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Edited Transcript of MEG.TO earnings conference call or presentation 5-Mar-20 1:30pm GMT

Q4 2019 MEG Energy Corp Earnings Call

Calgary Mar 27, 2020 (Thomson StreetEvents) -- Edited Transcript of MEG Energy Corp earnings conference call or presentation Thursday, March 5, 2020 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Chi-Tak Yee

MEG Energy Corp. - COO

* Derek W. Evans

MEG Energy Corp. - President, CEO & Director

* Eric Lloyd Toews

MEG Energy Corp. - CFO

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Conference Call Participants

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* Benny Wong

Morgan Stanley, Research Division - VP

* Emily Christine Chieng

Goldman Sachs Group Inc., Research Division - Associate

* John Macalister Royall

JP Morgan Chase & Co, Research Division - Analyst

* Manav Gupta

Crédit Suisse AG, Research Division - Research Analyst

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Presentation

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Operator [1]

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Good morning, my name is Joanna, and I will be your conference operator today. At this time, I would like to welcome everyone to the MEG Energy's 2019 Year-End Results Conference Call. (Operator Instructions)

Thank you. Mr. Derek Evans, you may begin your conference.

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [2]

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Thank you, Joanna, and good morning, everyone, and thanks for joining us to review MEG's full year 2019 operating and financial results. In the room with me this morning, I have: Eric Toews, our CFO; Chi-Tak Yee, our Chief Operating Officer; and Lyle Yuzdepski, our Senior VP of Legal, General Counsel and Corporate Secretary.

Just a reminder that this call contains forward-looking information. Please refer to the advisories in our recently uploaded disclosure documents filed on SEDAR and, of course, on our website. I'll limit my remarks to a few key highlights of the year to leave more time for questions.

In 2019, our priorities were to improve overall cost efficiencies, preserve financial liquidity and enhance MEG's competitive position. Since making that commitment to shareholders, we've had an extremely strong year. We've remained steadfast in maintaining long-term financial liquidity while aggressively pursuing cost and ongoing debt repayment.

Since the beginning of 2019, the corporation has repaid $633 million of long-term debt, including $501 million of long-term debt in 2019 and an additional $132 million subsequent to year-end. Additionally, in July of 2019, the corporation entered into a new 5-year revolving credit facility and letter of credit facility. The total borrowing capacity under the 2 facilities was proactively reduced to $1.3 billion, comprised of $800 million under the revolving credit facility and $500 million under the letter of credit facility. The facilities contain no financial maintenance covenants, unless MEG had drawn in excess of $400 million under the revolving credit facility. Cash cost savings from the reduction in credit fees and interest savings on debt repaid in 2019 are expected to be $45 million annually.

In January 2020, the corporation successfully closed a private offering of USD 1.2 billion in aggregate principal amount of 7 1/8% senior unsecured notes due February 2027. The net proceeds of the offering plus cash on hand were used to fully redeem USD 800 million of the 6 3/8% senior unsecured notes due January 2023 and partially redeemed USD 400 million of the USD 1 billion 7% senior unsecured notes due March 2024. Post this refinancing, MEG has a 4-year runway until its next debt maturity, represented by the remaining USD 600 million of March 2024 notes.

2019 was a year of exceptional operation performance. 2019 annual bitumen production of 93,082 barrels a day was a record high and a 6% increase over 2018. Nonenergy operating costs averaged a record low of $4.61 per barrel as the corporation continues to drive efficiency gains into its operations while maintaining production levels.

General and administrative expenses of $68 million or $1.99 per barrel of production in 2019 compared to $83 million or $2.58 a barrel of production in 2018. The $15 million decrease in aggregate G&A year-over-year is primarily due to the reduction in staffing levels and rationalization of ongoing administrative costs.

