MEG Energy Corp. (MEG) Earnings Call Transcript & Summary

Good morning. My name is Joanna, and I will be your conference operator today. At this time, I would like to welcome everyone to the MEG Energy 2021 Capital Budget Conference Call. [Operator Instructions] Thank you. Mr. Derek Evans, CEO, you may begin your conference.

Thank you, Joanna, and good morning, everyone, and thank you for joining us to discuss MEG's 2021 capital and operating budget. With me this morning is Eric Toews, our CFO; Chi-Tak Yee, our Chief Operating Officer; and Lyle Yuzdepski, our General Counsel and Corporate Secretary. Just a reminder, this call contains forward-looking information. Please refer to the advisory in our disclosure documents on SEDAR and on our website. Before I speak to 2021, I would like to discuss a few highlights from the last year, which set the stage for our 2021 capital program. In the first half of 2020, MEG cut its original $250 million capital budget by $100 million to $150 million in response to the very negative macro environment brought on by the impact of COVID-19 on global markets. At the time of the capital reduction, MEG, like the rest of the industry, didn't know what shape the physical market for our Canadian heavy barrels was going to be for the remainder of the year. Now as we come to the end of 2020, we've successfully managed our financial liquidity and plan to exit the year with our revolver undrawn and approximately $100 million of cash on hand. Full year 2020 production is now expected to average between 82,250 and 82,500 barrels a day, up from our previous guidance of 81,000 to 82,000 barrels a day. For 2021, we plan to invest $260 million and expect full year production to average 86,000 to 90,000 barrels a day, with approximately 2/3 of those volumes sold into the U.S. Gulf Coast. The deferral of capital out of 2020 into 2021 that I mentioned earlier, means that half of -- the first half of 2021 will see production trending lower due to the lack of investment in the second half of 2020. But then reversing midyear as the front-end loaded 2021 capital program ramps up production late in the second half of 2021, reaching full production levels in mid-2022. We expect to fund the $260 million capital program at a WCS price of approximately USD 30 per barrel, which approximates the average WCS price realized to date in the second half of 2020 and is below current 2021 WCS strip pricing. As I mentioned earlier, we expect to have approximately $100 million of cash on hand, built up through 2020 to support funding of the capital program should oil prices underperform this level in 2021. Additionally, given the experience the industry underwent in the second quarter of 2020, MEG has built in capital spending off ramps into the 2021 capital program to be utilized if the outlook for WCS pricing on a sustained basis is significantly below the USD 30 per barrel in the latter half of 2021. Any capital off ramps would defer uninvested capital related to production volumes in 2022 and beyond. Capital associated with this production is approximately $65 million, the majority of which is not scheduled to be invested until the second half of 2021. Deferral of any amount of the $65 million will not impact 2021 production levels, which will remain at approximately 86,000 to 90,000 barrels a day and is fully funded with $180 million of sustaining capital noted in our press release. In summary, I'm excited about 2021 and very proud of the MEG team who got us through a difficult 2020 and to this 2021 capital release. We exit 2020 with $100 million of cash on hand after repaying $130 million of long-term debt in January and enduring a full year WTI environment below USD 40 per barrel. In 2020, we reduced G&A and nonenergy operating expenses by approximately $50 million, $28 million of which we believe are repeatable savings. We are committed to funding the 2021 capital program with internally generated funds and have designed the program, including associated commodity price protections and capital off ramps to enable successfully executing our 86,000 to 90,000 barrel a day production guidance in a significantly weaker oil price environment than current outlook reflects. With that, I'll turn the call back to the operator and open up the lines for any questions.

[Operator Instructions] Your first question comes from Phil Gresh at JPMorgan.

Just a follow-up question on the capital spending. As you look longer term, obviously, there's some spending for future years here in 2021. But how do you think about the longer-term sustaining CapEx and target production levels? Is it still that $6 to $8 a barrel range on the sustaining Capex?

Phil, it's Derek. Yes. That range is very good, very solid range. Obviously, as we extend our gathering system, the -- and go to new areas inside of the existing lease, our costs will be higher and likely in that $8 range, but the $6 to $8 sustaining capital range remains intact.

