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Cenovus Energy Seeing Lower Oil Sands Operating Costs

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   |    Wednesday,April 29,2015

Cenovus Energy Inc. has achieved solid production growth in the first quarter compared with the same period in 2014, driven by 20% higher production at the company's oil sands operations.

  • Production from Cenovus's jointly owned Christina Lake and Foster Creek oil sands operations averaged more than 144,000 bbls/d net in the first quarter. During the quarter, Christina Lake production increased 16% compared with the same period a year earlier, averaging more than 76,000 bbls/d net. The increase was primarily due to phase E reaching design capacity in the second quarter of 2014, the start-up of new wells, including those using the company's Wedge WellTM technology, and improved facilities performance, all of which contributed to a lower steam to oil ratio (SOR). The current full-year outlook at Christina Lake is for production to be above the mid-point of the company's annual guidance of between 67,000 bbls/d and 74,000 bbls/d net.
  • Foster Creek production volumes averaged almost 68,000 bbls/d net in the first quarter, up 24% from the same period in 2014. After six months of ramp-up, phase F wells were contributing approximately 5,400 bbls/d net in incremental production in the first quarter. The phase F ramp-up is proceeding on schedule and is expected to be complete in the first quarter of 2016, approximately 18 months after first production. The start-up of new wells, including those using Cenovus's Wedge WellTM technology, also contributed to the production gain. In addition, last year's well workovers led to some flush production, which is starting to taper off, as expected. The company anticipates full-year production at Foster Creek to be above the mid-point of its guidance of between 62,000 bbls/d and 68,000 bbls/d net.
  • In the first quarter, oil sands operating expenses declined $4.99 per barrel (bbl), or 31%, compared with the same period in 2014. This was due, in part, to lower natural gas prices, which reduced fuel costs at Foster Creek and Christina Lake. Non-fuel per-unit operating costs declined primarily as a result of stronger production and high plant operating efficiencies. The company's efforts to improve productivity and further prioritize work also contributed to the decrease. For example, savings were achieved by reducing workover costs and lowering fluid, waste handling and trucking costs related to the optimization of the chemical application process. Lower repair and maintenance costs resulting from improved scheduling of less time-sensitive work also contributed to the savings. In addition, Cenovus is starting to see results from its efforts to reduce supplier costs. In general, the company is seeing cost reductions from its suppliers of between 5% and 10%.

John Brannan, Executive Vice-President & Chief Operating Officer said: "I'm pleased with the performance of both of our oil sands projects in the quarter. We've made progress in significantly reducing our operating costs, and further cost-cutting measures are underway. We expect many of these savings to be sustainable and to make our oil sands assets even more efficient and productive."

Commodity price impact

Production increases and lower operating costs and royalties during the first quarter were more than offset by a sharp decline in benchmark prices resulting from a global supply-demand imbalance that accelerated through 2014 and into the first quarter of 2015. Average Brent, West Texas Intermediate (WTI) and Western Canadian Select (WCS) prices decreased 49%, 51% and 55%, respectively, from the same period a year earlier. In addition, the timing of condensate inventory drawdown affected Cenovus's realized pricing for its heavy oil. Condensate purchased at higher prices at the end of 2014 was blended into product sold in the first quarter of 2015. These factors negatively impacted operating cash flow at Cenovus's upstream operations.

Operating cash flow from the refining and marketing segment declined to $95 million in the first quarter, down 61% from the same period in 2014. Cenovus's refining margins were impacted by lower average market crack spreads due to narrower Brent-WTI differentials and higher heavy oil feedstock costs relative to WTI. This was partially offset by improved margins on the sale of secondary products such as coke and asphalt, an increase in refined product output and the weakening of the Canadian dollar.

These factors contributed to a decline in Cenovus's operating cash flow to $549 million, 53% below the same period a year earlier. Cash flow was down 45% in the quarter to $495 million. After investing $529 million in the first quarter, Cenovus had a free cash flow shortfall of $34 million, compared with free cash flow of $75 million in the same period of 2014.

Since the first quarter of 2015, benchmark prices have improved somewhat. At current strip pricing and market crack spreads, Cenovus expects its 2015 cash flow would essentially cover its capital expenditures and its current level of dividends for the year.

