Husky Energy Inc. (OTCPK:HUSKF) Q3 2020 Earnings Conference Call October 29, 2020 12:00 PM ET
Leo Villegas – Director of Investor Relations
Rob Peabody – CEO
Jeff Hart – CFO
Conference Call Participants
Prashant Rao – Citigroup
Matt Murphy – Tudor, Pickering, Holt
Greg Pardy – RBC Capital Markets
Mike Dunn – Stifel
Benny Wong – Morgan Stanley
Thank you for standing by. This is the conference operator. Welcome to the Husky Energy’s Third Quarter 2020 Conference Call and Webcast. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions [Operator Instructions].
I would now like to turn the conference over to Leo Villegas, Director of Investor Relations. Please go ahead Mr. Villegas.
Hello everyone and welcome to our third quarter conference call. I’m joined by CEO, Rob Peabody; CFO, Jeff Hart; and other members of our senior management team. They’ll provide an overview of our third quarter results and take your questions.
Today’s call has forward-looking information and includes non-GAAP measures. The identification of the forward-looking information and non-GAAP measures, the risk factors and assumptions pertaining to the forward-looking information and additional information pertaining to the non-GAAP measures, are in this morning’s news release and in our annual filings on SEDAR and EDGAR. Unless stated otherwise, all numbers are in Canadian currency and before royalties. You are welcome to contact our Investor Relations team after the call to answer any questions.
Now, I’ll turn it over to Rob.
Thanks, Leo and good morning, everyone. A few days ago, we announced that we have entered into an agreement that we’ll see Husky and Cenovus combined in an all spot transaction. This is a great opportunity to join with Cenovus to create a new integrated energy company. Upon closing, this will be the third largest oil and gas producer in Canada and the second largest Canadian based refiner and upgrader.
It will have an integrated upstream and downstream portfolio that will provide for enhanced free cash flow generation and superior return opportunities for investors. This combination integrate Cenovus’ best in class in situ oil sands assets with our extensive upgrading, refining and transportation network and high net back offshore gas production. This creates a low cost integrated competitor with a long life reserve base and a commitment to leading ESG performance.
I’ll now turn to our third quarter results. In the third quarter, we took a large noncash impairment. Jeff will speak to the drivers for the impairment shortly. Over the quarter we remain focused on reducing costs and limiting growth investments in order to generate free cash flow. Just a quick reminder of our action so far this year. Capital spending has been lowered by more than 1.8 billion, that’s about $200 million lower than the last time we spoke with you. We continue to deliver on $150 million in identified cost savings. In the third quarter, we completed $1.25 billion public notes offering at 3.5%, which has further enhanced our liquidity.
To increase free cash flow, we started up to 10,000 barrels per day Spruce Lake Central thermal project in Saskatchewan at the end of August. It is already producing about 9,000 barrels per day. We have also increased our overall thermal production, and Sunrise production is also being increased towards full capacity. In Asia, the new 29-1 field at Liwan will begin providing natural gas to customers in southern China within the next few days. Both 29-1 Spruce Lake Central were completed safely ahead of schedule and within or below our original budgets, and both will generate immediate free cash flow at current pricing.
Turning to the downstream. Throughput of Lima Refinery was about 154,000 barrels per day in the quarter, up from around 130,000 barrels per day in the second quarter. Demand for refined products has been on a slow and uneven trajectory. We continue to optimize our refining rates yields for changing market conditions. At Lloydminster, we have wrapped up a major turnaround at the upgrader. Following the turnaround, we have increased our diesel capacity from 6,000 barrels per day to nearly 10,000 barrels per day. We also saw strong demand for Asphalt in the quarter. It’s allowed us to run the Lloyd refinery at full rates. And at the Superior Refinery, the repairs are continuing with the planned restart in 2020.
Moving to the offshore. We had another strong quarter in the Asia Pacific region, which delivered an overall operating margin of 227 million, and that will increase of course as we bring 29-1 field online in the next few days. In the Atlantic region, along with our partners, we have canceled the 2021 construction season at the West White Rose Project. The project is now being placed into safekeeping mode. The project will continue to be assessed as the external environment evolves.
Turning to ESG. We released our annual ESG report in early August. It included clear and achievable targets to reduce our greenhouse gas emission intensity by 25% by 2025. Ultimately, we aspire to achieve net zero emissions by 2050. We also set a target to achieve 25% female representation at the senior roles in the company. In the context of the Cenovus Husky transaction, the commitments of both Husky and Cenovus, those both of them that we have made to world class safety performance and ESG leadership will remain core to the combined company.
Now I’ll turn the call over to Jeff.
Thanks, Rob. I’ll start with an overview of our financial results. The net loss of $7 billion was impacted by an after tax impairment of $6.7 billion. This was related to lower long-term commodity price assumptions, reduced capital investment and higher discount rates based off of recent market indicators.