And lastly, we have continued to improve market access and maximize the pricing we receive. MEG realized an average AWB blend sales price of USD 46.19 per barrel in 2019 compared to USD 41.25 per barrel in 2018. The average WTI price decreased USD 7.74 per barrel year-over-year. But this was more than offset by USD 15.04 per barrel, narrowing of the average WTI:AWB blend -- or excuse me, AWB differential at Edmonton. Also contributing to the realized AWB blend sales price in 2019 was the corporation's ability to deliver 33% of its blend sales volumes to the U.S. Gulf Coast, where the WTI:AWB differential averaged USD 1.77 per barrel. Comparatively, in 2018, the corporation delivered 30% of its blend sales volumes to the U.S. Gulf Coast, where -- when the average WTI:AWB differential was USD 6.68 per barrel.

Excluding transportation and storage costs upstream of the Edmonton index sales point, MEG's net AWB blend sales price at Edmonton averaged USD 42.20 per barrel in 2019 compared to the posted AWB index price at Edmonton of USD 42.08 per barrel. Notwithstanding that the Enbridge Mainline apportionment averaged 43% during 2019, MEG was able to capture better pricing than the Edmonton index as a result of its marketing and storage assets and the ability to move barrels into the higher-priced U.S. Gulf Coast market. MEG's average pricing against the AWB index price at Edmonton is expected to further improve once MEG's contracted capacity on the Flanagan and the Seaway pipeline system doubles to 100,000 barrels of blend in mid-2020.

Looking out at 2020. In November of 2019, MEG announced a capital investment plan for 2020 of $250 million. That includes $210 million to be directed towards sustaining and maintenance capital; $20 million to be directed towards the completion of the in-progress Phase 2B brownfield expansion expected to be completed in the second quarter of 2020; and the remaining $20 million of capital spending is required for nondiscretionary field infrastructure, regulatory and corporate capital costs.

For the first half of 2020, MEG has entered into benchmark WTI fixed price swaps of approximately -- for approximately 70% of forecast first half 2020 production volumes at an average price of USD 59.15 per barrel. On a full year basis, MEG has hedged approximately 55% of forecast 2020 production via benchmark WTI fixed price swaps and WTI fixed price swaps with sold put options. Additionally, the corporation has hedged approximately 30% of its WTI:WCS differential exposure at an average price of USD 19.39 per barrel and approximately 50% of condensate exposure at an average price of 101% of WTI.

Looking forward, our objectives and priorities for 2020 are a focus on capital discipline and free cash flow generation; improved market access with our additional 50,000 barrels a day of Flanagan South/Seaway capacity coming on in July; debt reduction and financial liquidity, where all cash flow will continue to be earmarked for debt reduction. We remain committed to driving efficiencies in our business from a financial, operational and cost perspective. And as I said -- just said, we will continue to direct all available cash flow to debt repayment.

With that, operator, can we please open the lines for questions?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question is from Emily Chieng from Goldman Sachs.

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Emily Christine Chieng, Goldman Sachs Group Inc., Research Division - Associate [2]

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Just curious if you guys have the latest -- what your latest thinking is on each of the 3 major pipeline expansion projects and your best guess of when estimated start-up timing would be.

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [3]

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I don't think it's really changed very much from our last. I don't have the exact dates in front of me. But we continue to see that Line 3 is making progress, and we expect that it's either late this year or I think it was Q1 of 2021. TMX looks like it's sometime in 2022, towards the end of 2022. And Keystone is the one that's up in the air. And we would hope that that's coming on earlier than what is expected. We see some interesting movement in terms of people trying to push that ahead faster.

