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

Good morning. My name is Pam, and I'll be your conference operator today. At this time, I'd like to welcome everyone to MEG Energy's 2022 Capital Investment Plan Conference Call. [Operator Instructions] Thank you. Mr. Derek Evans, CEO, you may begin your conference.

Thank you, Pam. Good morning, everyone, and thank you for joining us to review MEG Energy's 2022 investment plan and operational guidance. 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 keep my remarks brief today and refer listeners to yesterday's press releases for more detail. In 2022, we plan to invest $375 million, with full year production expected to average 94,000 to 97,000 barrels per day after taking into account a planned 30-day turnaround in the second quarter on the Phase 2B facilities at Christina Lake that is expected to impact full year production by approximately 6,000 barrels a day. Sustaining and maintenance capital is estimated at $310 million, with approximately 15% directed towards turnaround activities scheduled for the second quarter of 2022, with the remainder directed towards drilling, completion and tying in of new SAGD wells and associated production. Optimization capital of $50 million represents the remainder of the previously announced $125 million of incremental well capital necessary to allow the corporation to fully utilize the Christina Lake central plant facility's oil processing capacity of approximately 100,000 barrels a day prior to any impact from scheduled maintenance activity or outages. The other $15 million of capital investment is targeted to field infrastructure, regulatory and corporate uses, and represents capital necessary to maintain MEG's business that is not directly associated with the sustaining and maintenance of production at Christina Lake. Budgeted capital costs reflect approximately a 10% year-over-year impact from observed inflation and supply chain pressures and ongoing challenges sourcing adequate manpower. Our focus on our operating and G&A cost structures has not wavered, with small increases in guidance being attributed to nonrecurring temporary cost reductions in 2021 as the company participated in various government-led initiatives aimed at supporting businesses facing the negative impacts of COVID-19. In the current commodity price environment, total capital investment represents approximately 35% of MEG's estimated full year 2022 adjusted funds flow. MEG has a capacity to ship approximately 100,000 barrels a day of AWB blend sales on a pre-apportionment basis to the U.S. Gulf Coast market via its committed capacity on the Flanagan South and Seaway Pipeline systems. MEG expects to sell approximately 2/3 of its full year 2022 AWB blend sales volumes into the U.S. Gulf Coast market, with the remainder being sold into the Edmonton market. In keeping with our focus and commitment to debt reduction, we announced yesterday that the corporation has issued a notice to redeem USD 225 million of MEG's 6.5% senior secured second lien notes due January 2025 at a redemption price of 101.625%, plus accrued and unpaid interest to, but not including the redemption date. Redemption is expected to be completed on or about January 18, 2022. Debt reduction over the last 4 years now totals approximately USD 1.8 billion. Continued debt reduction remains a core focus of the corporation. MEG expects to exit 2021 with a net debt of USD 1.9 billion. Until the corporation reaches its near-term debt target of USD 1.7 billion, 100% of the free cash flow generated will continue to go toward debt repayment. In the current commodity price environment, MEG expects to reach this near-term target early in the second quarter of 2022. Upon reaching its near-term net debt target, MEG intends to increase shareholder returns through the implementation of a share buyback program. MEG expects to allocate approximately 25% of the free cash flow generated to shareholder returns, with the remaining free cash flow applied to ongoing debt reduction until the corporation's net debt balance reaches USD 1.2 billion. At current production levels, this net debt target implies a net debt-to-EBITDA multiple of less than 2x at a long-term USD 50 per barrel WTI price. Assuming a USD 70 per barrel WTI price, MEG expects to reach this net debt target in early 2023, at which time the corporation expects to increase the percentage of free cash flow returned to shareholders while continuing to further strengthen its balance sheet. I look forward to reporting on our progress in building Christina Lake production capability to 100,000 barrels per day in non-turnaround months, as well as continuing to update you on our debt repayment progress and the initiation of our share buyback program. With that, we'll now open the line for questions.

[Operator Instructions] Your first question comes from Dennis Fong with CIBC World Markets.

The first one is just related to the production guidance. You indicated a range of 95,000 to 97,000 barrels a day. I'm just curious as to, given the size of the turnaround, what kind of metrics or how -- what kind of -- I don't think you need to go right, but what are kind of the benchmarks that allow you to achieve the upper end of production guidance? Is it a shorter-than-expected turnaround window? Is there incremental like low-hanging fruit with respect to Christina Lake facility that allows you to exceed the 100,000 barrels a day capacity for a short period of time? Just wanted to get a little bit more context there in terms of the ability to hit the upper end of guidance.

