Keyera Corp. (KEY) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us. This afternoon, we are extremely pleased to have David Smith, CEO of Keyera, joining us to walk through the story and talk about the current status of what's going on with Keyera.

To open it up, Dave, maybe I'll just kind of ask, broadly speaking, how has Key kind of embraced this scenario as far as the really the dual supply and demand shocks and an unprecedented level that we haven't seen before. What has Keyera's response been to that and obviously, the COVID-19 situation, changing everything from the world we knew before?

Yes. Sure, [ Jeremy ]. And first of all, thank you very much for the opportunity to participate in the conference. We're all learning how to use the technology a lot better, I think, over the course of the training program we've had in the last 3 months. In answer to your question, I think the first thing I would emphasize is that our priority from the very beginning has been the health and safety of our employees and their families and the communities that we operate in. And so we have -- we've taken every precaution that we can think of at the facilities that we operate to make sure that they stay safe. We have been physically separating our operating teams as much as possible. Managing shift changes so that the -- so that people are physically separate. We have contingency plans in place in case we do have a positive case. But so far, touch wood, and going on 4 months now, we have not had a positive COVID-19 case at Keyera. So the safe and reliable operations of our facilities has always been our top priority. The office staff have all been working from home since March 16. We here in Alberta are starting to get into stage 2 of the relaunch as the province calls it and starting to come back into the workplace and determining what the precautions are that we need to take to do all that. So just a tremendous job done by our team to manage through all that and to keep everything operating safely and reliably throughout. In terms of the business side and the commodity price shocks that we've seen, it's really been quite the roller coaster. We pay attention to the various crude markers, obviously, because that has an impact on many of the commodities that we deal with. We pay attention to the NGL markets, propane, butane and condensate. We also produce iso-octane, which is a high-quality gasoline additive. So we pay attention to RBOB in North America because that's the gasoline marker that our iso-octane is priced against. And like I said, it's been a roller coaster for every one of those commodities. I think in the April time frame, in particular, we saw significant shut-ins of bitumen production. We were anticipating that we might see shut-ins on the other products as well. But in working closely with our producers, we've managed to keep virtually all of the volumes flowing and have been able to kind of kept things operating reliably through the bottom of the commodity price cycles. And we've seen recoveries in most of the commodities, including condensate and RBOB and managed to kind of keep things on a pretty even keel throughout that. We saw a drop-off in condensate volumes certainly as bitumen production was curtailed in Western Canada. We were probably -- at the lowest point.,, We probably had about -- we were probably down about 225,000 barrels a day of condensate demand. But that's gradually coming back as we see demand coming back. And the supply actually responded fairly quickly in response to that downturn in demand. We were a little concerned for a while that we would run out of storage capacity, but that hasn't happened. And there's been an opportunity for Keyera to enhance the storage revenues and enhance the utilization of our storage capacity. That's been one of the positives for us. And as we come out of the second quarter here, I think we're looking at things kind of going into a gradual recovery. And we're cautiously optimistic about what the second half of the year looks like.

That's very helpful. And maybe kind of picking up on some of the points there. Just curious, your producer-customer conversations, how they evolved from March when there was so much uncertainty to now. I mean absent the second wave, do you feel that kind of the bottom is in at this point, and we're starting to see production kind of naturally tick up here? Or what type of slope of recovery do you think could be possible in this environment?

Well, we all worry about a second wave. I mean, I think that's the worry that many industries have across North America is that we'll have to go through this again. But I think if we all kind of exercise a certain amount of responsibility, I think we'll -- I think we will see a gradual recovery. We're already seeing the signs of that in terms of commodity prices stabilizing, supply/demand kind of coming gradually back into balance. And so I think -- as I said a moment ago, I think with respect to the commodities we deal with, the Gathering and Processing business that we provide as well as the liquids infrastructure, we see recovery in utilization. The -- what I don't expect to see in the near-term is a dramatic recovery in drilling activity. I think the producers in Western Canada certainly are going to be very cautious about investing capital in developing more volume. I think the -- there was a lot of caution right now. A lot of companies are making sure that they prioritize liquidity above growth. And so I think it will be a very slow return to any level of drilling activity. So for us, that means that we'll see much more muted recovery in volumes throughout our Gathering and Processing network. So it's -- we will be very stable, I believe, but we won't see a dramatic growth profile through the end of this year. That's my outlook.

