ARC Resources Q1 2023 Earnings Call Transcript

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May 5, 2023

Key Takeaways

  • Hitachi Phase 1 sanctioned: ARC approved a C$740 million investment to develop Hitachi with 40,000 BOE/d initial production expected late 2024 and full capacity by early 2025.
  • World-class reservoir and scale: Hitachi holds 300 net contiguous sections with about 9 billion barrels of liquids and 30 Tcf of gas in place, supporting at least four additional development phases.
  • Strong Q1 results and guidance upgrade: Q1 production averaged 338,000 BOE/d—above forecast despite third-party downtime—leading to a 5,000 BOE/d increase to 2023 guidance at unchanged capital spend (C$1.8 billion).
  • Robust free cash flow and shareholder returns: ARC generated C$230 million of Q1 free cash flow, returned 100% to shareholders via dividends and buybacks, and raised the quarterly dividend by 13%.
  • Funding resilience: At mid-cycle prices ARC can fully fund Hitachi, sustain dividends, and buy back shares, while at US$50 WTI and C$2.50 AECO the business remains fully funded.
AI Generated. May Contain Errors.
Earnings Conference Call
ARC Resources Q1 2023
00:00 / 00:00

There are 8 speakers on the call.

Operator

Good morning. My name is Lara, and I will be your conference operator today. At this time, I would like to welcome everyone to the ARC Resources First Quarter 2023 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

Thank you. Mr. Luca, you may begin your conference.

Speaker 1

Thank you, operator. Good morning, everyone, and thank you for joining us on our Q1 earnings conference call. Joining me today are Terry Anderson, President and Chief Executive Officer Chris Bibby, Chief Financial Officer Arman Jhahengiri, Chief Operating Officer Lara Conrad, Chief Development Officer and Ryan Barrett, Senior Vice President, Marketing. Before I turn it over to Terry and Chris to take you through our Q1 results, 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 and A. All dollar amounts discussed today are in Canadian dollars unless otherwise stated.

Speaker 1

Finally, the press release, financial statements and MD and 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.

Speaker 2

Thanks, Dale, and good morning, everyone. We'll get into the details of the Q1 performance here shortly. But before we do, I'd like to begin with Hitachi. This is an exciting day for Arc And one that we've been looking forward to for quite some time. We've officially sanctioned the first phase of Hitachi development.

Speaker 2

This is an important milestone, which triggers the next stage of profitable growth for our company and for our shareholders. Anyone who has been following ARC understands that Hitachi is a flagship development for us. So let me remind you why. 1st, asset quality. Hitachi is a world class condensate rich natural gas play in the heart of the Montney.

Speaker 2

It has all the characteristics of a high quality asset, a deep over pressured reservoir with scale and economics that competes with the best plays in North America. 2nd, scale. Over the past decade, Arc has accumulated 300 net contiguous Sections at Hitachi with approximately 9,000,000,000 barrels of liquids and over 30 Tcf of gas in place. To date, we have identified more than 1500 drilling locations, more than 95% of which are unbooked, Which can support at least 4 similar sized phases to what we are advancing with Phase 1. With these attributes, Hitachi has the scale to replicate CACWA in terms of production and profitability.

Speaker 2

And third, strong economics. Hitachi is one of our highest return investment opportunities in our portfolio. We are investing approximately $740,000,000 for Phase 1, Which at today's forward curve will generate about $300,000,000 of free cash flow annually. Project execution is one of Arc's greatest strengths. And over the past several years, our technical teams have narrowed in on the optimal Development plan, which includes the adoption of some best practices from Capua.

Speaker 2

Hitachi is set up to be our most efficient project to date. So with today's announcement, we are starting work immediately on the first phase of this development. Phase 1 production is approximately 40,000 BOE per day, which will come on stream in 2024, late 2024 and achieve full production in early 2025. Our team has done an excellent job in planning and preparing for today, which has been instrumental in mitigating risks to both project costs and schedule. We are on track for an 18 month construction time.

Speaker 2

Long lead items have been secured and we have the development plan in place to achieve it. We are ready to proceed from a subsurface, Surface and commercial perspective. The design for the 90,000,000 cubic feet a day gas processing facility is complete and all major infrastructure, including the 25,000 barrels per day of liquids handling is ready to construct. In addition, takeaway capacity has been secured for both Phase 1 and for future phases. Hitachi will also be one of the most responsibly developed projects of its kind.

