MEG Energy Corp. (OTCPK:MEGEF) Q1 2022 Earnings Conference Call May 3, 2022 9:00 AM ET
Derek Evans - President, CEO & Director
Eric Toews - CFO
Darlene Gates - COO
Lyle Yuzdepski - General Counsel and Corporate Secretary
Conference Call Participants
Greg Pardy - RBC
Neil Mehta - Goldman Sachs
Menno Hulshof - TD Securities
Good morning ladies and gentlemen. My name is Michelle and I will be your conference operator today. At this time, I’d like to welcome everyone to the MEG Energy’s 2022 Q1 Results Conference Call. All lines have been placed on mute at this time to prevent any background noise. After the speakers’ remarks, we will have a question-and-answer session. [Operator Instructions]
I would now like to turn the conference over to Mr. Derek Evans, CEO. You may begin your conference sir.
Thank you, Michelle. Good morning, and thank you for joining us to review MEG Energy’s first quarter operating and financial results. In the room with me this morning are Eric Toews, our Chief Financial Officer; Lyle Yuzdepski, our General Counsel and Corporate Secretary; and Darlene Gates, our Chief Operating Officer.
I’d like to remind our listeners that this call contains forward-looking information. Please refer to the advisories in our disclosure documents filed on SEDAR and on our website. I’ll refer listeners to yesterday’s press releases for more detail beyond the comments we prepared for this morning.
MEG continues its priority of maintaining safe and reliable operations as we work through the ongoing COVID-19 environment. Our teams continue to respond to the impacts of the pandemic, prioritizing the health and safety of our workforce and reliable operations at our Christina Lake facility. I commend our workforce for their efforts over the last two years and look forward to our continued focus on safety as we execute this year’s turnaround.
We had a record quarter from both an operational and a financial perspective. We continue to benefit from strong oil prices and low heavy oil differentials. Additionally, our team’s focus on safety, plant reliability, steam utilization and ongoing well optimization have contributed to a record quarter in terms of production. Highlights from the first quarter include record funds flow from operating activities and adjusted funds flow of 587 million or $1.87 a share, record free cash flow of 499 million. Record debt reduction having completed or announced the repayment of 396 million U.S. or approximately 499 million Canadian of outstanding indebtedness. Record bitumen production volumes of 101,128 barrels a day.
We exited the quarter with 1.72 billion U.S. of net debt. Total expenditures of 88 million were primarily directed towards sustaining and maintenance activities in the quarter. Net operating cost average $8.98 per barrel, including non-energy operating costs of $4.74 a barrel. Our revenue offset energy operating costs by 38%, resulting in energy operating costs net power revenue of $4.24 per barrel. We received approval from the Toronto Stock Exchange on March 7 for a normal course issuer bid which will allow MEG to buyback up to 10% of its public float, as defined by the TSX over a one year period.
And on March 16, 2022, MEG announced the planned retirement of its chief financial officer Eric Toews, effective September 1, 2022, to make us conducting an external search of our next chief financial officer and will provide an update on the successful completion of that search.
MEG realized an average AWB blend sales price of $83.55 per barrel U.S. during the first quarter of 2022 compared to $65.42 per barrel U.S. in the fourth quarter of 2021. The increase in the average AWB blend sales price quarter-over-quarter was primarily a result of the average WTI price increasing by $17.10 per barrel U.S. MEG sold 58% of its sales volumes in the premium priced U.S. Gulf Coast market in the first quarter of 2022 compared to 48% during the fourth quarter of 2021 as a result of apportionment on the Enbridge mainline decreasing from 21% in the fourth quarter of 2021 to 10% in the first quarter of 2022. MEG invested 88 million in the first quarter compared to 106 million in the fourth quarter of 2021.
Capital invested in the quarter was primarily directed towards sustaining and maintenance activity, and included incremental capital to allow the corporation to fully utilize the Christina Lake facilities oil processing capacity of approximately 100,000 barrels a day.
