Ovintiv Inc. (OVV) Earnings Call Transcript & Summary

Good morning, again. This is Arun Jayaram from JPMorgan's E&P Research team. Our next presenter is Ovintiv. Delighted to have Corey Code, who's the EVP and CFO of Ovintiv, and he's been with the company in various roles for over 20 years. As a reminder, Ovintiv is one of the largest independent North American oil and condensate producers, with a diversified multi-basin model. I'm going to turn it over to Corey to make some introductory comments, and then we'll do the rest of the session in a fireside chat format. Corey?

Thanks, Arun. Good morning, everybody. I hope everybody is staying healthy and safe. I'm joining here from our office here in Calgary, and just happy to get a little bit of normal back in our workday. So we've reoccupied some of our offices and are having some of the COVID protocols that -- make sure we can work collaboratively, but the new social distance norm as well. So thanks for joining us today. I just want to remind you a couple of the key things that differentiate Ovintiv, and Arun hit on a couple of them at the beginning. But I think when you think about Ovintiv, sometimes people forget that we are indeed one of the largest producers of crude and condensate in North America. We've spent a number of years transitioning our portfolio to have an abundance of oil investment options, but we still have a good piece of business in our natural gas space. So when you think about Ovintiv, some people are familiar with the plays that we're in, but they may also not remember that we've got about 200,000 barrels a day of crude and condensate in terms of scale and about 1.5 B a day of natural gas. So it provides us tremendous options to invest across the portfolio, and I'm sure we'll get into some of that today. When we think about the Permian, obviously, well-known to everybody as well as the Montney and the Anadarko more recently for us, as well as some of our other assets across the portfolio, which include either for Bakken, Uinta and the Duvernay. We also spend a lot of time talking about what we do from an operations perspective, and we like to benchmark ourselves. And we're happy when others do it across our different plays, just in terms of how we think about capital efficiency and deliver oil and condensate or natural gas as it might be for the least amount of capital possible. I think today, also, I'd be happy to address some of our liquidity and leverage comments. I think what you'll find when you dig into our situations that we have, a lot of liquidity, and it affords us the benefit of confidence that we'll be able to navigate through some uncertain times here with success and drive tremendous value. We've got a great track record. And I think where that becomes important, and we'll hopefully get into it today is -- when we talk about our view for the rest of the year and into 2021, we've got a lot of confidence that when we make statements about what we think we can deliver, that we are going to, indeed, deliver those and often try our very best to exceed them. So as a culture, we don't continue to take what we've said as lightly. We do make commitments and follow through with continuing to try and beat them. So a couple of things on that. We've had -- the last 2 years, we've actually delivered free cash flow. So this is a more common theme now where it's lower growth and delivering free cash flow. We're one of the few companies who's been able to do that with positive free cash of almost $500 million over the last 2 years. And I guess I'll just pause there and we can jump into some of the specific questions on the chat here, Arun. So back to you.

Great. Let's start with, call it, the bigger picture. Any thoughts from the OVV team on COVID-19, the oil macro and the demand shock? And what the company has done to preserve value in a low price environment?

Yes. And obviously, a lot has happened in the last couple of months. And so if you think about the macro component, there's really 2 pieces to it, what's happened to demand. And a lot of that is just a reflection of what's the various government initiatives around preventing spread and the various elements of reduced travel and lockdown. So as we see companies and economies start to return activity, and demand for transportation fuels increasing, obviously, that's starting to happen at various elements in different jurisdictions. So that's a positive sign. Obviously, that takes time to take hold. But it's starting to work in the right direction. So I think from that perspective, everybody's got their own view on what's happening with the different curves and different areas. I think there's been a lot of success, but people also realize that it's important to get economies back running and people back to work, and there's a balance of having people back at work with also being safe and managing the COVID. From a supply side, what Ovintiv did was very rapid response in the second quarter, where over a couple of successive announcements -- we took out about $500 million of capital. We took our activity level down from -- well, we had 23 rigs at the time, now down to 7. And we also took, which is pretty common, I think, a completion holiday in our operations. And we were able to do that without it having any penalties in our business. It's really demonstrating and using the flexibility that we've built into our business and preserving the liquidity that I referenced in the opening comments so that we can then make smart choices as we go through each successive month and quarter and into next year. So I think the portfolio and the strategy that we set up allowed us to then flex the capital program, and we did it significantly and rapidly such that then we can make decisions for good value as we see signs of economic recovery through activity as well as producer behavior in terms of the supply side on production.

