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Edited Transcript of CVE.TO earnings conference call or presentation 26-Apr-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Cenovus Energy Inc Earnings Call

CALGARY Aug 12, 2017 (Thomson StreetEvents) -- Edited Transcript of Cenovus Energy Inc earnings conference call or presentation Wednesday, April 26, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Charles Ferguson

Cenovus Energy Inc. - CEO, President and Non-Independent Director

* Ivor Melvin Ruste

Cenovus Energy Inc. - CFO and Executive Vice-President

* Kam S. Sandhar

Cenovus Energy Inc. - VP of IR & Corporate Development

* Kieron McFadyen

Cenovus Energy Inc. - Executive Vice-President and President of Upstream Oil & Gas

* Robert William Pease

Cenovus Energy Inc. - Executive Vice-President of Strategic Planning and President of Downstream

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Conference Call Participants

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* Chui Kit Wong

Morgan Stanley, Research Division - VP

* Fernando Valle

Citigroup Inc, Research Division - VP and Senior Analyst

* Greg M. Pardy

RBC Capital Markets, LLC, Research Division - MD and Co-Head Global Energy Research

* Michael Paul Dunn

GMP Securities L.P., Research Division - Director of Institutional Research

* Neil Singhvi Mehta

Goldman Sachs Group Inc., Research Division - VP and Integrated Oil and Refining Analyst

* Nima Billou

Veritas Investment Research Corporation - Investment Analyst

* Philip Mulkey Gresh

JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst

* Yim Chuen Cheng

Barclays PLC, Research Division - MD and Senior Analyst

* Dan Healing

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy's First Quarter 2017 Financial and Operating Results. As a reminder, today's call is being recorded. (Operator Instructions) Please be advised that this conference call may not be recorded or rebroadcast without the expressed consent of Cenovus Energy.

I would now like to turn the conference call over to Mr. Kam Sandhar, Vice President Investor Relations and Corporate Development. Please go ahead, Mr. Sandhar.

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Kam S. Sandhar, Cenovus Energy Inc. - VP of IR & Corporate Development [2]

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Thank you, operator, and welcome everyone to our first quarter 2017 results conference call. I would like to refer you to the advisories located at the end of today's news release. These advisories describe the forward-looking information, non-GAAP measures and oil and gas terms referred to today, and outline the risk factors and assumptions relevant to this discussion. Additional information is available in our most recent annual information form or Form 40-F. The quarterly results have been presented in Canadian dollars and on a before-royalties basis. We've posted a link to our quarterly results on our homepage of our website at cenovus.com.

Brian Ferguson, our President and CEO, will provide brief comments and then we'll turn to the Q&A portion of the call with Cenovus' leadership team. Please go ahead, Brian.

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [3]

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Thanks, Kam. Good morning, everyone. I'm pleased to report that the first 3 months of 2017 mark yet another solid operational quarter for Cenovus. We also mark a turning point for our company. While 2016 brought heightened commodity price volatility, Cenovus proved its resilience and entered 2017 in a position to take advantage of the significant liquidity and improved cost structures that we've achieved since 2014. In a volatile commodity price environment, economies of scale are important, and the acquisition we announced last month approximately doubles the scale of our company. This is something that I believe will give us a greater competitive edge, and it transforms us into a better, stronger company with long-term upside potential.

The oil sands will continue to be our prime focus. The production ramp-up of the latest Foster Creek and Christina Lake expansion phases as well as the go-forward capital efficiencies that we've been able to achieve for Christina Lake phase G and for potential future expansions, reinforces the strategic rationale for consolidating our ownership in these top tier oil sands assets.

In the first quarter of 2017, Foster Creek production averaged approximately 81,000 barrels per day net, a 33% increase from the first quarter of last year. Our successful execution of a focused well maintenance program and completion and startup of 7 new well pads, including the on-time startup of phase G in 2016, reaffirms our team's ability to leverage 15 years of experience operating these assets and apply a manufacturing approach to deliver on our plans.

As you will see from our results today, our Christina Lake asset continues its impressive operational performance. Production in the first quarter averaged more than 100,000 barrels per day net to Cenovus. Compared with the first quarter of 2016, Christina Lake production was up 31%, with the startup of phase F in the fourth quarter of last year contributing strong volumes over the first 3 months of 2017.

