we'd like -- as we open it up for questions we’d like to keep the focus of the questions at the strategic level of course and I’ll be around later to answer your more detailed modeling questions. So with after Mary why don't we open the lines for questions.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. The first question is from Joe Gemino from Morningstar, please go ahead.

Joe Gemino

Great, thank you very much. Just a quick question about transportation, how do you think about transportation and the logistics of that with the new production that you'll be bringing on in the next few years?

William McCaffrey

What we've done Joe is we've got in place secured availability and Flanagan pipeline and that moves up to 100,000 barrels a day in the latter part of this decade. And then we have ability to move to other markets such as Pad 2 as well in the meantime. So we feel good about that. Access pipeline is in good shape. It's got capacity to handle it and we do have the rail available to us if we needed it.

Joe Gemino

Great, that’s very helpful. Thank you very much.

William McCaffrey

Thank you.

Operator

Thank you. The following question in from Ashok Juda [ph] from Plax [ph]. Please go ahead.

Unidentified Analyst

Thank you. Hi Bill. Part of my question was just asked actually but, just a very quick follow up on that, the recent outage in the pipeline, the Flanagan-Seaway, how did you deal with it, what alternate modes did you use to transport your crude?

William McCaffrey

It was actually on a different league than what we are on so it didn't actually affect us.

Unidentified Analyst

Okay, alright. And Bill you mentioned about future expansion that's ramping up or going up to 210,000 in 10,000 to 20,000 barrel a day capacity, what was the capital cost in there?

William McCaffrey

The intensities will be between 20,000 and 30,000 of flowing barrel.

Unidentified Analyst

Right, okay. Okay, that's all that I had actually, thank you.

William McCaffrey

Thank you.

Operator

Thank you. The following question is from Benny Wong from Morgan Stanley. Please go ahead.

Benny Wong

Yes, thanks guys. Just wanted to get a sense of how you are thinking about the pace of growth beyond the near-term phases. Is it going to be more guided by the balance sheet or is there a specific growth where you guys are targeting or you think makes sense?

Eric Toews

Thanks Benny. What we've done is we've got the first two laid out and we think that because the cost of each of these projects is so small we can pace it based on market conditions. So we can accelerate it or adjust it if need be. But because they're highly economic and they're small in size relative to what we could have done, it offers us tremendous flexibility.

Benny Wong

Great, just in regards to the capital intensity of those brownfield phases, how much confidence in those other years in that number and do you think there's any risk of inflation creeping into that?

William McCaffrey

Sure, right now we've got some idea of those future phases as to what they are in terms of the bottlenecking of the plant. And so we've got a pretty good handle on it. We know what those costs are. We're not seeing inflationary costs right now and I think in the industry, in our industry, in oil sands I think you probably won't see that for a few years because there aren't mega projects being done. So there's a lot of labor around and there's a lot of competition on the service side looking for work to do if I could say it a little bit that way. And so we're thinking that first of all our business, we've really revamped it. So it's so simple now that we're really focused right now just on drilling and tying in wells. And so we don't have a lot of cost components but our industry is also not building all the big projects that it was a while ago.

Benny Wong

Great, and then just regards to the brownfield developments, any sense of when you got -- how long it would take for you guys to see first oil from the day you guys start spending?

William McCaffrey

Well on the first one, on the eMSAGP that's well by well once we start to bring them on. And they start coming on in small times like between drilling them and tying them in and steaming them. It could be six to eight or nine months on those. And on the second one we think it would be about 18 months on that. And on future ones beyond that we think those are similar time periods. We don't see them as being very long. Sometimes they can be shorter than that too. It just depends really on the work required.

I think the key point is that we have with the technology on eMSAGP, we're eliminating a lot of the equipment we would have had to build before. So for example by having such low steam ratios we're able to redeploy that steam which means we don't have to build water treating and steam generation capacity in order to grow. So we can focus on other components as we bring in the extra oil which we have shown we can operate significantly above the design capacity. And that's why this works so well, that is because we can put dollars towards wells and turn them around in such short order. And it could provide tremendous flexibility in that area.

Benny Wong

Great and just as a final question, just wondering how you guys are thinking about your Surmont asset these days, is this kind of a approach that you guys envision could be developed as well in this way?

William McCaffrey

Yeah, we really like Surmont, we think it's very high quality. We're still in the process of getting the regulatory approval on it. It's a short tie-in. We have all the learning curves and experience and knowledge from Christina Lake to apply it there and we can see ways of doing that far cheaper than we might have done in the past.

Benny Wong

Great, thanks guys.

William McCaffrey

Yeah, thank you.

Operator

Thank you. The following question is from Greg Pardy from RBC Capital Markets. Please go ahead.

Greg Pardy

Thanks, good morning. I joined a couple of minutes late but Bill I'm wondering if you can just frame the balance of 2017 maybe just milestones that we should be looking for as you move ahead with a growth strategy?

