- Horizon Oil Sands Facility
Profile and General Stuff
Canadian Natural Resources consists of four primary units. You have North America Crude Oil, North America Natural Gas, International, and Horizon Oil Sands. The International segment is relatively small compared to the others. International operations consist of the North Sea region and offshore West Africa (Ivory Coast and Gabon).
The company’s main focus over the last few years was getting the Horizon project up and running. They got first Horizon production in 2009 and expect to ramp up to full production this year. Targeted daily production from Horizon is 110K bopd for the rest of the year. Management expects yearly production from Horizon to be 90 – 105K bopd. They have had significant equipment issues getting this project started. Production has been below original guidance from the get-go, but management thinks they are starting to get a grip on things. They release their Horizon production figures in monthly 8-K statements. If you are considering starting a position in CNQ then you want to keep an eye out for these releases.
CNQ retains a high working interest in their projects which allows them to control infrastructure and timing of development. They are the largest producer of heavy crude in Western Canada and retain one of Western Canada’s strongest natural gas positions.
The introduction section of the 10-K brags about how the company generates significant free cash flow and all areas of the business provide free cash flow. OXY in contrast relied on its oil and gas operations to carry the load for the overall company with some contributions from the other segments. CNQ doesn’t have the midstream and chemical segments of OXY so you would expect them (CNQ) to be better off in this regard. Finally, CNQ management was happy with their “improving” balance sheet.
Going through their financials was a bit of a pain in the ass. The reported figures are in Canadian dollars and you have to find what conversion rate they used. When we get to the Financials section further down in this post, I have already done the conversions. Those figures are in USD so later on we can do some direct comparisons between all the companies. Assume all other $ amounts are in USD as well. CNQ used an average conversion rate of 1.14. I’ve used the same.
!!! IMPORTANT SHIT HERE !!!
But before we go one step further, let’s look at something very strange about these Canuck bastards. Remember back in the first post of this series I pointed out 99.9% of companies in the industry use Successful Efforts accounting and only little piss ant operators use Full Cost accounting? Wrong. Despite being one of the world’s largest independent oil and gas companies, CNQ uses Full Cost accounting. A shock to yours truly.
Oh and to make it better, starting Jan 1, 2011 they are required to switch to the equivalent of Successful Efforts. That can’t be good when they start reporting under this system 1Q 2011. Buried deep in their 10-K they estimate an $815 mln ceiling test impairment coming up end of this year. Great. But they go on to say the full impact of the change is “not reasonably determinable” at this time. Oh boy, if that doesn’t set off alarms I don’t know what will. You never know how Wall Street is going to react to things like this. Maybe it’s already being priced in, but I cannot see this being a non-event and certainly not a positive.
Plenty of time between now and then to bank some coin in CNQ, but I would have to suggest extreme caution. You never know if they might start writing off some of this $800 mln impairment in the next few quarterly reports.
!!! END IMPORTANT SHIT !!!
2009 Highlights
- Achieved first production from Horizon
- Achieved first production from Platform C in the Olowi Field offshore Gabon
- Cash flow from operations was $5.3 bln
- Paid off ~$3.0 bln in long-term debt. L/T debt at year end was $8.5 bln.
- Revenues increased every quarter in 2009.
- Significant changes to Alberta royalty payment policy should be a positive. Honestly I tried to figure out the impact but Jesus God almighty trying to sift through all the stipulations and rates was beyond my capabilities. Suffice it to say, in general this should provide a positive impact to CNQ. Quantifying the amount of impact is not so easy.
2009 Lowlights
- Took a ceiling test impairment charge in Gabon because production was below expectations. More impairments could come as they get even more bad news from this shithole.
- Previously mentioned start-up problems at Horizon have led to all sorts of delays and decreased production figures. They are struggling to meet expectations and have already reduced guidance once. Not a good situation when this is considered the “Flagship” operation for the future of the company.
- About $1.2 bln unrealized loss from risk management. Doesn’t sound like they managed risk too well if this is true. Risk management is defined as commodity price hedges, interest rate swaps, and foreign exchange swaps. CNQ is all over the place with their risk management. In 2008 they had a $1.8 bln gain and 2007 saw a ~$900 mln unrealized loss. They kindly pointed out in the 10-K that these gains and losses are expected to continue and contribute significant volatility to net earnings. Gee… ya think?
Diversification
CNQ’s reserves consist of 85% oil, 15 % NG. From a production standpoint, approximately 62% of production is oil and other liquids. Main reason for this is the significant contribution to reserves from Horizon, but production from Horizon has not reached full capacity.
Geographically, 89% of reserves are located in North America. Approximately 86% of production comes from North America ops. Obviously CNQ is very “oily” and very reliant on conditions in North America. If you think oil is going to outperform then CNQ fits the bill. If you are looking for a natural gas play, stay away.