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Emily Christine Chieng, Goldman Sachs Group Inc., Research Division - Associate [4]

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Great. And just one follow-up, if I may. Given the current macro environment, which we're sitting in today, is there a scenario where CapEx can be further reduced from the $250 million in 2020? Or should we expect that to be a limited flexibility here?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [5]

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Emily, I think as we think about CapEx, my Chief Operating Officer will tell me if I continue to drive down this CapEx and still expect him to make miracle -- or drive miracles into the business. So I think there may be some room. But the way we've tried to manage for the downturns in commodity prices that we've seen is with a very, very aggressive hedging program. And when you see that 70% of first half production hedged at 70% and a price of USD 59.15, we've got the ability to ride out some of the volatility that we're seeing in that WTI price. So we'll continue to look at driving efficiencies into the capital side of the business. But I'm not a big fan of whipsawing the capital in the business. That's poor planning on the financial side of the business if we're reducing and increasing our capital in response to short-term volatility in commodity prices.

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Operator [6]

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The next question comes from Manav Gupta from Crédit Suisse.

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Manav Gupta, Crédit Suisse AG, Research Division - Research Analyst [7]

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Derek, in the past, you have indicated that you are looking at ways to reduce the amount of diluent you use rather than investing in a DRU. Can you talk a little bit about that?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [8]

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Absolutely. We have 3 sort of areas that we continue to look at in terms of diluent reduction. Probably the single biggest one and the one that we're hoping that we'll be onstream with a permanent application is our butane blending facility, so minimizing or taking out some of the condensate that we're using to blend and really bring into the mix butane. We think that this could have an annualized sort of savings to the organization of somewhere in the neighborhood of $20 million a year. We continue to look at the concept of partial -- or not partial upgrading but partial blending of condensate to -- in our products.

So instead of blending up the full pipeline spec, could we blend up to half of pipeline spec and use rail, put that product in railcars and move it to refineries in the United States? And the final sort of bitumen or sort of condensate reduction initiative that we have is a black box technology that has arrived at our site that we're quite excited about, that could have quite a bit of impact. So this would be a technology that is set up to fundamentally -- that's been bench scale-tested but is set up to reduce the amount of condensate by a low-pressure, low-temperature catalytic reaction.

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Manav Gupta, Crédit Suisse AG, Research Division - Research Analyst [9]

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I have one quick follow-up. Your net operating cost for the quarter was $5.87, which was slightly higher versus the last quarter. Was this only a function of higher energy cost or -- and how should we model this number for 1Q 2020?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [10]

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It's definitely a function of higher energy costs. I think our operating costs will vary with energy and the energy component. That's why we really try and just speak to the nonenergy piece. I think you should expect that Q1 will have higher gas prices and, therefore, slightly higher prices.

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Operator [11]

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The next question is from Benny Wong from Morgan Stanley.

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Benny Wong, Morgan Stanley, Research Division - VP [12]

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Just wanted to follow up on the hedging question. Obviously, you guys are very active in that part of the strategy there. Just can you remind us if there's any parameters or guiding principles of your strategy on the hedges? Is there a max amount of hedging that you would do in your volumes?

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Eric Lloyd Toews, MEG Energy Corp. - CFO [13]

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Benny, thanks for the question, it's Eric talking. The strategy really is twofold. One is consistent with what we've done in the past, we've looked to hedge our sustaining capital. So that's what we did probably in the middle of last year. We completed that for 2020. And then what -- other thing we look at is opportunistically protecting debt repayment because obviously, as Derek said, that's the key touchstone that we're focused on in the medium term. So we'll look to do that with WTI. And we did that. Obviously, as Derek mentioned, we're 70% hedged on -- for the first half and 55% for the full year -- 55% for the full year. So you'll see us do more of that. Obviously, not in this environment, we won't. But as we move forward to see us sort of hedge the front-end months in excess of that 50%. But we also focus on where our volatility exposures, which is in PADD 2. So when we think about hedging differential we don't hedge through our Edmonton exposure.

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Benny Wong, Morgan Stanley, Research Division - VP [14]

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Got it. That's very helpful. And just my follow-up is you guys have done a tremendous amount of work in reducing your cost. Just wanted to see if do you guys see more opportunity to further reduce your nonenergy op cost even lower relative to your guidance this year going forward?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [15]

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Benny, I'm going to ask Chi-Tak to take that one.

