Cenovus Energy Inc

NYSE:CVE

Earnings Call Transcript 2020-Q3

[Operator]

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy's third quarter results conference call. 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 Ms. Sherry Wendt, Director, Investor Relations. Please go ahead, Ms. Wendt.

[Sherry A. Wendt, Director of Investor Relations]

Thank you, operator, and welcome everyone to our third quarter 2020 results conference call. Here with me is our President and Chief Executive Officer, Alex Pourbaix; our Chief Financial Officer, Jon McKenzie, our Executive Vice President, Upstream, Norrie Ramsay; and our Executive Vice President, Downstream, Keith Chiasson.I 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 annual MD&A and our most recent annual information form and Form 40-F. The quarterly results have been presented in Canadian dollars and on a before royalties basis. We have also posted our results on our website at cenovus.com. Alex will provide brief comments, and then we will turn to the Q&A portion of the call. Please go ahead, Alex.

[Alexander J. Pourbaix, CEO, President & Director]

Thanks, Sherry, and good morning, everybody. As you know, on Sunday, we announced a strategic combination between Cenovus and Husky to create a resilient, integrated energy leader. This transaction optimizes our cost structure, expands our market access and strengthens our balance sheet. It positions us as a more resilient company with increased and more stable free funds flow. It also gives us opportunities to expand margins across the value chain lowering our breakeven and accelerating deleveraging and returns to shareholders. You've already seen us drive significant costs out of our business through corporate and our operating optimizations. I'm extremely confident that we will achieve the goals we have set with the transaction and realize the potential of the combined company. But today, I'm here to talk about our third quarter results. I want to start by giving credit to our staff at Cenovus for keeping our operations running safely and reliably and for continuing to adapt to all the additional measures we've put in place in response to this pandemic. I continue to be impressed with the dedication of each and every one of our employees and how they continue to support each other through this time. Through all of this, our teams remained focused on delivering safe and reliable operating performance. We've had 0 significant incidents across our operations to date in 2020. Our teams have successfully navigated the health and wellness challenges of the pandemic, while increasing production and executing planned turnarounds at our 2 oil sands facilities as well as in our conventional operations. As well, this quarter, we saw some significant health and safety milestones across our operations. At Christina Lake, our drilling operations as well as completions and well services teams achieved 1 year without a recordable incident, and our conventional operations marked a 1-year milestone since recording a significant process safety event. This third quarter once again demonstrated our flexibility and ability to utilize our full suite of assets to maximize the price received for every barrel. It reinforced our commitment to disciplined spending, maintaining our low operating and capital cost structure and deleveraging our balance sheet. As crude oil prices showed signs of a gradual recovery through this summer, we were able to increase our crude oil production and clear our inventory of stored barrels to capitalize on the significantly improved benchmark price for Western Canadian Select. We continued purchasing low-cost production credits from peers, so we could produce above our curtailment limit that allowed us to produce high quarterly volumes at our Christina Lake facility. This increase was partially offset by planned turnaround and maintenance activities. Our oil sands operation this quarter averaged almost 386,000 barrels a day, up from 373,000 barrels a day in the previous quarter and a 9% increase from the third quarter of 2019. We recorded adjusted funds flow of $414 million which was a significant increase from the second quarter of 2020 when the unprecedented drop in oil prices resulted in adjusted funds flow of negative $462 million. And we generated free funds flow of $266 million in the third quarter and made meaningful progress on reducing our net debt. At the end of the third quarter, net debt declined to approximately $7.5 billion from $8.2 billion at the end of the second quarter of 2020. We had an operating loss of $452 million and a net loss of $194 million in the third quarter of 2020. The operating loss was largely due to an impairment charge of $450 million on the Borger refinery and negative operating margin from the refining and marketing segment. While we are pleased with our performance in this quarter, we expect commodity price volatility for the foreseeable future. That's why we look forward to the increased cash flow stability and enhance free funds flow the transaction with Husky will provide. With that, I'm happy to take your questions.

[Operator]

[Operator Instructions] First question comes from Menno Hulshof with TD Securities.

[Menno Hulshof, Research Analyst]

I have one question, and it's unrelated to the Husky transaction. Maybe you could just give us your thoughts on the outlook for your SAGD operations over the near term? And more specifically, to the extent that WTI continues to trade in the mid-30s and the heavy differential, call it, in the $10 range. What can we expect operationally through year-end and maybe even early 2021? I'm assuming dynamic storage becomes a part of the conversation, but any thoughts on that front would be helpful.

