ARC Resources Ltd

TSX:ARX

Earnings Call Transcript 2020-Q3

[Operator]

Good morning. My name is Colin, and I'll be your conference operator today. At this time, I would like to welcome everyone to the ARC Resources Limited Q3 2020 Earnings and 2021 Budget Conference Call. [Operator Instructions] I would now like to turn the conference over to Kris Bibby. Please go ahead.

[Kristen J. Bibby, Senior VP & CFO]

Thank you, Colin, and thank you all for joining ARC Resources Third Quarter 2020 Earnings and 2021 Budget Call. Today's remarks are intended to add color to ARC's quarter end results as well as our outlook on the business. On the call today, we have ARC's President and Chief Executive Officer, Terry Anderson; ARC's Vice President of Development and Planning, Lara Conrad; ARC's Vice President of Operations, Armin Jahangiri; and myself, Kris Bibby, Senior Vice President and Chief Financial Officer. Following a few brief remarks from Terry, we will open the line to questions. During this conference call, all statements made by the company are subject to forward-looking information and statements included in the news release yesterday afternoon and those found within our corporate presentation, which are available on our website. Now with all that excitement done, I will pass the call over to Terry.

[Terry Michael Anderson, President, CEO & Director]

Thanks, Kris, and thank you, everyone, for joining us this morning. I'll first start off with a quick review of our third quarter 2020 financial and operational results, and we'll then discuss ARC's plans for the balance of 2020 and 2021. 2020 has been a challenging year, to say the least. The impacts from the COVID pandemic have been profound not only in our daily lives, but also on commodity prices in ARC's business. Fortunately, ARC's proven history of financial discipline and prudent capital allocation have set our company on the path to recovery much quicker than some of our peers. This year, we have taken the time to focus development activities in the areas of our portfolio that generate the best returns while also ensuring that we are controlling the controllables of our business, which has resulted in robust financial and operational results during these first 3 quarters of the year, setting the stage for a strong exit to 2020 and even a stronger 2021. Firstly, I'm so proud that our employees have remained safe this year, with our employees having now worked 6.5 years without a lost time incident. Our operational performance has also been exceptional. Our third quarter production of 158,400 BOE a day was higher than expected as our field staff did a great job of turning around a major facility at Parkland/Tower ahead of schedule. Our year-to-date production of 158,900 BOE per day is above our guidance for the year. So we've adjusted our full year production expectations up by 4%. So the top end of our guidance range now sits at 160,000 BOE per day. Our field employees continue to efficiently manage our operations and cost structure with year-to-date operating expenses of less than $4 per BOE, which are well below our guidance range. So to better reflect our expectations for the year, we've adjusted our guidance down by about 15% to a range of $4 per BOE to $4.20 per BOE. ARC's capital investments in the second half of 2020 have been focused on our natural gas development at Dawson and Sunrise with $53 million of capital invested during the third quarter of 2020. The natural gas markets are structurally improving, so we've chosen to accelerate $50 million of capital from 2021 into the fourth quarter of 2020. This will allow us to maximize throughput of our low-cost natural gas production during 2021 to capitalize on that anticipated strength in natural gas pricing. This accelerated capital will also ensure efficient and continuous drilling operations at Sunrise and Dawson. Let me be clear, though, the $50 million of accelerated capital is not additive to ARC's capital development plans for 2020 and 2021, which, when combined, will range from $725 million to $775 million over the 2-year period. This truly is a pure acceleration from 1 year to the next. ARC is in an enviable financial position. In the third quarter of 2020, we generated $71 million of free cash flow, which was used to strengthen our balance sheet in a meaningful way. We've reduced our net debt by 10% since June 30 and 20% since March 31. Based on the current outlook on commodity prices, we expect to exit 2020 at approximately 1.2x debt to cash flow. We continue to pay a meaningful and sustainable dividend to our shareholders with a total payout to shareholders of $6.7 billion or $34.81 per share over the last 24 years. This has been the centerpiece of ARC's value proposition to our shareholders. So that's a quick look at the Q3 results. Now looking ahead to 2021, ARC's capital budget at $375 million to $425 million is the best moneymaking budget the company has put together in the last several years. From 2017 to 2020, ARC invested significant capital to build out our productive capacity at Dawson 3, at Sunrise 2, and then most recently, Dawson 4 earlier this year. These 3 facilities collectively added 360 million cubic feet per day of natural gas processing capacity and 15,000 barrels per day of liquid handling capacity. Now that these investments are behind us, we look forward to demonstrating how efficient our expanded Montney business has become. 80% of the 2021 budget will be focused on profitable half-cycle investments to sustain production at our core Montney properties. We expect to deliver production between 158,000 BOE per day and 165,000 BOE per day at an average capital efficiency of approximately $7,500 per flowing barrel. Included in ARC's 2021 capital plans are 2 minor infrastructure optimization projects at Sunrise and Parkland, both of which are incredibly robust economics. These 2 projects will collectively add over 40 million cubic feet per day of natural gas processing capacity. Projects like these are the strategic advantage of ARC owning and operating its infrastructure. We get to reap all the benefits of these robust optimization projects. We'll also advance our ESG leadership by investing $7 million to help reduce the company's carbon emissions, which will help ARC meet its air emissions reduction targets over the next several years. Considering these plans, ARC's 2021 budget is expected to deliver significant free cash flow. So that's after capital investments and dividends. Similar to 2020, free cash flow will continue to be directed at strengthening our top quartile balance sheet, which we believe could drop below the low end of our target range of 1 to 1.5x debt to cash flow during the year. So the 2021 budget is very robust and exciting. So commodity prices' volatility is expected to persist in the near-term as the global economy continues to navigate the COVID pandemic. At ARC, we are focusing our business activities on low-cost natural gas development in anticipation of strong natural gas pricing for the foreseeable future. We are uniquely positioned to profitably sustain our business and generate significant free cash flow next year while managing a best-in-class balance sheet and paying a meaningful and sustainable dividend. Our financial flexibility presents tremendous optionality and flexibility from a capital allocation perspective. And with a strategy that is founded on strong business fundamentals, we believe that the outlook for ARC is very compelling. And finally, I'd like to thank ARC's employees for prudently managing our business through these challenging times and for delivering strong results. Also, thank you to our shareholders for supporting our business plan today and in the future. Kris?

