ARC Resources Ltd. (OTCPK:AETUF) Q3 2022 Results Conference Call November 3, 2022 9:00 AM ET
Company Participants
Dale Lewko – Investor Relations
Terry Anderson – President and Chief Executive Officer
Kris Bibby – Chief Financial Officer
Lara Conrad – Chief Development Officer
Armin Jahangiri – Chief Operating Officer
Conference Call Participants
Michael Harvey – RBC Capital Markets
Patrick O’Rourke – ATB Capital Markets
Travis Wood – National Bank Financial
Jamie Kubik – CIBC
Operator
Good morning. My name is Marcella, and I will be your conference operator today. At this time, I’d like to welcome everyone to the ARC Resources Third Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] Thank you.
Mr. Lewko, you may begin your conference.
Dale Lewko
Thank you, operator. Good morning, everyone, and thank you for joining us on our third quarter earnings conference call. Joining me today are Terry Anderson, President and Chief Executive Officer; Kris Bibby, Chief Financial Officer; Lara Conrad, Chief Development Officer; and Armin Jahangiri, Chief Operating Officer.
Before I turn it over to the executive team to take you through our third quarter results and 2023 budget, 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 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
Thanks, Dale, and good morning, everyone. A year ago, we laid out a plan that prioritized debt reduction in a balanced investment in our asset base with incremental shareholder returns. The primary take away from the quarter is we are executing to plan.
Production, capital and operating expenses were in line with expectations and are tracking to guidance. Our financial performance has been exceptional. And from a debt perspective, we are closing in on our long-term debt target, which supports a greater proportion of free cash flow to shareholders.
The base dividend remains our primary method of returning capital to shareholders, which we have committed will grow as the business grows and as the share count is reduced. This quarter, we announced a 25% increase to our dividend, the fourth increase in the past six quarters, which remains sustainable through the commodity price cycle.
We also continue to invest through share buybacks. They’re an effective and accretive use of capital under, what we believe, are conservative pricing assumptions. Since renewing our NCIB at the end of August, we have bought back approximately 30% of the new NCIB allotment. Growing free cash flow per share is a focus, and we are executing on that by investing profitably in our assets and reducing the share count.
I’ll touch on a few operational items related to the quarter and also the 2023 capital budget before I turn it over to Kris to walk you through more details of our financial results. Production averaged just over 342,000 BOE per day over the course of a very active quarter. Our operations team completed several significant turnaround projects across our fields safely and efficiently.
With the majority of planned seasonal maintenance behind us, we anticipate production volumes will increase in the fourth quarter to over 350,000 BOE per day driven by growth at Kakwa. As a result, we anticipate that operating and transportation cost per BOE will decrease over the balance of the year.
Turning now to our 2023 budget. The capital program we put together balances profitable growth, with the flexibility to increase shareholder returns as net debt is reduced. Underpinning this budget is our commitment to a strong balance sheet, which is a critical part of our business that allows us to capitalize on countercyclical opportunities.
Next year, the preliminary budget of $1.8 billion is expected to deliver production of approximately 350,000 BOE per day, representing a 2% year-over-year growth and generating approximately $1.7 billion of free cash flow at the current forward curve.
Approximately $1.4 billion, which incorporates inflation, was allocated to sustaining production across our asset base, split 70% in Alberta and 30% to British Columbia.
The incremental $400 million above sustaining capital includes important production growth and margin expansion projects that further enhances the long-term profitability of the business.
The first is the expansion at Sunrise that will add 80 million cubic feet per day of production for approximately $100 million. Sunrise is a very strategic asset for our company. It is one of our most profitable assets and has nearly zero emissions facilities. In addition, Sunrise will be direct connected to Coastal GasLink, the pipeline that will supply natural gas to LNG off the West Coast.
At Kakwa, we plan to invest approximately $200 million in production growth and margin expansion. Of the $200 million, $130 million is in water infrastructure that will lower operating cost by $60 million per year or $0.50 per BOE at the corporate level, ultimately paying out in less than two years. The remainder will be used to increase production by 5% to 10% to approximately 190,000 to 200,000 BOE per day.
The Kakwa area continues to deliver exceptional results, with ARC wells dominating the top wells in Alberta month after month.
The final $100 million is earmarked to restore production in BC to previous levels following a year of relatively little activity. On this note, the budget we’ve outlined today is predicated on the timely and continued receipt of drilling permits on freehold lands in Northeast BC. We have one rig drilling in BC right now, and we remain confident we will be able to execute the capital program put forth to restore production and regain the operational momentum there next year.