Funds from operations were $148 million, up from $18 million in the second quarter. And while this reflects gradual improvement in headline crude prices, it was offset by much lower realized US refine margins. Capital spending was $354 million, which included $79 million related to the Superior Refinery rebuild. Net debt at the end of the quarter was $5.4 billion compared to $5.1 billion at the end of Q2. This was driven by negative free cash flow and the effects of foreign exchange on US dollar denominated debt.
Liquidity at the end of the quarter was $5.5 billion made up of approximately $1 billion in cash and $4.5 billion in available credit facilities. And as mentioned earlier, we used $1.25 billion in notes, the net proceeds were used in part to repay our $500 million longer term loan in early October. And with the completion of Spruce Lake Central, the 29-1 field and the upgrader turn around, our 2020 capital expenditures are trending towards $1.4 billion, excluding the Superior rebuilds.
Meanwhile, average overall Western production in the third quarter was just north of 258,000 BOE per day Husky working interest. This takes into account planned maintenance work on the SeaRose FPSO and at Tucker and an outage on a third party pipeline to Sunrise, which had an impact of about 7,000 barrels per day for the month of September. Downstream throughput averaged just over 300,000 barrels per day, which included a turnaround at the Lloydminster upgrader.
Thanks. And we’ll now go back to the operator for questions.
We will now begin the analyst question-and-answer session [Operator Instructions]. Our first analyst question is from Prashant Rao with Citigroup.
I wanted to start with the offshore performance. Pricing obviously was held up pretty well. And just wanted to kind of understand a lot of that to Liwan I would imagine. How the strength of that margin contribution has held up and how you’re thinking about that? I know you said on an absolute margin basis what we should be expecting with terms of sort of pricing with contract expirations coming up. What is that, sort of how should we be thinking about the puts and takes there is to sort of the going forward, like the through cycle profitability on that project? And it seems quite a handsome and accretive segment for you and for the combined entity, assuming the merger goes through. So just wanted to get your thoughts there.
First of all, it’s important to understand that the contracts are not expiring soon. The only thing that’s happening in 2021 is there is a price adjustment that is implemented under the contract. And that the price adjustments in the contract has to happen within a very narrow range kind of plus minus 10% of the current pricing. And they’re attached to Guangdong city gate prices but there’s a floor under that. The actual gas contracts for the field are for life of fields essentially. So they continue for the rest of the decade. So I hope that helps just understand that in terms of the potential variability there.
Yeah, thank you and I apologize. I should have said that adjusted to the pricing mechanism, not the expiration of contracts my [Multiple Speakers] The other question I had Rob and sort of more broadly speaking. We probably say heard you on the call on Sunday. But now that we have you alone, I think it’s been an interesting 12 months from the bid for MEG to now the perspective merger with Cenovus. Just if you could take us through the narrative, how this developed, where were you — how are you thinking now that we have a deal on table of Husky as we went through the past couple of months and through the pandemic, sort of the broad strokes of your thinking might have changed in terms of being bought versus acquiring someone, and maybe a little bit more background on when the conversations really started between you and Cenovus and picked up would be helpful, trying to just give us a bit more of a timeline.
I mean what’s in common with both transactions, they’re all driven by a kind of sense of consolidation needs to happen in the industry overall. And certainly — but that was a big driver and of course, the consolidation needs to happen in order to lower the cost base for the industry, but more particularly for us. And in the case of Cenovus, they have the same driver. Again, we see oil prices are a little further down today, we don’t know where they’ll be going tomorrow or the day after. But what we do know is the $1.2 billion of synergy that we can deliver makes more and more difference as the oil prices lower. And so that desire to create a resilient sort of integrated energy leader with a real low cost upstream platform, and really extensive midstream and downstream network to allow it to be totally integrated was a real strong driver on the part of both companies.
And so I think that kind of conversations been going on for a while. And of course, there’s a lot of people between Cenovus and ourselves that we know each other quite well. So some of those discussions went on for a while. But I would just go back to the driver here is, we need to consolidate more in this industry. I’ve made that point a few times before, and both of those moves were in that direction. In the case of MEG, clearly, in the end, there wasn’t a lot of desire to complete the transaction on their part. And so we didn’t — and in the case of Cenovus right from the start, both companies could see the compelling logic of putting this thing together. And so it was a great place to go.
The next question comes from Matt Murphy with Tudor, Pickering, Holt. Please go ahead.
Just wondering if you could talk about how Superior is progressing. And given we’ve now had some progress as you guys have disclosed outlaying capital with appreciation, as you’ve said many times, this will be largely covered by insurance. If you started to see some dollars trickling in on that yet? And apologies if it’s in the disclosures, it’s been a bit of a busy morning?