Speaker 2

Consistent with our other assets in Northeast BC, we plan to electrify the project, which will result in a low emissions profile. The facility's plan also includes water recycling infrastructure that will substantially reduce overall freshwater usage. As it relates to permitting, we have confidence there is a clear path forward following the recent agreements between the BC government And the Treaty 8 First Nations. This has allowed us to carefully plan and prepare for project execution. Over the past 5 years, We have worked closely with the Treaty 8 First Nations and over that time, we have evolved our development plan to ensure the community's needs and priorities are met.

Speaker 2

Moving forward, we'll continue to collaborate with the communities neighboring our projects to ensure our development practices demonstrate our commitment to responsible development, balance economic prosperity and honor treaty rights. Now I'd like to touch on some notable items related to our strong Q1 performance. First, the combination of higher production with less capital is having positive implications on free cash flow. Capital spending is trending below expectations and production was ahead of our forecast despite some third party downtime in the quarter. This was due to better performance from our base assets, resulting in an upward revision to annual production guidance.

Speaker 2

Above all else, we delivered strong results safely. My team hears this at length. Safety is truly our number one priority. In an industry where capital preservation and discipline Under the microscope of investors, it is critical that we never waver on our commitment to safety. Not only does it ensure our employees go home safely, but it forms our culture, allows us to attract top talent And strengthens relationships with our suppliers and counterparties.

Speaker 2

Thank you very much to our team for consistently delivering on this safety commitment. Continuing on our strategy to sustainably increase our dividend, we also announced a 13% dividend increase, Our 5th increase over the past 2 years. The combination of better profitability and lower share count are the primary factors. This will continue and only accelerate with the commencement of Hitachi. We also advanced our goal to further diversify our end markets with the announcement of our 3rd natural gas supply agreement to Cedar LNG.

Speaker 2

We announced a non binding MOU to supply 200,000,000 cubic feet a day of natural gas to the project for 20 years commencing around 2027. We are very pleased with the relationship with Cedar and the progress we've made to date as we work towards definitive agreements. With that, I'll turn it over to Chris to walk through the details on the quarter and positive changes to our go forward plan.

Speaker 3

Thanks, Terry. Good morning, everyone. I'll provide some additional context on the quarter end 2023 guidance and then send it back to Terry for closing remarks before we get into the Q and A. To summarize the quarter, we leveraged our competitive strengths and the outcome was stronger production and lower costs that resulted in positive revisions to 2023 guidance. Specifically, production guidance was increased to average 350,000 Boe a day after averaging 338,000 BOE per day in the Q1 of 2023.

Speaker 3

And second, capital budget was essentially unchanged at approximately $1,800,000,000 Despite an additional incremental $250,000,000 to $300,000,000 of capital for Hitachi. The benefits of infrastructure ownership and takeaway optionality were particularly relevant this quarter. Production of 338,000 BOE per day included a 7,000 BOE a day loss from 3rd party pipeline outage and the team limited downtime by warming up our facilities and leveraging our transportation optionality to maximize margins and minimize volume loss. Cash flow registered 5% above analyst forecast and we generated $230,000,000 Free cash flow, which was nearly double the median analyst forecast. Quarterly free cash flow can certainly be timing related on the capital, but in this case, there is a positive carry through to our go forward outlook.

Speaker 3

Once again, this quarter, Realized pricing was a meaningful contributor to our profitability. Arc realized a natural gas price of around $5.90 an Mcf, Which was 36% above the AECO average. Costs also registered at the bottom end of guidance, which resulting in $230,000,000 of free cash from the quarter and a 25% free cash flow margin adjusting for hedging costs. Now shifting to shareholder returns. In 2022, we returned 71% of our free cash flow to shareholders through dividends and share repurchases.

Speaker 3

In 2023, We will return essentially all free cash flow to shareholders now that the balance sheet is where we want it from a leverage perspective. In the Q1, we followed through on this commitment and returned 100% of our free cash flow to shareholders and also dedicated $74,000,000 of proceeds from non core asset sales to buy back additional shares. Our preferred method to return capital remain a growing base dividend and share repurchases. We view these options as fundamentally sound when the expected return on our shares is attractive like it is today. Now shifting to 2023 guidance.

