MEG Energy Q3 2023 Earnings Call Transcript

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November 7, 2023

There are 9 speakers on the call.

Operator

Good morning. My name is Ludi, and I'll be your conference operator today. At this time, I would like to welcome everyone to the MEG Energy's 2023 Q3 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session.

Operator

Thank you. I would now like to turn the conference over to your speaker today, Mr. Derek Evans, President and CEO of MEG Energy. You may begin your conference.

Speaker 1

Thank you, Luti. Good morning, everyone, and thank you for joining us to review MEG Q3 operating and financial results. With me on the call this morning are Ryan Kubik, our Chief Financial Officer Darling Gates, our Chief Operating Officer and Lal Uzhdevsky, our General Counsel and Corporate Secretary. 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.

Speaker 1

I'll keep my remarks brief today and refer listeners to yesterday's press release for more detail. Our top priority at MEG is our focus on health, safety and the environment that ensures nobody gets hurt, Eliminates Serious Incidents and Delivers Operational Excellence. I'm extremely proud of the safety, operating and financial performance delivered by our team. Their focus on plant reliability, steam utilization, project execution and ongoing well optimization have all contributed to a strong operational quarter. Before I turn the call over to Darlene and Ryan to share details of our results, I would like to briefly touch on the business highlights.

Speaker 1

MEG's financial performance continues to benefit from strong oil prices, which reflect favorable supply and demand fundamentals for both WTI and WCS heavy oil differentials. WTI prices averaged $82 a barrel U. S. In the 3rd quarter, supported by increasing global oil demand and coordinated OPEC plus production cuts and supply management. The WCS discount to WTI in Edmonton averaged US13 dollars per barrel during the quarter, driven by effectively 0 apportionment on the Enbridge system, strong U.

Speaker 1

S. Gulf Coast exports as a result of rising heavy crude capacity in Asia and tight global heavy crude markets as a result of OPEC plus reducing supply. That WCS differential is key indicator of pricing for our product in Edmonton, but it's important to remember that we sold 73% of our blend volumes in the Q3 into the U. S. Gulf Coast.

Speaker 1

Heavy oil in that market has been even stronger, allowing us to receive a premium over what is achievable in Edmonton. Our market access and market optimization activities in the Q3 generated a weighted average premium of $0.69 per barrel Diluent transportation cost to get our product to market, our bitumen realization was $84.75 per barrel at our plant gate in Q3. WCS prices have more recently widened, reflecting refinery turnarounds, higher Western Canadian Sedimentary Basin production, seasonal heavy oil blending requirements as well as perceived concerns about Alberta storage capacity and TMX timing. TMX pipeline to Canada's West Coast is on track for start up late in the Q1. Line fill of 4,500,000 barrels should positively impact the WCS differentials in Q1 2024.

Speaker 1

With 20,000 barrels per day of committed capacity on TMX, MEG will have over 80% of its production with access to Tidewater. Near term fundamentals remain strong as we head into 2024. Industry will also be positioned with excess takeaway capacity for first time in many years and that should narrow and reduce the volatility of WCS heavy oil differentials. We anticipate the current wide WCS differentials will narrow slightly as we head into the end of the year and will remain elevated until TMX moves into operation at the end of Q1. Q2 and Q3 2024 differentials should look similar to 2023 with Q4 2024 only marginally higher than Q2 and Q3.

Speaker 1

Our financial results reflect strong operating performance and enable our commitment to debt reduction and share buybacks. Since April 2022, we've repurchased USD 853 1,000,000 of senior notes $668,000,000 or about 33,000,000 shares at a weighted average price of $20.16 per share. Share buybacks represent approximately 10% of our 2021 outstanding share count. Free cash flow remains allocated at 50% to debt reduction and 50% to share buybacks, but that will ramp up to 100% shareholder returns next year when we reach our US600 $1,000,000 net debt target. Corporation published its first or excuse me, its 3rd ESG report in September 2023, which discusses its foundational commitments of business model resilience and Governance and the Corporation's priorities ESG topics, health and safety, climate change and greenhouse gas emissions, water management, Energy Security, Energy Affordability and Indigenous Relations.

