Strathcona Resources Ltd

TSX:SCR

Earnings Call Analysis

Strathcona Resources' Q2 2024 Performance and Future Outlook

Strathcona Resources reported strong Q2 2024 earnings, with production averaging 182,000 BOE per day and funds from operations of $548 million. The company noted stable oil production and increased oil sales volumes due to new infrastructure. Despite a slight drop in natural gas production, Strathcona is optimizing operations with efficiency improvements. They revised their annual natural gas guidance down by 15 million cubic feet per day. Financially, they hit a debt target of $2.5 billion and declared a quarterly dividend of $0.25 per share. The company's future plans include ambitious carbon capture projects aiming for completion between 2025 and 2027, funded through partnerships and federal tax credits.

Strong Production Performance

Strathcona Resources reported an average production of 182,000 BOE per day in Q2 2024, consistent with the previous quarter. The company's oil production was about 131,000 barrels per day, with a small increase in oil sales volumes attributed to the commissioning of a new rail offloading facility. This demonstrates Strathcona's ability to maintain stable output amid operational changes.

Free Cash Flow Generation

The firm posted funds from operations totaling $548 million, or $2.56 per share, indicating a healthy cash flow from operations. This resulted in free cash flow of $247 million, or $1.15 per share, after capital expenditures of $297 million. The ability to generate positive cash flow supports ongoing operational investments and shareholder returns.

Capital Expenditure and Efficiency Improvements

Strathcona continues to focus on operational efficiency, reporting an 8% improvement in the steam oil ratio compared to the same period in 2023 due to ongoing debottlenecking efforts. Additionally, the company has initiated new drilling projects designed to improve production efficiency and reduce costs by 10% per meter with the introduction of longer horizontal laterals in its Kakwa operations.

Natural Gas Production Adjustments

Natural gas production averaged 237 million cubic feet per day but saw a 6% decrease from the first quarter due to third-party outages. Strathcona has reduced its annual natural gas guidance by approximately 15 million cubic feet per day. The revised corporate production guidance now ranges between 185,000 to 190,000 BOE per day, with oil component increased to 72%.

Debt Management and Dividend Policy

Strathcona reached its debt target of $2.5 billion as of June 30, which enables the Board to approve a quarterly base dividend of $0.25 per share, payable on September 27. This strategy highlights a stable approach to capital allocation, allowing excess cash flow to be directed towards shareholder returns and potential growth opportunities.

Innovation in Carbon Capture Initiatives

Strathcona announced a groundbreaking partnership with the Canada Growth Fund to develop carbon capture infrastructure worth up to $2 billion, aiming for a final investment decision on the first project in mid-2025. This strategic move positions Strathcona as a leader in decarbonizing thermal oil production and is expected to yield substantial long-term sustainability benefits.

Investor Day and Long-Term Growth Outlook

An Investor Day is scheduled for November 14, coinciding with the Q3 results announcement. This event aims to provide greater insights into Strathcona's growth plans and asset management. The management team is optimistic about fostering additional investment opportunities and articulating the company's long-term vision for success.

Earnings Call Transcript 2024-Q2

[Operator]

Good morning. My name is Lara, and I will be your conference operator today. I would like to welcome everyone to the Q2 2024 Conference Call of Strathcona Resources Limited.

[Operator Instructions]

I now introduce Rob Morgan, President and CEO of Strathcona. You may begin your conference.

[Robert Morgan, executive]

Thank you, and good morning, everyone. Welcome to the Second Quarter 2024 Conference Call of Strathcona Resources. As the operator mentioned, my name is Rob Morgan, President and CEO of Strathcona, and with me today is Connor Waterous, our Senior Vice President and CFO; and Angie Lau, our Treasurer. Yesterday, Strathcona was pleased to release our second quarter results -- second quarter 2024 results and the news release, financial statements and MD&A, which are available on Strathcona's website as well as on SEDAR us.

We encourage investors to read those documents in full. I'm pleased to take note of the advisories regarding forward-looking information and non-GAAP measures included therein. Production for the second quarter averaged approximately 182,000 BOE per day with funds from operations of $548 million or $2.56 per share capital expenditures of $297 million, resulting in free cash flow of $247 million or $1.15 per share. Oil production for the second quarter was consistent with the first quarter at approximately 131,000 barrels per day. Oil sales volumes increased to approximately 135,000 barrels per day in the quarter due to a drawdown of inventory related to the commissioning of Strathcona's new crude by rail offloading facility on the U.S. Gulf Coast.

