As the carnage in the oil market continues to get worse by the day, it’s understandable that Canadian Natural Resources Ltd. (CNQ) like a lot of producers is getting anxious to make sure its investors don’t get anxious. To that end, they’ve released an update on their corporate operations, their Capex budget, and their operating costs at oil sands sites.
I have a lot of questions about this update, however, because it seems to raise as many questions as it answers.
The New Update
CNQ’s update is dated March 18th. March 18th was an especially ugly day in the oil markets, where prices that had only just hit the $26 low of 2016 the day before fell all the way to $20 – a 24% drop in a single day. Not surprisingly, CNQ felt the need to reassure everyone that this latest catastrophe wasn’t going to knock it offline completely.
The update is full of the typical boilerplate language, but there are basically two key points. First, CNQ is cutting its Capex budget until prices improve – no surprise there. Second, its oil sands operating costs for existing projects are $13 per barrel, so there’s no danger of them shutting down even with this latest downwards movement.
That’s a bit more of a surprise. CNQ’s 2019 operating cost number for these assets, the “Mining and Upgrading” portion of their production base, was disclosed by management as C$22.65 in their most recent earnings call. What’s more, that same call also disclosed that operating costs in that segment have never been lower than C$21.75. Now, suddenly, just three months later, they’re at C$18.88, which is $13 USD?
An Incredible Cost Cut, If Correct
Don’t get me wrong, I’m not surprised the number has gone down, at least in US dollar terms. The loonie has been slaughtered in recent weeks – well, pummeled, I guess, oil is what’s being slaughtered – and now trades down almost 10% from its previous level. As such, the USD operating cost line was always going to move.
But management is going beyond that and saying that its costs in local currency have also plunged, down almost 20% in just three months. If that is so, it’s one of the boldest, deepest, and quickest cost cuts in the Canadian oil sands in their entire history.
And yet management offers no color on this recent statement. How did costs drop this far, this fast? How long can it be maintained? We don’t really have any further explanation from management to put this in the proper context.
Perhaps Thermal Is In There Too?
One thought I did have, and it has to do with the nature of oil sands operations. Maybe this cost base is actually both halves of the pie, not just one.
For those who aren’t familiar, two very different kinds of oil sands extraction take place in Canada. First, there is the surface mining, where bitumen is literally sucked up from near the surface and refined into useful oil. This is not quite strip mining, but it’s something like it. Then, there is also thermal extraction, where deeper deposits are literally steamed out of the ground at high pressures.
This second method has far higher capital expenditures and lower operating costs than its surface mining counterpart. Thermal extraction had operating costs in 2019 of just C$8.65, and weighting the average according to production volumes produces a combined oil sands operating cost of C$18.40 a barrel – very close to the C$18.88 that management is claiming.
The Numbers Just Don’t Match
The problem is, this isn’t what CNQ management said. Their statement specifically refers to “Mining and Upgrading,” which is its own segment on the earnings reports and incorporates only surface operations. The thermal operations are part of CNQ’s “Exploration and Production” segment, along with its more conventional oil assets.
The production numbers don’t match, either. CNQ’s recent release touted its oil sands mining operations of 430,000-475,000 barrels per day. That is within the range CNQ reported for its surface operations in Q2 and Q3 last year (Q4 was below this level but that appears to have been a one-off.) Thermal operations accounted for 168,000 barrels per day last year all by themselves and are projected to grow this year.
No, my theory just doesn’t fit. Clearly, CNQ is claiming that it has achieved 20% operating cost reductions in surface oil sands in just three months.
I mean, if that’s correct, it’s outstanding news – albeit perhaps not outstanding enough if oil drops much lower, but it’s a vital cushion boost to efforts to conserve cash and ride out the oil downturn.
Ongoing Questions
My only concern is with the lack of color around this announcement. This is a rather bold claim to simply put out there and expect to stand on its own. I’m not claiming management has done anything improper in making the announcement this way, but I do wonder what it means that we haven’t heard anything more.
Is this a short-term decline that can only last a little while, or do they think they can maintain this? Where in the operation did the savings come from? Why was there no mention of this during the earnings call, which was only two weeks ago? Is this something the company has been working towards for a while or did the collapse of oil somehow rebound to their benefit and reduce costs somewhere? And those are only some of the questions I have.
For now, I’m going to take this as limited good news. My best guess, in the absence of guidance from management, is that they’ve locked in some near-term savings, maybe as a result of the oil collapse or maybe from some other source. Until I hear differently, however, I’m going to assume that this is strictly a short-term boost that can’t last very long, and I’m not really going to include it in my long-term projections for CNQ.
Investment Summary
CNQ has a number of strengths going for it, not least the $5 billion in liquidity its currently sporting and, apparently, a little boost to its cost-reduction efforts. However, it also has problems, like any Canadian oil producer right now: prices for its product are collapsing, it still can’t get all its oil out of the province, and it has some of the highest operating costs (even still) of any oil producer on the globe.
This cost cut is a nice little bonus for CNQ investors, but it doesn’t move the long-term needle much. As I explained in my last article, CNQ needs pipelines more than anything, to reduce the differential between what it gets for oil and what American shale producers get. That remains the key variable impacting CNQ’s future, in my view.
And since the new Line 3 pipeline won’t be up and running for a while yet, I’m going to hold off buying in, even at these depressed prices.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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