Speaker 1

I will now ask Darlene Gates, our COO, to speak to our operating results and ask Ryan Kubik, our CFO to talk to our financial results. Before I open the call to questions, I'll provide an update on the Pathways Alliance efforts this quarter. Darlene, over to you.

Speaker 2

Thank you, Derek, and good morning, everyone. In the Q3, as Derek mentioned, We delivered strong safety, health and environmental performance with no lost time injuries and no recordable spills. Production of about 104,000 barrels per day in the 3rd quarter was delivered at a top tier steam to oil ratio of 2.28, reflecting the successful completion of our short cycle infill and redevelopment programs and a continued emphasis on steam allocation to the highest quality resource. When compared to the same quarter last year, this represents a 2% production increase and a 5% reduction in steam to oil ratio. These results were achieved while successfully completing our planned facility and field structure projects, which will enable us to distribute a high pressure steam to future well pads.

Speaker 2

Operating expenses net of power revenue average $5.11 per barrel in the 3rd quarter, primarily reflecting higher production rates, planned maintenance activities and inflationary pressures Chemicals and Staff Costs. Power revenue exceeded energy operating costs in the quarter, generating a $0.04 per barrel net recovery, which continues to demonstrate the value of our cogeneration facilities. As we head into the Q4, lower facility and maintenance activity Our outlook for second half production continues to be approximately 105,000 barrels per day and half of exiting the year near our 110,000 barrel per day facility capacity. In October, we also achieved 1st production from our newest well pad, which will continue to ramp up throughout the Q4. I'd like to take this opportunity to thank our teams for this quarter's operational performance and confident they have positioned MEG for a strong finish to the year.

Speaker 2

With that, I'll turn it over to Ryan to provide the Q3 financial update. Brian?

Speaker 3

Thanks, Darlene. MEG generated adjusted funds flow of $492,000,000 in the Q3 of 2023, Bringing our year to date total to just over $1,000,000,000 Q3 cash operating netback was $58.64 per barrel, reflecting strong oil prices, lower diluent costs and the 1st full quarter of higher post payout crown royalties. After funding $83,000,000 of capital expenditures, we generated $409,000,000 of free cash flow in the quarter, Which was used for US68 $1,000,000 of debt reduction and to repurchase US58 $1,000,000 or 2,300,000 shares at an average price of $25.40 per share. In the 1st 9 months of the year, MEG generated $699,000,000 of free cash flow. That free cash flow allowed us purchase $227,000,000 or 10,300,000 MEG shares at an average price of $22.07 per share.

Speaker 3

In addition, we reduced debt by a further US194 million dollars At September 30, our net debt to $885,000,000 and at current oil prices we forecast reaching our $600,000,000 net debt target around mid next year. As we head into the last quarter of the year, we expect to achieve the low end of our 100,000 to 105,000 per barrel 1,000 barrel per day production guidance. Under that production forecast, non energy operating costs are trending to the top end of our $4.75 to $5.05 per barrel guidance range. And G and A will also trend to the top end of our 1.70 to $1.90 per barrel range. With continuing strong production in oil prices, MEG is well positioned to execute its strategy as we head into 2024.

Speaker 3

Guidance for 2024 is scheduled for release on November 27. Thanks. And with that, I'll hand it back to Derek.

Speaker 1

Thanks, Ryan. I'd now like to share a brief update on Pathways Alliance. MEG along with its Pathway Alliance peers continue progressing pre work on the proposed foundational carbon capture and storage project, which will transport CO2 via pipeline from multiple oil sands facilities to be stored safely and permanently in the Cold Lake region of Alberta. Significant engineering force based evaluation and environmental field work is enabling more detailed discussions with indigenous groups, landowners and local communities about the proposed project. Following early engagement over the last 2 years, formal consultation with 25 indigenous groups along the proposed CO2 transportation and storage network corridor is underway.