Speaker 3

It is a theme to the quarter. I would summarize it as finding ways to do more with less without sacrificing safety, efficiency For the long term needs of the business. As I mentioned, we increased production guidance by 5,000 BOE a day to 150,000 to 355,000 BOE a day and capital was essentially unchanged at $1,800,000,000 to $1,900,000,000 on Hitachi specifically, we're confident in the progress we've made to date. We have cleared the site in preparation for construction and through supply chain management, we've reduced to mitigate some inflation risk. Phase 1 capital of $740,000,000 includes the investments to complete the facility, Infrastructure and Liquid Handling and drill and complete the approximately 39 wells it takes to fill the facility.

Speaker 3

It does also include approximately $65,000,000 of infrastructure investments for subsequent phases of Hitachi. This year, we anticipate spending $250,000,000 to $300,000,000 at Hitachi with the remainder to be deployed in 2024. 1st production is anticipated by the end of 2024 and we expect to achieve the approximately 40,000 BOEs per day early in 2025. Capital sustaining facility will average roughly $150,000,000 per year over the initial 5 years, with the initial year skewing much higher As it is normal course with any new development when production is flushed and decline rates are at their highest. In terms of where capital is being removed in the 2023 budget to accommodate the Hitachi spend, there are 2 main areas.

Speaker 3

First, we simply need to drill fewer wells than previously forecasted. This is due to a stronger production performance across all of our base assets. And second, we executed a 3rd party agreement with an existing infrastructure network Pickwater Kennel, sorry, with a third party with an existing infrastructure network of water handling capability in the area. This is expected to reduce operating costs by $30,000,000 to $60,000,000 beginning in 2024 and at the same time allows us to remove $120,000,000 of capital previously earmarked for water infrastructure in the Kakwa area. In terms of our financial forecast, at strip pricing, Which is near our mid cycle pricing levels, Art can fund Hitachi, the revised higher dividend and buyback substantial amounts of our stock with forecast cash flow.

Speaker 3

Hitachi will add approximately $300,000,000 of free cash flow annually or greater than $0.50 per share. Equally important, in a low price environment, the business is fully funded. At US50 dollars WTI and US2.50 dollars AECO, We can fund Hitachi and sustain the business and dividend with Fundslow. In a more constructive price environment, all else equal, we will direct excess free fundslow to increasing shareholder returns. Looking ahead to 2024, objectives are simple.

Speaker 3

Sustain our base Business in a capital efficient manner and complete Hitachi Phase 1, setting us up to deliver a material increase in free cash flow growth in 2025, Which does happen to coincide with well LNG Canada is expected to come on stream. While LNG is not a prerequisite for this project or for ARC, It certainly represents a structural change in Western Canadian gas demand that our market has not yet experienced. And with that, I'll pass it back to Terry for some closing remarks.

Speaker 2

Thanks, Chris. I'm very excited about our strong performance and where we are heading. Our base business has momentum And we're delivering on strategic priorities, which are to maintain a strong balance sheet, improve our per share metrics And grow the dividend as we execute on these priorities. And instrumental in delivering on these strategic priorities, we sanctioned Hitachi. It's been a long time coming and I recall a few quarters ago mentioning an upcoming inflection point in our business.

Speaker 2

The path was less clear at the time, but we've made significant progress since then. With today's announcement, we've reached a major milestone in advancing our business. So to summarize, we are ready to execute. And while there's a lot of hard work between now and commissioning Hitachi, This is where we shine as an organization. Operational excellence has been the backbone of Arc's success over the past 26 years, And I'm extremely confident in our team's ability to execute and deliver strong results once again.

Speaker 2

Thanks, operator. Let's open the lines up for questions.

Operator

Thank you, sir. To an answer Please standby while we compile the Q and A roster. Your first question comes from the line of Michael Harvey from RBC. Please go ahead.

Speaker 4

Yes, sure. Good morning. Just a couple of questions on Hitachi. I guess, first, you mentioned you do have the takeaway for the gas. Just wondering if you've arranged the same on the liquids front and any material infrastructure investments, which might be required to move both the gas and the liquids.

Speaker 4

And then I guess just a longer term Question on Hitachi. I know you still have to build Phase 1 here, but as you think about the next 10 or 20 years, just wondering any broad Thoughts on how many phases you think the lands can support without over capitalizing? And just thoughts on kind of broad volumes, I know you've Broad peak volumes, I know you compared it to Cacro a little bit there.