As it relates to Attachie, we remain prepared to sanction Attachie Phase 1 once the BC regulatory environment on Crown lands becomes more certain. Phase 1 is expected to cost approximately $700 million, including the facilities capital and initial wells to fill it and would pay out in about two years at the current strip.
Like others, inflation is impacting our business, but we are managing it both today and in the future. Long-term planning and our scale are proving critical in ensuring we have access to services and materials to execute our program. And to that end, I’d really like to thank our people and service providers for their hard work and relentless focus on safety and efficiency in our operations.
With that, I’ll turn it over to Kris to walk through the financial results.
Kris Bibby
Thanks, Terry, and good morning, everyone. We delivered on all financial targets in the third quarter. Production, capital spending and cash flow were all in line with expectations, and generated returns on invested capital remain very strong.
Despite the inflation pressure Terry just mentioned, we are on track to achieve our 2022 guidance, which notably was unchanged in the quarter. ARC invested approximately $375 million or 40% of our cash flow in the quarter. We generated an operating netback of $45 per BOE, reflecting strong commodity prices, our condensate-rich asset base and our low-cost structure.
Our business yielded $580 million of free cash flow, a 30% increase on a per share basis year-over-year. Our infrastructure network and pipeline takeaway were once again important contributors to our financial performance.
Seasonal maintenance on the NGTL system resulted in relatively low AECO prices at times in August, and we were able to mitigate our exposure by sending the majority of our natural gas to the U.S. via pipeline agreements we put in place many years ago.
In August, when AECO was below $3, less than 10% of our natural gas was exposed to this market. As a result, ARC realized a natural gas price of approximately $9.30 an Mcf in the quarter, which was $3.50 an Mcf greater than the AECO monthly index.
While AECO was volatile, condensate fundamentals were strong, and we capitalized on that as the largest condensate producer in Canada. Our condensate production was up 6% year-over-year to 82,000 barrels per day, and we realized $110 per barrel for our product in a seasonally lower demand environment. The fundamental outlook for condensate moving forward is similarly strong, notwithstanding the macro uncertainty we’re experiencing.
It is a loan product in Western Canada, where demand exceeds supply by approximately 250,000 barrels per day. Meanwhile, supply is growing slightly in response to high prices, but remains governed by high decline rates and producer discipline, as we head into a seasonally strong demand environment.
Since inception, ARC has been a balance sheet first company. At quarter end, long-term debt was reduced by approximately $100 million to $1.1 billion, with net debt of $1.5 billion. The net debt approach is $1 billion, which is the value of our note — senior notes outstanding, the amount of free cash flow that is returned to shareholders logically increases.
We demonstrated this commitment in the third quarter where we returned 94% of our free cash flow to shareholders through a combination of base dividends and share repurchases. This is a trend we anticipate continuing into 2023.
As it pertains to free cash flow allocation, our longstanding commitment to return capital remains. We continue to challenge our internal views on the optimal way to return capital. Today, we believe it is a combination of growing base dividend and reducing the share count when the shares are trading below intrinsic value. We measure intrinsic value in different ways, but always anchor at under reasonable lower commodity prices. And today, we believe that value exceeds the share price.
Finally, moving forward, we will continue to reinvest in our assets in a disciplined manner and, as announced, intend to allocate between 50% and 100% of our free cash flow to shareholders, up from our previous 50% to 80%. This will come through in the form of base dividends and share repurchases, assuming repurchases — repurchasing our shares provides the value that it does today.
Since initiating the NCIB in September of 2021, ARC has repurchased 93 million shares or 13% of the shares outstanding at that time at an average price of $15. While we recognize we cannot predict or control commodity prices, we have scale in the best assets, a strong balance sheet and excellent people across the Company to deliver attractive and sustainable returns for our shareholders.
With that, I’ll turn it back to Terry for closing remarks.
Terry Anderson
Thanks, Kris. We have met with an increasing number of investors over the past year. There is more interest in the sector than I can recall for quite some time. It spans different geographies, investor mandates and time horizons.
There could be several factors driving this. For one, different factors have contributed to a prolonged period of underinvestment in the industry. Capital spending is roughly half of what it was a decade ago, and yet demand and, therefore, price is strong.
Second, the globalization of natural gas via the LNG build-out in North America is a positive development for Canada and ARC, specifically.
And third, it could be the change in behavior that has improved corporate return on capital.
In addition to these factors, there’s definitely a heightened focus on energy security, underscoring a more accepted view that commodities we produce form a critical part of the energy ecosystem and will remain that way for a very long time.