Cost management and financial resilience


Over the next 18 months, Cenovus expects to add approximately 100,000 bbls/d of gross incremental oil sands production capacity from its phase F expansion and optimization work at Christina Lake as well as the phase G expansion at Foster Creek. That would bring total expected oil sands production capacity to 390,000 bbls/d gross in 2016. To help ensure that it has the financial resilience to carry out these expansions and continue to focus on strong operational performance in this low oil price environment, Cenovus has adjusted its business plan for the next three years. This includes taking steps to cut costs and strengthen the company's balance sheet.

During the first quarter, the company conserved cash by:

  • Cutting its 2015 capital spending budget by $700 million in January. At $1.8 billion to $2.0 billion, the 2015 capital budget is about 40% below 2014 levels
  • Largely completing a 15% workforce reduction which primarily affected its contract workforce
  • Deferring executive and employee salary increases for 2015
  • Reducing discretionary spending on items including travel, conferences, offsite meetings and information technology upgrades. Cenovus expects most of the savings from its discretionary spending reductions to be evident in the second quarter.
  • For 2015, Cenovus expects to be near the low end of its guidance range for operating expenses. Compared with the previous year, general and administrative (G&A) expenses were 34% lower in the first quarter of 2015. The decrease was primarily due to lower employee long-term incentive costs. The company anticipates its G&A expenses will also be near the low end of guidance for the year.

As a result of initiatives already underway, Cenovus expects to realize approximately $200 million in G&A and upstream operating and capital cost savings in 2015. The company continues to look for additional cost savings for the year and is pursuing opportunities it has identified to potentially achieve hundreds of millions of dollars in additional sustainable annual cost reductions in the years ahead.

After careful consideration and lengthy discussion with its board of directors, Cenovus's management decided to issue 67.5 million common shares during the first quarter. The net proceeds of approximately $1.4 billion are expected to be used to fund any potential shortfall in the company's capital expenditure program for 2015 and for general corporate purposes. Part of the proceeds was used to repay commercial paper outstanding as it matured.

Ferguson said: "We examined a number of alternatives, including issuing debt, lowering the dividend, further reducing capital and issuing preferred shares.  In the end, we believed that issuing common shares was the best option to strengthen our balance sheet, provide greater certainty of funding for our planned capital program and reinforce our strong investment-grade credit rating over our three-year planning horizon. This should also position us well to be able to take advantage of opportunities that only come about in market conditions like these."

To further conserve cash, the company exercised its ability under Cenovus's Dividend Reinvestment Plan (DRIP) to offer shareholders the opportunity to reinvest their dividends in Cenovus common shares issued from the company's treasury at a 3% discount to current market prices. For the first quarter, more than one-third of Cenovus shareholders participated in the discounted DRIP, resulting in cash savings for the company of approximately $81 million. The 3% discount on the DRIP will remain in effect for the second quarter and will be reassessed by the company on a quarterly basis thereafter.

Royalty production and fee lands

The company has been evaluating opportunities to crystalize value for shareholders from its existing portfolio of assets. Cenovus is pursuing various potential options with respect to its royalty production and fee lands, including a possible sale or initial public offering, so that the company is market-ready when an appropriate opportunity presents itself.

Oil sands

Cenovus has a substantial portfolio of oil sands assets in northern Alberta with the potential to provide decades of production growth. The two operations currently producing, Christina Lake and Foster Creek, use steam-assisted gravity drainage (SAGD), which involves drilling into the reservoir and injecting steam at low pressures to soften the thick oil, so it can be pumped to the surface. Cenovus has a third major oil sands project under initial development at Narrows Lake, which is part of the Christina Lake region. These projects are operated by Cenovus and jointly owned with ConocoPhillips. Cenovus has a significant opportunity to deliver increased shareholder value over the long term through production growth from several identified emerging projects and additional future developments.