Last month has also provided important developments relating to our continued involvement in the oil sands Pathways to net zero alliance which aims to achieve net zero emissions from our operations by 2050. On April 7, 2022, the Canadian federal government announced an investment tax credit for carbon capture and storage projects for industries across Canada. MEG believes this announcement is a positive step in the oil sands Pathways to net zero alliance efforts to work collaboratively with governments to help Canada achieve its climate goals and ensure our country can be the world’s preferred supplier of responsible oil.
The Pathways Alliance anticipates that this tax credit, together with support from the Alberta government will help advance the pathways alliances unprecedented plan to achieve meaningful emissions reductions by 2030 and ultimately, the goal of net zero emissions from oil sands operations by 2050.
MEG continues to execute on its deleveraging and shareholder return strategy, makes redemption of the remaining 171 million U.S. outstanding of it secondly, notes was completed on April 4. Post this redemption MEG will have paid approximately 2 billion U.S. of outstanding indebtedness since 2018. MEG exited the quarter with 1.72 billion U.S. of net debt. As MEG expects to soon reach its previously announced near term debt target of 1.7 billion U.S. makes NCIB which became effective on March 10, allows the corporation to initiate a share buyback program whereby 10% of the corporation’s public flows as defined by the Toronto Stock Exchange may be brought back up to a maximum of approximately 27.2 million common shares of MEG.
MEG intends to allocate approximately 25% of free cash flow generated to share buybacks with the remaining of being allocated to debt reduction until the corporation net debt balance reaches 1.2 billion U.S. In the current commodity price environment MEG expects to reach its 1.2 billion U.S. net debt target in the third quarter of 2022. Once MEG reaches its 1.2 million U.S. net debt target the corporation intends to increase the percentage of free cash flow allocated to share buybacks to approximately 50% with the remainder being applied to, excuse me, to further debt reduction until the corporation reaches net debt floor of 600 million U.S. at which time 100% of free cash flow will be returned to shareholders.
At current production levels, this net debt floor applies and net debt to EBITDA multiple of approximately one times at a long term $50 per barrel U.S. oil price. As I bring my remarks to a close, I once again want to extend my thanks to our team for their commitment and perseverance. I’m proud of what we’ve been able to accomplish and confident in our future and our commitment to sustainable, innovative and responsible energy development. On behalf of the board of directors and our management team, I want to thank you all for your support.
With that. I will turn the call to our operator to begin the Q&A.
Thank you, Mr. Evans. Ladies and gentlemen, we will now conduct the question and answer session. [Operator Instructions] Your first question comes from Phil Gresh of JPMorgan. Please go ahead.
Hey, good morning, guys. This is John Royal filling in for Phil. The 600 million net debts I think is a new concept for you guys in terms of the framework you laid out in the prior quarter. Can you just talk about the decision to put in a floor and why 600 million is ultimately the right number? I know you talked about one times leverage, and maybe just a little more color there.
For sure, John it’s Eric Toews speaking. We spent a lot of time thinking about that net debt floor. The key drivers for us were there’s basically three fold. One is we’ve always prided ourselves on financial liquidity. And we think at a U.S. $600 million floor when you couple that with the structure of our credit facility which is a modified covenant light structure which continues to provide us with if we needed it, liquidity unencumbered by covenants up to $400 million Canadian. So that was an important factor. And the other thing was, we look at our term structure of our debt.
We’ve always tried to maintain balance term structure and in this concept, the first maturity we have is 2029. So that is well out into the future. And the third piece, which I think is important is the ability to actually refinance that debt when it came to that $600 million U.S. And we think at that level, given the credit quality of MEG, we will not have an issue in enrolling that debt, whether that’s in the capital markets, whether it’s in the bank market, wherever that market is. So from that perspective, we feel very comfortable that that’s sort of a bullet proof debt number. And it’s one we wanted to play against at one time, at $50, WTI.
Maybe I just jump in and say it’s entirely consistent with where we were before at two time’s net debt to EBITDA at $50 WTI price. We pointed to that as being one of our first stopping off points. And now we’ve laid out our final landing spot at 600 million at that $50 WTI price.
Thank you, it’s really helpful. And then we can switch up just to speak a little bit too inflationary pressures you’re seeing out there. I know you maintained your guidance, but what do you think on the OpEx and CAPEX side and comparative what you expected going into the year?