[Keith A. Chiasson, Executive Vice]

Sure. Menno, it's Keith Chiasson. I'll start and maybe Norrie can talk about the operational side of things. But when we look at kind of the economics, even in the mid-$30 WTI range and the tight differential that we see, we still see ourselves as variable cost net back positive. So we would anticipate to produce through this time at full rates. As we look forward, obviously, with curtailment ending in December, we are unconstrained and no longer have to acquire production credits to be able to do so. So we -- it's something that we watch really closely and monitor. And because of the low-cost nature of our production, we're able to produce and generate a positive variable cost netback.

[Norrie C. Ramsay, Executive Vice]

And just to add to that, it's Norrie Ramsay from our Upstream business. If you remember, in the second quarter, we actually curtailed our production in our oil sands business by month-on-month, about 60,000 barrels a day. And it's some -- in some days, it was actually down 80,000 barrels a day. We brought that all back on, as you can see in our third quarter, it's 9% higher than our second quarter overall average production, and we have full flexibility to increase that up to our higher levels. And again, curtailment was obviously limiting what we could do. And once we -- from December onwards, we'll have a lot more flexibility. But it's always going to be a value conversation, and it's the value rather than the actual volume of production that we're most interested in.

[Operator]

Next question comes from Greg Pardy with RBC Capital Markets.

[Greg M. Pardy, MD & Co]

A couple for you. Maybe, Alex, just to pick up on the safety theme. Just wondering if there are specific actions or thoughts you have that will be taken to ensure that the combined entity here proposed is going to have similar safety and reliability at Cenovus. Is there anything you can add around that?

[Alexander J. Pourbaix, CEO, President & Director]

Yes -- no, Greg, I'm happy to talk about that. And I think, as you guys can tell, every quarter, I usually start out by talking about our safety performance, and it is the #1 focus of this company. Commodity prices can come and go, but our commitment to human safety and process safety is our #1 criteria at all times. So as we get through this deal and the deal closes, everybody can expect that the exact same focus on human and process safety that you've seen from us over our entire history is going to continue, and we're going to ensure that we put the resources towards it to ensure that we can deliver that exact same track record.

[Greg M. Pardy, MD & Co]

Okay. Great. And the second one really comes back to how we should be thinking about hedging policy, again, in the context of the new organization, very different integration prospects. But also kind of tied to that question would be is, if you were to continue hedging would it remain connected with storage optimization? I'm just wondering if you can dig into that.

[Alexander J. Pourbaix, CEO, President & Director]

Sure. Maybe Keith can start that, and then Jon may want to weigh in.

[Keith A. Chiasson, Executive Vice]

Yes. Thanks for the question. When we look at hedging, there's kind of really 2 different components. One is around kind of the optimization side of the business, where we're really trying to capture value from our storage and our transportation assets. When we think about that, really, we're seeing a value opportunity over a period of time or in different locations. And to capture that opportunity, we lock up both sides of that transaction. So from a financial side, we may lock it up. And then as that price settles, there could show plus or minuses, but when we actually physically sell the barrels, we realize that on the netback side of things. So we actually see an uptick. And maybe just a key example of that was kind of in April where our barrels were selling for about $4 a barrel. We could have produced and sold then Hardisty for that price. We chose not to do that. We stored those barrels or transferred those barrels down to the Gulf Coast and stored them there. And then come June or July, we sold those barrels and realized an uplift of almost $25, $30. In that transaction, though, we would have locked in the WTI components as well as of the physical sale. And because of that, if WTI settled at $35, we may have shown a realized loss, even though our netbacks were materially higher than what they would have been in April. So when we think going forward, obviously, the combined entity has a lot less exposure to the WCS/WTI differential in Hardisty so that becomes less of a concern for us. But the combined entity still has exposure to WTI. So maybe with that, Jon, if you want to pick on kind of our corporate hedging.

[Jonathan M. McKenzie, Executive VP & CFO]

Sure. So Greg, I think there's 3 answers to your question that I would give you. And I think Keith really touched on the first is part of this transaction is about us acquiring a number of other assets that give us many, many more options to take our molecules to market, to optimize the value that we get for them. So you should absolutely believe that we're going to continue with the type of optimization hedging that Keith has just described. And for example, today, we would have about 10 million barrels of storage. Going forward, we're going to have closer to 16 million as well as incremental pipe. So those opportunities are going to present themselves in an increased ways for us, and we intend to take full advantage of that. Secondly, I would say that one of the major reasons for doing this is to reduce the volatility in our cash flows streams. So sort of at a core level, that becomes an inherent hedge -- or this transaction will become an inherent hedge in how we manifest our cash flow streams. But finally, I would come back to something that Alex might have said, time and time again is an underlevered balance sheet is the best way to hedge at a corporate level to ride through these commodity price fluctuations. And we've been really clear since we started talking about this transaction, that the balance sheet deleveraging is our #1 commitment and you can expect us going forward to continue to prioritize the balance sheet on a free cash flow basis until we've reached a point that we're comfortable with our debt levels.