Christina Lake

Production

  • Production at Christina Lake averaged 76,471 bbls/d net in the first quarter of 2015, 16% higher than in the same period a year earlier. The increase was primarily due to phase E reaching design capacity in the second quarter of 2014, the start-up of new wells, including those using Cenovus's Wedge WellTM technology, and improved facilities performance. Wedge WellTM technology allows the company to increase production with the use of very little additional steam.
  • The SOR was 1.7, compared with 1.9 in the first quarter of 2014.
  • Operating costs at Christina Lake declined 38% to $8.22/bbl in the first quarter from $13.30/bbl in the same period of 2014. The decrease was primarily due to higher production, lower fuel costs and a decline in fluid, waste handling and trucking costs related to the optimization of the chemical application process. The decrease in costs also reflects a reduction in workover activities related to well servicing, primarily due to fewer pump changes.
  • Non-fuel operating costs were $6.03/bbl, a decline of 29% from $8.47/bbl in the first quarter of 2014. Fuel costs were down 55% to $2.19/bbl.
  • The netback the company received for its Christina Lake crude oil production was $10.30/bbl in the first quarter, compared with $39.53/bbl in the same quarter in 2014.

Expansions

  • Cenovus continues to progress its plant optimization project at Christina Lake. The optimization is expected to increase total production capacity to 160,000 bbls/d gross, starting in the fourth quarter of 2015.
  • The company is continuing construction at Christina Lake phase F. Plant construction is mostly complete. First oil from this phase is expected in the second half of 2016. Due to the substantial decline in crude oil prices, construction work on phase G has been deferred to conserve cash.
  • First-quarter capital investment at Christina Lake was $207 million, compared with $182 million in the first quarter of 2014.

Foster Creek

Production

  • Foster Creek production averaged 67,901 bbls/d net in the first quarter, 24% higher than in the first quarter of 2014. The increase was primarily due to additional volumes from phase F, which began producing in the third quarter of 2014, and the start-up of new wells.
  • Phase F wells are ramping up as expected and ended the first quarter with production of approximately 5,400 bbls/d net (10,800 bbls/d gross). The phase F plant has a gross design capacity of 30,000 bbls/d.
  • The SOR at Foster Creek was 2.4 in the first quarter, down from 2.7 in the same period a year ago. The decrease was primarily due to boiler maintenance which temporarily reduced steam use during the quarter. The SOR was also lower due to production from new wells, including wells using Cenovus's Wedge WellTM technology. Foster Creek's SOR is expected to range between 2.6 and 3.0 while expansion phases F and G are ramping up. After ramp-up, the SOR is expected to drop below 2.5.
  • Operating costs at Foster Creek declined 24% to $14.48/bbl compared with $19.09/bbl a year earlier, mainly because of higher production and lower fuel costs. The decrease also reflects a reduction in workover activities related to well servicing, primarily due to fewer pump changes. Non-fuel operating costs declined 16% to $11.52/bbl in the first quarter, compared with $13.64/bbl in the same quarter a year ago. Fuel costs declined 46% to $2.96/bbl.
  • The netback the company received for its Foster Creek oil declined to $5.80/bbl in the first quarter compared with $45.86/bbl in the same period a year earlier.

Expansions

  • Construction is continuing on phase G, which is anticipated to begin producing in the first half of 2016. Plant construction at phase G is approximately two-thirds complete.
  • As previously announced, due to the significant decrease in crude oil prices, construction work on phase H has been deferred to conserve cash.
  • First-quarter capital investment at Foster Creek was $149 million compared with $221 million in the first quarter of 2014.

Narrows Lake

  • Cenovus believes Narrows Lake has the potential to achieve total production capacity of 130,000 bbls/d. Narrows Lake is expected to be the industry's first project to use a solvent aided process (SAP) on a commercial scale, combining butane with steam to improve oil recovery.
  • As previously announced, in response to the substantial decline in crude oil prices, Cenovus has decided to defer further work at Narrows Lake to conserve cash. The company plans to take advantage of the slower pace of development to optimize its engineering and execution strategy with a focus on achieving the lowest capital efficiencies for the Narrows Lake project.

