ARC Resources Ltd

TSX:ARX

Earnings Call Transcript 2024-Q1

[Operator]

Good morning. My name is Ina, and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Resources First Quarter 2024 Earnings Conference Call. [Operator Instructions] Thank you. Mr. Lewko, you may begin your conference.

[Dale Lewko, executive]

Thank you, operator. Good morning, everyone, and thank you for joining us for our first quarter earnings conference call. Joining me today are Terry Anderson, President and Chief Executive Officer; Kris Bibby, Chief Financial Officer; Armin Jahangiri, Chief Operating Officer; Lara Conrad, Chief Development Officer; and Ryan Berrett, Senior Vice President, Marketing.

Before I turn it over to Terry and Kris to take you through our first quarter results, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP and other financial measures with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars unless otherwise stated. Finally, the press release, financial statements and MD&A are all available on our website as well as SEDAR. Following our prepared remarks, we'll open the line to questions.

With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

[Terry Anderson, executive]

Thanks, Dale, and good morning, everyone. Q1 was another quarter of steady execution, which resulted in strong operational and financial performance. Average production of 352,000 BOE per day was 2% above consensus and increased 8% on a per share basis compared to the first quarter of 2023. This now marks the 11th consecutive quarter where production per share has increased. This aligns with our strategy to grow free cash flow per share by investing in our assets in a disciplined manner and buying back our shares when it's good value for investors like it is today.

If I look back on the quarter and were to summarize, we executed a capital-efficient program, advanced our marketing strategy with another long-term LNG agreement and completed several critical milestones for Attachie Phase 1. Discipline, efficiency and execution, these are themes that have long underpinned our operational excellence. At the asset level, we achieved better-than-expected operating performance, which drove the production outperformance relative to our forecast. This was largely due to revisions we've made in terms of how we develop the Sunrise asset.

We recently modified the well layout at Sunrise to further improve capital efficiencies and lower the supply cost at what is already one of the most economic natural gas plays in North America. As a reminder, Sunrise is a tremendous resource with long development runway, and it is now direct connected to Coastal GasLink, which supplies natural gas to the LNG Canada project.

Moving to Kakwa. In the quarter, we saw production average 175,000 BOE per day, which included 65,000 barrels per day of condensate. This is directly in line with our expectations as we plan to maintain Kakwa production near this level going forward to optimize free cash flow. For perspective, Kakwa generated over $300 million of asset level cash flow in the quarter. And since acquiring it in 2021, it has accumulated approximately $5 billion of asset-level free cash flow, well above what we paid for the asset.

Looking ahead, following the turnaround activity we have planned in Q2 at Kakwa, we anticipate growth in the second half of the year as we return to developing a higher condensate gas ratio region of the field. We have also implemented some frac design modifications here and while it's still early, preliminary results are looking positive. Turning to a few financial highlights. ARC generated $100 million of free cash flow in the quarter and returned all of that to our shareholders as planned.

Of note, we achieved this free cash flow in a lower natural gas price environment and a more capital-intensive quarter as we complete Attachie Phase 1. This validates the sustainability and resilience of our business, enabled by the competitive strengths established over the past 28 years, which include having a low cost structure underpinned by our owned and operated infrastructure, having a balanced commodity mix that includes being the largest condensate producer in Canada and having a diversified transportation portfolio that allows us to sell our natural gas to key demand markets across North America and capture higher margins.

ARC's diversified transportation portfolio stood out this quarter with a realized natural gas price of $3.19 per Mcf, which is greater than 150% of the AECO Benchmark. We have discussed at length the benefits of market diversification. Our long-term takeaway agreements to access U.S. markets have been a major contributor to corporate profitability. In fact, over the past 10 years, ARC has realized greater than 125% of the AECO Benchmark on average.

As an extension of this strategy, ARC has entered into long-term agreements to supply natural gas to LNG projects on the U.S. Gulf Coast and the Canadian West Coast. Most recently, we announced a 20-year agreement with Cedar LNG, whereby ARC will supply 200 million cubic feet a day of natural gas commencing in the second half of 2028 when the project enters commercial operations. And currently, ARC has entered into a nonbinding Heads of Agreement with a global investment grade counterparty to the purchase and sale of these LNG volumes for which we will receive international pricing.

We are now in the process of working towards definitive agreements, and we are pleased with the progress made to date. With this announcement, ARC has entered into 3 LNG supply agreements that will connect our physical gas to global markets in return for international or LNG-based pricing. This will take effect in 2026 with our first Cheniere contract. And by the end of the decade, we'll achieve our target of marketing 25% of our natural gas production to global markets.

