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Earnings Call Analysis
Q3-2023 Analysis
Strathcona Resources Ltd
Strathcona Resources Limited recently became a publicly traded company, with its shares debuting on the Toronto Stock Exchange under the ticker SCR on October 5, 2023, following the closure of its acquisition of Pipestone Energy Corp. on October 3, 2023. Although Waterous Energy Fund continues to hold a dominating 91% stake, this marks a new beginning for outside investors to participate in the company's growth.
In Q3 2023, Strathcona reported a 3% rise in production compared to the previous quarter, averaging 147,000 barrels of oil equivalent per day (BOE/d). This increase was largely credited to new wells and better base production in their Cold Lake Thermal segment and supplementary wells in the Montney segment, totaling an average of 58,000 and 38,000 BOE/d, respectively. However, the Lloydminster Heavy Oil segment saw a moderate decline due to scheduled turnarounds.
The company ended the third quarter with a substantial debt load of approximately $2.8 billion. Over the short term, they aim to keep this debt level stable until the end of 2023, strategic free cash flow from the fourth quarter is earmarked to manage debt from the Pipestone transaction. By the end of February 2024, the goal is set to repay the bank term loan, marking a significant step in Strathcona's financial roadmap.
Looking ahead, Strathcona predicts a 9% year-over-year boost in 2024 production growth from its legacy assets, anticipating midpoint production between 190,000 to 195,000 BOE/d. The flat production on legacy Pipestone's assets is to result from a calculated $120 million capital program emphasizing on base production optimization for improved well economics.
Strathcona's 2024 capital budget aims to generate about $1.0 billion in free cash flow. The company intends to follow a disciplined financial approach by allocating all its free cash flow to debt reduction until they achieve their target debt of $2.5 billion. Upon reaching this milestone, shareholders can expect the company to reveal its plans for returns, hinting at a likely generous allocation of its free cash flow to its investors.
Strathcona underscores its strategy of prioritizing long-term value creation over short-term gains. By adhering to its core investment principles, such as maintaining a margin of safety and focusing on controllable factors, the company projects that its market valuation and intrinsic asset value will eventually align.
Good morning. My name is Mark, and I will be your conference operator today. I would like to welcome everyone to the Q3 2023 Conference Call of Strathcona Resources Limited. [Operator Instructions] After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to introduce Rob Morgan, President and CEO of Strathcona to begin the conference.
Thank you, and good morning, everyone. Welcome to the Third Quarter 2023 Conference Call of Strathcona Resources Limited. As mentioned by the operator, I am Rob Morgan, President and CEO of Strathcona. With me today is Connor Waterous, Senior Vice President and CFO; and Angie Lau, our Treasurer. Before we begin, please take note of the advisories regarding forward-looking information and non-GAAP measures included in our third quarter disclosure materials. At the end of the call, we will be taking calls from analysts. Strathcona is very excited to host our first conference call as a publicly traded company.
We closed the acquisition of Pipestone Energy Corp., on October 3, 2023, and Strathcona shares began trading on the TSX on October 5, 2023, under the symbol SCR. Waterous Energy Fund, Strathcona's controlling shareholder retains an ownership position of approximately 91%. As the Pipestone transaction closed after quarter end, please note Strathcona's third quarter results do not include the contribution of Pipestone's assets. Pipestone's third quarter results have been filed separately and are available on SEDAR.
Production for the third quarter of 2023 averaged approximately 147,000 BOE per day, up 3% from the second quarter. Production at our Cold Lake Thermal, Lloydminster Heavy Oil and Montney segments averaged 58, 51 and 38,000 BOE per day, respectively. Third quarter production was higher in the Cold Lake Thermal segment due to new wells coming online and improved base production performance at the Lindbergh property. Montney production increased due to additions from new wells and production returning to normal after an outage at a third-party operated processing facility late in the second quarter.
Lloydminster Heavy oil production was down slightly from the second quarter, primarily due to planned turnaround activity at the 4 Saskatchewan thermal assets. During the third quarter, Strathcona tied in and began -- at the Cold Lake Tucker asset on the H-pad consisting of 8 new well pairs, the first new well pairs to be drilled in approximately 5 years. The H-pad is expected to benefit from improved reservoir characterization versus legacy well pairs drilled previously, driving higher production and a lower steam oil ratio for Tucker into 2024.
