MEG Energy faces net loss for Q1 2020
MEG Energy Corp. has reported its first quarter 2020 operational and financial results. MEG continues to respond proactively to the safety and financial challenges associated with the COVID-19 pandemic.
"We are committed to ensuring the health and safety of all our personnel and the safe and reliable operation of the Christina Lake facility," said Derek Evans, President and Chief Executive Officer. "The current business environment demands swift, decisive actions to enhance MEG's already strong financial liquidity position. To that end, we are reducing production to minimum levels and advancing the planned plant turnaround, cutting capital by $100 million versus original guidance, and reducing non-energy operating cost and G&A guidance by $20 million and $10 million, respectively."
MEG remains well positioned from a financial liquidity perspective, benefiting not only from its significant 2020 hedge book, the term and structure of its outstanding indebtedness and credit facility but also from the low decline, low cost structure of its high-quality Christina Lake asset.
First quarter financial and operating highlights include:
- Free cash flow of $24 million driven by adjusted funds flow of $78 million ($0.26 per share) and disciplined capital spend of $54 million;
- MEG exited the first quarter with $62 million of cash on hand. Based on the current commodity price environment, MEG does not expect this level of cash on hand to materially change in the second quarter of 2020;
- Bitumen production volumes of 91,557 barrels per day (bbls/d) at a steam-oil ratio (SOR) of 2.31;
- Net operating costs of $5.51 per barrel, including non-energy operating costs of $4.57 per barrel and strong power sales which had the impact of offsetting 70% of per barrel energy operating costs resulting in a net energy operating cost of $0.94 per barrel;
- MEG utilized cash on hand to repay an additional $132 million of long-term debt concurrent with the refinancing of US$1.2 billion of existing indebtedness announced January 16, 2020. The combination of these transactions is neutral to ongoing cash costs and results in no outstanding debt maturities before 2024;
- Realized commodity price risk management gain of $106 million. At current strip pricing the full year 2020 value of MEG's commodity price risk management hedge positions, including the $106 million realized gain, is estimated at $525 million, providing strong financial liquidity through the remainder of the year;
- On March 10, 2020, MEG reduced its full year 2020 capital investment by 20% to $200 million from original guidance of $250 million. Notwithstanding the Corporation's strong hedge position, in light of the current weak oil price environment and MEG's focus on maintaining its financial liquidity, MEG is further reducing full year 2020 capital investment by an additional $50 million to $150 million, or 40% below original guidance and reducing non-energy operating cost and general and administrative ("G&A") expense by $20 million and $10 million respectively; and
- Subsequent to quarter end, a decision was made to roll back salaries across the company, with an emphasis on Board, executive and senior leader compensation. Effective June 1, 2020, Board members will receive a 25% cash compensation reduction. The President and Chief Executive Officer will have his annual base salary reduced by 25%, the Chief Operating Officer and Chief Financial Officer will each take a 15% annual base salary reduction, vice presidents will receive a 12% annual base salary rollback and all other employees will receive a 7.5% annual base salary rollback. In addition, the value of the 2020 long-term incentive awards issued to employees and directors on April 1 was reduced by 20% compared to 2019 levels.
Blend Sales Pricing and North American Market Access
MEG realized an average AWB blend sales price of US$27.12 per barrel during the three months ended March 31, 2020 compared to US$42.83 per barrel in Q4 2019. The reduction in average AWB blend sales price quarter over quarter was primarily a result of the average WTI price decreasing by US$10.79 per barrel combined with the average WTI:AWB differential at Edmonton widening by US$4.34 per barrel. MEG sold 23% (21% via pipe and 2% via rail) of its sales volumes to the US Gulf Coast ("USGC") in the first quarter of 2020 compared to 34% (28% via pipe and 6% via rail) in the fourth quarter of 2019. The reduction in sales to the USGC in the first quarter is a result of substantially all rail sales in the first quarter being sold freight on board ("FOB") at rail terminals at Edmonton, and 50% apportionment on the Enbridge mainline in the first quarter compared to 45% in the fourth quarter of 2019.