[Operator]

Next question comes from Prashant Rao with Citigroup.

[Prashant Raghavendra Rao, Research Analyst]

I just wanted to talk about the hedges, just a little bit more. I appreciate all the color that you've given. On the current program, though -- and I think communications team, the IR staff at Cenovus, did a good job of communicating this to all of us in the MD&A disclosures highlighting that from 2Q. But the current program, how should we be thinking about how much volatility that might cause in FFO per share next quarter or I guess, this quarter and next quarter? And I guess, related to that question, if I -- if we adjust for those impacts this quarter, it seems that the core sort of FFO per share was really mid $0.40 per share, which I think, speaks to the underlying quality of the asset base to perform in this environment. So just curious about that sort of thinking about how we should think about the remainder of this hedging program you entered into going forward over the next sort of, call it 4 to 6 months and also sort of if that's the right takeaway there about the core reliability and performance of the assets?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes, Prashant, it's Jon McKenzie. I think you're thinking about the hedge program in the wrong way. And the hedge program that we've put in place locks in additional profitability. And my suspension is your confusing accounting treatment with straight up economics. And you'll notice in this quarter, we sold many more barrels than we produced, and we took the opportunity in Q2 to start storing barrels rather than sell them into the current market. And what we do is we lock in that contango along the curve so that we're locking in sort of a $4, $5 per barrel margin by selling in Q3 versus selling in Q2.Now if WTI rises by more than that $4, $5 increment that the curve was showing us back in Q2, we will show a hedging loss, but the reality is we're not speculating in the market. And what we're doing is locking in incremental margin by selling in one period versus another. So don't get confused by the hedging gains and losses. They really are a function of how WTI is moving in the marketplace, whether it goes up through one period or down through one period. But our hedging program is designed not to speculate but to lock in incremental margin.

[Prashant Raghavendra Rao, Research Analyst]

Okay. I think another question I had was sort of turning to the transaction. I appreciate that you probably can't give too much color around this right now, but when you look through asset monetization opportunities or sort of, I guess, optimizing the portfolio past post-transaction, post-merger, could you maybe help us to think about how you evaluate that? Just sort of what's the construct by which you go through and balancing profitability versus synergies with the overall portfolio? Specifically, I was thinking outside of sort of black oil production, that portfolio that you'll have on a consolidated basis? Any color there would be helpful.

[Jonathan M. McKenzie, Executive VP & CFO]

Sure. Any time you put 2 companies of this kind of scale and scope together, you're going to go through a process, and we have and are continuing to go through a process of determining what is core to this business and what is noncore. And as you can imagine, there are a lot of criteria that kind of go into those decisions. But really at the base of them. It is about the value those assets can generate and their strategic importance to the company. So we will -- I think people can take it as a given, that we are going to proceed to look at monetizing noncore assets that are falling out of this combination. And I, from my own perspective, I mean, I think I don't know that I'm willing to share it right now, but I think we already have a pretty good understanding of the kind of assets that we're going to take a really hard look at in that regard. And we're also going to be cognizant of are they worth more to other people. But -- and I think the other issue is going to be is, is the time right and can we actually transact at values that are value-creating for our shareholders. So expect more from us on this. I think we're going to act fairly quickly and just -- yes, I mean it's just going to take us a little bit of time to -- till we're at a point where we can talk a little more freely about it.

[Operator]

Next question comes from Phil Gresh with JPMorgan.

[Philip Mulkey Gresh, Senior Equity Research Analyst]

Yes. I was just thinking about the rail contract that you have that you signed up a little while ago, I think it goes maybe till the end of 2022. And I apologize if you addressed this on the last call, but wanted [Audio Gap] around what happens with that once we get to the end of the period and now that you have the takeaway, the excess takeaway that Husky would provide?