In the Montney, Strathcona also completed the expansion of its Groundbirch gas plant to 60 million cubic feet per day from 30 million, which we expect to fill with 3 new wells that were also completed in the quarter. Connor will now provide a financial overview.
Thank you, Rob. In the third quarter, Strathcona generated approximately $290 million of total operating earnings and approximately $155 million of free cash flow. Q3 free cash flow was roughly flat versus the second quarter as the impact of higher oil prices was offset by slightly higher royalties, higher realized hedging losses and higher CapEx.
Strathcona ended the third quarter with total debt of approximately $2.8 billion, which we expect to be roughly flat between now and the end of 2023, with the fourth quarter's free cash flow largely being used to repay the assumed debt from the Pipestone transaction. Strathcona is on track to repay the bank term loan by the end of February 2024.
Strathcona's oil production for the fourth quarter of 2023 is approximately 80% hedged on a net after royalty basis at an average WTI price of USD 78 per barrel. A summary of the company's risk management contract is available in Strathcona's MD&A. Back to you, Rob.
Thank you, Connor. As part of our third quarter earnings release, we have updated guidance for the fourth quarter of 2023 and provided preliminary guidance for 2024. Strathcona expects its fourth quarter 2023 production to be approximately 185,000 BOE per day, incorporating the Pipestone assets from closing on October 3, with resulting 2023 annual production of approximately 155,000 BOE per day and full year capital expenditures of approximately $1 billion.
Looking at 2024, I am pleased to report that Strathcona's Board of Directors has approved a capital budget of approximately $1.3 billion. Capital is expected to be allocated roughly evenly across Strathcona's 3 core operating areas. Of the total $1.3 billion, approximately $800 million is sustaining capital. Approximately, $250 million is directed towards filling existing facility capacity and will contribute to near-term production growth.
Approximately $250 million is capital dedicated to long lead debottlenecking and brownfield facilities capacity expansion, which will contribute to growth in the longer term. On a combined basis, these expansion projects are expected to increase production capacity by 25,000 barrels per day above current capacities by the end of 2026 at a combined capital efficiency of approximately $25,000 per barrel per day. Strathcona expects 2024 production to be between 190,000 and 195,000 BOE per day weighted 77% to liquids.
The midpoint of this guidance reflects approximately 9% year-over-year production growth on Strathcona's 2023 legacy asset base and approximately flat production on legacy Pipestone's full year 2023 production of 33,000 BOE per day. The guidance for the legacy Pipestone assets reflects a disciplined capital program of approximately $120 million focused on optimization of base production, which is expected to result in a reduced base decline rate and enhance future well economics. Back to you, Connor.
The company's 2024 capital budget is expected to generate approximately $1.0 billion of free cash flow at USD 80 per barrel WTI assuming a $15 per barrel WCS WTI differential 0.73 USD-CAD and $3 per Mcf gas price and is expected to be fully funded down to as low as approximately USD 40 per barrel of WCS. These figures do not take into account the retirement of approximately $150 million of previously disclosed call premiums and foreign exchange collars inherited from a previous transaction, neither of which are sensitive to oil and gas prices.
Strathcona's Board of Directors has approved a debt target of $2.5 billion. The company intend to allocate 100% of its free cash flow towards debt paydown until this debt target is reached, after which the company is expected to provide further details of its shareholder return program. Back to you, Rob.
Thanks, Connor. Lastly, with this being our first quarter as a public company, we wanted to comment on some of the bigger picture priorities for our company in both the short and longer term. In the short term, we recognize that the market has been volatile since the close of the Pipestone transaction, and we expect it to continue to be volatile for some time as legacy Pipestone shareholders cycle out and new long-term investors begin to cycle in. We also recognize that many in the public markets are still not familiar with the unique characteristics of our company, and we are committed to increasing investors' knowledge of our business.
Strathcona was built with a focus on long-term value creation, and we are confident that we remain focused on our core investment principles of compounding long-term value per share, managing the business with a margin of safety and focusing on the items we can control, our share price and the long-term value of our assets should converge over time. Thank you very much for your time this morning, and we would be pleased to take any analyst calls.