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Chi-Tak Yee, MEG Energy Corp. - COO [16]

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Chi-Tak here. Yes. In terms of the nonenergy OpEx, the very large component is the fixed -- the people aspect of the cost. And if you look at our last several years, we kind of reached a steady state in terms of the absolute component of it. And I think the opportunity is really in the bottom aspect of it to further drive it lower. We, obviously, will look at incremental reduction from this point on. But those would be relatively minor in that sense.

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Benny Wong, Morgan Stanley, Research Division - VP [17]

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Understood. And just finally, just a final question. ESG is clearly something that investors are increasingly focused on. Derek, just curious to see and get a sense of your conversations with investors and what that's like. Do you think the market recognizes the technological advancements you guys made? Or has discussions really predominantly preoccupied by focus on leverage and egress?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [18]

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Benny, that's a really good question. Obviously, the leverage and debt reduction is a big part of our story. And you've heard us continue to make sure that the message that we leave people with today is that we're going to continue to focus on that. The egress piece, interestingly enough, is it's one that we find new investors that that message isn't getting out. We've got 33% of our production that's going on in Flanagan South and Seaway. And we're going to go to 2/3 of our production in the second half of 2020.

And that has pretty big impact in terms of our annualized cash flow as we move forward. So people are maybe a little bit more preoccupied with Line 3 and TMX, whereas we are delivering in the second half of 2020, a substantial increase in our egress. So maybe that's my bad for not stressing that enough and making sure that people know that we have -- we're not waiting on a pipeline egress. We actually have realizable pipeline, incremental -- significantly incrementally beneficial pipeline egress that's going to show up here in the second half of 2020.

The third aspect, ESG, we are working harder on this to try and explain just exactly the trajectory that we've been on really since the company started. One of the reasons I was so excited to join MEG was the tremendous innovative nature of the company and the work that it had been doing on reducing greenhouse gas intensities and different technologies that we could bring to the table to positively impact those. So we'll be doing a better job of trying to connect that innovation to the intensities and to the ESG. But we are definitely seeing a much higher level of interest in ESG. And quite frankly, we welcome that.

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Operator [19]

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(Operator Instructions) The next question is from Phil Gresh at JPMorgan.

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John Macalister Royall, JP Morgan Chase & Co, Research Division - Analyst [20]

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This is John Royall sitting in for Phil. So my question is on transportation. What's the actual volume you expect in 2020 for a pipe to the Gulf Coast, given mainline apportionment? And then relatedly, how should we think about the evolution of overall transportation cost per barrel as more pipe comes on?

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [21]

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John, I'm going to let Eric take that one.

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Eric Lloyd Toews, MEG Energy Corp. - CFO [22]

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John, it's Eric speaking. The answer to your first question is in the back end of -- it depends on what your view on apportionment is. If you assume, say, a 40% apportionment for 2020, we expect through rail and pipe to get about 55% of our volumes down to the Gulf Coast. That's with apportionment. And from a transportation cost perspective, you'll see it go up marginally due to the fact that we're going from 50,000 barrels a day of capacity on Flanagan to 100,000 barrels a day capacity. So you'll see that in the back end of 2020.

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John Macalister Royall, JP Morgan Chase & Co, Research Division - Analyst [23]

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And sorry, on the cost as well, the cost per barrel?

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Eric Lloyd Toews, MEG Energy Corp. - CFO [24]

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The cost on Flanagan is about USD 7.58 a barrel.

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Operator [25]

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Thank you. There are no further questions at this time, you may proceed.

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Derek W. Evans, MEG Energy Corp. - President, CEO & Director [26]

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Well, operator, thank you. And I'd just like to thank everybody that has joined us on the call this morning, and remind them that should you have any questions or follow-up request, please don't hesitate to reach out to us. We're more than happy to talk to you about the results and get your answers in an appropriate fashion. And so thank you all, and have a great day.

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Operator [27]

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