Transportation and storage costs averaged US$4.39 per barrel of AWB blend sales in the first quarter of 2020 compared to US$5.69 per barrel of AWB blend sales in the fourth quarter of 2019. The quarter over quarter reduction in transportation and storage costs is primarily due to the suspension of delivered rail contracts to refiners in January 2020 in favour of FOB rail contracts at Edmonton entered into during the fourth quarter of 2019, combined with improved rail facility utilization. MEG's AWB blend sales by rail increased to 30,152 bbls/d (27,867 bbls/d FOB Edmonton) in the first quarter of 2020 from 17,111 bbls/d (8,675 bbls/d FOB Edmonton) in the fourth quarter of 2019. The increase in first quarter 2020 rail sales was a direct result of fourth quarter 2019 rail contracting to allow MEG to take advantage of the Alberta Government's Special Production Allowance program for curtailed producers announced October 2019.
Excluding transportation and storage costs upstream of the Edmonton index sales point, MEG's net AWB blend sales price at Edmonton averaged US$24.55 per barrel during the three months ended March 31, 2020 compared to the posted AWB index price at Edmonton of US$23.39 per barrel. Notwithstanding that Enbridge mainline apportionment averaged 50% during the first quarter of 2020, MEG was able to capture pricing better than the Edmonton index as a result of its marketing and storage assets and the ability to move barrels to the higher-priced USGC market.
Bitumen production averaged 91,557 bbls/d in the first quarter of 2020, compared to 94,566 bbls/d in the fourth quarter of 2019. Bitumen production in the first quarter was impacted by a combination of extreme cold weather in January, scheduled planned maintenance activities in February and implementation of the COVID-19 response plan in March which resulted in a significant reduction in operating personnel on site, which impacted production levels. Net operating costs in the first quarter of 2020 averaged $5.51 per barrel, a 6% decrease compared to the fourth quarter of 2019, directly impacted by higher sales revenues from surplus power from MEG's cogeneration facilities. Non-energy operating costs averaged $4.57 per barrel compared to $4.49 per barrel in the fourth quarter of 2019. Net energy operating costs averaged just $0.94 per barrel in the first quarter of 2020.
G&A expense was $16 million, or $1.96 per barrel of production, in the first quarter of 2020 compared to $20 million, or $2.25 per barrel of production, in the fourth quarter of 2019. The decrease in aggregate G&A quarter over quarter is a result of the Corporation continuing to drive efficiency gains into its operations.
Adjusted Funds Flow and Net Loss
MEG's bitumen realization averaged $19.45 per barrel in the first quarter of 2020 compared to $46.86 per barrel in the fourth quarter of 2019. The reduction in average bitumen realization quarter over quarter was driven by the same factors that drove the reduction in average AWB blend sales price. In addition, the widening WTI:AWB differential also resulted in a lower recovery of the cost of diluent through blend sales, which increased the Corporation's cost of diluent.
The decline in bitumen realization was the largest contributing factor to the 41% decline in MEG's cash operating netback. The lower cash operating netback drove a decrease in the Corporation's adjusted funds flow from $157 million in the fourth quarter of 2019 to $78 million in the first quarter of 2020.
The Corporation recognized a net loss of $284 million in the first quarter of 2020 compared to net earnings of $26 million in the fourth quarter of 2019. The decrease is due to decreased bitumen realization combined with a number of non-cash charges, including an unrealized foreign exchange loss of $267 million, an exploration expense of $366 million associated with certain non-core growth properties and an inventory impairment charge of $29 million partially offset by a $429 million unrealized gain on commodity risk management contracts.
Capital expenditures in the first quarter of 2020 totaled $54 million compared to $72 million in the fourth quarter of 2019. Of the $54 million incurred in the first quarter, approximately $40 million was directed towards sustaining and maintenance activities and $13 million towards the brownfield project at MEG's Phase 2B central processing facility.
COVID-19 Global Pandemic
The Corporation is continually monitoring and responding to the ongoing evolving COVID-19 situation. The Corporation's business activities have been declared an essential service by the Alberta Government and the Corporation remains committed to the health and safety of all personnel and to the safety and continuity of operations. The Corporation has established a COVID-19 task force, comprised of senior management and employees as well as third party expert consultants to promptly implement measures to protect the health and safety of the Corporation's work force and the public, as well as to ensure continuity of operations. The Corporation is monitoring daily developments in the COVID-19 outbreak and actions taken by government authorities in response thereto. In accordance with the guidance of provincial and federal health officials and to limit the risk and transmission of COVID-19, the Corporation has implemented mandatory self-quarantine policies, travel restrictions, enhanced cleaning and sanitation measures, and social distancing measures, including directing the vast majority of its office staff and certain non-essential field staff to work from home. Only location essential personnel are currently working at the Corporation's Christina Lake site and Calgary head office. The Corporation believes that it can maintain safe operations with these pandemic-related procedures and protocols in place. Additionally, in order to prevent and/or minimize any COVID-19 outbreak at its Christina Lake site, the Corporation has implemented additional measures as part of its pandemic response, including changes to crew size and shift durations, screening measures prior to allowing employees and contractors on to the Corporation's Christina Lake site (or flights departing to the Christina Lake site), and mandating the use of masks and other measures to ensure continued safe and reliable operations.