Finally, I'll close with an update on Attachie. I am very pleased with the progress our team has achieved to date. This is a pivotal year for our company as Attachie will add significant value over the next decade and it begins with Phase 1 coming on stream later this year. As a reminder, ARC has 300 sections of contiguous Montney acreage at Attachie, and this asset has the scale to replicate Kakwa, which is the largest condensate-producing asset in Canada. This initial phase will add approximately 40,000 BOE per day in 2025, representing 10% production growth year-over-year and the project is tracking on schedule and on budget with 0 safety incidents.

This past quarter, we've achieved a few important milestones worth highlighting. We recently completed a pipeline bridge that is key to our takeaway strategy. This was the single, biggest critical path item to achieve our planned time line, so we are pleased to complete this. We are on track with our drilling program, having now drilled 22 of 40 wells needed to initially fill the 40,000 BOE per day facility. Finally, we are making excellent progress towards electrifying Attachie through BC Hydro, which will establish Attachie as one of the lowest emissions, condensate-rich natural gas developments in North America. This will also lower our corporate emissions intensity and maintain our status as one of the lowest emissions producers in North America.

To conclude, we are on track and focused on achieving the long-term plan we put forth a year ago. With that, I'll pass it over to Kris.

[Kristen Bibby, executive]

Thank you, Terry, and good morning, everyone. I'll provide some additional context on the quarter and financial results before turning it back to Terry for closing remarks, and then we'll get into some questions. In terms of operational performance, we delivered quarterly production of 352,000 BOEs per day, weighted 63% to natural gas and 37% to condensate and liquids. This was ahead of our first quarter guidance despite the extreme cold in January and provides good momentum to start the year.

We generated first quarter cash flow of $607 million and free funds flow of $102 million, which were 3% and 8% above analysts' forecast, respectively. Lower operating costs and lower capital spending contributed to the outperformance relative to analysts' estimates. Operating and transportation expenses were both below the bottom end of company guidance, with operating costs specifically benefiting from lower power pricing in Alberta. G&A came in above guidance, primarily due to higher-than-budgeted share-based compensation expense related to recent share price performance.

Starting with liquid side of our business. We continue to see strong pricing realizations with condensate averaging over $94 in the quarter. And in turn, condensate and crude oil represented roughly 60% of our revenue in the quarter. Terry already stole the thunder on price realizations on natural gas, but it is worth repeating.

ARC realized an unhedged natural gas price of CAD 3.19 per Mcf, which compared to the AECO benchmark of $2.05 and the NYMEX Henry Hub of around USD 2.25 or roughly $3 on a Canadian basis. In total, ARC invested $505 million in the quarter, right in line with our expectations, which included approximately $180 million of spending at Attachie Phase 1. About 75% of the capital was invested in drilling and completions, with the balance directed mainly to facilities, including Attachie Phase 1 and the super pad we are constructing at Kakwa.

As planned, net debt stayed flat quarter-over-quarter at $1.3 billion or approximately 0.5x cash flow on a trailing basis -- 4-quarter basis. We continue to demonstrate our commitment to a total balance return, which includes returning essentially all free funds flow to shareholders. This quarter, dividends and share repurchases equated to 114% of free cash flow. Quarter-to-quarter, this will fluctuate. But on a full year basis, we expect to return essentially all free funds to shareholders, very similar to what we did in 2023. There's no change in our thinking of the optimal way to return capital.

In our view, it is a growing base dividend in combination with share repurchases. Not only is this a fundamentally sound and accretive use of capital, we have received overwhelming support for this strategy from our shareholders. Since initiating our initial NCIB in September of 2021, we've invested over $2.1 billion to buy back 18% of the shares outstanding. And based on our current assumption, this trend will accelerate in 2025 given the expected increase in free cash flow with the addition of Attachie Phase 1 to our producing assets.

Now looking ahead, production and capital spending guidance in 2024 remains unchanged. ARC anticipates investing approximately $1.8 billion and full year production is expected to average between 350,000 and 360,000 BOEs per day. Second quarter production is expected to average between 325,000 to 330,000 BOEs per day before growing to an average of roughly 370,000 BOEs per day in the second half of the year.

The decrease in Q2 reflects planned turnaround activity at Kakwa and Greater Dawson. These are planned to coincide with significant third-party turnarounds to minimize overall downtime. Operating momentum in the second half of the year will be driven by Kakwa and Greater Dawson, with some contributions from Attachie as we look to begin commissioning this asset before year-end. As we look ahead, the outlook through 2028 is largely unchanged from the 5-year plan we provided a year ago.