Speaker 1

Remain encouraged by the work and collaboration with both the federal and Alberta governments to get the necessary agreements in place to advance this ambitious and important project. I'd be remiss if I did not remember and acknowledge with great sadness, Ian Bruce, MEG's Chair, who passed away tragically at his cottage in Ontario in October. Ian was passionate about our industry and brought a wealth of experience and wisdom to MEG. It was a tremendous order of MEG and our management team and will be greatly missed by all of us at MEG and all who knew him. On behalf of our Board of Directors, management team and employees, I extend our deepest sympathies to Ian's wife, Darlene, his family and many friends.

Speaker 1

As I bring my remarks to a close, I once again want to extend my thanks to our team for their commitment and perseverance, proud of what we have been able to accomplish and confident in our future and our commitment to sustainable, innovative and responsible energy development. On behalf of MEG's Board of Directors and our management teams, I want to thank you for your continued support. With that, I'll turn the call back over to Luti to begin the Q and

Operator

A. Thank you. And ladies and gentlemen, we will now begin the question and answer and your questions will be pulled in the order they Your first question comes from the line of Dennis Fahl from CIBC World Markets. Your line is open.

Speaker 4

Hi, good morning and thanks for taking my questions. The first one is just around capital structure. You've obviously been very focused around repurchasing the 2027 notes. Just wondering, and Especially focusing also on the US600 $1,000,000 net debt floor here. How are you thinking about your exposure to term notes and kind of longer term debt.

Speaker 4

I know the next kind of tranche after the 2027 is quite

Speaker 1

Yes, Dennis, thanks. I'm going to ask Ryan to talk to that.

Speaker 3

Hey, Dennis. You should think that we're just going to continue buying back those 2027 notes, take that to 0. At that point in time, we do have the 2029 outstanding US600 million dollars that's our debt target. Those are at an attractive rate relative to where we could finance So we're going to keep those outstanding and that'll provide us significant liquidity obviously going forward without any near term maturities.

Speaker 4

Great. Thanks. And then my follow-up here is just around, I guess, inventory and sales levels. You guys built up inventory through the quarter. I just wanted to some degree around what was potentially an anticipation around line around Line Fill 4 TMX.

Speaker 4

Can you speak to that a little bit and just kind of some of your plans with the relatively elevated inventory levels that you currently have That may or may not be at Hardisty and maybe in other locations like close to the coast.

Speaker 3

Yes, I mean we did inventory will move around, Dennis, and we did have a couple of 100,000,000 build in working capital At the end of September, I guess, versus the end of June, that was due to a couple of things. We did see oil prices rally, so receivables rallied into the end of quarter. On the inventory side, you can see movements around various factors, whether we're building a cargo, for example, that might ship off coast, which was the case at the end of September, whether we're buying non proprietary volumes to manage our pipeline space and add some optimization activities through our marketing activities, etcetera. So you will see movements up and down in that inventory level. With respect to TMX, we're expecting we'll be holding about 160,000 barrels a day or 160,000 barrels of 1,000 barrels a day or 160,000 barrels of line fill.

Speaker 3

That will be long term. It will be classified as long term assets, I guess, in our financial statements and won't be classified as inventory for working capital.

Speaker 4

Great. Thanks. And then if you may permit me one last question here. I understand that you obviously have a lot of experience With respect to marketing some of your production, not just within North America, but even potentially globally, how do you view that as being a potential advantage when TMX eventually comes online in terms of finding buyers for your crude and obviously, I guess, a different means of accessing that market. Thanks.

Speaker 1

Yes, Dennis, it's Derek. I'll take that one. A big part of our marketing strategy is to ensure that We don't move all of our crude into the U. S. Gulf Coast and overwhelm that market and create a bigger differential.

Speaker 1

Just instead of moving the instead of having a differential egress related differential in Edmonton, we've now got an over Gulf Coast. So we spent a fair amount of time working to develop Asian markets, both in India and in China. I think we have a very good idea of people that like the quality of crude that we have. And this was a big driver behind tankage and dock space in the U. S.