Nonfuel operating costs at both Foster Creek and Christina Lake were lower in the first quarter compared with the first 3 months of last year, primarily driven by increased production and reduced workforce costs as well as improved prioritization of maintenance activities. At Foster Creek, nonfuel operating costs averaged $7.06 per barrel, that's down 26% from the first quarter of 2016. Christina Lake nonfuel operating costs averaged $5.51 per barrel in the first quarter, that's down slightly from a year ago. Late last year, we announced our plans to resume investment in the Christina Lake phase G expansion. Fuel construction has resumed and we expect activity to ramp up in the first half of 2017. We continue to anticipate first oil in the second half of 2019.

Our conventional oil and natural gas portfolio remains the most flexible component of our capital and continues to generate significant free funds flow to invest in our company-wide growth opportunities. In the first quarter, our conventional oil and gas portfolio generated $57 million in free funds flow, after the investment we made to resume our tight oil program in southern Alberta. We have successfully completed planned turnarounds at both the Wood River and Borger refineries. While this reduced our crude utilization rates, higher-average market crack spreads improved operating margins over the year.

The refining and marketing segment generated $53 million in operating margin in the first quarter of 2017 compared with an operating margin shortfall of $23 million for the first 3 months last year. As I mentioned earlier, the first quarter of 2017 marks a turning point for our company. As we look ahead to the successful completion and integration of our recently announced acquisition.

Let me say once again how excited I am about this transaction. We are transforming our company, at what I believe is a pivotal time in the industry, and the beginning of a technological renaissance. Following the completion of this acquisition, we will have full exposure to our future oil sands growth opportunities, and significant upside potential from emerging technologies that are already underway. We will also gain an established expansive position in the Deep Basin, where we see substantial opportunity for short cycle, high internal rate of return growth potential.

We will nearly double our existing production capacity with a clear line of sight to meaningful growth, resulting from our large inventory of regulatory approved oil sands projects and a decade of identified drilling opportunities in the Deep Basin. The greater size and scale of Cenovus significantly enhances our cash generation capacity over a range of commodity prices. Assuming the successful closing of the acquisition and including the anticipated impact of planned asset sales, Cenovus expects to have capacity to generate 2018 free funds flow of approximately $500 million, assuming WTI price of USD 50 a barrel and NYMEX gas prices of $3 per million BTU. With this kind of capacity, we'll have the scale and flexibility necessary to have a far greater competitive edge. Since the agreement was announced on March 29, Cenovus has made good progress in executing its acquisition plan. To reduce debt associated with the transaction and to strengthen our balance sheet, we've begun marketing our legacy Pelican Lake and Suffield conventional oil and natural gas assets.

We're very pleased with the response that we've seen to date, and our data rooms have been very busy. There is strong interest in high-quality Western Canadian properties right now, and we received a number of inbound calls on both our existing legacy conventional assets and components of the newly-acquired Deep Basin assets. We are evaluating all options available to us and we'll take a portfolio approach as we look ahead to further streamline our asset base, preserve our financial resilience and deleverage our balance sheet.

In addition, we successfully completed a $3 billion bought-deal equity financing and closed a USD 2.9 billion debt offering of senior notes. I'm also pleased to announce that we now have commitments from our lending syndicate to extend the tranches of our existing credit facility out to 2020 and 2021, and to increase the total capacity to $4.5 billion. We expect this credit facility transaction to close later this week.

To further support our financial resilience, while the asset sale bridge loan remains outstanding, we plan to hedge a greater percentage of our forecast liquids and natural gas volumes, allowing us to increase certainty on a larger portion of our expected cash outflows. For the remainder of this year, we have 87,500 barrels per day of crude oil hedges in place at an average minimum price of USD 49.20 per barrel and 50,000 barrels per day hedged at an average minimum price of USD 49.74 per barrel for the first half of 2018. The solid financing plan that we have in place, coupled with the post-acquisition liquidity of approximately $4.5 billion affords us the flexibility to execute on our planned divestitures.

I'm extremely pleased with the milestones that we've achieved to date. We're doing what we said we'd do, and as we move forward with our plan to complete this acquisition, preserving our financial resilience and remaining committed to our investment-grade credit ratings remains top of mind. I'm confident and excited about our new company, and I look forward to sharing more with you following the close of this transaction.