And Corey, just given the impact of pricing, what's the strategy to kind of create value in this type of environment?

Yes. I mean so longer term, and, I guess, longer term might not feel as long as it used to, to some people. But for us, we still think at this current sort of price strip, obviously, that varies a lot. But there's good returns from investments in a lot of our assets today. I'm sure you've heard this before, but depending on where you are in our portfolio, you can generate decent returns at the $35 and $2.75 that we talked about kind of for next year. And it does vary depending on whether you're more optimistic on the oil side or the gas side where you might think about optimal allocation of capital in the portfolio. But the strategy that we've had for some time now of modest growth in high-value products, along with free cash flow and returning that to shareholders, that's still intact. We've delivered on that for the last 2 years. Obviously, this year is more challenging given the volatility and the big adjustments in price. But when you think about our business, we came into the year with a pretty significant hedge book, and we increased it even further, such that we're almost completely hedged on oil and condensate production, and we're probably in the range of 75% to 80% on natural gas. So we've got a lot of protection on the hedge front. And also, we've demonstrated that we believe we can run the business into next year while keeping scale and not using liquidity to run the business. So we don't need to debt finance the business, but also whenever you believe there's a recovery to come, we're still going to have enough scale to participate in a meaningful way and deliver value to our shareholders through that approach. So I think what you're seeing is us demonstrating the success of the strategy setup, which is the multi-basin portfolio, the flexibility and also a good financial and risk management setup that allow us to make smart choices in a time that things are changing pretty rapidly.

Yes. I wanted to ask you about your -- any updated views on sustaining CapEx requirements this year or next year. I know as part of your 1Q update, you did provide a hypothetical scenario, call it, maybe $1.9 billion of spending this year. I know it's not a guide, but just -- but you did put that scenario out there, maybe $1.5 billion next year. And maybe you could discuss potential production outcomes if you did indeed spend at that scenario level.

Yes. Thanks for introducing this one. I think this is probably the area we spend the most time talking to investors and, of course, sell-side about -- since the first quarter. And part of the reason we put it out during the first quarter was we saw a very different view from the outside versus what we believe strongly internally. And so as I mentioned before, with our track record of delivering continuously improving capital efficiency in our business, as we looked at 2020 and 2021, we had a lot of confidence that we're going to be able to deliver a much lower capital program to keep our business at scale. And it was time to communicate that as a scenario. And part of the reason we talk about that as a scenario is underneath that, there's a number of different pathways we can take to deliver that, and that's also what gives us confidence in delivering that. So with a multi-basin portfolio, we can flex investment in the Permian or the Montney and deliver the same results and outcome, and basically adjust to the various market dynamics. But if you think about 2020, we talked about a $1.8 billion to $1.9 billion scenario for the remainder -- or for the total 2020, and what that kind of would have us doing is completing the wells that we had drilled over the course of the year. We've got 7 rigs running across our core plays, so that's 3 in the Permian and then 2 in each of the Montney and the Anadarko. And it would leave us with what we would consider a normal inventory of DUCs exiting 2020. And it would probably put us in the neighborhood exiting of 200,000 barrels a day of crude and condensate. And then from there, we talked about what would it take to keep that level of scale into 2021. And that's where we talk about a plus or minus $1.5 billion capital program. And if you think about that, and you'll be familiar with this as I'm sure some of the audience is, but our old sort of reference, as we talk about maintenance or stay flat, or however people want to refer to it, we would call that kind of in the low $2 billion range previously. And there's a few things that drive that number significantly lower. One of them is continuous improvement in the capital efficiency of the business. So if you think about the first quarter, we demonstrated that the capital efficiency improved almost 10% just in the first quarter. Now that -- a lot of that came before all the COVID really hit the tape, and you could perhaps consider that there was price adjustments in the supply chain. So that really was just being more efficient in the operations, and then that creates a big tailwind in terms of reducing your overall capital required to stay flat next year. The other component of it is as you moderate your growth, as I'm sure you're aware and lots of conversations about this, as the business model of E&P becomes more about modest growth and free cash and less about high growth, as you moderate that growth level, your base decline also moderates. So we think we pick up another sort of 5 points on the base decline, which means you have less investment to -- required to keep that flat. More importantly, in terms of levers that we can control is the cost structure. I'm sure you've heard a lot about this from us and others. But for 2020, we think we've already identified $200 million to take out of our cost structure. And we think that number is more like $300 million next year because next year, we also get the benefit of what we call these legacy costs roll-offs. And for those that haven't followed us for a long time, there's $100 million that roll off of contracts that relate to prior natural gas strategies where we were effectively 100% natural gas company. So those are very certain and give, again, a lot of confidence that we can deliver that staying flat, 200,000 barrels a day of crude and conde for about $1.5 billion. So I think there's -- in terms of updates, we continue to have confidence that we can deliver that, and we've added to that as we get closer to that period. But we're still standing behind that improvement. I think the other thing I may have just glossed over on that is we do get questions on this piece, too. Underlying that, we did assume that we can deliver capital efficiency that's 20% better in 2021 versus 2019. I've already talked about almost 10% of that in the first quarter. But what's interesting is if you dig in and look at the well costs we use there, we've already drilled wells at lower cost than those that we've used. So as you're familiar with, we talk about our pacesetter wells, so that's the best well we drill in each play. And we think a pacesetter takes 6 to 9 months depending on who you ask to become the average well. And so our wells and our capital efficiency assumptions for next year, we didn't even go all the way to the pacesetter in next year's program. So again, we think it's a reasonable scenario, but it's based on a true experience as opposed to an aspiration. And we don't know how to get there yet.