Speaker 1

Gulf Coast. As we move To Burnaby. At this juncture, we think Burnaby's got basically 2 markets, West Coast of the United States at California market and fundamentally China. We don't think transportation rates are going to our netbacks are going to be sufficient to access India. But Our understanding of those markets, our understanding of buyers in those markets, our historic ability to have ship them samples of our product so that they can determine whether they would want to get in a queue to buy some of that is all Very, very important, not only to finding a market, but helping us be less reliant on U.

Speaker 1

S. Gulf Coast operators, refinery operators to give us a fair price for our product.

Speaker 4

Great. Appreciate that color and context. I'll turn it back. Thanks.

Speaker 1

Thanks, Dennis.

Operator

Your next question comes from the line of Greg Bardy from RBC Capital Markets. Please proceed with your question.

Speaker 5

Yes. Hey, thanks. Good morning. Thanks for the rundown, guys. Derek, I wanted to come back to Pathway.

Speaker 5

So let's just say in a hypothetical world that the incentives are Inclusive of operating costs, like you've got pathways, it's got adequate incentives in place, let's just say, by the end of this year. And The trunk lines in place for 2029. What's the plan then for MEG? I'm just trying to think in broad strokes, What are the series of steps that you're going to take in terms of decarbonization?

Speaker 1

Great question, Greg. And a little more forward looking. I guess I appreciate this because we're not going to talk about when Pipeline is going to be and let's just assume that all of that has taken place. What that means for MEG is in 2026, 2027, 2028, 2029. In those 4 years, we would probably spend somewhere in the neighborhood of a net $50,000,000 to $75,000,000 of capital building our first carbon capture facility at SAIC.

Speaker 1

So that would be a facility that would capture a net capture of Somewhere between 0.63 and 0.73 megatons a year of carbon. So Once we've got the sort of the fiscal certainty and the regulatory certainty, which would be associated with having the pipe in place and up and running by 2029. We will then start to push forward, past our feet type of work to an FID decision, which have capital being spent in that timeframe of 2026 to 2029.

Speaker 5

Okay, thanks. Because I was going to ask you about the capital. So that's super helpful. And then Maybe kind of related because it sounds like you'll be doing probably going with post combustion capture. Where does EMVapex fit into everything or is that something that might be several years away?

Speaker 1

I think E. M. Vapex, so just for other people on the call, E. M. Vapex is a solvent process that was developed at MEG and helps us reduce our steam oil ratio significantly.

Speaker 1

It replaces steam with solvent effectively. So Very important if you're trying to reduce not only your steam oil ratio, but also to keep down the amount of carbon that you have to capture. We have spent an extensive amount of time working with EMVapex. We think it's a technology that In a new greenfield development is something that we would look at very seriously or if we decided to move a significant ways away from our central processing facility and we were going to create a brownfield facility that was connected back to our central processing facility. We would look at it there.

Speaker 1

But at this point in time, there's a number of commercial aspects that we don't have in place to contemplate that. The biggest one, which would be really the solvent that we would need and a long term agreement and pipeline transportation agreement, both for the supply and the transportation of that product. And Just to be very clear, we thought about those, we've costed those out. At this point in time, the brownfield work that we continue to do inside of the facility is much more economic and significantly lower cost on a dollar per flown BOE than EMV Apex would be at this point in time.

Speaker 5

Okay, terrific. Thanks very much.

Speaker 1

Thanks, Greg.

Operator

Your next question comes from the line of Manu Hulshap from TD Securities. Your line is

Speaker 6

open. Thanks and good morning everyone. I'll start with a question on Sermont. Given Conoco's relatively recent decision to exercise its Roper on Total's working interest on its Surmont project right next door. Can you just give us a refresh on the status of Your Surmont asset and the various options or scenarios longer term.