With that, the Cenovus leadership team and I are ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Benny Wong from Morgan Stanley.

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Chui Kit Wong, Morgan Stanley, Research Division - VP [2]

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Just in regards to Deep Basin, you put out a target of potentially reaching 170,000 barrels per day or 40% growth by 2019. What are the gating factors to reaching that? Are there any other strategic considerations you got to balance out that growth other than, say, commodity prices?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [3]

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Thanks for the question, Benny. So they -- you're correct. We believe that we have the opportunity to increase production in the Deep Basin by 40% between now and 2019, and that is largely focused on simply reactivating the -- some drilling rigs there. We have more than sufficient firm transport takeaway capacity. The existing infrastructure is only about 40% utilized. So this really is a primarily a focus on drill, complete and tie-in. There is a small amount of pipeline that has to be done to make sure that we've got gas flowing to the right facilities. But it's primarily drill, complete and tie-in. I would just emphasize that we have identified 1,500 economic-risked locations, which is a decade of drilling activity for us.

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Chui Kit Wong, Morgan Stanley, Research Division - VP [4]

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Brian, and you mentioned in your opening remarks, you guys plan to take a portfolio approach as you look at more divestitures. Can you maybe give us a color on how you're thinking about this? And what the key strategic considerations you're balancing when you're going through this process?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [5]

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Sure. So we have Suffield and Pelican Lake, which are 2 legacy Cenovus conventional properties. In data rooms right now, they're very active. We've got lots of [CAs] signed on both of those assets, and there is quite a variety of potential purchasers in the data rooms. So our prime focus here over the next several weeks is to continue with the divestiture program on those assets. We have got a number of other alternatives, whether it's -- other producing assets, whether it's potential infrastructure, those sorts of things. Also, we had a lot of inbound calls already on portions of the acquired assets in the Deep Basin. So we'll be taking and really thinking about the pro forma portfolio and where and how we will allocate capital as we think about how we achieve the minimum of $3.6 billion divestiture target. And just to reiterate, our target is to have that substantially complete by the end of this year to delever our balance sheet.

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Chui Kit Wong, Morgan Stanley, Research Division - VP [6]

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Got it. Okay. And just for the final question. It seems like the markets have reacted pretty strongly to the deal. What do you think the market may not be focusing on? And what do you think are the key steps needed from this point forward, before that value becomes more clear to investors?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [7]

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Thanks, Benny. So we've had a lot of feedback around the short-term increase in leverage on the balance sheet. So we've absolutely gone from having a very, very low leverage and low level of net debt to -- which is actually one of the key reasons we've got the financial strength to take advantage of all of the things that we've been able to accomplish over the last 2 years, in terms of changes in our cost structure, to be able to undertake this. So there is -- has been a lot of feedback on the short-term increase in leverage and the plan to delever the balance sheet. I would just reiterate that we have got 3 investment-grade credit ratings, Standard and Poor and DBRS have reaffirmed their investment grade. Fitch is a new investment-grade credit rating for us. And we are very focused on making sure that we continue to manage the company as an investment-grade company. So that's been the prime feedback. We've also had feedback expressed around the price of the total transaction, and I strongly believe that we have paid a fair price for top-tier assets that position us for a decade of organic growth opportunities as we go forward in 2 of the very strongest oil and gas plays in Canada and in the oil sands and in the Deep Basin. And once we've substantially completed the divestitures, then we will be absolutely revisiting the optimal level of our dividend. And returning cash to our shareholders is going to be a very top priority for us as we go forward. I think this transaction really does make us a better, stronger company. We more than doubled the cash generation capacity of the company. We do not double our capital. We've got a lot of flexibility in our capital program go-forward. If we see downward excursions in oil prices, we've got $4.5 billion in liquidity, pro forma, when we close this transaction. So we've got a very strong financing -- financial plan in place. And now it's really up to us to demonstrate that we are going to continue to deliver just as we have quarter after quarter for the last several years.

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Operator [8]

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You're next question comes from Greg Pardy from RBC Capital Markets.

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Greg M. Pardy, RBC Capital Markets, LLC, Research Division - MD and Co-Head Global Energy Research [9]

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Brian, in your opening remarks you mentioned scale being an important driver, just on this deal. But when you think back to the motivation in terms of doing this, did you feel as though you had just too many eggs in the long-cycle-time basket, and there needed to be sort of a rebalancing, especially, in the oil price environment we're in? Or am I missing -- at this point, I can't understand that motivation.