Yes. My next kind of question is just -- it's a question I wouldn't have asked you a month ago. But how has the capital allocation strategy changed? If you think about crude maybe being around $40 today, if we move into a $45, or dare I say, $50 kind of environment, what would be any potential changes to capital allocation?

Yes. So I mean if -- there's really 2 pieces to the capital allocation question, and it depends who you're asking, I suppose. But from a capital structure standpoint, as we go from the $35 to the $45, or in your case, if you're more optimistic, then you can say $50, that creates a lot of free cash flow for us. And one of our priorities for next year will be to reduce the overall level of debt. And so as prices go up next year, it's not going to draw into growth in capital. For next year, we're committed to reducing leverage, and that means not just growing the EBITDA, it means reducing debt. So if you think about that scenario we talked about in 2021, every $5 over top of the $35 is $375 million of free cash flow. So it doesn't take a lot to increase over $35 before you've got meaningful free cash flow that almost covers the debt maturity we have at the end of next year.

Got it. Got it. Another thing that's been on investors' mind is we've seen a bit of an improvement in the '21 gas strip. You mentioned in your preamble how the company still does have a lot of torque towards higher natural gas prices. Can you talk about -- as you look -- as we think about the '21 strip, is -- are there any opportunities to invest in natural gas projects next year? Or how do you play, call it, an improvement in gas for '21?

Yes. And I think the base business, where we've got about 1.5 B a day of gas, a good part of that, probably about a Bcf a day comes from Canada, it's legacy sort of Montney production, right? So we're going to have that exposure and upside one way or another. We don't necessarily need to invest to add to that. As you think about our economics, though, and this is maybe back to your previous question on capital allocation, we do have opportunity within each play to the extent gas prices were stronger to just move within the acreage to change the mix of liquids versus gas. Now I think to do that, though, we'd need to see stronger gas prices further out the curve as well. So just having a -- next year's gas price improve, obviously, the payout on those wells is -- can be very short inside of a year. But you'd need to see stronger economics to then move your capital within that. At this point, I would consider it more upside on the existing gas production that we have today. But it certainly could be upside for us from there. I think for each quarter, we talked about -- sorry, each $0.25 improvement in NYMEX, about $140 million in free cash flow next year.

Got it. Corey, next topic. This is kind of -- wanted to ask you about the dividend, the sanctity of the dividend. A lot of peers have cut, eliminated, slashed and done some things to the dividend. But where do you kind of stand regarding the dividend, and thoughts on a go-forward basis?