Reserves As indicated in the following tables, the vast majority of CNQ’s reserves are domestic. Anybody care to venture a guess as to when the SEC decided to allow oil sands mining to be counted as normal oil and gas activity? I’ll give you three guesses and the first two don’t count. If you are still having difficulty figuring it out, call 1-800-IMA-DUMAS. Operators are standing by.
Production
We see a drop in production between 2007 and 2008, but then it kicked back up last year. This is without a significant contribution from Horizon. For 2010, management has guided 2010 daily production between 586 – 642K boepd. I went back through the previous three 10-K’s to see how management’s guidance compared to actual results. Overall they do very good. They are always within the stipulated range. Doing an average comparison and applying to 2010 guidance I got a reasonable estimate of 410K bopd (oil) production and 1,162 MMcf / d natural gas production. This works out to 604K boepd daily production. Use that figure however you wish. If they hit this number it is another yearly production rate increase.
Reserve Life Ratio
As you can see in this table, being able to count Horizon reserves has provided a huge gain. Note to those of you that never figured out when the SEC changed the rule and could not get through to an operator on the 1-800 number, the answer is 2009. Clear? Make sense now?
Production Replacement Ratio
Hopefully this table is readable. I noticed on the OXY post I had no problems reading the table on my laptop’s small screen, but on a regular size monitor it was complete garbage.
Main thing is, once again being able to count Horizon has saved their asses here. Until then they were consistently producing more volumes than they were replacing. Remember, it is EXTREMELY critical that an oil and gas company replace reserves faster than they use them up. Horizon buys them some time. Personally I don’t like the trend prior to Horizon getting added to the books. However I do like the fact that almost all their reserve replacement is done organically. In other words they are not going out into the open market throwing cash around chasing reserves. Overall we can live with this but it could be better.
Well damnit, the table is unreadable on my monitor. I assume it’s the same for others. Just in case, here are the relevant numbers:
PRR “All-Sources”: 2007 = 0.96, 2008 = 0.82, 2009 = 8.43
PRR “Organic”: 2007 = 0.96, 2008 = 0.75, 2009 = 8.42
Reserve Cost Ratio
I had to get a little creative with this one. Since they were able to drop Horizon into 2009’s reserves it greatly increases the reserve portion of the ratio. However the costs associated were doled out in previous years. What I did was back out the reserve volume increase due to Horizon to see how these dudes did on a comparable basis. You can find those figures at the bottom in the “Net SCO Revision” portion. Their RCR has been increasing each of the last three years. And not increasing by just a small amount either. We are looking at about 30% increase each year since 2007.
Financials
All per share ratios below have been adjusted for the recent 2:1 split. All financial figures have been converted from Loonies to Greenbacks. As of year-end 2009 CNQ was trading at a historical premium in all regards except Price / Book Value per Share. This is similar to what we saw with OXY. Even with Friday’s closing price of $32.80 the same situation applies.
Some other notes regarding their financials:
- 17% of revenues come from outside North America – 9% North Sea and 8% West Africa
- Realized sales price for oil averaged ~90% of the WTI spot price in 2009. This is pretty much the same as OXY.
- One metric used by management is Debt to Book Capitalization. Management looks for a range of 35 – 45%. End of 2009 they were at 33%. Management claims they are below the range when cash flow from operations is greater than investing activities.
- Current debt is C$ 400 mln with an interest rate of 5.5%.
- 60% of long-term debt expires after 2014.
Other Notes from the 10-K
- CAPEX for 2010 is planned to be $3.9 bln (C$)
- Company forecasts for 2010 are based on WTI = $79.17 and NG = $5.70
- Each $1 change in crude changes Cash Flow Ops by $91 mln, net earnings $76 mln, and EPS by 0.14. Each 0.10 change in NG changes Cash Flow Ops by $18 mln, net earnings $14 mln, and EPS 0.03 (I assume these are all C$ figures).
- In 2009 they drilled 500 heavy crude oil wells. In 2010 they expect to drill 93 NG wells and 956 crude wells. Not sure how many of the crude wells are “heavy crude”.
- For those trying to make models on CNQ, they expect income tax for 2010 to be C$ 740 mln.
- They are allowed to hedge up to 60% of near 12 month budgeted production and 40% of 13 – 24 month production. At the end of 2009 they were approximately 39% hedged.
- Outstanding stock options are equal to 6% of current shares outstanding
Conclusions
CNQ has been an all-time favorite of mine. I guess a 1,400% return will skew your opinion in a positive direction. For the last year it has been a great swing trade with somewhat predictable tops and bottoms. However, after reading their 10-K I do have concerns. I knew CNQ was pretty high beta compared to peers, but finding out that hedges, forex swaps, etc. are a main contributor to the volatility scares me more than just a little bit. Also, the problems they have been experiencing with Horizon are another problem. But the biggest problem I have is the potential shock when they switch from Full Cost accounting to Successful Efforts. I could be over reacting with that one. Maybe they have something up their sleeves to make this a positive, but to me the risk is too high.
Final opinion… CNQ is great for some short-term swing trading, but the easy money from a long-term hold perspective has already been made. Invest in CNQ with caution.
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