[Operator Instructions] And our first question comes from the line of Greg Pardy at RBC Capital Markets.
It's Justin Ho on for Greg Pardy. Congratulations on going public. So we do recognize that more detail will be provided on the mode of shareholder returns after you reach that $2.5 billion debt target as you touched on their Connor. But broadly speaking, how should we be thinking about shareholder returns, especially when we think of the limited public float?
Sure. Thanks for the question, Justin. So first, going back to our debt target. We sized that $2.5 billion based on approximately 1x debt to EBITDA at a mid-cycle price of $70 WTI. Our plan is to use 100% of the free cash flow that we generate to get down to that level as quick as we can, post which our plan will be to flip the switch, so to speak, to send as much of the free cash flow that our business generates out to the shareholders of the business post that. While Board of Directors has not yet approved a formal dividend or other form of shareholder return plan. We think it will be the vast majority of free cash flow going back to shareholders.
Perfect. And just to dig a little bit deeper into that, if I can. If you were to go the dividend route with the -- would you view a suitable dividend policy as perhaps a base dividend supplemented by variables as your free cash flow coverage of course?
That's right, Justin. Going back to Rob's comments about trying to manage the business with a margin of safety. The focus for the team and the Board when we sign that base dividend, we'll need to make sure that it is still a fully funded post maintenance capital down to a very low trough point in the oil and gas price cycle. And post setting that base dividend, the balance of the capital sent back to shareholders will likely in the form of variable dividends, although based on where our share price is at the time, a buyback...
The next question is from the line of Menno Hulshof of TD Securities.
I'll just start with a question, I believe, for Rob, on the 8-well paid pad at Tucker, what can you tell us about the well design and how it does differ from what Husky was doing back in the day. And maybe as a follow-up to that, what should we expect in terms of the overall profile for Tucker into 2024 and 2025 from a production and SLR perspective?
So what we've actually done is we build slightly longer horizontals and have provided for vision of inflow control on those wells necessary to help support conformance over the well bore. We've also -- where we characterized the drilling of these wells. I think back in the day, given some early time struggles back in the day the Husky drilled wells, they probably used a bit more of a margin of safety drilling at the next levels of wells. And so we're really trying to optimize the amount of good quality reservoir above these individual wells.
So we expect these wells to come on at a much stronger steam-oil ratio than the overall average of the field. And I think when you look at the current time, with the amount of steam we're injecting, not really getting new production, the steam-oil ratio moving up into that 6% range. We expect that over time, bringing that filling that capacity we have at Tucker that we can start to move that steam-oil ratio down into the 4% to 5% range.
Terrific. And then maybe moving on to the Pipestone assets. You have a few months under your belt now a bit longer. What are you seeing in terms of positive or negative surprises, if any, and how is the integration going so far?
So I think the integration is going very well. We have a number of new team members here at Strathcona, consistent with how we have incorporated corporate acquisitions we've done in the past. I think on the asset side, we have intentionally decided and we've communicated that we intend to hold production there, flat, basically really optimize focus on base production. I think the Pipestone team did an excellent job of growing the asset base very quickly. And our focus will be -- as we've done with almost everyone one of our acquisition take our time, really evaluate the opportunities in the asset and then move forward with perhaps additional capital as we move through '24 into 2025.
Terrific. Thanks again.
And our next question comes from the line of Dennis Fong at CIBC.
The first one here is just around cash cost. As you further deploy CapEx to backfill existing facility capacity as well as implement a waste heat recovery unit at Orion. Can you characterize approximately what the target happened to be for unit cash costs or cost savings that you expect through those various projects?
Sure, Dennis. Thanks for the question. So for speaking on the waste heat recovery project that we're currently in the middle of on our Orion project. We forecast finishing the tie-in of that waste heat unit, which will add 16 megawatt hour or less than 90% of the power needs of the project, call it, in the first half of the calendar 2025 year. And we think that will work towards shrinking the go-forward field operating costs on that project by about $2 per barrel going forward. I think a bit more broadly speaking, one of the reasons we're very excited about the various drill to fill and larger major expansion projects that we have in our 2024 capital program is that when we look at almost all of the transport and processing costs and the vast majority of our nonenergy field operating costs, the vast majority of those costs are fixed.