[Keith A. Chiasson, Executive Vice]

Phil, it's Keith Chiasson. Yes, you're right that some of those contracts fall off kind of at the back end of 2022. So we'll evaluate that at that time. What I would tell you is we quickly ramped down the program in the first part of this year when commodity prices collapsed. But we didn't sit on our hands through that time. We actually continued to negotiate around those contracts and have been able to further reduce our variable cost on those contracts. And because of some small investment that we made in the Bruderheim facility last year, we're actually able to store a bunch of unit trains at the facility, which allows us to ramp up the program relatively quickly. So I think in the past, we've talked about this overall program, not lending itself to kind of quick ramp-up and ramp down in the span of kind of less than 6 months. But what we've been able to do is take a portion of the program and really have agility and flexibility to ramp it up and ramp it down over the period of a couple of months now. So we will look at kind of market opportunities to be able to do that at those reduced costs for transport to the Gulf Coast kind of over the next couple of years. And then coming at the end of the contracts, we'll kind of look at egress and how it's all shaken out, whether or not we would want to extend those or not.

[Philip Mulkey Gresh, Senior Equity Research Analyst]

Right. Okay. Yes. I guess my follow-up to that would just be with your comments about having lowered the costs, does this mean that the new transfer cost that we've seen this quarter which is lower than prior quarters is a function of that cost reduction, given rail not being utilized? And then is this the right way to think about the go-forward and if we go into -- for coming out of curtailment, do you think you'd actually maybe start using that rail as we move into 2021?

[Keith A. Chiasson, Executive Vice]

Yes. So Phil, you shouldn't be surprised to see us use the rail kind of in the fourth quarter here. We are looking at starting up a portion of the program. In November, it still enables us to accumulate additional production credits versus having to acquire them in the market through the supplemental production allowance. And then in December, it really comes down to a cost-benefit analysis. And with the cost reductions we've been able to achieve on the variable costs, we can actually make this program economic to run barrels down to the Gulf Coast and realize higher netbacks. So you shouldn't be surprised to see us move some volume, obviously, not the full program through the fourth quarter, but some volume through the fourth quarter. Which will help improve our overall netbacks.

[Alexander J. Pourbaix, CEO, President & Director]

Yes. Phil, it's Alex. Just maybe one thing I'd add to that. It -- this improvement in pricing we've been able to achieve is really significant, and it's a tribute to Keith's team, but also our freight partners, they have been really good to work with in making this a much more compelling opportunity going forward.

[Philip Mulkey Gresh, Senior Equity Research Analyst]

And Alex, from a macro perspective, with the removal of the curtailment, do you think the broader industry is going to need rail? I know that the commentary suggested not until mid-2021. And as the decision point for why to remove the curtailment. So what's your view?

[Alexander J. Pourbaix, CEO, President & Director]

Yes, I mean, I suspect -- I mean I think I've been pretty consistent about this, but I think one of the very clear features of our industry is I think all of us have been very successful in driving costs out of our operation. And I suspect with curtailment going away, those barrels on the sidelines, be they sort of 200,000 to 400,000 barrels a day. I do expect them to come back. And I would not be terribly surprised at all to see rail -- I don't think we're going to see it at where it was a year and a bit ago. But I -- as Keith said, it looks like it's making real economic sense for us. And I wouldn't be at all surprised to see rail volumes moving up here over the next few months.

[Operator]

Next question comes from Manav Gupta with Crédit Suisse.

[Manav Gupta, Research Analyst]

Quarter-over-quarter, there was a lot of improvement in the netback. Obviously, the benchmarks are more supportive. But just trying to understand what -- was condensate pricing a big headwind for you in 2Q? And as that kind of lag went away, you started closing the gap to the benchmark and that led to an improvement in netbacks? If you could comment a little bit on the condensate pricing lag and how it helped you or her during 2Q versus 3Q.

[Keith A. Chiasson, Executive Vice]

Manav, it's Keith. I think this is kind of a build on what Jon had talked about earlier and kind of how we are trying to improve our netbacks by moving barrels out of one period into another. So in the second quarter, we were able to store a lot of barrels. Obviously, those -- the pricing if we had sold them in that quarter would have been at very low pricing. We stored those and moved those into Q3 quarter. And realized much higher realizations for those. So I think if you look at our sales relative to production, you can see an increase in sales in the third quarter relative to production, and that's really putting those barrels in the market in a higher price environment. And that obviously all flows back into an improved netback for us.

