Cenovus Energy Inc. delivered strong operating and financial performance in the first quarter of 2019, generating more than $1 billion of adjusted funds flow, $731 million of free funds flow and cash from operating activities of $436 million. The company's excellent financial results were driven by strong operating performance, a significant narrowing of light-heavy oil price differentials in early 2019 and Cenovus's low-cost structure and continued commitment to capital discipline.
Over the first four months of this year, the company further reduced its total debt outstanding by repurchasing US$515 million of unsecured notes at a discount. Cenovus managed its first-quarter oil sands production to comply with the Government of Alberta's mandatory curtailment program, producing approximately 343,000 barrels per day (bbls/d). The company completed construction of the Christina Lake phase G expansion project ahead of schedule and 25% under budget.
Cenovus's financial performance in the first quarter of 2019 was driven by stronger Western Canadian Select (WCS) prices. Following the implementation of mandatory oil production curtailment in Alberta on January 1, 2019, the price differential between West Texas Intermediate (WTI) and WCS narrowed to an average of US$12.37 per barrel (bbl) in the first quarter from record highs reached in the fourth quarter of 2018. There was a corresponding increase in the price of WCS to an average of US$42.53/bbl, more than double the average price in the fourth quarter of 2018 and up 10% from the first quarter of that year. Cenovus's safe and reliable operating performance, low cost structure and continued focus on capital discipline and deleveraging also drove the company's financial results.
In the first quarter, Cenovus generated cash from operating activities and adjusted funds flow of $436 million and more than $1 billion respectively, compared with a shortfall in cash from operating activities of $123 million and an adjusted funds flow shortfall of $41 million in the same quarter of 2018. The company had free funds flow of $731 million compared with a $565 million shortfall in the same period a year earlier. Cenovus generated net earnings from continuing operations of $110 million in the first quarter, compared with a net loss of $914 million in the same period in 2018, and operating earnings from continuing operations of $69 million compared with a $752 million operating loss in the first quarter a year earlier.
"These results emphasize the true potential of our company," said Alex Pourbaix, Cenovus President & Chief Executive Officer. "All of the positive momentum we've been building over the past few years through focusing on safe and reliable operations, deleveraging our balance sheet, maintaining capital discipline and firmly establishing our position as an in-situ cost leader is translating into strong cash flow generation and shareholder value. At current commodity price levels, I'm optimistic we will generate material free funds flow over the remainder of the year."
Deleveraging and capital discipline
Cenovus continues to make progress in deleveraging its balance sheet. In the first quarter, the company paid US$419 million to repurchase unsecured notes with a principal amount of US$449 million, a discount of almost US$30 million. In April, Cenovus repurchased an additional US$66 million of unsecured notes outstanding for US$63 million. Combined with other recent deleveraging activity, this brings the total debt repurchased in the last six months to almost US$1.4 billion. Net debt at the end of the first quarter was C$8.1 billion, compared with C$8.4 billion at the end of 2018.
Deleveraging continues to be a top financial priority for Cenovus in 2019 after funding its sustaining capital requirements and maintaining its current dividend level. If commodity prices remain at current levels, Cenovus expects to be in a position to make significant progress this year towards its long-term target of reducing net debt to approximately $5 billion. At that level, the company anticipates being in a position to achieve and maintain a target ratio of less than two times net debt to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) at low-cycle commodity prices.
While Cenovus's oil sands operations continue to produce at lower rates to comply with the government-mandated curtailment program, the company has made the decision to maintain normal steam injection levels. While this has contributed to a modest, temporary increase in per-barrel operating costs and steam-to-oil ratios (SORs), it has allowed Cenovus to continue mobilizing and storing production-ready barrels in its reservoirs for sale at a later date when curtailment is eased.
As a result of higher WCS prices, Cenovus paid $191 million in royalties to the province of Alberta during the first quarter. In the fourth quarter of 2018, when price differentials reached record levels, Cenovus had a royalty credit of $29 million.
"It should now be crystal clear that the government's temporary curtailment program is doing what it was intended to do and has had an immediate, positive impact not only for our industry, but for all Albertans, in the form of improved royalty revenue," said Pourbaix. "To put it in context, when price differentials reached record highs in the fourth quarter of 2018 due to a lack of takeaway capacity, our company was in a royalty credit position with the provincial government. Over the last three months, we paid nearly $200 million, and we only account for about 10% of Alberta's total oil production. This has been a big win for Alberta."
The significant improvement in WCS pricing resulting from the government's mandatory curtailment program more than offset the impact of reduced oil production and increased oil sands operating costs during the first quarter.