And so as we drive towards a 6% to 8% year-on-year growth in volumes when a meaningful portion of our cost structure is fixed plus the line of sight we see to decreasing our cohort power costs. With that, I'd -- waste heat unit, that really sets us up for a better breakeven price and ongoing margin on the business going forward.
Great. Appreciate that color. Shifting gears, I'd like to focus in on cash flow. You've shown a fairly good ROI from the Montney broadly. Can you talk about some of the initiatives that you're pursuing to bolster inventory in the region, specifically in cash flow, especially as you're keeping pipestone relatively flat for the time being while you evaluate that asset further?
Thank you, Dennis. So part of what we are actually working on is one of the minor transactions we did is we've done actually a bit of a land swap within the quarter, where we looked at swapping out some manual rights that we had for additional Montney rights in and around our core area, again, bolstering the number of locations we would have on a go-forward basis. And within the Montney acreage itself as we continue to expand out not only exploring our acreage across the asset base, but also looking at the 3 benches that we are testing and how to optimize the spacing, if you will, and the drilling of those benches to optimize overall recoveries from the assets.
So we continue to look at on our subsequent pads paths how we space the sequencing of the individual wells within the 3 benches and also always looking to optimize our completion techniques when it comes to our frac spacing and even sand concentration. So it's an ongoing process, as you know, but we've been pretty happy with our progress that we've made in terms of evaluating the benches as well as any revisions to our completion techniques.
Yes. I think what I'll put forth further on that Rob, is when we think about our Kakwa asset for most of the first 4 or 5 years that we spent drilling it, it was really focused on the top 2 layers in our Middle Montney. Over the last couple of years, we've moved to derisk the third layer on that middle Montney, which we've been very pleased with and has seen a much stronger condensate gas ratio. And then going forward into the 2024 year part of our 2024 budget is to start proving up the Lower Montney in Kakwa, which will mean that there will be 4 separate layers with production at Kakwa. And since we can drill all 4 of these layers all off the same pad. We think that there will be some very large savings on a per well basis going forward. And we've generally seen that the lower benches have seen higher condensate gas ratios.
Great. Thanks. Appreciate the color. I'll turn it back.
Thank you. And we have a further question from Menno Hulshof of TD Securities.
I just thought I'd ask a question on the float since it's a question I'm getting fairly often. Can we just get a refresh on your thought process for increasing the float and overall liquidity over time. And of course, the big potential driver of future liquidity is Waterous Energy Fund. Is there a scenario where we could see the fund trim its position a bit sooner than later to address that?
Thanks for the question, Menno. So the way we've thought about the float is maybe in call it 2 to 3 different stages. In the short term, obviously, as folks know, the legacy Pipestone business was about 70% of it was held by the 3 big shareholders in that business. And we think just naturally, there is going to be some turnover within that big 3 legacy Pipestone shareholder based over time. And so just on a natural basis, the pro forma float of the business should grow. In the longer term, how Waterous Energy Fund has thought about monetizing the stake that it currently holds in the business has largely not been through pure secondary sales of its shares, but will likely come in the form of a step-by-step liquidation of the various partnerships that it's managed.
And that's likely going to take place or call it the over the next 2- to 3-year time frame, post which the business will have a very broadly held stock. Prior to that, we certainly think that there's some chance that we can use the public currency that we now have to as a form of purchase price consideration for a given transaction that we find. But the piece that we'll be laser-focused on there is making sure that it's a value per share accretive transaction, which we recognize will be -- which will be quite a high bar to clear for the business in the short term. And then finally, just to be precise in terms of how that fund my trim at stake in the business in the short term, we don't think that there's any plan or thought for the fund to start doing any pure secondary sales at the current stock price.
Appreciate the thoughts Connor.
Thank you. And as there are currently no further questions in the queue, I'll hand the floor back to Rob for the closing comment.
Thank you. Once again, we are very excited with our debut as a publicly traded company, and I want to thank you all for your interest this morning, and I wish you all the best for the day. Thank you again for joining.
Thank you. This now concludes the conference. Thank you all very much for attending. You may now disconnect your lines.