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [10]

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Sure. Thanks, Greg. So I think -- as I mentioned, I think that this transaction really anchors us in 2 of the best oil and gas plays in Canada. It gives us 2 growth platforms. Our -- Cenovus' existing Conventional business has always been managed as a financial asset, and it's -- we manage it to optimize free cash flow coming off of it. This positions us to have a free cash flow generating growth platform in the Deep Basin, which is immediately free cash flow generating at a $50 WTI and $3 AECO price that, very importantly, has got meaningful organic growth opportunities ahead of us for the next decade. So really what it does -- and I think about Cenovus in a fluctuating commodity price environment where to have the appropriate complement of short, medium and long-term operator -- opportunities to grow earnings and cash flow. So as a going concern, this gives us that, and that to me is critically important. As I mentioned also, in response to the earlier question here, it doubles our cash generation capacity. Now that's part of the opportunity of scale, and economies of scale are critically important, I believe, in a commodity business. We've got to have a very robust business model in a $50, $55 WTI environment as we go forward. So anything that we can do to continue to take advantage of scale. And one of the great opportunities here, I think, for us as we go forward is going to be on supply chain as an example. And the opportunity to apply manufacturing techniques that we are really focused on in the oil sands, to be able to apply that now to a decade of investment opportunity in the Deep Basin, are going to be very important in terms of how we focus on continuing to drive improvements in our cost structure, again, in what will likely be a fluctuating commodity price environment. Our ability to be able to organically grow cash flow in earnings at flat oil prices of $50, without reliance on commodity prices, to be able to grow cash flow, to be able to do that in a flat price environment, I think, is going to be a very powerful model for us as we go forward.

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Greg M. Pardy, RBC Capital Markets, LLC, Research Division - MD and Co-Head Global Energy Research [11]

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Okay. Last one from me. Telephone Lake, where is it -- where does it fit or not fit into the portfolio now?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [12]

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Telephone Lake has got a very focused small team looking at how we derisk it. There's a very small amount of capital. Our prime focus for the next 5 years is going to be on the great organic opportunity that we see today at Christina Lake, Foster Creek, Narrows Lake. That's 5 years of full regulatory approved growth for us on those assets, which is largely, essentially, brownfield expansion. Telephone is a tremendous long-term asset for us, but it's not in the near term going to get a lot of capital applied to it.

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Operator [13]

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You're next question comes from Phil Gresh from JPMorgan.

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Philip Mulkey Gresh, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [14]

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First question, just -- you made a comment about your focus over the next few weeks on these asset sales, so I don't want to read too much into it, but I was just curious if you feel like you've made enough progress at this point that you might be able to see something in the second quarter? Or is it too early to call that?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [15]

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I think it's too early to give a specific date. We have got, and are running very competitive processes there. We've got a lot of interest, so it's going to take us a little bit of time to actually get through all the management presentations and get through first-round bids. But certainly, we would anticipate that -- sort of in that late third quarter time frame that we should be able to give very clear information about the -- those 2 packages, in particular, and the timing of their divestiture.

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Philip Mulkey Gresh, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [16]

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Late third quarter, okay. And then, second question, just in terms of kind of the oil price. Yet you talked about the hedges that you've put in place. So I'm just curious -- I know it's not the base case for the market at this point, that OPEC wouldn't extend the cuts. But in the event that we do see oil prices fall, I'm just curious how you're thinking about the additional levers that Cenovus could pull to protect the balance sheet as you work through the asset sale process and work down the leverage?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [17]

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Yes. Thanks, again. So we did announce that we have added additional downside protection. You should anticipate that we will continue to increase our hedged positions to protect downside excursions in, particularly, in oil price, but also potentially natural gas price to ensure that we've locked in a minimum floor in terms of our cash generation on a pro forma basis to make sure that we have got a very strong backdrop to continue to proceed with the divestitures and accomplish those. I would just also, as part of that, just remind you that we are keeping $1 billion in cash on the balance sheet. We will have $3.5 billion in undrawn capacity on our credit facilities. And the asset bridge has 12-, 18-, 24-month tenor to it. So we've got lots of capacity under: one, first, the asset bridge; number two, the backstops on liquidity between cash and the undrawn; and we've also got a good selection of opportunity on the divestiture side to ensure that we achieve that minimum $3.6 billion divestiture target. We also have flexibility on the capital program. So you'll recall in the prospectus that capital forecast was kind of in the $2 billion to $2.2 billion range. The sustaining capital component of that is $1.5 billion to $1.6 billion. So we estimate that at $45 WTI, we can cover all the sustaining capital plus the pro forma level of the dividend on a pro forma basis post-closing.