Since early March 2020 global crude oil prices have experienced multi-decade lows coupled with extreme levels of volatility driven primarily by the unprecedented demand shock due to COVID-19. Notwithstanding MEG's strong financial liquidity driven by its estimated $525 million full year 2020 hedge book, MEG is further reducing its 2020 full year capital budget to $150 million from the previously revised level of $200 million, of which $125 million will be directed toward sustaining and maintenance activities, including approximately $25 million related to major plant turnaround activities at the Corporation's Phase 1 & 2 facilities scheduled to begin in early June 2020. Relative to the original budget, the turnaround is expected to be longer in duration, with completion expected in August, while being undertaken at a lower total cash cost by relying more heavily on internal resources. This will allow the Corporation to take advantage of the current low oil price environment by reducing turnaround requirements in 2021. The remainder of the revised capital budget will be directed primarily towards regulatory, corporate and other.
MEG currently expects first half 2020 production to average approximately 76,000 bbls/d. In light of the current oil price environment, the Corporation is suspending full year 2020 production guidance. At present, MEG expects to produce approximately 30,000 bbls/d during the Phase 1 & 2 turnaround. This production volume reflects the minimum production level required to maintain the integrity of its operations and reservoir performance at the Phase 2B facility, which has current productive capacity of approximately 60,000 bbls/d. During the turnaround, if oil prices improve from current levels, MEG will have the ability to efficiently produce up to this 60,000 bbls/d level. Upon completion of the turnaround activities at MEG's Phase 1 & 2 facilities in August, MEG will determine, based on the oil price environment at that time, when to bring these facilities back into operation. Irrespective of actual production levels in the second half of 2020, which will be a function of the oil price environment as we move through the year, based on full year $150 million capital investment for 2020, the Corporation will have the ability to achieve production levels in excess of 80,000 bbls/d post turnaround, once Phase 1 & 2 are brought back into operation.
In consideration of the significant impact COVID-19 is having on the corporation's bitumen realizations, MEG has taken further steps to reduce its 2020 full year non-energy operating costs and G&A expense. Non-energy operating costs are now targeted at $140 - $150 million, which is $20 million, or approximately 12%, lower than original guidance. G&A is now targeted at $52.5 - $55 million, which is $10 million, or approximately 16%, lower than original guidance. The majority of these cost reductions were a result of a reduction in staffing levels and rationalization of ongoing administrative costs. Targeted 2020 G&A expense is approximately $15 million, or 20%, lower than actual 2019 G&A expense, and approximately $30 million, or 35%, lower than 2018 G&A expense.
MEG exited the first quarter with $62 million of cash on hand after making a debt repayment of $132 million in the quarter. Based on the current commodity price environment, MEG does not expect this level of cash on hand to materially change in the second quarter of 2020.
The Corporation's earliest maturing long-term debt is four years out, represented by US$600 million of senior unsecured notes due March 2024. None of the Corporation's outstanding long-term debt contain financial maintenance covenants. Additionally, MEG's modified covenant-lite $800 million revolving credit facility has no financial maintenance covenant unless drawn in excess of $400 million. If drawn in excess of $400 million, MEG is required to maintain a quarterly first lien net leverage ratio (first lien net debt to last twelve-month EBITDA) of 3.5 or less. Under MEG's credit facility, first lien net debt is calculated as debt under the credit facility plus other debt that is secured on a pari passu basis with the credit facility, less cash on hand.
2020 Commodity Hedges
For the second quarter of 2020, MEG has entered into benchmark WTI fixed price swaps for approximately 66,100 bbls/d of bitumen production at an average price of US$57.75 per barrel. The table below reflects all of MEG's current 2020 financial and physical hedge positions. At current strip pricing, MEG's financial hedge book is expected to add $525 million to full year 2020 adjusted funds flow, including the $106 million realized gain in the first quarter.