And as you look at 2022 and the potential for higher production, how do you think about what sustainable level of production you'd want to be run rating at in 2022 and beyond?

I think the -- as we think about 2022, which is a full year ahead of where we're talking about today, sustainable production will come down to really what the commodity price tells us in terms of available cash flow to continue to reinvest. Obviously, our goal here is to continue to live within cash flow and be sustainable. So to the extent that we can slowly grow the production through -- because we have incremental cash flow, we'll be putting it to work in that $6 to $8 per barrel-type range.

Sure. Yes. I only asked because you mentioned in the release that production would potentially be higher in '22. In terms of the fourth quarter, just one clarification on working capital. In terms of the $100 million of cash at the end of the quarter, is there any working capital contribution to that? Or just how should we think about that?

Phil, it's Eric. There's no working capital. I mean, at the end of the year, we expect to have $100 million of cash on the balance sheet. So just assume that, that is cash we have available to us to fund capital if needed in 2021.

The next question comes from Manav Gupta at Crédit Suisse.

So you kind of mentioned the bear case on oil and what bad could do to capital spending. Can you also -- are you also thinking at least of a scenario where things really improve from here and WCS prices are significantly higher than the projection. In that scenario, is there a possibility that MEG could pull forward some growth projects and the CapEx could be $270 million or $280 million or at this point, $260 million is absolutely the maximum that you will spend in 2021?

Manav, that's a great question. $260 million is what we've got -- that we've gone out with today, and we're tooling up to execute that program as efficiently as and effectively as possible. Whenever we think about adding additional capital to the program, we need to make sure that it's shovel ready. I think we'll continue to work. I know we will continue to work on making sure that we have some of those. But the magnitude and the size of those that we could bring to the table at this point is undetermined.

Okay. Second thing, sir, we have seen a lot of progress on pipelines. Are you reasonably confident that start of Enbridge Line 3 could now be a 2021 event? Or there are more things we need to watch as a sector which could derail that start up?

No, we're -- with respect to Enbridge Line 3, we think that will be a second half of 2021-type event. We're very encouraged there. Obviously, we're also encouraged with the progress being made on the Trans Mountain pipeline, which we expect to come on towards the end of 2022. And we've continued to see fairly good rail volumes being utilized to increase egress from Western Canada. So the transportation situation, and we see this reflected in the differential is very positive and getting better and better as we move forward.

The last quick question, sir. I mean generally, condensate trade with Syncrude, maybe a little lower. What we're seeing is Syncrude is trading at some like 3 to 4 below WTI, but condensates are trading right in line with WTI. I'm just trying to understand what's driving that? Is it temporary? If you could just give us some idea what's driving the strength in this condensate prices up there?

I think the biggest strength in the condensate prices is being driven by incremental demand for conde out of the U.S. Gulf Coast at the moment. The U.S. Gulf Coast is a bit of a -- well, as you know, we source a large amount of our condensate -- about half of our condensate from the U.S. Gulf Coast. And we've seen prices tighten up in there in the last couple of months, which is, I think, tight -- by extension, tightened up prices in Western Canada. We don't see this as a long-term trend. We're not -- but more seasonal at the moment.

The next question comes from Greg Pardy at RBC.

Derek, we're all trying to get to the same kind of number on the production side. So let me ask it a different way. With the $260 million capital you have in place, I know this wouldn't be a peak rate, but where would you exit 2021 at, give or take? I mean just ballpark-ish, just like it's obviously north of 90, right? So it's between 90 and 100.

I'd say we're going to comfortably exit at 90.

Comfortably exit. Okay. But knowing you, that means another 3,000 to 5,000. So anyway, I'll just put words in your mouth. Okay, 90,000. And then let me shift gears a little bit just on -- just a line of questioning then is -- what's the best -- what do you think the best benchmark is for you guys in the Gulf Coast given now that you're going to fully utilize the 100,000 and presumably you're going to get a nice uplift in netback presumably?

Yes, Greg, it's Eric speaking. We're -- I'd say the best benchmark is WCS. You can see AWB traded down there. And we trade about $1 off of WCS. So you can use that as a good proxy for AWB.