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Philip Mulkey Gresh, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [18]

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Okay. And then, one question, just on the quarter, with Foster Creek. I noticed that the OpEx was kind of below the range guided for the year, and then the royalty was actually above the range for the year. So I was just wondering if either of those did something kind of more one-time in nature? Or the -- kind of the sustainability on both of those?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [19]

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I'm going to ask Kieron McFadyen to respond to that.

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Kieron McFadyen, Cenovus Energy Inc. - Executive Vice-President and President of Upstream Oil & Gas [20]

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Yes. Thanks, Phil. It's essentially a story of 3 parts, Phil. Production growth, first of all, helped us on OpEx in Foster. I think our team up there has done a great job in terms of focus on optimize well and facility maintenance. So we are seeing a significant impact there. Earlier, this year, we went through some reorganization work in Foster Creek. So we're seeing the impact of manpower reductions overall. So these are the 3 things, growth, maintenance focus and manpower levels.

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Philip Mulkey Gresh, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [21]

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Got it, okay. And then on the royalties? I can take it offline, if you guys don't have it in front of you.

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Kieron McFadyen, Cenovus Energy Inc. - Executive Vice-President and President of Upstream Oil & Gas [22]

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Yes, no it's...

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [23]

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The prices were a little bit higher in the quarter, so royalties are price-sensitive because Foster Creek's in payout.

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Philip Mulkey Gresh, JP Morgan Chase & Co, Research Division - Senior Equity Research Analyst [24]

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Okay. And then, just in terms of modeling the deal-in, should we be factoring it in as a 2Q event, given the effective date that you've talked about for the transaction? Or should we think of it more in the second half?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [25]

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So we do expect to close the transaction, mid- to late May is the target. And you're right, it is effective the beginning of the year. So the cash flow that we'll get for that first 4.5, 5 months will be treated as a purchase price adjustment.

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Operator [26]

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You're next question comes from Neil Mehta from Goldman Sachs.

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Neil Singhvi Mehta, Goldman Sachs Group Inc., Research Division - VP and Integrated Oil and Refining Analyst [27]

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I wanted to circle back on asset sale potential. I appreciate the color on Pelican Lake and Suffield. Can you talk about other opportunities, potentially within the portfolio, as you think about going above the $3.6 billion level? And with the framework you guys are using internally to that, what are the assets that are best for divestiture?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [28]

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Thanks for the question, Neil. So I'm going to be primarily focused on our pro forma portfolio, and where and how we're going to be allocating capital in the pro forma portfolio. So as you mentioned, once we've closed the transaction, then we're going to very quickly be assessing which parts of the new portfolio in the Deep Basin, for example, we'll be focusing on in the near term, in terms of reactivating capital there, and be in a position to assess which parts may be noncore. You should expect that one of the things we'll be doing in the Deep Basin, in particular, is looking to continue to high grade through swaps, so on and so forth. Obviously, it'll also be influenced by initial drilling success that we would have there. But that's a very competitive part of the basin, so expect there to be ongoing activity there to continue to high grade and increase capacity utilization at the various processing facilities. So there are things that we've had numerous inbound calls, and I think within the -- in the first 24, 48 hours, I had calls from 7 other CEOs expressing interest in various components, not just at the Deep Basin, but Cenovus' existing portfolio. So we've got lots of opportunity, I think, and it really will be focused on where and how we're going to allocate capital in the pro forma portfolio go-forward. So we'll be really trying to be focused on that, and where we think we're going to be able to generate the best value through both divestiture and then the pro forma portfolio investing go-forward. So multiple opportunities. We've had inbounds on infrastructure, for example, as well. So lots of ideas and stay tuned. We'll be able to give you a lot more color at our Investor Day in June.