For ARC, we have positioned our company over the past several decades to play a leading role in this regard. We’ve amassed a world-class asset base and infrastructure network and have a longstanding culture of capital discipline, operational excellence and ESG leadership.
Even though we cannot exactly predict future commodity prices, our strategy is built to withstand and thrive through all parts of the cycle, like we have for the past 26 years. I have never been more confident in where ARC is heading, and we look forward to delivering sustainable value for many years to come.
With that, I’ll turn it back over to the operator for questions.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from the line of Michael Harvey from RBC Capital Markets.
Michael Harvey
So I just had a question on Kakwa. Obviously, lots of wells going down there this year and next. Just wondering kind of what’s working well there from an operational perspective, just as the drilling density increases. So that could be spacing, well length, frac sizing, where you put in the wells.
Just kind of some broad thoughts on some of those well level development strategies, just given that, as you mentioned, the results there are still pretty good. And then just kind of remind us of the inventory figures you’ve got. That would be helpful as well.
Lara Conrad
You bet, Michael. This is Lara Conrad. Thanks for the question. So yes, I think we’ve spoken quite a few times about our strategy with Kakwa as far as widening out the wells. We enacted that immediately upon completing the business combination.
And now here we are 1 year, 1.5 years later, able to see the results of that. So effectively, all of the wells that we’re drilling have that wider spacing, and we’re seeing really strong results from those. We are indeed accessing the resource still at that wider spacing, so we’re getting that productivity while putting less capital in the ground.
We’ve also optimized our fracs by putting less water. So same sort of tonnage, but less water pumped, which reduces the overall cost. And again, we’re seeing very similar productivity. We’re not really seeing any negative from lowering the water volume in.
So both of those — those will be sort of the two major drivers as far as Kakwa pad and well designs, and both are occurring — or creating the results as predicted. So very happy with that.
As far as inventory at Kakwa, I think, as always, we have a fairly conservative booking strategy. But when we look forward, we have an inventory well over 1,000 wells at Kakwa, so a long life to that asset.
Operator
Your next question comes from the line of Patrick O’Rourke from ATB Capital Markets.
Patrick O’Rourke
I think I’ll leave the standard return of capital question for others here this morning, but I will say I think you guys have driven — drawn a very definitive line in the sand with respect to how compelling you see the value in your equity today through your action.
I just want to kind of build upon Mike’s question there. And at Kakwa, the results are very intriguing. And I know that he touched on the technical changes that you referred to in the release. Just wondering, with respect to inventory and development of the Lower Montney, what you’ve seen on the assets since you’ve acquired it.
Lara Conrad
Yes. So thanks, Patrick. As far as the lower inventory, the Lower Montney, so we’re looking at it as far as what the overall development strategy should be for the full 3D volume. I think the way we all talk in industry, it’s really easy to simplify these things and talk about inter-well spacing. But it is a simplification compared to what our technical teams look at.
So we still like the lower, but we do think it needs to be codeveloped with the upper, and that opportunity does not exist across the entire Kakwa inventory. So when I talked about that broad inventory, that does include what we have confidence and conviction in regarding that lower inventory.
Patrick O’Rourke
Okay. And then just a quick question with respect to Attachie. You referred to it as sanction ready. I’m just wondering, is sanction ready synonymous with shovel-ready as well or drill — shovel-ready, construction-ready, drill-ready once you see kind of a resolution in terms of the surface level issues and permitting there?
And then is this a situation, you have the budget out there the capital budget for 2023, where if you do get that resolution on the regulatory front, we can see an augmentation of that budget and effectively an immediate start to the project?
Terry Anderson
Yes. Patrick, it’s Terry Anderson here. When we say shovel-ready, sanction-ready, we are ready to roll. As soon as we get that clarity from the BC government on the regulatory framework, we’ll approach our Board, and we will decide to move forward at that time.
So in 2023, we expect that to be coming here soon. We will make sure that we go talk to the Board, and we’ll be adjusting our capital budget go forward to start moving forward on Attachie.
Operator
Your next question comes from the line of Travis Wood from National Bank Financial.
Travis Wood
Patrick kind of asked the question I was going to ask, but maybe you could expand on kind of the cadence and time lines upon kind of driving shovels in the ground, in terms of how we should think about the $700 million portion of it, the kind of wells to drill to fill in terms of the capital portion and then kind of the chunkiness of the volumes probably into potentially late ’24.