William McCaffrey

Sure, Greg. We went through there as trying to get a little profile of 2017. First quarter what we're going to do, we're doing some work on the frontend of positioning some of the wells. As we drill wells we typically, if we are drilling on existing Pads we will typically have other wells that we will shut down temporarily just to make sure we're safe and everything. And we're also preconditioning some of those wells that exist for the eMSAGP process. So for 2017 first quarter will be in the 77,000 to 79,000, second quarter has got the turnaround in it, and then we'll ramp up to 86,000 to 89,000 towards the end of the -- at the end of the 2017. And all the way along we'll be drilling wells and tying them in.

Greg Pardy

Okay, that's perfect. Thanks Bill.

Operator

Thank you. The following question in from Craig Aldrich [ph] from Linden Advisors. Please go ahead.

Unidentified Analyst

Hi, thanks for taking my question. I just had one on your view about the differentials. You mentioned that you were encouraged by the OPEC actions and the reduction in heavy supplies, can you provide a little bit color on how you see those differentials maybe WTI versus WCS playing out over the next several years?

Eric Toews

Sure. Well that's obvious dangerous to forecast I’m starting with that.

Unidentified Analyst

You know better than I do.

Eric Toews

Okay, I will just share the insight. I think right now we are seeing real hunger for the heavy oil, the oil sands. Part of the rationale on it is Saudis reduce their supply and Venezuela and Mexico are also declining. The Gulf Coast is in need of crude because that's the type of crude they prefer, the heavy oil. And so they are in connection with Pad 2 right now. And so it becomes a bidding exercise of who’s going to pay what to get the barrel. I think we'll see those dynamics continue over the next few years.

Unidentified Analyst

And in terms of Keystone, I mean presumably that would be a positive, is there any -- I mean can you put any numbers around possibly what that would mean?

Eric Toews

We have probably started on that but it's clearly a positive anytime you have another pipe going out of the area that relieves pressure on the mainline and that just allows it to -- the systems to be more in balance with each other. And then everything I just said about the demand at the Gulf Coast, the hunger for the heavy oil it stays really true. So everybody has to pay up to get the barrels then and so I think it definitely strengthens the oil sands opportunities as a general statement.

Unidentified Analyst

Okay, thanks very much.

William McCaffrey

Thank you.

Operator

Thank you. The following question is from Arthur Grayfer from CIBC. Please go ahead.

Arthur Grayfer

Yes, good morning. Just a quick question on the comment you made how the financing allows for further delevering opportunities and I apologize if you answered this. I came on a bit late, but the question I have is what are some of those opportunities. I think Access is quite an obvious one, you talked about it in the past. But beyond Access what are the potential divestment opportunities and if you could rank those in order of priority or preference that would be helpful?

William McCaffrey

Well, we look at a number of opportunities. It wouldn't be right for me to comment on them right now. We do look at certainly Access and we are looking at other possibilities as well. But the general comment on it would be they all have to stand on their own merit. They have to make sense financially to us and they can’t have too high a cost to us. And so we are -- we did work while we got our debt restructured to allow us freedom to do more of that if it makes sense with those conditions in mind.

Arthur Grayfer

Thank you.

Operator

Thank you. The following question is from Mia Williams from Reuters. Please go ahead.

Mia Williams

Hi guys, thanks for taking my question. First of all just following up on the Keystone XL comments you're making, has that approval and other pipeline approvals spilled any of these plans to take 210,000 barrels a day or were they in place anyway?

William McCaffrey

They were in place already. We feel we're well positioned. We’ve done a lot of work over this last few years. The task we felt was most appropriate for us was the Flanagan Seaway pipeline and that is already in place and operational and we've got the volume Access to the Gulf Coast secured that we need. And so we're comfortable with it. We do like the KXL pipeline. It is a logical thing to move forward on. It's good for our industry, good for Canada on it, and so we're highly supportive of those projects. But we have other pathways that we have been following.

Mia Williams

Okay thanks. And then my other question is about the U.S. border adjustment taxes being talked about, do you have any concerns about that coming in?

Eric Toews

Well right now we don't really know what the outcome could be on it. But if we poke through it a little bit, I think the intent would be to try and strike better balance between the U.S. and its trade partners. Well Canada is already in a good balanced position because they are almost seen as a poster child for the U.S. in terms of balance trade. When it comes to exports from the U.S. to Canada that I believe Canada is the number two destination for exports from the U.S. So that also provides incentive to work together. And then when I look at energy, Trump has been very focused on the idea of reducing exposure to the Middle East. When you look at it that way you are going to want account on Canada to be part of that energy equation. And we don't compete with the light oil in the U.S. They have different products. So, the U.S. refiners are built and want the heavy oil from Canada. So I think there is no -- I'm cautiously optimistic that it won't be as negative as people have been portraying in that and there are cases where it could be positive. If it creates an advantage for Canada versus say other countries like Mexico, well that could be a positive. But really absent we're all in the speculative mode at this stage until we can get more information.

Mia Williams

Okay. Thank you.

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, thanks Mary and thanks everyone for listening to our conference call, and Toews and I will look forward to talking to you in the near future if you have any detailed questions. Other than that everybody have a good day. Thank you.

Operator

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

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