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Neil Singhvi Mehta, Goldman Sachs Group Inc., Research Division - VP and Integrated Oil and Refining Analyst [29]

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Well, I appreciate that. Actually, this one might be for the Investor Day in June as well, but as you think about potential growth projects, Narrows is certainly one of those, with this FCCL transaction, how do you think about Narrows in the context of growth opportunities?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [30]

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So Narrows Lake is a tremendous growth opportunity. We've got regulatory approval for 130,000 barrels a day there. We are right now going through a very rigorous capital review on Narrows Lake. One of the things that's particularly attractive, strategically, about Narrows Lake is the application, commercially, of the use of solvents. So it -- in addition to being an attractive economic opportunity, it's got some strategic value because of the commercial use of solvents there which, I think, is going to be a real step-change in the SAGD business. So you're right, we'd -- our plan is, at our June Investor Day, that we'll give good fulsome update, both on capital efficiencies and on timing of Narrows Lake A and Foster Creek H.

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Neil Singhvi Mehta, Goldman Sachs Group Inc., Research Division - VP and Integrated Oil and Refining Analyst [31]

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Last question from me is just on the Conoco's stake in Cenovus. Can you walk us through, again, the mechanics of that to the extent that they do want to sell down their stake as they said publicly? It's not their intention to hold other publicly traded companies. What would be the timeline and what sort of protections do Cenovus investors have against any premature sale?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [32]

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Thanks, Neil. I am glad you asked that question, so we can give some good clarity on that. So there is a 6-month lockup period after closing where they're not able to sell or no hedging or derivative activity is allowed during that 6-month lockup period. We do have agreed-upon mechanisms that allow them to execute an orderly disposition of the shares, that's through a registration rights and investor agreement. And in addition, there are securities rules in the U.S., which limit the ability to sell shares in the open market as long as they hold more than 10% of our outstanding shares. But there's -- I think the key message is, that we don't expect that they will be a long-term shareholder, and that for the first 6 months after closing, there's no activity, and then after 6 months that there are mechanisms to provide for an orderly divestiture of their position should they choose.

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Operator [33]

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Your next question comes from Paul Cheng from Barclays.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [34]

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Brian, just want to clarify, you're saying that Foster Creek is already in the post payment period? They're not in the prepayment?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [35]

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That's correct. For royalty purposes, it reached payout a few years ago.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [36]

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And so if we don't, we sanction the phase H. That will continue to be the case. And for Christina Lake, if after we sanction phase G, which is probably not the case, but if you stop sanctioning any project, when that is going to become post payment? Any rough idea? (inaudible) oil?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [37]

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Yes. That depends -- yes, you hit the [nail] on the head there. It depends upon price -- the actual realized prices, but it's -- that price deck that you talked about, it's 2 or 3 years outbound before it would reach payout for royalty purposes.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [38]

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And with the addition of Deep Basin, does it, in any shape or form change your drilling program in the Palliser well?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [39]

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No. It does not change the -- and we've had good success on Palliser, with the appraisal drilling program that we have undertaken. We'll certainly, as I mentioned, after closing, be taking a look at the pro forma portfolio and where we see the strongest returns in the portfolio.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [40]

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The final one, just on the accounting. In the event that -- if there's any contingency payment to Conoco. When that occur, would they be record as a P&L item from your book? Or that is just a cash flow, and would be balance sheet adjustment to the purchase price? Accounting-wise, how should we look at it or treat it?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [41]

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I'm going to ask our Chief Financial Officer, Ivor Ruste to respond to that.

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Ivor Melvin Ruste, Cenovus Energy Inc. - CFO and Executive Vice-President [42]

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Thanks. Paul, we recorded an estimate for accounting purposes in our pro forma financial information of about $422 million, I think, for that contingent payment. So any payments against that would be to reduce that liability in a go-forward basis.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [43]

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So that way you'll essentially just say, balance sheet item then, I presume. It's not a P&L item?

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Ivor Melvin Ruste, Cenovus Energy Inc. - CFO and Executive Vice-President [44]

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That's correct.

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Yim Chuen Cheng, Barclays PLC, Research Division - MD and Senior Analyst [45]

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And in the event that you go above it, would that still be a balance sheet item? Or that is just adjusting further on your purchase cost? Or it would become a P&L item?