I’ll turn it over in a minute to, I guess to Jeff, to talk a little bit more. But one thing I did want to point out in the quarter was when it came to superior, actually is going well slower than the original plan because of COVID. We’ve kind of recognized in the construction program but actually it isn’t affecting productivity, it’s just slowed up the pace a little bit. So I’m pretty pleased with that. And again, the insurance — the relationship discussions are going fine. But in this particular quarter, this was a quarter where the difference between the money we put out in superior and the money that came back was in the order of $120 million. So one of the reasons you see a little less funds from operations here in aggregate is kind of a difference between inflows and outflows on superior. But overall that’s going pretty well. But Jeff, do you want to add…
I think, Rob, got hit on it. We spent about $79 million in CapEx for the queue and then just ongoing kind of cost around the facility for the quarter was about $30 million. And to Rob’s point, we didn’t have insurance proceeds this quarter. We do expect that as activity levels really start to ramp up on site really in line with that start to see insurance recoveries come in, and we’ve collected I think about over $300 million on business interruption to date and a little under $200 million on property damage to date. So we’d expect that recoveries to ramp up with the project. And to Rob’s point this quarter we didn’t and kind of net-net little over $100 million kind of outflows in around Superior.
Maybe on the path forward for West Shite Rose. Just wondering if you could talk from a high level what sort of cost might be necessary if the decision ultimately is taken, going forward not to proceed with it. Deconstructing, if you will? What has been constructed to date or maybe perhaps if you can keep that incubated for some time without having to rush into anything on the cost front?
I think what I would say there is, first we canceled the construction season for next year. Of course, you have to kind of do this on a seasonal basis, because you can only do the installation on a seasonal basis. So you probably get the chance once a year to decide whether or not you’re going to try to keep it on schedule or defer the year. And the other point I’d make, again is that, looking forward on the project, the project has reasonable economics and quite low oil prices to go forward with. However, with quite low oil prices, you just only have so much money coming into the company and we need to — we’re always conscious of protecting the balance sheet and ensuring we continue with the investment grade credit rating. And so we just want to pace capital spending very carefully.
So looking forward on West White Rose, we’re putting the project into safe keeping mode, that means with the desire to move it forward again sometime in the future. And we’re also talking to the new Finland government about ways that they could help to ensure that this project ultimately moves forward. So I’m optimistic we’ll eventually get going again. And as far as sort of in the case where that doesn’t happen, we can kind of — we haven’t gone into all that — I don’t want to get into all that scenario at the moment. Certainly, we’ve modeled it and we’re happy with it.
And for the purposes of this transaction, I know that we took a very conservative case on this and assumed almost the worst case on West White Rose. And still, we were able to show in the transaction, again, with the synergies and everything else that under all scenarios for both companies, the transaction would result in higher funds flow per share and higher free cash flow per share that neither company could generate on its own.
The next question comes from Greg Pardy with RBC Capital Markets.
I guess first guys, this is probably the last call we’re going to be doing for a while. So it’s been a lot of years and it’s been great to work with you and all the very best as you go forward. Really it was just kind of an operations call and wondering if we can maybe just dig into Liwan a bit. If you can just remind us on 29-1, just maybe a bit more on, we know it’s ramping up as you go into quarters or is that going to be additive do you think to the production profile, not going too crazy but just want to better understand Liwan? And then also fully recognize there’s a merger coming down here. But the other piece of the equation would just be getting a sense as to kind of what’s locked and loaded with respect to offshore Indonesia development? Thanks very much.
I think the good news is 29-1 of courses actually came in a reasonable amount under budget and on schedule, and it is expected to start up production. It’s all ready to go everything’s been clean. It’s just actually the offtaker taking the gas on the first day and their contractual — the contract kicks in on November 1st and we expect them to start lifting gas on November 1st. And it will be incremental in the near term to the base Liwan production. Of course, over the longer haul over — as we move forward and Liwan starts coming off, the starts have been more of an infield. But certainly in the next year or so, it’s going to be incremental to the base load on Liwan. So that’s great to see and it’s been a really solid project and we’re in a really good place.
On Indonesia, again, it actually feels like, Indonesia is always a place where you have to be patient as Bob Hinkel who runs that area for us, of course, as Indonesia moves slow until it moves really fast. And so we are getting some very positive indications right now on the next two fields. It looks like there were issues with some of the contractors involved in putting the FPSO in place and not getting all their proper financing in place. It looks like that’s essentially been all tied up now, all the permits are in place to move forward, the gas contracts are in place. So that’s looking like — we’re now looking much more confident about a start up in about 2022 for the next two sort of development and innovation.