Could we see first gas and volumes late ’24? How can we think about that cadence over the next couple of years and that capital — incremental capital portion as well?
Terry Anderson
Yes. Travis, this is Terry here again. So we’ve talked about it’s a $700 million project for the — all the facilities capital and drilling. And once we are — we have that clarity and start moving forward, like we’ve already — and I should remind everybody that we’ve already did a lot of pre-spending on this on long lead time equipment.
The lease has already been constructed. Some of the water handling ponds and stuff have been constructed. So we are ready. It will be 18 months from the time we get going is the plan. And so it depends on when we start within the year, but 18 months to — I’m pushing our team that it’s 18 months.
We talk about 18 months to two years. But from when we get going to 18 months to two years is when that first production will come on. And then we will take a couple of months to ramp that production up to the 40,000 BOE a day. But the actual cadence and how much we would spend in 2023 all depends on when we actually start.
Operator
[Operator Instructions] Your next question comes from the line of Jamie Kubik from CIBC.
James Kubik
Just a question on how ARC is looking at gas pricing in Western Canada. I mean, we did see considerable weakness on AECO and Station 2 dips through Q3 relative to NYMEX.
Just curious about how you’re thinking about summer gas prices moving forward and if you think we see a repeat of Q2 — Q3 differentials over the next couple of years until LNG Canada comes online.
Kris Bibby
Jamie, it’s Kris here. Obviously, so we are excited for the immediate near term in the winter. We would anticipate very healthy pricing heading through winter just given the demand construct that we’re seeing and how strong it is.
As we move into the summer, one of the key things is there will be some expansions on the NGTL system that should alleviate some of the pressure that we saw this last summer. The key — there’s two key things that will obviously need to happen, which are one of them is the cadence of production growth from the basin overall, and then the other is weather.
So it’s a possibility. But with the expansion of the system, we’re optimistic that we won’t have a repeat of, again, very limited periods of weakness in the summer. So we don’t want to paint it as it was broken all summer. It was a matter of a couple of weeks that there was a bit of weakness.
And again, our plan around that is just to make sure that we’re selling as much gas as we can into the U.S. when there’s periods of congestion at AECO.
James Kubik
Got it. And maybe just to expand on that perhaps a little bit. You do have a line in your press release on ARC continuing to evaluate and execute additional downstream diversification initiatives. Can you expand on maybe what you’re looking at on that front a bit further?
Kris Bibby
Yes, you bet. And obviously, I’m not going to give you any details or any of the secret sauce. But generally speaking, we’re always open to evaluating is there other places we can sell our product where we can get premium pricing, and that would also include things like LNG, which are clearly a longer-term type of contract.
But we will evaluate all types in the near term and in the medium and long term. I think we spoke publicly about, in the longer term, we would like up to 25% of our gas receiving international pricing. And it’s going to be a measured approach and a lot of contracts to get to that. So it will take some time, but we are still committed to it and putting contracts in place.
Operator
Your next question comes from the line of Travis Wood from National Bank Financial.
Travis Wood
I had a follow-up question just with respect to the facilities across the land base. Could you help us kind of get a sense of where you have incremental capacity at any of the plants in terms of kind of easy, low-hanging growth potential and where we see some of those plants being at capacity? Kind of specifically, I’m thinking of Gold Creek mostly, I think.
Terry Anderson
Yes. Travis, it’s Terry here again. So typically, for our BC facilities, they like to run them at max capacity, and they are there. For — yes, you’re right, in Kakwa and Gold Creek, we do have some spare capacity.
Some of that spare capacity comes in very handy for when we bring on some of these pads. They’re very turkey wells. And so it’s not unusual for us to bring on an eight-well pad and increase production by over 20,000 BOE a day.
And so the nice thing of having a little bit of that spare capacity is we’re able to capture that early flush production. And so obviously, it helps pay the wells out quicker.
But we are looking at other — obviously, we have the Montney, we have the cretaceous, the Deep Basin that runs through Kakwa also. And there’s opportunities for us to look at maybe drilling wells there and filling up more of that spare capacity. But as of right now, Kakwa is the place where we have the spare capacity to move any kind of — anything of significance on volume.
Travis Wood
Okay. And would it be fair to say that at Gold Creek, there’s about 200 a day of capacity, plus or minus?
Terry Anderson
Now you’re getting to details that I have to talk to the operation team about.
Operator
[Operator Instructions] There are no further questions at this time. Please proceed.
Dale Lewko
Excellent. Thank you, everyone, for joining. And that concludes the call today.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
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