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Ivor Melvin Ruste, Cenovus Energy Inc. - CFO and Executive Vice-President [46]

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It will become a P&L item to the extent it's above that, over the 5-year period.

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Operator [47]

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Your next question comes from Mike Dunn from GMP FirstEnergy.

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Michael Paul Dunn, GMP Securities L.P., Research Division - Director of Institutional Research [48]

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Brian, just wondering with respect to, I guess, your other legacy conventional assets, specifically the Palliser block and Weyburn. Public processes have not begun for those 2 yet. Is that because the fate of those, in terms of whether you wanted to sell them and how much, might depend on what you want to do with divestitures from the Deep Basin assets? Or are there other reasons why you were ready to go with Pelican Lake and Suffield, but not with those 2 assets?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [49]

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Thanks for the question, Mike. So you may recall, in the third quarter of 2016, I said that we had 2 noncore conventional properties that were data room ready. Those were Suffield and Pelican Lake. So that was a portfolio decision that we had made at that point in time. I would like to stress that these are both great free cash flow generators, and the nature of the parties in the data rooms, I think, are finding these very attractive. They've been well maintained and have very gentle shallow declines to the [minimal] opportunities to offset those declines. So they're very strong assets. You're absolutely, right. We've had numerous inbounds on both Weyburn, on Palliser, on parts of the Deep Basin. So we've got lots of flexibility ahead of us, and we will be moving in a very prompt fashion to ensure that we will achieve that $3.6 billion divestiture target, but we have not made specific decisions yet on which other, either producing or infrastructure assets, we will utilize to accomplish that. But I'm very comfortable that we've got a good portfolio of opportunities there to achieve that divestiture target.

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Operator [50]

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Next question comes from Fernando Valle from Citi.

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Fernando Valle, Citigroup Inc, Research Division - VP and Senior Analyst [51]

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On the Deep Basin, I just wanted to understand the sensitivity that for investments and on netbacks as gas prices of AECO changes. And also, if you've identified any opportunities for marketing the gas and NGLs outside of just growing the production and economies of scale. Is there anything you can do differently than what Conoco was doing to maximize your netbacks in that part of the play?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [52]

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So maybe I'll take the first part of the question there around gas prices, and then I'll ask Bob Pease to just comment on things that we're thinking about in terms of the transportation and marketing side. The thing that's -- really drives a very attractive economics in the Deep Basin is, that it's liquids-rich natural gas. So it's very robust in terms of having 2 revenue streams, but also very importantly, it's got low operating costs in the range of $7 to $8 per barrel of oil equivalent today, and we see opportunities to continue to improve that, partially around just simply increasing throughput through the existing processing facilities that are only running at about 40% of capacity. We also have additional opportunity, if we choose, to look at additional third-party processing revenues in the basin as well if we think that, that will improve economics there. So I think it's very resilient to potential downward excursions in natural -- in natural gas prices because of the 2 revenue streams. And the opportunity to continue to drive unit costs even lower. Bob, if you wanted to comment on future marketing?

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Robert William Pease, Cenovus Energy Inc. - Executive Vice-President of Strategic Planning and President of Downstream [53]

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Sure. And thanks for the question, Fernando. We're actually very excited about what the Deep Basin assets can bring to us in this space. In natural gas, we've been relatively limited on optionality from what we currently have. The Deep Basin -- its location gives you the potential to reach more markets. So we're early in the discussion, obviously, with potential midstream opportunities, but we know we can get to different markets there. We see the potential for infrastructure that could make a better connectivity to our existing oil sands operations as well. And some of the things we're looking at, even from an upgrading and a value-added standpoint, we see the potential that could unlock additional value from natural gas production in the region. So again, it's relatively early on us exploring these, but it's -- the Deep Basin assets are a good position to go multiple routes to market. So we think we're going to find additional value that hasn't been tapped yet.