Now early in the process, Keyera decided to defer caps for 1 year at this point. I'm just wondering your thoughts on that time line to reassess. Is that kind of where you see things recovering back to where it was before, before everything happened? Or just trying to get more into the drivers of the 1-year time line? And I guess, what it would take to go forward with caps at this point?

Well, I think we still have all the volume commitments that we had when we made the decision to go ahead a year ago. We've come through the regulatory process successfully. We have virtually all of the regulatory approvals that we need to proceed. The reason why we chose a year is primarily just because of the construction schedule. With that we'll -- that kind of -- 2 winter seasons is really what that pipeline will need to get constructed. So kicking things off midyear 2021 is logical for us and allows us to be ready to put the pipeline into service in -- around the end of the first quarter of 2023. That's our target. We're certainly very committed to continuing forward with the project, and our customers, the producers that made commitments to that pipeline are still very excited to see it go forward. Some of the customers, I would say, were maybe a little bit disappointed that we weren't going ahead on the same schedule because they very much want to see that capacity. And so I think they wanted to see us charging forward. But I think they understand the reasons for us slowing things down. It's both to make sure that we preserve our capital and preserve our flexibility, but also just adjusting to the pace of industry activity as well. And so the commitment is still there. We are still very excited about not only the attractiveness of the investment by itself, but also what it means for further development, both upstream and downstream of the pipeline and what it means, I think, for the outlook for the industry as well. The Northwest Alberta and further north up into Northeast BC is clearly where the development activity is going to be in the Western Canada Sedimentary Basin for the next 2 decades.

That makes sense. Maybe just kind of building off that a bit. Could you discuss the competitive advantages of your integrated condensate system, maintains -- how that stacks up versus competitors out there?

Sure. We saw the opportunity to start to develop infrastructure focused on the demand for condensate in Western Canada. It's at least 15 years ago now and with the existing pipeline infrastructure and fractionation storage facilities that we had centered in Fort Saskatchewan, we realized that we had a -- we were a step ahead of the rest of the industry in our ability to provide the transportation storage, terminaling and logistics services for condensate. If you look back, I forget what year it was exactly, but the demand for condensate started to grow as oil sands producers developed bitumen supplies without upgrading. Previously, most of the oil sands development had been in conjunction with an upgrader. And when you're producing synthetic crude oil, you don't need diluent. But as companies started to develop bitumen production, they needed diluent, and condensate is the preferred diluent just because of its characteristics. We -- so we started to develop the relationships with the bitumen producers. We started to develop the services, the capacity in our storage caverns, the pipeline connections, the -- we developed a rail terminal at Edmonton, called the Alberta Diluent Terminal, which we still use for importing condensate by rail. And all of that led to further investments in the pipeline infrastructure between Edmonton and Fort Saskatchewan. We joined with Enbridge and constructed the Norlite pipeline, which takes condensate from our network up north to Fort McMurray to supply the -- some of the producers up there. And it has been a gradual series of incremental investments to continue to expand and connect the Keyera network in the Edmonton, Fort Saskatchewan area to the point where we are the de facto trading hub for most of the condensate that transacts in Western Canada. Our system probably sees, on a daily basis, something like 60% or 70% of the total condensate demand. Our focus has been on the consumer side on the bitumen producers who are the source of demand for the condensate, but we also provide a lot of services to the producers of condensate. And as you know, the production of condensate in Western Canada has exploded over the course of the last decade or so. Having said that, we still need imports to meet the demand. And so the Keyera system is also connected to both of the import pipelines, the Cochin pipeline and the Southern Lights pipeline.

Maybe building on that last point a little bit more there. Just wondering, the near term, obviously, is a bit murky here, hard to determine. But condensate supply/demand in Western Canada, just curious how do you see that kind of evolving over time? And kind of how that fits with Montney and Duvernay economics? How competitive do you see those basins? How do you see the outlook there over time, just thinking about the interplay there?