Speaker 2

Great question, Michael. Thanks. It's Terry here. So on Hitachi, yes, we have the takeaway on the liquid side. We have the takeaway on the gas side.

Speaker 2

We are prepared to execute on this project with everything in hand here. So it's good from that perspective. So as for bigger picture, yes, this 40,000 BOE a day is the first phase. We see another 4 phases on top of that. We think that Hitachi has the potential to be replicate Capua, so that 180,000 BOE a day roughly.

Speaker 2

Both properties are very similar, 60% liquids. So it's a great Analog Forest, Kakwa and Hitachi. So that's kind of what we're thinking down longer term for the size of Hitachi.

Speaker 4

Great. Thanks for that.

Speaker 5

Welcome.

Operator

Thank Your next question comes from the line of Mike Dunn from Stifel. Please go ahead.

Speaker 5

Well, thanks. I think Mike Harvey I asked the main part of my question, but maybe I know in your disclosures you talked about $65,000,000 of the $740,000,000 being for future Is that how we should think about, I guess, the

Speaker 4

we wanted

Speaker 5

to think about the scope of work, Reduce scope of work for a future phase, would that be sort of proportionate? Or would there be other synergies there with the Phase 2 that wouldn't be captured with that number. And I have a follow-up question.

Speaker 6

Hey, Michael, this is Armin. So the $65,000,000 that the team referred to is primarily the capital that we are spending in building the infrastructure in a manner that is suitable for multiple phases of development. So obviously, the Phase 1 will take the burden of all these infrastructure costs. But when we come back to do Phase to we don't have to spend as much money obviously because we have some of these pipes and infrastructure already available.

Speaker 5

Thanks, Armin. And I guess my second question is a separate topic, but I I think for the last maybe few weeks, we've seen a dip in the condensate price relative to WTI. Is that anything else other than like seasonal spring maintenance downtime in the oil sands? Or is there anything else going on there? Thanks.

Speaker 3

Hey, Mike. It's Chris here. So yes, we would attribute that just to seasonality at this point in time. Certainly, nothing structural happening. And as you recall, the outlook for condensate going forward is extremely strong.

Speaker 3

It's the only product we are short in Western Canada. So Longer term, we structurally still see a huge benefit to being the largest producer of condensate.

Speaker 5

Yes, I agree. That's all for me, Chris. Thanks folks.

Speaker 3

Thank you.

Operator

Thank you. Your next question comes from the line of Travis Wood from National Bank Financial. Please go ahead.

Speaker 7

Yes, thanks. Good morning, guys. My question, I just want to understand the flow or kind of the waterfall chart. I think you guys have done a good job explaining the shifts in capital allocation across the program here to effectively fund Hitachi. Could you walk through those chunks again and how they kind of triangulate back to the 250, 300?

Speaker 7

And then is there any change to at Sunrise as well from the capital program or expansion on top of the drilling program there as you get for LNG. Thank you.

Speaker 3

You bet, Travis. It's Chris here. I'll take a stab. I mean realistically, there's the 2 main areas where we're pulling capital from the business. The $120,000,000 related to the Capital Water Infrastructure is pretty straightforward.

Speaker 3

We are just pulling that capital with the 3rd party service agreement we have that will handle the water for us. And then the other area is just Base outperformance and this is across all of the asset base. And what that really does, it allows us to drill less And still maintain the production at levels where we want. And that really results in the remaining quantum. When you add those 2 together, it is $250,000,000 of capital that we can pull that gives us the allows us the luxury of being able to sanction Hitachi and not having to change production sorry, capital guidance very much.

Speaker 3

And then because of that base production outperformance, that's what allowed us To also at the same time actually increase our production guidance range.

Speaker 7

Okay. And any in that 130, is there Is it kind of across each of the assets or is there any additional infrastructure there, specifically at Sunrise, I guess, as we were thinking about the facility expansion.

Speaker 3

Right. Sorry, I forgot to address your Sunrise component. So it is across the asset base, where we're able to pull some of that capital from. Some of it is at Kakwa where we pushed out some activity into 2024 and then sort of some other drilling at Dawson and places like that where we're able just to pull some capital. And as far as Sunrise, No change to the plans there, where we would expect to have, that expansion full, in early in 2024.

Operator

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

Speaker 1

All right. Thanks, everyone. That concludes the call. Thank you.

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.

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