And it’s fairly low CapEx, you talk anything at the year, $60, $70 million or…
And can you just remind us on pricing. It’s pretty good as I recall, gas pricing…
Typically what we see in Indonesia is that $6 inflating and we sell into industrial users, and this is I think more in kind of line closer to $7. So it’s right in the range of ex-US…
The next question comes from Mike Dunn with Stifel. Please go ahead.
It’s might not be an overly topical question with the quarter, but just thought I’d look for the detail while I can get you on the phone here. But the Superior Refinery coming back online in 2022 versus I guess the refinery design pre the fire. There’s some enhancements being added. Can you maybe just frame for us like what you might expect, I guess on a gross margin and operating margin basis, where the 2022 new refinery will be expected to stack up relative to Toledo and Lima in terms of margin, it’s a smaller refinery. So I’m assuming the operating cost per barrel would be higher, but your less pipeline tools and et cetera. So maybe if you could just frame that for me that would be helpful. Thank you.
I’ll let Jeff talk to sort of specially talking to what are the capabilities of the refinery. And then of course, it all depends on the margins on the day and things like that. Thanks.
The main thing that we’re doing differently with the configuration of the refinery when we started back up again is the refinery will be able to run in continuous mode. And in the past, this is a refinery that swung back and forth between heavy mode and light mode. And when you’re constantly swinging back and forth between slates like that, you get lower utilization. So the new refinery, same configurations in process units roughly the same product slate, but it will be able to run in continuous mode with higher utilization. So we’ll get the same — we’ll get more throughput on an annual basis through roughly the same size, that’s the main difference.
And in terms of what the margin performance is going to be, we like the strategic location of the refinery, we always have. It’s the first refinery on the Enbridge mainline when you go into the US. So it’s really a good location for both, for access to crude and also for a company that likes trading along integrated value chain like we do, it’s really a very valuable asset. And so in terms of margin performance, you just got to just — it is going to depend of course on what kind of heavy spreads we get. The refinery will be able to run about 25,000 barrels a day of heavy out of total throughput of about 45,000 barrels a day.
So in terms of just being a heavy refineries, its kind of in the range of Toledo in terms of percent, heavy in the feed and more heavy than Lima is. And of course it’s not a fully upgraded refinery, it is an asphalt refinery not a coking refinery. So it’s a little bit lower margin than a fully upgraded refinery. So that’s broadly how we’re thinking about it. I don’t think about Superior, the value it creates not just the refinery piece, but also its location in the value chain and what that allows us to do as well.
It’s also a great addition for our asphalt business, which is a very consistent earner for us, much less variability in the margins there. And we’re, I think, as Husky stand low around we’re 5% of the North American sort of asphalt business, and this will get us up to sort of 7% or something in that range. So it’s a nice extension to that business.
Understood, thanks, that’s helpful. You can probably understand it’s always tough for us in our chairs to model a lot of those logistical synergy outside of the refinery itself. But we certainly understand that they exist, even though our models might not be forecasting it. Thank you.
The next question comes from Benny Wong with Morgan Stanley.
Just had a quick question around the synergies, I know you guys have the 1.2 billion target as a combined basis and there’s potential for upside. And one of the things was indicated was potentially reading some of the [Indiscernible] [STCL] barrels through your upgrader at Lloydminster system. Is there any level way to think about the benefits of that? Is it just really hedging out the differential volatility, or is there any yield benefit or product benefit that might come from running those barrels through that system that we should think about?
Benny, you know Jon and I’ve had many sort of chats on this, and Jon McKenzie and of course he knows our assets very well, too. So he’s got some pretty clear ideas. Now some of them are longer term and will require a bit of capital as well. So they’re not short term things that we’re doing. And that’s one of the reasons we didn’t include them in any sort of initial synergies for 600 and 600. But looking forward a lot of them have to do with the ability to shorten the diluent loop in North America, he’s very conscious of just how much diluent he has the truck all around North America. And he sees that Lloydminster site and the equipment there plus potentially some additions as a really great opportunity to shorten that diluent loop and take a whole bunch of money out of the production cost base over the long haul. I think that’s kind of I would summarize it. There’s lots of other ideas that they have. But that’s one of the big ideas I think that comes into the thinking.
This concludes the question-and-answer session. I would like to turn the conference back over to Mr. Rob Peabody for any closing remarks.
So thanks very much. I really appreciate everybody who’s tuned in. We’re certainly looking forward to working with Cenovus on the planning to unite our people and the complementary suite of assets to deliver on the full potential of this resilient new company. There’s a new chapter for all of us. I look forward to working closely with the team in the coming months to complete this transaction. So that combined company can continue to responsibly provide essential energy to North American world. Thanks again for joining us today.
This concludes today’s conference call. You may disconnect your lines.