Speaker 1

Good morning, Meno, and thanks for the question. Sirmon is a fabulous asset. I would say it's As good, if not better than what we are currently developing at Christine Lake. The reason it hasn't been developed is because it's substantially further away. At one point in time, a number of years ago, we had worked a license for the facility through the Alberta Energy Regulator.

Speaker 1

We no longer we let that license go because as we thought about it, it's going to be at least 10 years before we get there with the low hanging fruit that we have at Christina Lake. And really, I think The challenge for us is not to go out there and build another once through steam generator type of facility. The challenge will be, is this an opportunity for us to put solvents to work, warm solvents to work and to bring a different So nothing in The medium term is going to be developed and that's primarily because we still have massive amount of running room going from, say, 110,000 all the way up to 210,000. There's 100,000 barrels of incremental capacity that we can develop at Christina Lake, which has got our full and undivided attention at the current time.

Speaker 6

Thanks for that, Derek. And then moving on to buybacks, it looks like activity in the quarter Was a bit light at $58,000,000 roughly 14% of the Q3 free cash flow. Why was that? And does it imply an uptick in buyback activity in Q4 to get you closer to your 50% annual target?

Speaker 3

Hey, Menno. The main I guess couple of reasons for that. We already talked about working capital. We did see a build in working capital requirements in the quarter. And so that meant we didn't have the cash available to actually buy back the stock.

Speaker 3

When we look at stock versus the debt buybacks, the stock market is actually more liquid, I guess, than the debt buyback market. So we're a little bit more opportunistic On the debt side, if we see opportunities to buy different pieces, those may be chunkier. So we may buy back a little bit more debt than We actually buy back stock in the period. But over time, we do expect that we're going to do exactly what we said we would do fifty-fifty debt shares as we kind of move toward our net debt target. And you can depending on where oil prices go, etcetera, you'll see those working capital requirements potentially

Speaker 6

Perfect. Thanks, Ryan. I'll turn it back.

Speaker 1

Thanks, Manu.

Operator

Your next question comes from the line of John Royall from JPMorgan. Your line is open.

Speaker 7

Hi, good morning. Thanks for taking my question. So you mentioned energy OpEx net of power revenue was actually negative this quarter and I've noticed that net number has trended down a bit this year from an average of maybe $2 to $3 per barrel over the few years before that. Is Is there anything structural there with the relationship between energy OpEx and power revenue? Or is it maybe just kind of a Goldilocks scenario of the relationship Between gas price and power price, and do you expect it to normalize?

Speaker 1

John, it's Derek. I'm not sure Which one of the Goldilocks scenarios we should be going as too hot, just right or too cold. But We do have a unique situation on the go. I think we've got very high power prices in the province and very low gas prices, Which has driven that. As we look forward into next year, we see those power prices or we're forecasting They're going to normalize down into that $90 a megawatt.

Speaker 1

So I think you shouldn't believe that this is a trend that is going to Continue. We're very pleased with what we've been able to achieve or receive, I guess, in terms of That combination over the last couple of quarters, but it will I think revert to historic norms as we drive forward here.

Speaker 7

Got it. Makes sense. And then, I know you'll come out with a formal budget later this month, but just thinking about next year's CapEx and Am I thinking about it correctly, at least directionally, if I think about higher than 2023 levels of the ramp in the second half after you achieve your net debt for and start to invest in the next phase of growth. Is that kind of directionally the right way to be thinking about it?

Speaker 1

I think directionally, I would tweak it a little bit and say, you should be thinking about it as this year was sustaining capital. And as we've talked to you and others about what our sort of our growth project would be taking it from 110,000 to 125,000. We think that's somewhere in the neighborhood of 300,000,000 and you should expect that a third of that notionally would Get allocated in the 1st year.

Speaker 7

Got it. And just to be clear, that would be after you So probably more second half loaded?

Speaker 1

No, I think and this is all Dependent upon where our Board lands on this, but so it's subject to their approval. We haven't gotten This across the line with them yet, but I think we are comfortable enough that we are going to achieve that $600,000,000 debt target. So we would be planning on this would be a full year capital budget, which would basically be starting growth plans are making allowances for and doing a long lead time work on the growth program starting as soon as budgets approved.