Thanks. It’s Darlene Gates we’re definitely seeing inflationary pressures and continue to watch this space very closely. We’ve budgeted about 10% in the 2022 budget, but we’re seeing pressure, upward pressure on labor, steel, fuel and chemicals. And this is probably pushing us closer to about 15% as we continue to watch the market and how things are evolving, working very closely with contractors. We’ll see how that evolves through the year. As we look ahead into 2023, we continue to expect upward pressure on inflation and believe this could translate into an additional 15%. Again, those are perspectives probably will change with time, but just to give you a little bit of what we’re seeing strong dialogue though with our community and with our contractors to manage the space.
It’s very helpful. Thank you very much.
Your next question comes from Greg Pardy of RBC. Please go ahead.
Thanks. Good morning. Thanks for the rundown. Derek and Eric the 600 million U.S. net debt floor the trailer on that a shareholder returns as opposed to a buyback which is attached to the other two. I’m just curious, would that begin to include concept around a dividend or not?
Hey Greg, it’s Eric. I think right now, it’s too early to tell from a modeling perspective. As always, I will consider all avenues that make sense for shareholders. But right now our focus is on buybacks.
Okay, thanks for that. And then just a couple of quick ones. Have you moved into turnaround at Christina? And how should we sort of think about the path of utilization on planning and seaway to the balance of the year?
Darlene you want to talk about turnaround?
All right. Thanks. It’s Darlene. We have started on April 28. We’re in the process of the execution of the turnaround. So far, the team is we’ve got very experienced team and they’re managing very well. Every day is a new day. But they’re prepared and have plans in place to manage the changes that may occur. But also all is going well so far. Keep our fingers crossed. But pretty confident in the team and it’s about a 30 day turnaround.
Do you expect to be done the end of April.
Around end of May. Yes.
Flanagan sorry, Greg, you were asking about the utilization on Flanagan.
Yes. So you ran 58% in Q1 obviously, with the turnaround year. You’re not going to have the volumes. But it’s like sort of think about the back half of the year with very limited portion. And I’m assuming that you’ll be using probably a good chunk or all of your capacity.
Absolutely. Obviously through turnarounds, we’ll be draining, we’ll be pulling volumes out of storage to utilize that space. And we’ve all made some alternative arrangements to make that space available to other people on a discounted basis. But you should expect us to be running with effectively zero apportionment through the remainder of the year.
Your next question comes from Neil Mehta of Goldman Sachs. Please go ahead.
Yes. Congratulations on good results and the continued progress around capital returns. I wanted to get an early flavor. I recognize that we’re early here in 2022. But your thoughts around 2023 and whether it makes sense to build out capacity at Christina Lake and have growth be a bigger part of your CapEx budget or do you feel like you’re still in relative sustaining investment mode as you go into 23 as well, and in tying that into your capital budget, which do you see that moving higher, as if there is a growth component to it?
So, Neil, I mean, I think we should be asking you the question whether our shareholders are what you’re hearing from our shareholders with respect to growth. But fundamentally, as we drive forward, we are very-very focused on debt reduction. That is our primary goal and responsibility and return of capital to shareholders. And that has been sort of the major focus. We haven’t turned our mind to growth or to optimization other than to say, it’s an ongoing part of Darlene’s responsibilities is to find ways to make our central processing facility and our capital dollars go further in terms of expanding the capacity and adding to our production capabilities.
I’ll tell you, at this point, we have no plans to expend capital above and beyond what we consider our sustaining capital at this point. But I think we got a strong message from our shareholders that once we were at certain depth levels, or whether they were, they saw the level of commitment to debt reduction and that share buybacks starting to happen if there was a change in the tone, and there was an opportunity to put more capital to work in sort of a small percentage of free cash flow that’s something we definitely look at trying to achieve on their behalf.
And so if you think about three years $75 million capital budget next year or this year, what are all the moving pieces as you go into next year? What are things that are going to be rolling off? And what are potentially inflationary factors we should be watching.