Yes. And I think it's important when talking about the dividend, too, is the business model and the strategy of the company. So for us, we've been committed to a modest growth in valuable products with a return to our shareholders. And we've committed to the dividend and set the dividend, frankly, at a level that we've tested to price that's probably even lower than they are today. So we think the dividend is an important part of the overall offering to the shareholders. And we believe it's probably, on a nominal basis, just under $100 million annually. But it's an important signal to investors and shareholders that we're committed to delivering cash back to shareholders. Now next year, as I alluded to, the free cash goes to repay debt. And in a -- maybe an indirect way, I think that's an important rebalance of the capital structure, and our equity investors will benefit from that, at least as we bring our leverage more towards our longer-term target and where we think the optimal level is. So we're happy with where the dividends at. We think, if you consider our 2021 program is fully funded on the dividend at $35, it doesn't -- it shouldn't feel like it's something we're using borrowed money to pay either. So that's an important piece to consider and how it fits together as well.

Yes. I did want to shift gears and talk a little bit about the liquidity situation and some of the unique features of your credit facilities. And just overall thoughts on any conversations you had with the rating agencies around your investment-grade credit rating.

Yes. And so as I'm sure you're aware, we talk to rating agencies on a regular basis. Our goal is that they get tired of talking to us because the more we think they understand our business and how we would operate, the better decisions they'll make when coming to their rating outcomes. So I mean, as a matter of practice, we talk to them quarterly. We talk to them any time there's a big transaction or change in the company. And in fact, we met personally with them in New York not long before the various lockdowns began, and that was just a regular, just get to know them as part of the redomicile aspect as well. So we have ongoing dialogue with the rating agencies. And I think one of the things that helps protect the investment-grade rating for us is just the scale of the business that we have across a number of different plays as well as the liquidity that you referenced that helps them get confidence that we're going to be able to get through whatever period of weakness they see for demand and pricing for our products. More specifically on the liquidity front, we do have and we recently renewed $4 billion of credit facilities, and those mature in July of 2024. And they're basically -- in case the listeners aren't familiar with it, the $4 billion is a fixed amount, so there's no quarterly redetermination. It doesn't vary with our market cap, with prices, with the amount or value of the reserves that Ovintiv has. It's a fixed amount. And then we can draw on that as we need to on an unsecured basis. So that's a tremendous advantage, I think, when you're sitting in a world like we are today, where you can get probably incremental liquidity. But it's going to be very expensive for companies to do so. But we also then, importantly, don't use that to run the business, and you design a 2021 scenario that says how do I fund the business without using that tremendous asset, which is our liquidity. And the other piece, just to highlight, within that credit facility, there's one primary financial covenant. It's a book to -- debt-to-cap on a book basis, and it has an add-back into that where we get to add back our historical impairments of $7.7 billion. So effectively, that means it's a very insensitive test to changes in book amounts, and it gives us a lot of confidence that it will be there when we need it over the period of time to get through to midyear 2024. Now all that being said, like I mentioned, we don't design the business to use the liquidity, but it's a nice backstop, and it should give people confidence that you can make smart value choices rather than being forced into difficult trade decisions.

And Corey, the next question, you do have some debt maturities that are due, I think, just under $600 million in '21, $660 million in '22 and $1 billion in 2024. One of the things we've seen is the credit markets have really thawed when you think about some of the spreads we're seeing and kind of the margin. Perhaps you can thank Jerome Powell and the Fed in the U.S. for really helping. But just your overall thoughts on addressing some of these nearer-term maturities, given how we have seen the capital markets open up, particularly on the bond side.

Yes. And I think the way it's opened up has been pretty typical of recovering from a shock event, right? If you go back to the 2015, '16 period, we saw a similar pattern where the higher credits come and stock up on liquidity through the debt markets. And then you get down into the lower end of investment grade and now you're starting to even see some of the higher quality, high-yield names come to the market. So for sure, the market has improved. And as you alluded to, there's structural components that are enhancing that. I think what we're watching is what's the right balance for us of coming into market and doing a refinancing versus waiting a little bit to go ahead and move some of that out further into the curve. I think you got to pair that with, though, our commitment to reduce debt, right? So we do have some availability to repay without penalty on our revolver as well. So for us, it's constructive to see the market open. I think when you have a business that we think works very well in $35 and $2.75 world and liquidity that has us with ample space until 2024, you can be a little bit more patient and see how it comes through. But I think we're watching and encouraged with the direction that it's headed in the last -- even in the last couple of weeks.