In 2025, we would expect a meaningful increase in production and free funds flow per share. This is largely driven by a 10% increase in production, reflecting a full year contribution from Attachie and lower capital spending as we transition from growth to sustaining capital at Attachie Phase 1. At strip pricing, we forecast free fund flow per share to more than double to roughly $3 per share in 2025.

With that, I'll turn it back to Terry for closing comments.

[Terry Anderson, executive]

Thank you, Kris. Our strategic priorities are to deliver sustainable free cash flow per share growth adhering to our long-standing principles of capital discipline, profitability and financial strength, and we plan to deliver this by investing in our most profitable assets and balancing that with a meaningful return of capital that includes a growing base dividend and buying back our shares.

I'm confident in our ability to achieve this. In many ways, the momentum and enthusiasm I've observed across the organization reminds me of our initial Montney development at Dawson. 14 years ago, we embarked on Dawson Phase I which had a facility capacity of 10,000 BOE per day. We learned a lot that year. And while we knew the Dawson asset had tremendous potential, we did not fully appreciate that the Dawson area would grow to its current level of approximately 100,000 BOE per day.

Now we're on the verge of commissioning Attachie, a much more significant development opportunity with the first 40,000 BOE per day phase coming on stream later this year. While similarities exist relative to Dawson, one of the biggest differences is we have a far better understanding of the development potential of the asset. Today, we have more experience, better technology and depth of Montney knowledge, all working together in our favor.

This gives me confidence in our ability to efficiently execute and develop Attachie, and I'm truly proud to be part of this next chapter in our company's history. So thank you to all of our staff for your continued focus on profitably growing our business in a safe manner. With your support in executing our 5-year plan, we are set to deliver significant shareholder value, nearly tripling free cash flow per share by 2028. With that, thank you, and we can open the line up for questions.

[Operator]

[Operator Instructions] Your first question comes from the line of Michael Harvey from RBC Capital Markets.

[Michael Harvey, analyst]

Yes, sure. So just a couple of questions. I guess, as it relates to Phase 2 Attachie 2028, I think, is there anything that would cause you guys to accelerate that a little bit earlier, whether it's commodity prices, performance, et cetera? Or is 2028 kind of set in stone? And then just on the Sunrise outperformance, nice to see that. I guess when you start shipping gas to LNG Canada, I just wanted to confirm that was the gas you were in fact going to be sending there to satisfy that commitment? And then maybe for Ryan, maybe if you can just walk us through some of the pricing dynamics, if there's, what kind of benefit you'll see above and beyond Station 2? And then kind of how you backfill that on the West Coast system?

[Terry Anderson, executive]

Mike, it's Terry Anderson. I'll take your first question here and then turn it over to Ryan for the second one. So Phase 2, it's still planned for 2028. We're trying to really be disciplined here and make sure we're balancing our capital allocation and really focused on that reinvestment ratio around that 50% across the 5-year plan. So if commodity prices are extremely robust, we'll obviously take that into consideration. But we're planning for the 3-year cadence and that's what it is.

[Ryan Berrett, executive]

Awesome. Michael, yes, so just in regards to your question on Sunrise. So the gas that we -- that we'll be feeding the LNG Canada is a deal that we completed a couple of years ago with Shell. We are the only nonequity participant in LNG Canada to have a direct tie-in into CGL pipeline. So this gas today is currently hitting AECO and will be redirected into Coastal GasLink likely sometime in early 2025. And the pricing for that will be some modest premium to the AECO benchmark.

[Operator]

And your next question comes from the line of Patrick O'Rourke from ATB Capital Markets.

[Patrick O'Rourke, analyst]

I'm just kind of curious, your 22 of 40 wells into the program here at Attachie of potentially hundreds, maybe thousands of wells that you're going to drill. Obviously, you guys have been pretty thoughtful over the years in terms of sort of augmenting and improving your processes. We saw that Kakwa sort of widening of inner well spacing. It sounds like you've changed a bit of the wine racking of the horizontals at Sunrise here as well.

Just kind of curious, as you're getting your hands and your arms around this project, how you're thinking about sort of well configuration design and completion design and what could potentially come next as you sort of roll out what the opportunities are?

[Terry Anderson, executive]

So Patrick, it's Terry here. So obviously, we're early into this project, and we're always going to be optimizing. We have a plan in place at how we're drilling the wells right now. But we're going to -- it's going to be optimized as we move through it, and we're going to incorporate. So just as a reminder, 2019 was the last time we drilled our 2-27 pad and that completion design.