So and we haven’t talked about this nor have we landed on a number. But if we’re thinking about capital for 2023 notionally, I think we’re thinking of that sort of in the $400 million range at this point. Obviously there’s a big inflationary impact that we’re seeing this year. And as you heard Darlene a little bit earlier talking about that we expect that inflationary impact to continue. In the 375, this year, there was $50 million for ongoing sort of facility, and well work to keep us at that 100,000 barrels a day. Next year, we’ve got some fairly significant pipelines that we’re going to be moving that we’ve got to build to move from one of our producing areas into our next and that likely will take us, will cost us somewhere in the neighborhood of $30 million to $40 million. So that $400 million number is not a bad place.
But that’s right off the top of my head, that is not something that we’ve got any precision to and then the biggest part of that, and the most concerning part is going to be the impact of inflation in 2023 which at this juncture, we’re having, we’ve talked about it in that 15% range, and we hope that that’s where it’s going to land, but it could be it’s obviously been significant this year, and could be significant next year.
Thanks. And then the follow up is just around royalties. Can you just talk about how we should be thinking about that it’s a good problem to have, as the cash flow continues to ramp. But any modeling considerations that we should take into account as we think about when the project goes into post Pam?
I think at the sorts of commodity price we expect to be to hit payload sometime in the fourth quarter.
And Neil I mean, it’s consistent with the last quarter, if you assume sort of 10% to 15% for this year, and 20% to 25% next year, in effect, the royalty rate that’s good from a modeling perspective.
Your next question comes from Menno Hulshof of TD Securities. Please go ahead.
Good morning, everyone. And thanks for taking my question. So I’ve just got a two part question on CCUS in the Pathways Alliance, given the news from the feds. But you mentioned the province so when can we expect news from the province in terms of what they would be prepared to chip in? And what do you think in terms of the possible outcomes there? And the second part of the question relates to the CCUS spend profile over the next several years. When do you expect that this start to show through in your own budget? You mentioned, sort of rough numbers 400 million for next year. So I don’t think its next year. But is it 2024, 2025? Is that a reasonable expectation?
So Menno thanks for the question on sort of on Pathways. We are extraordinarily pleased that the federal government stepped up with their 50% investment tax credit. That’s a huge start to getting us over the line. We are very interested and waiting with bated breath when the province is going to step up. We have talked publicly about the need for 75% support at the capital level. So obviously, we’d love to see the province, finding a way to bridge that gap. And that 75% is not a number we picked out of the air. 75% sort of is a number that other constituencies that we need to be competitive with, be they the Netherlands or Norway or the U.S. have received in terms of capital support for this.
I think that the province is we expect to hear from the province sometime before in late May with respect to we know they’re looking at that various different ways that finance could potentially help to make this happened. But at this juncture, we don’t have any firm handle on what the timing would be. But we’re very hopeful that they will find a way to step to the table and help us make this happen. On the, sorry, on the spend profile, I’ll stop interrupting you.
No, no, I was just going to follow up on the spend profile. So you are going to hit it. Apologizes.
Yes. It’s very hard to predict what the spend profile is until we know we have a project. So obviously, that provincial support is important. But also we don’t have the pore space as of yet. The pore space application went in at the end of April. We expect to hear sometime throughout the summer, but at the very latest by the end of October. And fundamentally, the most important part for us is once we’ve got that, then we would go to work on putting the pipeline and we don’t expect that pipeline and pore space or storage facility would be available until likely late 2028. So then you would start to back into your own well. Obviously, there will be some capital associated with that. But I don’t think you’re going to see significant spending much before 2025, 2026. And when you do see that spending that capital spending, we’re hoping that it is going to be at going to have the 75% sort of investment tax credit type of impact. So our contribution would be in that 25% of the capital.
Terrific. Thanks, Derek. That’s all I had.
[Operator Instructions] Mr. Evans, there are no more questions from the phone lines. I’ll turn the conference back to you for closing remarks.
Thank you, Michelle. And thank you everybody that joined us this morning for our first quarter call. As I said a little bit earlier, we’re very excited about what we’ve been able to achieve and very confident what the remainder of the year is going to bring forward. We look forward to reporting on that at our next one released Q2 on July 27. So have a great day everyone. Thank you for your attention.
Ladies and gentlemen, this concludes the conference for this morning. We would like to thank you all for participating and ask that you please disconnect your lines.