At Cold Lake, we continue to make progress on debottlenecking projects that have resulted in an 8% reduction in our steam oil ratio compared to the same period in 2023, improving the efficiency of our operations. Production of natural gas was 237 million per day, down 6% or approximately 16 million per day from the first quarter due to planned and unplanned third-party outages. Associated natural gas liquids production was essentially flat to the first quarter at approximately 11,500 barrels per day. At Kakwa, Strathcona has sanctioned our first pad to incorporate 2.5-mile horizontal laterals to more efficiently exploit our land base. These wells are expected to reduce costs by 10% on a per meter basis versus our previous 2-mile laterals.

At Groundbirch initial testing of our 3 new drills has indicated strong results comparable to our initial 2 wells. The wells have been tied in and are awaiting stronger natural gas prices to preserve the economics of our investment. As third-party outages have extended into the third quarter, along with a significant turnaround at one of our facilities late in Q3, and with the continued deferral of dry gas from our Groundbirch wells, Strathcona is reducing year natural gas guidance by approximately 15 million cubic feet per day, resulting in a revised corporate guidance range of 185,000 to 190,000 BOE per day, with an increased oil weighting of 72%. Our capital budget guidance remains at $1.3 billion.

As of June 30, Strathcona achieved our previously disclosed debt target of $2.5 billion. As a result, Strathcona's Board of Directors has approved a quarterly base dividend of $0.25 per share payable on September 27 to shareholders of record on September 16. Going forward, Strathcona's run rate debt target remains at $2.5 billion, leaving 100% of excess free cash flow beyond the base dividend available for further shareholder returns or additional investment opportunities. On July 10, Strathcona was pleased to announce a first of its kind partnership with Canada Growth Fund to develop up to $2 billion in carbon capture infrastructure on Strathcona's thermal assets with a targeted FID for the first project in mid-2025. We are excited to be a leader in the decarbonization of thermal oil production in Western Canada.

Strathcona is also pleased to announce its first Investor Day to be held on Thursday, November 14, coinciding with the release of our Q3 results. The Investor Day will provide shareholders with further details highlighting both our near- and long-term plans for our assets and to properly introduce additional members of the Strathcona team. Thank you very much for your time this morning, and we'd be very pleased to answer any questions you may have.

[Operator]

[Operator Instructions]

Our first question comes from the line of Menno Hulshof from TD Cowen.

[Menno Hulshof, analyst]

Thanks, and good morning, everyone. I'll start with question on the looming rail strike. Presumably, it's not going to last that long, but how could it potentially impact your 30,000 barrel per day crude by rail business and maybe even supply for inputs like diesel end, what proactive steps have you taken to mitigate the overall risk?

[Connor Waterous, executive]

Sure. So it's something we've been super focused on have been in close to contact with the folks from CN over the past couple of months to be as prep as we can. The first thing to bear in mind is we've got about 2 to 3 weeks of available storage capacity at our various Lloyd thermal -- our various Lloyd thermal fields, which we will be able to use to effectively cushion the blow of a strike if it lasts in that 2- to 3-week time frame.

If the strike lasts longer than that 2 to 3 weeks. We still have the option to effectively truck the vast majority of our Lloyd's Thermal crude to various pipeline terminals and sell a blended crude until the CN strike ends.

[Menno Hulshof, analyst]

Terrific. Thanks for that Connor, and then maybe the second question is on the CCS agreement that was reached with kind of the growth fund during the quarter for up to $2 billion dollars. Can you just walk us through the next steps and key milestones that you hope to achieve over the next, say, 12 months or so as it relates to CGF specifically? And where is the risk in delivering on those milestones?

[Robert Morgan, executive]

So thanks again for the question, Menno. Where we progress now and we've been looking at CCS for quite some time, given the nature of where our assets are, particularly in Saskatchewan, where we do have access to sequestration report space there, and basically support for injection and sequestration of CO2. We expect that our first project likely will be in the province of Saskatchewan at this point. And we are progressing with initial FEED assessments.

We actually have done some FEED work previously on our Saskatchewan thermal assets. And so we'll progress through that over the next year or so, finalizing on both technology as well as the appropriate partners we would need for that project. We are working in partnership, as you highlighted, with Canada Growth Fund, and there essentially will be a committee of individuals from Canada Growth Fund and Strathcona, that will work through to get to essentially the -- what will be our first funding agreement, which we expect will be in that mid-2025 time frame.

So I think you can expect us to provide some updates as we go down this path, and we still are working with the Alberta government in terms of securing port space in Alberta, but -- and we feel fairly confident that we should be able to get something resolved there as well and be progressing our decarbonization strategy, both in Saskatchewan and our Alberta thermal projects.