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Terry, for those opening remarks. Before we hand the call back over to the operator for questions, I think it might be worth touching on a few items that have been very topical in recent discussions with analyst community and investors. One item is around further improvements in our drilling and completions cost and whether there's an opportunity to further reduce these costs compared to our results to date, and specifically, what is driving these reductions. Armin, why don't you give us an update on where we have come from and where we're headed on this front?

[Armin Jahangiri, Vice President of Operations]

Sure, Kris. We are expecting 2021 to be one of ARC's best years in terms of capital cost performance. Relative to 2019, we are budgeting 25% reduction in total drilling completions, lease and facility construction costs per unit of lateral drilled. This number is the weighted average of 69 wells that we have planned for 2021. The cost improvement is driven by 3 factors: design optimization, team's achievements in improving the efficiency of execution and reduction in cost of services. In terms of design optimization, we are drilling longer wells, which helps reduce our unit cost. We have also fine-tuned our completions design in terms of sand and perforation intensity based on the learnings we've had from the past couple of years. Our drilling and completions teams continue to improve their efficiency of execution by drilling and completing wells in record times. And finally, we have also seen about 5% to 10% reduction in cost of services as a percentage of our budget.

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Armin. Some great stats there, for sure. I'm pretty happy to hear that. Continuing on that theme, the cost side of the equation is obviously critical, but what equally is critical in our business is the capital efficiency that results from these expenditures. Lara, can you walk us through our learnings and results on the capital efficiency side, both in terms of what we've done so far this year as well as how do we plan to achieve the previously mentioned $7,500 per flowing barrel capital efficiency in 2021?

[Larissa Marianne Conrad, Vice President of Development & Planning]

For sure, Kris, I would love to. Capital efficiency continues to be a metric ARC teams focus on as it is a great indicator of profitability. ARC's capital efficiency leads the Canadian E&P sector. The wells we brought on production between July of 2019 and June of 2020 delivered an average capital efficiency of $7,400 per BOE per day. This has been achieved through continuous improvements in our well and pad designs as well as in our execution performance. On the design side, we have refined the landing zone for our wells and some benches. We have widened our interwell spacing while tightening the interfrac spacing to capture the same reserves but with less wells. And we have revisited our completion designs to ensure that we've optimized our sand placement to maximize productivity per tonne pumped. We've also increased our lateral length, thereby directing a higher percentage of our capital investment to deliver cash flow. Before making any changes to our well designs, ARC teams perform reservoir modeling, they analyze analogous wells, and they're also including data analytics workflows to be able to look at a wider suite of data and dig deeper into their interaction of multiple parameters. With these ongoing optimizations, I have confidence in our multidisciplinary team's ability to continue to drive improvements to ARC's business, and that, therefore, we will achieve a capital efficiency of $7,500 per BOE per day in 2021.