Yes. Well, we still see growth in condensate demand gradually over the course over the next couple of decades. It probably -- the growth probably won't be as dramatic as it's been over the last 15 years or so. And a big part of the -- a big question mark in the outlook is really the development of additional pipeline egress capacity. The good news is the Trans Mountain Expansion is moving forward. We'd love to see Enbridge expand, and we'd love to see the Enbridge Line 3 replacement. We'd love to see the Keystone XL pipeline going forward as well. If those 3 projects go forward, then that will mean a significant increase in capacity to be able to move diluted bitumen out of Western Canada. I think that will ultimately lead to the kind of price signals that the bitumen producers need to develop -- incrementally develop more bitumen production, and that will lead to growth in the demand for condensate. The condensate supply in Western Canada, as long as the price is healthy, I think it will continue to grow. But our crystal ball would suggest that it will be a long time before we run out of the need for imported condensate barrels from the U.S. So the 2 pipelines I mentioned, Cochin and Southern Lights, we expect that there'll be a need for that capacity for quite a few years yet. But a lot of the answers to these questions depend on those pipelines getting built that I talked about earlier.

That makes sense. And then maybe just kind of thinking about your footprint more broadly. We've seen notable volatility in commodity prices. AECO had really kind of stepped up there and then was volatile, and we've seen NGL prices kind of recover as well. Just wondering how this kind of influences volumes that you see across your footprint, as far as where producer activity maybe kind of shift around depending on some of those commodity price movements there? How has that progressed across your footprint?

Yes. It's a great question. There's so many different directions we can take this conversation. The -- one of the catch phrases or one of the key words in our strategy is flexibility. We try and make sure that we build as much flexibility into all of the assets we build to be able to adjust to the changing supply/demand and price fundamentals that you just referred to. We have, for instance, not invested in big-ticket petrochemical types of facilities. What we've done instead is we've invested in rail terminal and storage facilities for things like propane, butane and condensate that we can easily repurpose for other requirements as the fundamentals shift. And so -- in the gathering and processing world as well, I would make a similar comment that obviously, you have to try and make sure that you locate your facilities in the areas where the geology is sustainable long term. And that means -- in Western Canada that means the western side of the basin, where the reserves are rich in liquids. And then building in the flexibility to accommodate different kinds of gases in different volumes and compositions over the course of decades. So that's really what we've tried to do. We do have a little bit more volume exposure, volume sensitivity in our Gathering and Processing world, and we've been adjusting to that over the course of the last 5 years as the industry has gone through some refocusing. But I think if you look at the numbers over a long period of time, you'll realize that our asset portfolio is pretty resilient.

Makes sense. Yes, I think there's been a great tracker for -- Keyera has had in creating value with the processing plants. More recently, I think there's been an exercise to kind of optimize some of the portfolio on the processing side. I wonder if you could just walk us through there as far as what went into the decision-making process and what type of savings you think could be harnessed out of those efforts?

Sure. Well, as I mentioned earlier, the growth in activity or the focus of activity and the growth in volume in Western Canada has been in Northwest Alberta and further up into Northeast BC. The Montney and Duvernay zones in particular have been very prolific, and the economic results that the producers have seen there have been very strong. A lot of that has to do with the value of the liquids, and in particular, the value of the condensate. A lot of the Montney production up around Grand Prairie is very rich in condensate. So we've made investments in expanding Simonette plant, building the Wapiti plant and working with Ovintiv on the Pipestone plant, which is nearing completion. So we've made some significant capital investments in that area to respond to the growth and respond to the need for capacity. In the southern region, where we have more legacy facilities, some of which have been operating for more than 50 years, we've -- it's still a very attractive geology, and it's still liquids-rich, not as rich in condensate as the Montney is, but still very attractive and still has, I think, decades yet to go. But the drilling activity in that area in the last 5 years as a result of the downturn in commodity prices has been -- has resulted in a gradual drop-off in production and volume. And so we made the decision to rationalize the portfolio. We have 12 or 14 plants, depending on how big you draw the circle in that area. And most of those are connected with existing gathering systems as a result of the investments we've made over the years. So we have the unique advantage of being able to shut down capacity at some plants and redirect the volume through existing pipeline network to other facilities, which are larger, more efficient. And if we can get the utilization up to something north of 60%, which is our goal, then we'll end up with a lower per unit cost, lower maintenance capital requirements, lower greenhouse gas emissions, by the way, and at the same time, able to enhance the netback for the customer, enhance our bottom line as we both benefit from those changes. So that's the goal, is to basically accommodate the same amount of gas through fewer facilities through less capacity and increase the overall utilization. Last year, we shut down the Nevis and Gilby gas plants. Last month, we shut down the Minnehik Buck Lake gas plant. And we've announced plans to suspend operations at the West Pembina plant later this year. And then the Nordegg River and Ricinus plants next year. So those are significant changes. As you can appreciate, they're tough decisions to make because there's people involved in operating each one of those facilities. To the extent possible, we've tried to reassign those people to other facilities. But there's still probably a couple of more opportunities that we're continuing to look at to continue to rationalize the capacity and optimize the portfolio. We're trying to still -- as I mentioned earlier, the word flexibility. We're trying to still preserve flexibility. We do see this area still being quite attractive from a geology standpoint. But at the same time, we have to make sure that we're competitive and as cost-efficient as we could be.