[Operator]

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

[Patrick O'Rourke, analyst]

Congratulations on the inaugural dividend announcement there. I guess sort of first question with respect to some of the commentary on go-forward return on capital strategies, you've put the base dividend in place looks pretty defensible, I think, in the presentation down $54.

But with respect to sort of the $2.5 billion net debt target and the commentary around ad hoc decisions sort of what -- how often you'll be looking at, will that be on a quarterly basis? And then appreciating that the opportunities for both growth and acquisitions might not necessarily [ co-last ] with a specific quarter, do you plan to go below that billion at any point in time? Or can we expect sort of a cash sweep if there's no opportunities out there?

[Connor Waterous, executive]

Yes, sure. So on that front, Patrick, so the way that we've always thought about it is that we're still comfortable with a long-term debt on the business of that a $2.5 billion number that equates to about 1x debt to cash flow of what we view as a mid-cycle price of about $70 WTI. And of course, based on the cash flow that the business is forecasted to be making at anything close to the price levels that we're at now. There's certainly going to be a lot of excess free cash available beyond the quarter-per-quarter base quarterly cash dividend.

And the way we have thought about the use of that cash flow going forward, is that our first choice is always going to be able to -- is always going to be looking to find things to further grow the per share value of the business, either on an organic or on an M&A basis, in the event that we can't find something like that to do then it just makes sense to send that excess cash flow out to the owners of the business. In the short term, when our public float is small, unfortunately, a buyback is not going to make sense for us even though we think our even though at our current share price, with a bigger public float, it certainly would.

But in the short term, what that means is we'll likely pay out a series of special dividends with the excess cash that is made. Importantly, we don't want a fixed quarterly formula and a series of quarterly special dividends. Instead, that might be something that's paid out at 1x to 2x per year, based on what we see as the current and forecasted alternatives -- forecasted all alternative uses of that cash. And in turn, what that will mean is that prior to getting to one of those, one or two moments per year where we choose to pay out some form of special that the debt will fall of that $2.5 billion level. And in turn, we will drop back up to it to fund that special.

[Patrick O'Rourke, analyst]

And then just a little bit more on the operational side. Obviously, some strong improvements in the steam oil ratio at the Cold Lake projects there. Sort of looking at Lindbergh in the public data, it looks like it's below where its long-term trend is, Tuckers may be a little bit above. I know the netback advantages of the crude grade and transportation, probably outweigh the steam oil improvement here, but just kind of where these things could go to over sort of the next 12, 24 months? And what's sort of the opportunities for improvement that are left are?

[Robert Morgan, executive]

For sure, Patrick. Thank you. So obviously, as we move towards filling our capacity and where we have sort of the most available capacity today is in our Tucker asset. We've continue to reactivate some of the legacy operator drills that maybe were not optimum drills at the time, but now benefited from the fact that the steam chambers have matured. So we continue to bring those online.

We've been pleased with the results of our first [ D-east ] pad, first 8 wells -- we're drilling our [ C-Central ] pad, and that's -- again, production will start to come online. So just by virtue of bringing that production into the capacity, we'll start to improve our steam-oil-ratio. And I think when we look at the longer term, we suggested that as an overall -- all 3 of our assets, we could get into that sub-4 maybe mid-3 category over the next sort of 24 months as we bring on those new wells and continue to optimize our lower steam-oil-ratio wells.

At Orion, Orion is primarily a Clearwater asset. The formation is the Clearwater, but we also have some upper Grand Rapids that typically is a lower steam-oil-ratio. We had some success on our G5 pad last year and have sanctioned our next pad pursuing that upper Grand Rapids. So all little bits and pieces that over the course of the next, we expect 24 months, we'll bring our steam-oil-ratio down and improve the overall thermal efficiency of the business on top of the already strong economics.

[Operator]

Our next question comes from the line of Greg Pardy from RBC Capital Markets.

[Robert Mann, analyst]

This is Rob Mann on for Greg Pardy. Just one for me. I know you touched on the shareholder returns earlier with Patrick's question. So just on the production side of things, just given the deferral of some natural gas production from the Groundbirch pad, maybe you could just frame your outlook for natural gas in the 2025 and maybe how you're thinking about production for next year?

[Robert Morgan, executive]

Yes. So we expect or hope that there is some recovery in prices and maybe late this year, we'll be able to bring those Groundbirch wells on. We're very cognizant, particularly the Groundbirch being the dry gas, they're very prolific wells. And so much of the rate of return of that investment is captured in basically the sort of initial 12 months. So we would like to see supportive gas prices 250-ish and above -- and we think if we're comfortable in that point, we'll bring the gas production on.