So Dennis, I would say it's all of the above, tempered with supply chain challenges and manpower potential challenges. So to the extent that we can shorten up the turnaround, to the extent that there's less found work, to the extent that we've got great access to all the people that we need in a timely manner and that COVID has not impacted this [ in terms ] which we can work or how we can work, that's part of the reason it's such a wide guidance. And successful completion in all of those or successful results in all of those areas would help us achieve the high end of the guidance.

Okay. Great. And then I guess the second question for me is just related to the cash return to shareholder thought process here. You indicated essentially a larger focus on share repurchases. Can you give us a little bit of insight as to the rationale and the certain reasons as to why you chose share repurchases over potentially a dividend and kind of your thoughts as it relates to how MEG is currently positioned from, we'll call it, a capital level or a capital allocation level and so forth?

Dennis, it's Eric. I might get you to repeat the last part of your question. But with respect to the first part of the question, the way that we thought about the return of capital portion that we talked about in the press release, the 25% of free cash flow, we look at the intrinsic value of MEG today. And we think from an investment perspective, there's high value there. This also provides, I think, better flexibility for shareholders on a go-forward basis. And what we've said as we move through this, we'll look to see -- once we hit that $1.2 billion target, we'll reconsider what that makeup looks like. But for right now, we think the right way to go is share buybacks from an intrinsic value perspective of MEG shares.

Okay. Perfect. And then the second part of the question was just related to just how you thought about that in terms of capital structure, if there was any kind of component, obviously, layering in a smaller amount of -- or percentage of free cash flow in terms of cash returns and still focusing on debt repayment. Obviously, those kind of -- the USD 1.2 billion target is kind of how you march towards a more ideal or, I guess, efficient capital structure is the way that you guys are thinking about that. Is that correct?

Yes, Dennis, that's correct. Yes, the interim point is $1.7 billion and all free cash flow is going to go against debt repayment until we hit that target. And then as we march down to the $1.2 billion, you're right, that's -- debt repayment still remains a priority, but there's also a material portion of free cash flow kind of go towards shareholder returns, post that $1.7 billion target.

Your next question comes from Neil Mehta with Goldman Sachs.

Eric, I guess the first question is just on the basis environment. You said in the release that you didn't hedge out the WTI:WCS differential, which makes sense because it's pretty wide relative to at least what we would characterize as mid-cycle. Maybe you could take a moment to talk about why you see the differential being so wide? And inventories, I think have built up considerably up there. And I know there are a lot of pipeline dynamics, but it feels like there could be some more of that. And how you see that resolving itself over the course of 2022? So maybe just step back and talk about the Western Canada oil macro.

Sure. Do you want to take that, Eric?

Yes. Thanks, Neil. I'll go back to the third quarter call, we spoke of this in the third quarter call and it sort of moved through to this period of time where we're right now, Neil, just given the fact that TMX has been shut down just given the storms out in BC. So what we saw in Q3, we thought was transitory just given the buildup in inventories in Western Canada, primarily from Line 3 coming on some unplanned outages downstream, and that sort of moved through time here into today. We do see that normalizing once TMX -- we think -- we understand TMX is going to come on in some limited capacity at the back end of this week. Once we get that fully ramped back up and we start to draw down inventories, which we expect to happen, we expect to see normalization differentials pushed out now maybe into sometime in the first quarter of 2022. But we still believe that from a supply/demand fundamental in the Gulf Coast, we expect to see differentials in Western Canada in that sort of 14% to 15% range for next year. And that view of ours hasn't changed from a month or so ago as it relates to the differentials in Western Canada and on the Gulf Coast.

Is there an element of energy costs globally as well and demand for heavy barrels that's impacting the balances for -- or the pricing mechanism for Western Canada? Or do you think this is more idiosyncratic around pipeline issues with Line 3 and Trans Mountain issues?

Yes. We believe, Neil, it's the latter.