That makes sense. Maybe pivoting over to the AEF business. Just want to touch base there. I think utilization and margins might have held in a bit better than some expected there. And I was wondering if you could talk about, I guess, the hedging strategy you have there and what kind of fed into some of the resiliency in that outlook?

For iso-octane specifically?

Yes.

Right. So yes. So our Alberta EnviroFuels facility is the -- I guess, it's fair to say it's the largest contributor to our marketing segment these days. The production of iso-octane -- that's a facility that we purchased in 2012, and the production of iso-octane represents about 14,000 barrels a day at full capacity. And we -- iso-octane is a high-quality gasoline additive. So we sell it as a -- at a negotiated premium above RBOB, which is the gasoline marker in North America. The premium -- the iso-octane premium is not something that trades. It's a negotiated premium with our customers on every deal we do, every turn deal, every spot deal we do. But the RBOB marker is clearly, it trades, and there is a very liquid-forward curve for RBOB. So we use the RBOB spread against WTI as a way of hedging the margin on the forward iso-octane sales. And we typically will go anywhere from 12 to 18 months. The closer you get, the near -- in the near term, we would be hedged probably 60%, 70%, maybe as much as 80%. And then as you go out into Q4, Q1, Q2, we would have lower amount, lower percentage of the production hedged. But we -- and we do it somewhat opportunistically, but we have targets to try and make sure we lock in margins at attractive levels. We also will use WTI hedges to hedge the WTI exposure that's in the margin. And then we contract on an annual term supply basis for the butane feedstock for AEF. And we will also hedge the foreign exchange. That's an element of the margin as well because most of our iso-octane sales are priced in U.S. dollars. So we try and forward-hedge all of the elements of the margin exposure that we can, but there's still elements of it that you can't hedge. And obviously, supply/demand for gasoline and specifically supply/demand for iso-octane are things that can vary. We saw a tremendous dislocation in March and April in the gasoline markets. I think we've already seen signs that gasoline demand is coming back. Folks in North America are getting back in their cars and driving, and we actually expect that this summer, maybe -- may see some very robust demand for refined products certainly and for gasoline, in particular, as people get back -- as people get in their cars and get away by road travel rather than by air travel. And so we think -- as we look towards the second half, we think that the outlook for iso-octane is pretty healthy. The AEF facility has been essentially at 100% all the way through this. So we've continued to move the volumes. The margins have moved around a little bit, but we're pretty comfortable with where we are now as we look forward.

That's very helpful. Maybe just kind of going back to one of your earlier comments with regards to contango. I was wondering if you could dive in a little bit more as far as what types of -- what commodities you're able to get the benefit of contango there? How sizable or meaningful of an opportunity can this be to Keyera over time?