And that will allow us to fill -- we did do a modest expansion at that Groundbirch facility to about 30 million a day of capacity, and that will allow us then to fill that capacity and we would go forward in that. So that will add probably in the order of 15 million a day, 20 million a day of of new production that we expect we could maintain with supportive prices in 2025. Beyond that expectations of 2025, I think that's partly where we will highlight in our Investor Day presentation, not only our expectation for 2025, but how our -- how we see our growth plans over the next number of years play out as we look at the opportunity base we have in each of our assets.

[Operator]

[Operator Instructions]

Our next question comes from the line of Dennis Fong from CIBC World Markets.

[Dennis Fong, analyst]

My first one is maybe following on from Menno's question on carbon capture in the next steps. With the mid-2025 FID timing, can you talk towards your view of, we'll call it, the cadence and capital associated with carbon capture infrastructure, the recovery of FID capital spent via the investment tax credits and balancing that with returning fee can to shareholders over the next couple of years? And I've got a second one on operations.

[Connor Waterous, executive]

Sure. So in terms of how we see the cadence of capital -- on the cadence of the build-out of our carbon capture hubs in both the Lloyd side of the border and in Cold Lake. As Rob said previously, what we're hoping to do is reach FID on our first effectively pilot project on the carbon capture front in mid-2025 to give you a very round number on the size of that, that might be around 200,000 tons -- per tons a year and in turn about $200 million of gross capital spending.

And then effectively, assuming that hopefully goes well, that's going to be coming on in the early to mid-2027, mid-'27 time frame. Then our hope would be to follow that up with a much bigger set of carbon capture projects to get -- to fully fill the total $2 billion partnership that we formed with the Canada growth fund folks over the subsequent couple of years. In terms of how that $200 million of gross capital for our first pilot is going to be funded from Strathcona's perspective. The big-picture math to think about is effectively $100 million of that gets funded by the Canada Growth Fund folks and $100 million from the federal carbon capture in investment tax credit and a few other small brands that Strathcona has earned over the past couple of years.

The actual timing of the cash inflows and outflows will be such that all of the $100 million from Canada -- from the Canada Growth Fund will effectively flow through to fund their 50% share on an as needed basis as the project is built. And then on the tax credit piece, there might be couple of quarter time lag prior to us being a cash taxpayer between when we spend the CapEx in the project, and when we get the tax credit back from the federal government. Post us being a cash taxpayer in the 2027 plus time frame, there will effectively be no lag in terms of when we earn the cash from the carbon capture tax credit.

So in turn, what that means for Strathcona and our -- and the Strathcona balance sheet is that effectively, there should really be no burden, or no net use of cash from us as we go to build these carbon capture assets and, in turn, there should be no change to any kind of base or feature special dividend for our shareholders.

[Dennis Fong, analyst]

I appreciate that context, Connor. Shifting gears more to the operations side and focusing on development at Druid, can you talk towards the potential on your existing land base to develop a manage stack through multilateral wells? And can you also kind of touch on leveraging some of the expertise you view your team is having to optimize that asset base in the Lloyd region?

[Robert Morgan, executive]

Yes. Thanks for that, Dennis. I think we are fortunate where our assets are located that and it's always the benefit of having assets in this region is you have often that Mannville stack as part of your ongoing business. So certainly, in the Druid area, we will drill our first well. I think every formation has unique characteristics, and we just want to make certain that this technology. We've had some -- there's been a small amount of, I'll call, two leg wells that have been drilled here. But this is the first time that we'll get a little more into the pure multi-leg technology.

If that is successful, we think there could be a number of follow-up locations in Druid in the order of half a dozen to a dozen I guess, at this point in time. There are other parts of the reservoir that we also want to assess the applicability of that technology. And then that will lead us to, I guess, the other parts of our asset base. And hopefully, as we get to the Investor Day, we'll be able to provide even more context of what the potential could be for Strathcona. Again, having those multiple manual horizons in a number of our assets.

[Dennis Fong, analyst]

Thanks, Rob. I appreciate the context. And I also appreciate that you don't really want to front run your Investor Day in terms of the takeaways from there.

[Operator]

There are no further questions at this time. I'd now like to turn the call back over to Mr. Morgan for any final closing comments.

[Robert Morgan, executive]

Well, I want to thank everyone for taking the time today and the great questions. And we look forward to seeing all of you, not only for our Q3 conference call, but at our Investor Day in November. Thanks very much. Enjoy the rest of your summer, and have a great day.

[Operator]

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.