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Lara. Some exciting topic for sure. Finally, I think a topic that we've spent a significant amount of time discussing with many people, including a lot on the line right now, is the state of the North American natural gas market and our outlook for 2021 and beyond. I'll take a stab at this one. So it shouldn't be a surprise to anyone listening the call on natural gas markets for -- has significantly improved over the past 18 months. We expected this to happen and expect them to remain strong going forward. The driving forces behind the strength in the natural gas markets are both on supply and the demand side. Basically, we have a situation where, on the supply side, natural gas supply is not growing. It's not expected to be growing. And it's expected to be down significantly year-over-year across all of North America, largely due to a couple of things: lack of investment and also the loss of associated gas reduced to crude oil pricing that we've been experiencing. On the demand and egress side, locally, we've been expanding this part of the equation, which has resulted in continued build-out of the natural gas export system and continued conversion from coal-to-gas on the power side. So effectively, you've got an equation where you've got flat to reduced supply into an increasing demand and egress situation that will see natural gas continue to have strength for 2021, and very importantly, continuing after 2021. With those topics at least briefly addressed, I'd like to hand it back to Colin for the Q&A portion of the call, please.

[Operator]

[Operator Instructions] So your first question comes from Michael Harvey from RBC Capital Markets.

[Michael Steve Harvey, Analyst]

So just a couple of questions on the Attachie West project. I guess the first one would be, as you think about late 2021 and into '22, has your thinking changed at all as far as how well Attachie ranks amid the portfolio? So is Attachie still head and shoulders, #1? I'm sure that gas versus liquids conversation comes up pretty regularly in the boardroom. And I guess, also on that topic, can you just remind us about how you're thinking about the size of that potential project? I know the numbers have bounced around a bit. You've kind of thought about making it meaningfully larger than the original plan. Maybe you could just refresh us on some capital and production guideposts on that one.

[Terry Michael Anderson, President, CEO & Director]

Thanks, Michael, for the question. Good question. It's Terry here. So definitely, Attachie ranks #1 for us from their next development opportunity. Obviously, it has more higher rating or ranking of liquids than gas compared to like a Dawson. It's closer to that 60% liquids versus Dawson is more of a 20%. So -- but we're excited where we've advanced Attachie. And we've confirmed, I guess, from our most recent wells, the well design is -- we're confident on full-scale development that we have that optimized well design, which helps lead into that facility capacity and give us that confidence on the size. Yes. We've been looking at a couple of sizes. We've talked about starting with a 60 million cubic feet a day gas plant and the liquids on top of that or a 90 million. I would say, at the moment, we are still evaluating that and looking at the benefits of both of those. But for the size of resource going bigger, it probably makes sense for us. And I think the way the year is shaping out and the strength in our business, with our debt to cash flow coming down quicker than what we originally expected, strong free cash flow, we see a line of sight to being able to support this development. And we're still thinking that -- it's probably later in the year or next year, about a year from this time, that we look at sanctioning that project. That way -- at that time, our debt to cash flow is going to be closer to that 1x that we talked about we wanted to get to before we advance Attachie. And we're also looking for a little stability in the oil price, and having -- with the second wave of COVID and all the uncertainty out there, it would be nice to have some more stability on the direction of that oil pricing. So that's kind of how we're thinking of it. But definitely, it is right up there. It's some of the best wells that we've ever seen in the company. So we're still excited about Attachie.

[Michael Steve Harvey, Analyst]

Got it. And did you have any just kind of broad capital numbers? I know your costs have come down on a bunch of stuff in terms of what it would cost for the initial facility build plus the initial batch of wells. Or is it kind of too early to really have a more formal number out there?