Well, our -- most of it has -- is in our fee-for-service -- the fee-for-service storage capacity that we have. So all of our crude oil storage facilities -- above-ground crude oil storage facilities in Edmonton are contracted on a long-term basis. We were able to garner some shorter-term additional revenue there. When it comes to the other products, condensate, butane and propane, the -- there's a combination of fee-for-service storage revenue that we receive for leasing out the capacity, but there's also opportunities that we have as principal, where we're storing condensate or propane or butane in our own name. Most of the butane that we purchase that we would have an inventory under Keyera's name would be for the production of iso-octane at the Alberta EnviroFuels facility. So it's an example of that integrated value chain. But we have taken advantage of the contango in the propane markets with typical seasonality. And we've seen opportunities as well to capture some arbitrage around condensate with condensate being so cheap in the U.S. for a while. So none of that is what I would describe as material, but it all adds up to a pretty good outlook for the marketing segment. And I think, especially with condensate, the disruptions that we've seen in the last 3 months have really demonstrated the value of the flexibility of the network that we have, the storage -- the underground storage capacity, the various connections that we have to supply and to outlets for the condensate. I think our customers have been reminded of how important that is with the need to be able to find places to put condensate with the disruptions that we saw in March and April.

That makes sense. And I think Keyera, in the recent past has entered the Cushing market. And I was just wondering if you could touch on the drivers there, the vision there. And I think you -- Keyera has contracted out vast majority of what you're looking to build at this point. Do you expect to contract all it? Could you expand your position going forward there? Just kind of thoughts on this part of your business would be helpful.

Sure. We announced our Wildhorse investment. That's what we call the terminal. We call it Wildhorse. It's at Cushing. It's connected to a number of the significant other storage terminal facilities that are at Cushing. Cushing is one of the largest, most flexible crude oil storage hubs really in the world, but certainly in North America. And as the variety of different crude oils has continued to diversify at Cushing, we saw an opportunity to build a state-of-the-art facility that would be not only for storage, but also for blending capability with different hydrocarbon streams at that site. And so our focus there was to try and basically hold on to the capabilities that we already had in our liquids business here in Western Canada as well as building on some of the commercial relationships that we have. As the COVID-19 pandemic unfolded here, we had a lot of inbound calls from people wanting to know if we could make that storage available. Unfortunately, we were still several months away from having it complete and operational. But I think it's -- it has demonstrated to us that we've got a great opportunity here. What I would say is that the -- a large proportion of the capacity is contracted, but it's not contracted long term, like our baseline facility is here in Canada. The nature of the business at Cushing is the contracts tend to be of shorter duration. And so there will be opportunity, as we demonstrate the capabilities of that facility to recontract, we hope, at stronger fees for a greater term once we've been able to demonstrate the capabilities. And yes, we do have expansion capacity -- room to expand the storage capacity, but I think job one is to demonstrate what the facility can do and then see what sort of demand will materialize for growth in the capacity.

I think we're running thin on time at this point, but just wanted to see if there's any final thoughts that you want to leave our audience with.

Sure. I mean I think our Keyera's stock price has gone through the roller coaster ride that a lot of other companies have as well. Folks get concerned about the -- both the health of our customers in the Gathering and Processing segment, and they get concerned about the potential impact of commodity price exposure in our marketing segment. I think as we look at it, we think those concerns are way overdone, the Gathering and Processing Business as we look at them long term. Our facilities are focused in the right part of the basin from a geology standpoint. We may, from time to time, have producers that go through some financial challenges. One of our customers, Bellatrix, has gone through bankruptcy proceeding. But as a result of that, their assets have been -- they've now changed ownership, and we're now dealing with a new company called Spartan Delta, which has a much stronger balance sheet and a much better platform from which they continue to grow. So that's by virtue of being in the right places. And we see the strength of that strategy focusing on the quality of the geology. And in the marketing business, I think, as I've said, we will see opportunities to actually enhance value through these kinds of disruptive periods. And even though there might be some concern about the short-term impact of commodity price fluctuations, we manage the business very conservatively. And we had a record year in 2019. And as we look forward to 2020 and 2021, we're still very optimistic. And finally, our liquids infrastructure, as I mentioned a moment ago, we continue to demonstrate the value of the connectedness and the flexibility that's built into our hub infrastructure in the Edmonton, Fort Saskatchewan area. So we're coming out of this pretty optimistic. We've got a very strong balance sheet. We've made the decisions that we need to make to be strong and healthy and to be ready to grow when things start to recover.

Well, David, that's very helpful. I want to thank you again for taking the time to meet with us today to discuss the Keyera story, and hopefully, we can do it all again next year in person.

Yes, that's -- that would be great. I look forward to that [ Jeremy ]. Thank you very much.

Great. Thank you.