[Manav Gupta, Research Analyst]

Perfect. A quick follow-up here is you are seeing a very positive trend in transport and blending costs going down at Foster. Obviously, rail is a part of it, but if you look at from 1Q, where it was $1,437 now all the way down to $860. Is there anything else that you're doing at Foster Creek to push the costs down in transport and blending besides rail, which is helping you out?

[Keith A. Chiasson, Executive Vice]

Manav, I think you'll see a lot of variability quarter-to-quarter. It all depends on barrels that we move by rail, as you indicated, but also barrels that we move on pipeline and which production we choose to move down the pipeline. So some months and quarters, it may be Foster, some months and quarters it maybe Christina Lake. It all depends on how we can get the maximum value for our barrel. And that will drive some of that variability in transport cost, but we are going to utilize, obviously, our assets to maximize that value. You are right that with rail off through the third quarter, our transportation costs are down because of that, but we will use those assets to capture incremental value for the company. So you will see a bit of variability quarter-to-quarter asset to asset.

[Manav Gupta, Research Analyst]

And last question is Enbridge Line 3 replacement, any color, anything you're hearing out there? Do you think this could be a 2021 event?

[Keith A. Chiasson, Executive Vice]

Everything that we're hearing, Manav, is that they are marching towards a 2021 startup. Obviously, some critical decisions coming here in the November time period around some permits, and that will then drive construction of that project. So we'll be watching kind of through the fourth quarter intently. And if they get their permits and start construction, then we do think a 2021 start-up is realistic.

[Operator]

Next question comes from Chris Cox with Raymond James.

[Christopher Cox, Director & Equity Research Analyst]

Maybe just the first one really on the quarter. Just any comments on why you didn't also record any impairment at Wood River? And just anything that may be differentiated that asset test versus what you conducted at Borger?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. Thanks, Chris. It's Jon McKenzie. One of the things we do with all our assets every quarter is assess for indicators of impairment. And obviously, with the refining cracks dropping as precipitously as they have been and not recovering as quickly as they have. We took that as an indicator of impairment in our downstream. So we evaluate both of those assets. Now one thing I would say is that Wood River is a more complex refinery with much greater scale efficiency than we have at Borger. So the reality is when we looked at that 1 versus the net book value and we kind of ran it out on the discounted cash flow basis. We got to the answer that it is -- that we did get to. But relative to the carrying value of Wood River we did not have an impairment.

[Christopher Cox, Director & Equity Research Analyst]

Okay. And then maybe circling back to the transaction with Husky here. Just wanted to dig a bit deeper into some of the talk about kind of physical integration between FCCL and Lloyd complex. And I'm curious how much of your diluent value chain you think you could integrate there? And I believe your current diluent value are also tied to longer-term contracts on Cold Lake and Polaris? And how do you think those contracts on those pipelines might play into those plans or even some of your other contracts for the downstream?

[Keith A. Chiasson, Executive Vice]

Yes. We're right on the front end of this Chris. And when we did our synergies and put out our targets, we were really clear that we didn't want to include any of that in our synergies. The $1.2 billion that we put out as capital and operating synergies are really those synergies that we have a really high confidence that we're going to be able to get in a very short period of time. So when you talk about the broader physical integration between FCCL and Lloyd through time, that's an exciting opportunity for us. We think that through time, Lloyd is going to be a very strategic asset. And how we integrate that and work through the molecular integration, not just on FCCL molecules going into Lloyd, but the condensate coming back is something that we are working through today, but it's too early in our minds to be talking about future values and magnitude of integration that's possible there. But it's really clear to us that, that is a legacy asset at Lloydminster, and it's going to give us a lot of optionality on the integration going forward.

[Christopher Cox, Director & Equity Research Analyst]

Maybe just I'll ask in a slightly different way to you, to achieve that physical integration, will it require negotiations with other parties between other than just you and Husky?

[Keith A. Chiasson, Executive Vice]

Yes, it will.

[Operator]

Next question comes from Matt Murphy with Tudor, Pickering, Holt.

[Matthew Murphy, Director of Integrateds and Upstream Research]

I appreciate with the acquisition really playing out your carbon ambitions over the long-term and that it will take some time to work through firming up plans there. But I guess, given the perception of oil sands as being more emissions sensitive, and other barrels around the world and certainly appreciate that all oil sands isn't quite the same. But given those ambitions, just wondering if you guys could provide a bit of a teaser on some of the things you're thinking about in meeting those ambitions, whether we're talking solvents, carbon, zincs or otherwise?