And not to pigeonhole you, but is this something that you could look to do perhaps this year? Or any thoughts on potential timing?

Yes. I mean, obviously, if you're going to do a refinance, you want to do it when you can and not when you have to. But for us also, like I said, if you're more optimistic for next year than $35, we have a lot of free cash flow that goes with that, right? So I think obviously, the sooner we could do it with strong rates -- I mean we're probably not going to get back to pre-crisis rates for a while. But that's not sort of how we're looking at it. It's the balance of what's the right time to do it with all of the other options that we have in front of us. So I think it's very dynamic. As you know, it opens and closes on a daily basis. It's not as straight ahead as it used to be, but we're watching it very closely. I think if you look at the way our fixed income trades, which is maybe not as transparent as the equity, obviously, it's improved a great deal over the period of time here. But we still have some that trade at discounts to the par as you get further out into the curve. So there is a little bit of the structural component as to how the fixed income trades that we watch and try and talk to different investors about as well.

Okay. I wanted to switch to the next topic, which is the redomicile from Canada to U.S. The goal is to attract a larger pool of passive money. And obviously, this occurred during a time where the markets kind of went haywire. So -- but I did want to get your thoughts on what you're seeing in terms of the opportunity set for the passive flows. I know you're just added or will be added to the Russell 3000 Index, I believe, at the end of this month. Then maybe you could talk through some of the potential demand factors there for passive money.

Yes. And I think you've done a nice intro there. So as part of the domicile in the U.S., there was -- a big component of that was related to getting better following from the passive funds as well. And if you reflect back to kind of where we were pre-domicile, we had about 7% of our shareholdings in passive funds. And if you looked at any of our peers across market cap ranges, it kind of varied between 25% to 30% for a U.S. company, regardless almost of whether they were in one of the smaller cap indices or in a larger cap indexes. So it wasn't something where we saw a small pickup. This was a potentially 3 to 4x improvement. And so while the 7% that existed at the time was largely Canadian or international passive, it has been largely replaced. And I think, as you mentioned, we'll go into the Russell 2000 later this month. That's already been announced. We expect CRSP to follow probably this month as well. They're typically a June number. S&P, we expect they'll include us in their total market index. And with the 3 of those combined, we'll have effectively tripled our passive shareholdings even before going into any of the S&P 1500 constituents. So obviously, the period of time between their domicile change in mid to late January and today has been volatile in the market. But the passive flows have largely played out how we expected. And June is really going to be a big month in terms of some of those hitting the scoreboard officially.

Great, great. I think we have time for one more -- or final question. Can you give us some thoughts on the portfolio where you and Doug kind of think it stands today? And just overall thoughts on how you think the portfolio is positioned for what you see as the future outlook in terms of oil and gas development through shale?

Yes. Well, I think when you look at our portfolio, I did give kind of the quick rundown of all the multi-basin assets that we have. But I think what's really interesting and when you look at ours and if you go back even to 2013, one of our original principles was that we need to be in the best rocks. And so we've spent a lot of time trying to make sure, within the place that we choose to be and that the acreage we have, we believe, is the best part of the acreage because good rocks are hard to find, and good rocks tend to get better as you develop them more. So in the Permian example, like we've been adding new inventory just within our acreage by derisking new zones. Well, they're not new zones, they've been there for a long time. But commercializing zones like the Jo Mill as an example. So we look across our portfolio, we're happy with the inventory that we have, especially in the core plays. We've talked about those being in excess of a decade. And especially as you slow your growth rate, that does extend that runway. But it also means, in some of your other assets, you've got optionality in terms of how much you invest, at what pace, because some of those assets we've been developing to deliver cash flow and to help overall shareholder return. So largely, I'd say we're happy with the portfolio. The things that sit outside the core are there not because they don't have a great rock. It's just a potentially more limited set of inventory and scale, such as things like the Eagle Ford or the Bakken, right? They can deliver great returns, but they don't have the decade-plus inventory that we would have in the other plays.

Corey, thanks. That was a fulsome update on the company. Thanks again for participating in our fifth annual energy conference, this time virtually. Hope to see you in New York City live next year where we don't have to stay 6 feet apart. Anyways, thank you to you and the rest of the team at Ovintiv.

Thank you. Likewise. Look forward to seeing people in person soon.

Yes. Great.

Thanks a lot.