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Operator [54]

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(Operator Instructions) Your next question comes from Nima Billou from Veritas Investment.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [55]

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I think a lot of the concern stems around potential clarification of what the company would look like. Just wanted to get a sense. You know the 2018 number in terms of funds flow. I'm glad you put that out free funds flow. In the absence of asset sales, then, what would be pro forma debt-to-funds flow look like for 2018 even at USD 50? Just to give investors a sense of where the ratios would play out? Or if you will, post the $3.6 billion, can you give us a figure of what the debt-to-funds flow would look like at USD 50?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [56]

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Sure. I can comment on that, and I'll focus on the latter part of your question there, post the divestiture. So as I mentioned, we intend to continue to manage the company as an investment-grade company. So our long-term target ranges are 30% to 40% debt-to-cap and 1x to 2x debt-to-net-EBITDA. At a flat $50 WTI and flat $3 NYMEX for 2017, '18, '19, post the divestitures, then we see ourselves being inside the debt-to-cap range that I mentioned, by the end of the 2019 period, and we see ourselves being just slightly above the top of the 2x on debt-to-net-EBITDA. I would say that if you looked at it on a net debt, then those ratios, obviously, are lower. And if you do any kind of price sensitivities, then you'll see that there is -- and we've got a slide on our website that can actually give you some price sensitivities and forecast on those credit metrics.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [57]

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And just wanted to get a sense. Royalties, again. Why did they creep up so high at Foster Creek? You'd mentioned they'd been -- it's been in payout for several years. But just the jump relative to prior year quarter, obviously, because of pricing, but even relative to Q4 to sort of the 8% arena. Why did they jump so quickly in the quarter?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [58]

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It's -- it is largely related to higher pricing. So royalties in Alberta are price-sensitive.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [59]

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So it's a bitumen threshold that it crossed for the quarter?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [60]

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It's -- yes, and it's also tied to WTI movement.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [61]

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Is that 8% fair going forward?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [62]

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We've got some guidance -- there's guidance on our website. And I think that it's a little bit less than that, but if you want to have a better understanding of how the royalty regime is calculated here in the oil sands, we can certainly follow up with you separately, if you'd like to walk in detail through how the royalties are calculated.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [63]

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Okay. And for the quarter as well, there is not much growth-related spending overall, correct? There was a focus mainly on sustaining within the oil sands operations?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [64]

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There was some growth related to reactivation of Christina Lake G, but the majority of oil sands capital -- you're right, was for sustaining capital.

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Nima Billou, Veritas Investment Research Corporation - Investment Analyst [65]

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Can you just carve out the amount? Was it $30 million to $40 million in the growth-related spend?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [66]

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Sorry, I don't have an immediate answer on that one, but we're happy to follow up with you after the call.

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Operator [67]

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(Operator Instructions) The next question comes from the line of Dan Healing from Canadian Press.

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Dan Healing, [68]

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I just had a quick question on this injunction application from, I think, it's pronounced, Coerente -- Coerente Capital Management, talking about getting -- helping the acquisition -- the decision to a shareholder vote because of dilution of the float. What -- what's your comment on that? Is that something that the company's worried about?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [69]

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No, I'm absolutely not worried. I believe that this is a very strong transaction, that it makes us a better and stronger company. I believe it is the right transaction for us, and that we have struck -- structured the transaction in the right way to help maintain our financial strength in terms of the components of cash and equity. And just to give you an example on that, more than 50% of the purchase price is funded between cash on hand and the bought-deal plus the vendor take back, and a little over 20% has already been funded through the long-term debt issuance that we did a couple of weeks back on the 10-, 20- and 30-year paper. This is a transaction that management and the board has spent several months analyzing and doing very rigorous review of. We are focused on having a very solid financial plan, which I've just described. We're focused on having strong investment-grade credit ratings. Our board is focused on the long-term strategy for this transaction. And obviously, our shareholders are going to hold us accountable, management and the board, to making sure that we execute on the plans that we've talked about. We've got to demonstrate that for our shareholders. I don't know what specifically has been asked of the Ontario Securities Commission -- I've not seen what's been asked out of them, but I would just emphasize that the transaction was undertaken in full compliance with all securities regulations.

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Dan Healing, [70]

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Okay. Was there a, just a governance issue there, that the company should have asked shareholders to vote on this?

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [71]

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I don't know, specifically, what the concern is. I can tell you that there's a shareholder vote at 2:00 p.m. this afternoon.

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Operator [72]

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At this time, I'll turn the call over to Mr. Ferguson.

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Brian Charles Ferguson, Cenovus Energy Inc. - CEO, President and Non-Independent Director [73]

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Thank you for joining us today. I appreciate your questions and your ongoing interest. Our call is now complete.

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Operator [74]

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This concludes today's conference call. You may now disconnect.