[Terry Michael Anderson, President, CEO & Director]

Well -- and we're still tweaking all of those details. Originally, we were talking $500 million for the original plant size, the 60 million. That was for the wells, the facilities, the pipelines. But we've made a lot of headway in the efficiency of the design, and that cost is coming down. But like I said, we're looking at the bigger facility. So it's too early to put out a number on the larger facility.

[Operator]

Your next question comes from Amir Arif of Cormark Securities.

[Amir Arif, Analyst of Institutional Equity Research]

Just a quick question on Sunrise. I understand you're doing some smaller expansions. But at what point, just given the economics of there, would it make sense to potentially do another 60 million a day plant or another larger size expansion?

[Terry Michael Anderson, President, CEO & Director]

Well, so yes, our first step here is optimizing what we have, and that's where that 40 million cubic feet a day -- we're only spending $10 million roughly to deliver 40 million cubic feet a day, which is exceptional, robust economics. And that's why we talk about owning and operating our infrastructure. As for our next expansion, the way we've been looking at it, and obviously, everyone's probably looking at natural gas price and going okay. We now [indiscernible] Sunrise again. But we truly are wanting to have more balance in our commodity mix, and that's why we like Attachie, that 60% on the liquid side. If we went to expansion of Sunrise, we'd probably go bigger than the 60 million. It's such a great asset and opportunity there that we think is exceptional for that area, that rock. But right now, we're thinking more -- growing more of the liquids and have more balance in our portfolio. Then we'll still look at optimizing everywhere on our gas side of the business right now, but no major expansion plan for Sunrise.

[Amir Arif, Analyst of Institutional Equity Research]

Okay. Sounds good. And then just a second quick question. Just on the capital spending guidance range of $375 million to $425 million. Is there any guidepost for what would bring you down to the lower end versus higher end? Or is that just normal variance around the $410 million midpoint that you're showing in your release?

[Kristen J. Bibby, Senior VP & CFO]

Yes. Amir, it's Kris here. I think what we're really just trying to do is put some flexibility in there. I mean, it could be that if we have some additional cost savings, that could drag us down to the lower side. It does give us the flexibility to maybe add a pad later in the year as well. But as you picked up, the pinpoint guidance here is $410 million. So it just meant to provide some flexibility on how the year is going to play out.

[Operator]

Your next question comes from Jamie Kubik from CIBC.

[James Kubik, Research Analyst]

ARC included a number of comments around its capital allocation priorities when you get towards the low end of the targeted range of 1.0 to 1.5x at the cash flow. I mean we've seen a bunch of M&A take hold on the U.S. side of the border and some up in Canada as well. Can you talk about how you're weighing the M&A market versus some of the other allocation opportunities that you've laid out here?

[Terry Michael Anderson, President, CEO & Director]

Thanks, Jamie. Good question in today's environment of M&A. So we continue to look at all the M&A opportunities that we think are relevant for our company out there, and we keep coming back to the fact that we have great assets to develop. And so when we're looking at opportunities, we want to make sure that those assets are as good or better than what we currently have, where we have a tough time of buying lesser-quality assets. We want to try to be improving and growing the profitability of the company by doing an acquisition. So that's a sticking criteria for us, for sure. But we are definitely looking at those opportunities out there to see if there's something that makes more sense than actually -- or adds on to, I guess, the development of our existing asset base. But we haven't been able to, I guess, find that key opportunity at the moment. Doesn't mean that it's not out there. We just need to continue to work hard in looking at that. But on the whole capital allocation, to your point, we're going to focus on making sure we bring that debt down to that 1x range, continue paying that dividend. We still believe in investing organically in our business when the commodity prices are constructive and stable to do so. But we have a lot of flexibility and optionality when you have a significant free cash flow. We can look at other means like the M&A you talked about or share buybacks. Or a combination of a number of these is something that would be another avenue to look at, having a more balanced approach in managing that risk and reduce the volatility in the return to shareholders by having a more balanced approach to that. So that's kind of a little more add-on in M&A about how we're looking at the capital allocation, Jamie.

[Operator]

[Operator Instructions] Okay. So it appears there are no further questions. Please proceed.

[Kristen J. Bibby, Senior VP & CFO]

Thanks, Colin. So this concludes ARC's Third Quarter 2020 Earnings and 2021 Budget Call. If you do you have any additional questions, please feel free to follow up with the others, myself or any member of our Investor Relations team. I'd like to thank everyone for their participation and for following ARC. Have a great day, everyone.

[Operator]

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