[Keith A. Chiasson, Executive Vice]

Yes. Thanks, Matt. I mean when we came out with our targets and our ESG targets in the spring, I mean I think we gave a little bit of color around that. And what I would tell you is we didn't come out with those targets until we had done a comprehensive economic and engineering analysis of sort of what options -- not just what were possible but what options were actually achievable within our business plan. It would be pointless to come out with an ESG targets that weren't grounded in the business plan. And so that was what we did. And if you think about it, I would kind of say it's a little bit all of the above it that we've obviously been a leader in solvent technology. I expect that solvent technology will be a part of it. Carbon zincs is something we are -- we're looking at carbon capture and sequestration. But one of the things I -- and there may be -- there could be an element of acquiring carbon offsets. But the one thing I would say that I think a lot of people don't appreciate although there are a lot of projects that require capital, whether it's cogen, whether it is solvent technology, carbon capture, there's actually -- we believe there are a great deal of benefits that we can reduce our GHG intensity by changing how we operate the assets. And so there's actually a whole suite of things. And now with Husky coming on, there's not only how we operate assets but what assets on a go-forward basis get capital and what assets don't get capital, and all of those have the ability to meaningfully improve the GHG intensity.

[Matthew Murphy, Director of Integrateds and Upstream Research]

Yes. I appreciate the thoughts there. If I may, a follow-up on a completely unrelated note. Just on the approach to integration with the Husky transaction. I guess if I go back to the 2019 Investor Day -- excuse me, for example, which I appreciate is a world away at this point. But I think the strategy at the time was to take advantage of accessing a healthy amount of refining capacity in the U.S. market. Rather than owning it yourselves from a sort of integration. I guess, can you talk about what's changed there in the thinking? Was it just an opportunity with Husky that was just really hard to pass up? Or did something, I guess, changed in how you're thinking about the value of integration, whether a read-through on how you're thinking about pipeline progression from Canada?

[Alexander J. Pourbaix, CEO, President & Director]

Yes, I mean, it's a whole lot of things, but what I'd maybe go back to where my comments have been on integration from the start, Matt. And I think what I've been very consistent on and I have always said, look, I love the integrated business model. I looked at our competitors and said it would be fantastic to have that kind of business model and take the volatility out of our cash flow and earnings related to our exposure to Alberta heavy oil pricing. But when we looked at that, like very in depthly, a couple of years ago, at the time, crack spreads were $18, $20. And every refining or processing, upgrading business or asset we looked at was just extraordinarily highly valued, and I'm just not very interested in picking off assets at the peak of the market. And that's why we came to a strategy at that time of focusing on rather than on processing of actually looking at opportunities to get our barrels to market via logistics whether it was pipe or rail, where we could achieve a global price for our heavy barrels. And the obvious differences is since the pandemic you've seen a situation where everybody's values have come down. But if you look at the valuation metrics of the Husky merger, you would see, if you kind of break that business up into an upstream and downstream business, however you do it, that downstream, 400,000 barrels a day of molecularly integrated, upgrading and refining to our barrels. I mean the valuation was absolutely compelling.

[Keith A. Chiasson, Executive Vice]

Yes. I would just add to that, Matt. I think Alex used a really important phrase, they're called molecular integration. And that's what this opportunity really presents for Cenovus going forward is the ability to have processing units that are tied to our molecules that consume the molecules that we produce. And I think that gives a whole different level of optionality as well as a whole different reduction of volatility going forward. So this isn't just about integration. It's about molecular integration going forward and tightening up our value chains and shortening up them to the extent that we can.

[Operator]

Next question comes from Chris Tillett with Barclays.

[Christopher Paul Tillett, Research Analyst]

Yes. Just a quick one for me. On the conventional side, it looks like you're resuming some activity there in the fourth quarter. And then my read is that it's just tied to sort of stronger seasonal pricing but just wanted to confirm that or see if maybe this was a sign of interest to pursue some incremental opportunities on the conventional side in 2021?

[Alexander J. Pourbaix, CEO, President & Director]

Chris, it's Alex. No, I mean you look at -- we've obviously been very disciplined over the last few years with the Deep Basin. And given gas prices where we found them over the last 2 or 3 years, the right decision was not to put material capital to that asset. And this is an opportunity with the gas prices, as you've mentioned. We can lock up gas prices for a few years at very attractive levels. It's a short cycle. These are very, very high IRR kind of drill to fill opportunities, and it allows us to take that asset from a decline to basically keeping it at least flat to modestly growing.

[Christopher Paul Tillett, Research Analyst]

Understood. And then maybe just as a follow-up, anything you can offer in terms of the role that those assets might play in the pro forma company?