And so there's other wells in the area up north into Conoco's lands and around there that we're looking at and reevaluating and trying to optimize. So without getting into details, we're going to continue to optimize where we're at. And that's no different than any other field in any development that we've started. And we've taken learnings from Kakwa and incorporating that into it. So I know I'm not specific on anything, but it's too early for us to get specific on how we're going to be changing things up.

[Patrick O'Rourke, analyst]

Okay. Great. Just a quick one here, maybe building on Mike Harvey's question with respect to Attachie Phase 2 before I've got a return of capital question too. But do you guys -- one of the things here is the electrification of Attachie Phase 1 and the carbon footprint. Do you have power supply secured for the future phases already? Or how does that market look for you?

[Armin Jahangiri, executive]

Patrick, this is Armin. Yes, we have power available for Phase 2. We are working through the details in terms of all the transmission lines and everything to get power to the site. But the plan would be for Phase 2 to be also electrified.

[Patrick O'Rourke, analyst]

Okay. Great. And then just finally here, in terms of return of capital, you spoke to this a little bit in the prepared remarks. But between the dividend and the share buyback slightly outpaced the free cash flow in the first quarter, so just wondering, if you could give a little bit of color with how you plan to manage that through the year? Is it sort of a level load? Or is it going to look more like a free cash flow sweep from quarter to quarter?

[Kristen Bibby, executive]

Patrick, it's Kris here. Yes, so in 2023, we were slightly above free cash flow in terms of distributions, Q1 at 114%. The way we really look at it, it's on an annual basis. So it will come up and down quarter over quarter. Q2, pretty heavy capital spend with lower production as well. So I wouldn't be terribly surprised if we're marginally above our free cash flow [ macro ] as well. But second half of the year, with the significantly higher production and pricing, we'll certainly bring that back in line would be the plan. So there's no set formula on a quarter-to-quarter basis. Part of it is where the share is trading in terms of our times of buyback and then balancing it kind of on an annual basis is the plan.

[Operator]

[Operator Instructions] And your next question comes from the line of Jamie Kubik from CIBC.

[James Kubik, analyst]

Maybe just with respect to Sunrise production during the quarter. Correct me if I'm wrong, it was actually lower than Q4 '23 levels. Can you just expand a little bit on the well outperformance that you're talking about in that asset?

[Larissa Conrad, executive]

Yes. Thanks, Jamie. Lara Conrad here. So overall, as far as the well outperformance goes, we've changed our design at Sunrise. We used to drill 3 layers in the Upper Montney and one in the lower. And what we found is, we can access the resource with just 2 layers in the upper and still maintaining that one in the lower. So we have to increase our tonnage per meter intensity, but we're really finding that design as much improving the capital efficiency of what is already an excellent asset.

[James Kubik, analyst]

Okay. And then I know that you have stated gas processing capacity from that asset of 360 million cubic feet a day, but ARC's produced through that in previous quarters. Can you just talk about what the productive capacity is in the area from that region?

[Armin Jahangiri, executive]

Yes, Jamie, this is Armin. Yes, that plant's capacity is 360 million cubic feet. Obviously, when you're operating the plant, depending on the seasonal conditions, you could potentially put a bit more on through the plants. But as far as plant capacity is it's 360 million cubic feet per day.

[James Kubik, analyst]

Okay. Great. And then maybe just sticking on gas here. AECO and Station 2 pricing on forward strip still pretty weak through the next 4 to 6 months below $1.50 a GJ. Is there a chance that you delay bringing production on in that type of price environment and just defer until later in Q3 or Q4?

[Kristen Bibby, executive]

No, Jamie, it's Kris here. The plan right now is it's not -- as you commented, pricing is not great, but it's still well in excess of what we need to make our rates of return, reminder, the only dry gas asset we have at Sunrise. And you've heard us talk about the low-cost structure of that property. So it still makes sense to produce in that environment. Heading into the second half of the year here, we do anticipate some stronger pricing.

[James Kubik, analyst]

Okay. Great. And then maybe last one for me is just with respect to Attachie and Kakwa. Can you just talk about water availability for ARC in these regions? And the remaining completion programs in 2024, how you expect to phase that with water availability?

[Armin Jahangiri, executive]

Yes. As far as Attachie is concerned, Jamie, we have water in our ponds, and we also have access to a long-term license. So we don't expect any issues or concerns in Attachie. And Kakwa benefits from the same exact situation. We have extensive water infrastructure built in the field already that supports all our drilling and completions activity for the year.

[Operator]

[Operator Instructions] There are no further questions at this time. Mr. Lewko, please proceed.

[Dale Lewko, executive]

All right. Thanks, everyone, for joining. Have a good day. That concludes the call.

[Operator]

Thank you. That concludes our conference for today. Thank you for participating. You may all disconnect.