Okay. Okay. Great. And then the follow-up is just on production capacity. You talked about making the ramp to 100,000 barrels a day. Remind us again, when do you think you can get there? Is that a '23 event? And Eric, there are points in time where we talked about growing over 100,000 barrels a day, is the view that actually that makes less sense here, run the business for free cash flow not for growth, is that the mantra?

So the mantra is very much run the business for free cash flow and very focused on debt reduction, as you would have seen in both of the press releases we put out yesterday. I think, Neil, as you think about our facility capacity and when we're going to be consistently producing above 100,000 barrels a day on a non-turnaround month basis, we're currently estimating that will occur post the second quarter turnaround next year. And that turnaround, as we stated, is about 30 days. So it takes a little time to recover from that turnaround as we pump off some of the condensed water that accumulates in the wells. But in the second half of the year, we're anticipating hitting consistently 100,000 barrels a day.

And Derek, if I could sneak one last one in. Embedded in the CapEx, there's no CapEx associated with pathways, right, because it's still in preliminary mode here as you develop the project?

That's correct. I mean where we're -- there's no pathways CapEx in our capital budget this year.

Your next question is a follow-up from Dennis Fong with CIBC World Markets.

Sorry, the other question I had was just around -- obviously given -- there's been a significant pullback in oil price. But how should we be thinking about hedging policy here forward? Especially, you have a plan to delever, it seems like even in a bit of a pullback in oil price, that still is relatively intact. But how do you think about managing, we'll call it, the downside risk in oil price here given kind of the backdrop of trying to accelerate returns back to shareholders as well?

I'll take a stab at this. Dennis, our current plan is not to hedge either the WTI commodity price. We think that our shareholders are -- they would like us to return as much free cash flow to them as we possibly can, but they do not want us to truncate the upside in terms of commodity price. So we will stay unhedged on that front. And quite frankly, our reason for hedging previously was to ensure that we could execute on our capital program and we have enough cash flow. We are comfortable that, that will be the situation and that, fundamentally, the commodity price has to get down into that $40 range before that's at risk. So no plans to hedge WTI. And as we look at the WTI:WCS differential, as Neil on a previous question said, it looks like it's somewhat higher. We believe this is a short-term phenomena that once we line out or we get TMX back on and -- you're going to see storage levels dropping in Western Canada and a fairly -- and bringing some of the refineries that are on turnaround down in the U.S. Gulf Coast back on, that we will be back into a that $14 or $15 WTI:WCS differential that we talked about earlier. So...

[Operator Instructions] Your next question comes from Phil Gresh with JPMorgan.

This is actually John Royall sitting in for Phil. He's traveling today. So the first one is just housekeeping. But when you discuss cash flows in the current commodity price environment, can you just clarify your assumptions on WCS differentials? Is it the current higher levels on the dip? Or is it more like the $14 to $15 you talked about with Neil's question?

No, it's the current strip at the time of the press release.

Okay. Great. And then can you also talk about your assumptions on apportionment just over the course of 2022 and how it progresses throughout the year, kind of average to your 2/3 of your barrels going to the Gulf Coast?

Yes, John, the way that we sort of model or look at apportionment is we -- as I said in the earlier question or answer to an earlier question, we expect to see apportionment perhaps a little bit higher in the first quarter of 2020, just as we work through TMX coming back online and the inventory is drawing down. And then we see that sort of normalizing. And on average, sort of 5% to 10% for the full year. So it'd be a little bit heavier in the front end of the year and then flatter in the back end of the year.

There are no further questions at this time. Please proceed. My apologies. We do have one other question from Menno Hulshof with TD Securities.

I might have misheard, but I think you mentioned that there wasn't any pathways CapEx in the budget. So is that because we're still waiting on the government to show its hand? Or is -- what's driving that? And is it safe to assume that it will show up in 2023?

No. I think the major reason that there's no CapEx in the budget is we're still working to refine our capital programs. And to your point, we're still trying to understand what the pathway or what the federal government and the provincial government contribution would be to that project. So we're still at fairly early days. Do I expect CapEx -- pathways CapEx to show up in coming years, in 2023? Absolutely.

There are no further questions at this time. Please proceed.

Well, thank you, operator, and thank you for all of those that joined us this morning for the call. And may I be one of the first people to wish you a wonderful holiday season. Look forward to updating you with our year-end results at the end of February. Take care, everyone.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.

Thanks, Pam.

Thank you. Have a good day.

You, too. Bye-bye.