[Alexander J. Pourbaix, CEO, President & Director]

Yes. I mean I had responded to that question earlier about asset sales. And I think as everybody knows, we took a really hard look a couple of years ago at whether there was an opportunity to monetize a portion of that conventional business for Cenovus. And I think you can kind of assume if you put Cenovus' conventional business, together with Husky's in a higher price environment. I -- we're going to take a really hard look at that. I think my observation today is even though the prices have come up, it's still a pretty tough market for value, but I expect that will likely improve over the next little while, especially if prices stay where they are. So we're going to take a very hard look at that.

[Operator]

Next question comes from Neil Mehta with Goldman Sachs.

[Neil Singhvi Mehta, VP and Integrated Oil & Refining Analyst]

Twice in a week. So I guess the first question here, maybe it's for you, Jeff (sic) [ Jon ]. Given you know the Husky assets really well. But as you looked at the last couple of years of Husky, one of the challenges has been operational execution and excellence? And is that showing up in different ways in both upstream and downstream in terms of performance? As you look at those assets, do you think there are things Cenovus can bring to the table to kind of get them up to speed? And how do you -- as you went through the process of valuing these assets, how did you take that into consideration?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. It's Jon, not Jeff.

[Neil Singhvi Mehta, VP and Integrated Oil & Refining Analyst]

I thought I said Jeff. Sorry. I didn't get it.

[Jonathan M. McKenzie, Executive VP & CFO]

I think you might be 20 minutes ahead of yourself.

[Neil Singhvi Mehta, VP and Integrated Oil & Refining Analyst]

No, so -- oh, I see, I am sorry, yes.

[Jonathan M. McKenzie, Executive VP & CFO]

But I will tell you, this was an absolute #1 concern for us. Alex has mentioned right off the top of this call, that safety is always, has been and always will be our #1 concern going forward. So when we looked at this asset base, I would tell you that we had unfettered access to do our due diligence, and we have been at this for nearly 6 months. And I would say the diligence that was done on all aspects of these assets is really unprecedented in terms of my experience with the M&A market, particularly on the E&P side. When we look at the asset base that we acquired, everything on the upstream that is operated is really right in our wheelhouse, and it's right inside what we really do well as a company, and we are very comfortable with the reservoirs, the conditions of the assets, the conditions of the commercial arrangements over the top, and we think we can add value there. And we think that, that value can be realized in a fairly short period of time.As it relates to the downstream, we took a lot of time to look at some of the improvements and some of the changes that Husky has been making through time all the way from new personnel coming into their operation all the way through their safety process, safety systems as well as their asset condition reports as well as reliability and safety practices. And I remind you, we have 2 directors on our Board who are very, very deep in terms of refining assets in the operations thereof. So it's something we took our time on. It's something that was absolutely top of mind for ourselves and the Board. I think we've done a thorough job of ferreting out our level of comfort in this, and we're comfortable that on a go-forward basis, we're on the right path and that we've satisfied ourselves that we are not going to have these kind of instance going forward.

[Neil Singhvi Mehta, VP and Integrated Oil & Refining Analyst]

Yes. Great. And a follow-up here is, I had asked about this over the weekend, but I don't know if there's been a subsequent update to any conversations with either the ratings agencies or your -- or credit investors about how they view this transaction a pro forma way and whether this gets us the breadcrumbs to get them back to investment grade?

[Jonathan M. McKenzie, Executive VP & CFO]

I can't speak for the rating agencies. They've all put out their comments now, and you can read into those what you will. But it's our expectation that we are sowing the seeds for a return to investment-grade in short order. That would be something that's very important to us.

[Operator]

Next question comes from Mike Dunn with Stifel FirstEnergy.

[Michael Dunn;Stifel FirstEnergy;Analyst]

Not to beat it to death, but I did have another question on the -- I guess, the hedging strategy around timing of your sales versus your production. Maybe naively, I had thought that this was something that generally, maybe some of the oil sands big players would do based on their outlooks for maybe seasonal turnarounds for them and others. So just wondering, Jon or Alex, if timing of sales versus production was something that was strategically done in the past without hedging. And then a second part to that is, how did you weigh the cost benefits of delaying the sales of your own equity barrels versus locking in that contango by buying third-party barrels and delivering them later?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. Mike, it's Jon. Listen, this is something we've always done. But what I would tell you going forward is what is really important to us is maximizing the free cash flow to the organization. So what we look at is, can we sell into the future using the assets that we have, and we have pipelines in about 10 million barrels of storage available to us to increase the free cash flow in any future period. Now we do attach a cost of that. There is an internal cost of doing that. And that kind of approximates a few hundred basis points beyond our cost of capital. But we do that on a diligent and rigorous basis to make sure that we're maximizing free cash flow, maximizing returns to shareholders.