Speaker 7

Understood. Thank you.

Speaker 3

Thank you.

Operator

Star followed by the number one on your telephone keypad. Your next question comes from the line of Neil Mehta from Goldman Sachs. Your line is open.

Speaker 8

Hi, good morning. Thanks so much for taking the time. This is Nicole Espesser on for Neil Mehta. So just the first question here would be on pricing dynamics. Curious, any thoughts in terms of what you're seeing in the Gulf Coast?

Speaker 8

And then also more broadly, as you think into 2024, Any outlook that you can comment on for the WCS differential would be helpful.

Speaker 1

Yes, good morning. And I think that one thing that we would say about the WCS differential is, For some reason, people aren't factoring in the 4,500,000 barrels a day of line fill that TMX is going to need. So if you think if you go and you look at the differential today and you see a part of the reason that the differential has expanded or blown out is because of increased production or increased diluent. And you think that that's somewhere in the neighborhood of 100,000 barrels a day of incremental capacity. What we're talking about in terms of line fill is taking half of that away.

Speaker 1

4,500,000 barrels over the Q1 is about 50,000 barrels So I think my own personal opinion is the Q1 2024 differential is too high. It's not factoring in that TMX,

Speaker 3

the line

Speaker 1

fill. And I think there's also some concerns about storage, which I don't understand either. I mean, last week storage in the the Western Canadian Sedimentary Basin was about 26,000,000 barrels or somewhere in the sort of the low to medium 30%. We've got lots of room for storage. So I don't think we're going to see a tight storage situation.

Speaker 1

I think there's going to be effectively less or less product moving down the line. I said in my previous remarks, I provided My predictions as to where I think you're going to see Q2 and Q3 land. And Q3 was under $13 this year and Q2 was in that $15 range. I think that those are quite achievable again next year. I think they'll actually be a little bit high, but if I were modeling, I'd be using those.

Speaker 1

Where I think it's going to get very interesting is as you model Q4 of next year because obviously with an incremental TMX volumes. I don't think you're going to see that historic run up as you've moved into the Q4 Of the differentials. I think it will stay quite flat through that period. So, maybe $1 or $2 more, but I think we are out of finally out of a period of egress driven lack of egress driven WCS differentials. And I think we'll have a lot less volatility on that front going forward.

Speaker 8

That context is incredibly helpful. Thank you so much. And then not to come back to this question again, I know some other analysts have asked. But Just on Pathways, any key updates we should be looking out for towards the end of the year or anything maybe early next

Speaker 1

Where to start on pathways? I think fundamentally as we drive forward, you're going to hopefully hear something at some point over The next couple of months about how the federal and the provincial government or pathways are continuing to work forward. I think we owe the market an update in that regard. And I think you'll Something will be coming in that regard, I hope over the next month or 2. I can tell you that we've got A few hundred people working on this project at the moment inside of the companies, continuing to work on the pore space, continue to work on the Speed engineering continuing to try and get the pore space approval through.

Speaker 1

So I worry sometimes that because we haven't hit milestones or we're not moving as fast as people Think we should be moving that they think there's nothing going on in this project. I can assure you there is a massive amount of work that is going on in terms of indigenous consultation, pipeline sizing, looking for appropriate mills that could roll this type. So lots and lots of work going on as well as the important work with both the federal and the provincial government trying to arrive at the appropriate fiscal terms that will make this project economic.

Speaker 8

That's great. We'll definitely be on the lookout. Thank you so much for taking the time.

Speaker 1

Thank you.

Operator

And there are no further questions at this time. I would like to turn it back to Mr. Derek Evans for closing remarks.

Speaker 1

Thank you, Luthie, and thank you to everybody that joined us this morning for our Q3 results conference call. We're excited about what we have been able to achieve and look forward to updating you on our 2024 outlook when we release our budget at the end of the November. Have a great day and thank you.

Operator

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Have a good day.

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MEG Energy Q3 2023
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