Okay. But even -- Eric, even for Gulf Coast, even for the pricing you're going to get in the Gulf Coast?

Yes.

So you're saying WCS in the Gulf Coast?

Yes. Yes. WCS in the Gulf Coast, yes, sorry. Yes.

The next question comes from Neil Mehta at Goldman Sachs.

I want to key off Slide 9 here where you talk about leverage and highlight that you still have many years to your next maturity, but leverage levels are still high. Is there an absolute debt level, Derek, that you want to get to? Or are you looking at it more in terms of net debt to cash flow or net debt to EBITDA?

Yes, Neil, we do have a target debt level that we're focused on. The impact of 2020 on the business has been one where we have a facility that's not quite full. And it's very, very economic and important to our netbacks to fill that facility. So the focus has been -- as you can see from 2021, focus is on the production level. The target that we focused on is sort of 2.5x net debt-to-EBITDA on a sort of a trough basis. Yes, you can pick your WTI price. That's sort of what we focus on. And the reason 2.5x is sort of our first stopping off point, Neil, just given the nature of the asset, the low decline in the very -- in the basically nonexistent geological risk to the business. So that's sort of our target on a longer-term -- or medium-term basis.

Yes. Okay. Great. And then just a big picture quite as we go into '21. Just your thoughts on differentials, there are a lot of moving pieces, right? There's -- Line 3 likely comes online by the end of '21. OPEC barrels might start to come back into the market. Canadian production is still relatively depressed, but probably coming back, but the flat price is still low. So it's hard to put a finger exactly on how that WCS story plays out. But curious on your guys' view and whether you think the bias is still a tighter differential in '21 versus history, even without Line 3?

Yes, Neil, it's Eric again. We -- as Derek said earlier, there's a very positive story momentum on Canadian heavy sour in the Gulf Coast. There's a real pull there from Asia right now. We're seeing sort of the first quarter on the Gulf price in that sort of $2, $2.50 off of WTI. And when you bring that back up into Canada, we do see Line 3. We're taking -- Enbridge's queue here, but seeing that come on the second half of 2021. So we do see apportionment in the first half of the year higher -- significantly higher than the second half of the year, but there's a lot of spare inventory in Western Canada to be able to buffer that when we get barrels put back to us. So we still think that, that $12 WTI:WCS differential in 2021 is a reasonable estimation for us. Strip right now is about $13, $13.50. We think that's a little bit wide. But that's obviously, there's some -- there's 2 refiners and producers on what that number is right now, and what it should be. So we still -- we're very constructive on differentials. We see that in that sort of $12 range for the full year 2021. And we think there's tailwinds on the differentials.

Maybe I'll just jump in. It's -- we're seeing a very interesting dynamic in terms of big export demand out of the U.S. Gulf Coast and as well, real market pull into the West Coast. It appears that Alaskan crude is short-circuiting the U.S. West Coast, which is its normal home and heading straight to Asia in big length. And this is creating pull for -- incremental pull for Canadian heavies into the refineries on the U.S. West Coast. So that is an element that you hadn't talked about, but another positive element that we're seeing in terms of the demand for this product. So we're -- as Eric just said, we're very constructive in terms of what the differential is going to look like as we drive forward.

The next question comes from William Lacey at ATB Capital.

Just following up on the comment that you guys did about differentials. Obviously, you've taken the hedges off the line back in October. So you're exposed on that side, which is a positive. And just trying to get a little bit more of a, I guess, a positive spin on this. The budget you've outlined that you basically said is sort of bulletproof down to the low 30 number. Obviously, WCS is looking much stronger right now, especially over the Gulf Coast for potential increases in your cash flow. What would be your priority of surplus cash flows right now? Would you be looking to sort of build-out for 2022 in terms of incremental production? Or is it going to be a debt focus?

I think -- William, it's Derek, in the short term, we will be looking at continuing to try and find ways to put that capital to work to grow our production volumes.

There are no further questions in queue. You may proceed.

Thank you, Joanna. I see that we are out of questions in the queue. So I'd like to thank everybody for participating this morning. And just wish them the best of the holiday season and hope that they all find a small vial of COVID vaccine under their Christmas tree this year.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines. Enjoy the rest of your day.