[Michael Dunn;Stifel FirstEnergy;Analyst]

Okay. That's it from me.

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. The other thing I would say, Mike, is this is not something we're speculating on. What we're doing is taking what the market gives us in terms of the shape of the futures curves. And all we're doing is using our assets and playing along the length of that curve to maximize future cash flows for the company.

[Michael Dunn;Stifel FirstEnergy;Analyst]

Great. And Jon, forgive me, there's been a lot of quarterly press releases out. So if I missed it in the body of your MD&A. Did you guys quantify, like all-in, including the financial WTI hedging losses, the net gain from that strategy versus, I guess, timing your sales to be in line with your production volumes?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. What we haven't given you is the net gain, but what you see is the accounting in the MD&A, and I think that's what's causing the confusion. Is the mark-to-market on the financial components of this versus what the underlying physical business is doing.

[Michael Dunn;Stifel FirstEnergy;Analyst]

Okay. So you're keeping that number close to your chest. Okay.

[Jonathan M. McKenzie, Executive VP & CFO]

Yes.

[Operator]

Next question comes from Harry Mateer with Barclays.

[Harry Mead Mateer, Head of Global Energy Credit Research & Co]

First question, can you maybe talk about your intentions with the pro forma debt structure? And if you had planned out pari passu treatment for the Cenovus and Husky volumes after closing? And perhaps, if so, how you're going to go about doing that?

[Jonathan M. McKenzie, Executive VP & CFO]

Yes. Harry, it's Jon again. We're looking at all the options as around to your question around pari passu and that's something we'll -- we're going to have to get back to you. And I'm not going to talk about that this morning. What I would say, though, is we are of the view that investment grade is very important of this new company. It's one of the synergies that we believe haven't taken any value for, but we think it's really important going forward. So you can expect us to do everything required to get us back into that space. Now what we've also committed to do and we'll do this in a reasonably short term is, we'll come back to you with a complete financial framework that would not only talk about capital structure and how we see debt playing into that but it will also talk about capital allocation and the screens that we intend to run on that, together with shareholder returns. But we want to do that in a comprehensive way rather than give you one piece of the framework or do it incrementally through time.

[Harry Mead Mateer, Head of Global Energy Credit Research & Co]

Okay. Great. That certainly, that will be helpful. And then apologies if I missed this, either on the call last weekend or earlier today. But have you guys talked about upfront costs to realize your synergy targets? And clearly, they're a major driver of the deal. But I'm just wondering sort of how much cash you think goes out the door initially to actually capture those?

[Alexander J. Pourbaix, CEO, President & Director]

Harry, it's Alex. I think the -- if you want to think about sort of the costs of putting the 2 companies together, think about a onetime cost of just over about $500 million, and that compares to the $1.2 billion a year of annual run rate synergies that we expect to largely get in 2021 and get the entirety of them in 2022.

[Operator]

Our last question comes from the media with Robert Tuttle with Bloomberg News.

[Robert Tuttle;Bloomberg News]

Yes. I noticed there was a permit or something filed with the AER about a DRU that's going to be built near your rail terminal, and you guys were looking at DRUs. What's your outlook on that? I mean is there a plan to perhaps have one there at a bigger operating one at your rail terminal?

[Keith A. Chiasson, Executive Vice]

Robert, it's Keith Chiasson. We filed that regulatory application, just to give us the flexibility around that project. Obviously, with the transaction that's underway. Obviously, we're taking another look at, obviously, the DRU and the location of the DRU. So that was just a step in the process to make sure that we had flexibility.

[Alexander J. Pourbaix, CEO, President & Director]

Yes. Robert, it's Alex. Just to be really crystal clear on that. We kind of said when we were looking at the DRU that we were going to do the engineering and permitting to give us the ability to have the option to go forward on a DRU. And no one should think about that filing as anything more than just carrying through on that direction.

[Operator]

And at this time, I will turn the call over to Mr. Pourbaix.

[Alexander J. Pourbaix, CEO, President & Director]

I think that's the end of our questions. So thanks, everybody, for taking the time and enjoy the rest of your day.

[Operator]

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