Based on production levels and operating costs experienced during the quarter, Cenovus has adjusted its 2019 Guidance to reflect the anticipated impact of curtailment across the full year. The company now expects total oil sands production to average between 350,000 bbls/d and 370,000 bbls/d in 2019, a 7% reduction at the midpoint of the range compared with the company's December 10, 2018 Guidance. Cenovus has increased its guidance for the fuel portion of its per-barrel oil sands operating costs to reflect its decision to maintain normal steam levels while reducing production volumes. Fuel costs are now expected to range between $1.75/bbl and $2.25/bbl in 2019 at both Foster Creek and Christina Lake, compared with $1.50/bbl to $2.00/bbl in the December 10, 2018 Guidance. The company expects operating costs to return to more normalized levels once mandatory curtailment has been lifted. Cenovus's guidance for 2019 capital investment remains unchanged.
Including the anticipated impact of curtailment, Cenovus expects its second-quarter 2019 bitumen and crude oil production will be a maximum of 355,000 bbls/d.
Cenovus's updated Guidance document is available under Investors on cenovus.com. Guidance reflects the adoption of International Financial Reporting Standards 16, "Leases."
Cenovus is on track with its previously announced plan to ramp up to approximately 100,000 bbls/d of rail shipping capacity over the balance of this year.
With its previously announced positions on Keystone XL and the Trans Mountain Expansion Project, Cenovus has 275,000 bbls/d of potential future pipeline capacity to the West Coast and U.S. Gulf Coast. The company has current firm capacity to the West Coast, U.S. Gulf Coast and PADD II of 118,000 bbls/d combined.
Cenovus continued to improve its safety performance in the first quarter, completing its winter delineation drilling and seismic work in the oil sands with zero significant incidents and no recordable injuries or reportable spills.
In compliance with government mandated curtailment levels, Cenovus had first-quarter oil sands production of 342,980 bbls/d, a 5% reduction compared with the same period of 2018 when the company was voluntarily reducing production in response to wide WTI-WCS price differentials. The company had first-quarter oil sands operating costs of $9.06/bbl, up 3% from $8.78/bbl in the same period a year ago. The increase in operating costs per barrel was mainly the result of lower sales volumes due to mandatory curtailment as well as higher natural gas prices and consumption.
Cenovus achieved oil sands netbacks of $27.88/bbl, excluding realized hedging impacts, up 63% from the first quarter of 2018. First-quarter production at Christina Lake was 188,824 bbls/d, a 7% decrease compared with the same period in 2018, while Foster Creek averaged 154,156 bbls/d, 2% lower year over year. First-quarter oil sands operating costs at Foster Creek were relatively flat at $10.44/bbl, while Christina Lake operating costs rose 6% to $7.84/bbl compared with a year earlier.
At Christina Lake, the SOR was 2.0 in the first quarter, compared with 1.8 in the first quarter of 2018. At Foster Creek, the SOR was 2.9 in the first quarter compared with 2.8 a year earlier.
Cenovus continues to have flexibility on start-up of oil production at its phase G expansion at Christina Lake and will consider bringing on the phase once the company has clarity on market access and the duration of production curtailment.
Production from the Deep Basin assets averaged 104,290 barrels of oil equivalent per day (BOE/d) in the first quarter, an 18% decrease from year-earlier levels, partly due to the September 2018 divestiture of the Pipestone business, which was producing approximately 8,800 BOE/d prior to being sold. Production also declined due to lower capital investment, natural declines and weather-related outages.
Average operating costs in the Deep Basin were $9.24/BOE in the first quarter, up 26% from $7.36/BOE a year earlier, partly due to lower sales volumes related to the Pipestone divestiture. In addition, in order to maintain production levels during a prolonged cold weather period in the quarter, Cenovus decided to carry out proactive work at its wells and facilities, leading to additional chemical and workforce costs. Electricity rates also increased from the first quarter of 2018 due to the cold weather.
Cenovus continues to work to optimize its Deep Basin operating model with a view to reducing costs, improving efficiency and maximizing value.
Cenovus's Wood River, Illinois and Borger, Texas refineries, which are co-owned with the operator, Phillips 66, delivered solid financial performance in the first quarter, largely due to lower feedstock prices, as crude oil purchased at a discount in late 2018 was processed in the first quarter of 2019. Crude runs were impacted by a fire at a unit at Wood River in February. Wood River returned to normal operations in late March.
Refining and marketing operating margin was $304 million in the first quarter, compared with an operating margin shortfall of $48 million in the year-earlier period, when both refineries underwent major planned turnarounds. Cenovus's refining operating margin is calculated on a first-in, first-out (FIFO) inventory accounting basis. Using the last-in, first-out (LIFO) accounting method employed by most U.S. refiners, operating margin from refining and marketing would have been $143 million lower in the first quarter, compared with $21 million lower in the same period of 2018.