Emerging projects

Grand Rapids

  • Cenovus continues to operate a SAGD pilot project at Grand Rapids with two producing well pairs. A third pilot well pair was completed in early March 2015, and steam circulation is expected to begin in the second quarter. It is anticipated that data from these well pairs will be used to help determine the company's development plan for Grand Rapids.
  • The company has completed the dismantling and storage of an existing SAGD facility that Cenovus purchased in 2014 and plans to relocate to the Grand Rapids site once the development plan has been finalized, subject to a recovery in crude oil prices. The project has received regulatory approval for total production capacity of 180,000 bbls/d.

Telephone Lake

  • Cenovus continues to review development options for Telephone Lake after receiving approval from the Alberta Energy Regulator for the project in late 2014.

Conventional oil

  • Cenovus has tight oil opportunities in Alberta as well as the established Weyburn operation in Saskatchewan that uses carbon dioxide injection to enhance oil recovery. Cenovus also produces conventional heavy oil from the Wabiskaw formation at its 100%-owned Pelican Lake operation in northern Alberta. Cenovus has been injecting polymer since 2006 to enhance production from the reservoir, which is also under waterflood.
  • Total conventional oil production fell 4% to 73,648 bbls/d in the first quarter compared with 76,410 bbls/d in the same period a year ago due to the divestiture of non-core assets in 2014. Production from the divested assets averaged 3,174 bbls/d in the first quarter of 2014.
  • Operating costs for Cenovus's conventional oil operations were $16.29/bbl in the first quarter, a 23% decline from $21.06/bbl in the first quarter of 2014. The decline was primarily due to reduced expenses for workover activities, repairs and maintenance, electricity and fuel costs.
  • As previously announced, Cenovus has temporarily suspended the majority of its conventional drilling program in southern Alberta and Saskatchewan for 2015. This suspension, along with asset dispositions completed in 2014, is expected to reduce production to between 66,000 bbls/d and 70,000 bbls/d for 2015 compared with approximately 75,000 bbls/d in 2014.
  • Cenovus invested $62 million in its conventional oil assets in the first quarter, compared with $263 million a year earlier. These assets generated $104 million of operating cash flow in excess of capital investment in the first quarter.

Natural Gas

  • Cenovus has a solid base of established, reliable natural gas properties in Alberta. These properties are managed as financial assets, not production assets, generating operating cash flow well in excess of their ongoing capital investment requirements. The natural gas business also acts as an economic hedge against price fluctuations because natural gas fuels the company's oil sands and refining operations.
  • Natural gas production averaged 462 million cubic feet per day (MMcf/d) in the first quarter, down 3% from 476 MMcf/d in the same period in 2014. Cenovus anticipates continued declines in its natural gas production in future quarters, as the company continues to direct the majority of its capital investment to its crude oil properties.
  • The company invested $5 million in its natural gas assets in the first quarter compared with $9 million in the same quarter a year earlier. The natural gas assets generated $76 million in operating cash flow in excess of capital investment in the quarter.
  • Cenovus's average realized sales price for natural gas, including hedging, was $3.34 per thousand cubic feet (Mcf) compared with $4.47/Mcf a year earlier.
  • Natural gas use at Cenovus's operations is forecast to be about 180 MMcf/d in 2015.

Financial

Cash flow, earnings, capital investment, G&A and debt ratios

  • Capital investment was $529 million, a 36% decline from $829 million in the first quarter of 2014, as the company reduced capital spending to conserve cash. Almost 80% of the investment was at the company's oil sands operations as it progressed expansion phases at Christina Lake and Foster Creek.
  • G&A expenses declined 34% to $72 million in the first quarter from a year ago. The decrease was primarily due to a recovery of employee long-term incentive costs resulting from a decline in the company's share price.
  • Over the long term, Cenovus continues to target a debt to capitalization ratio of between 30% and 40% and a debt to adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) ratio of between 1.0 and 2.0 times. At March 31, 2015, the company's debt to capitalization ratio was 35% and debt to adjusted EBITDA was 1.9 times, on a trailing 12-month basis. The net debt to capitalization ratio was 27%, and net debt to adjusted EBITDA was 1.3 times, on a trailing 12-month basis.

Commodity price hedging

  • In the first quarter, Cenovus added Brent fixed price contracts for the period March through June 2015 of 45,000 bbls/d at an average price of US$56.45/bbl, 18,000 bbls/d for the third quarter of 2015 at an average price of US$60.03/bbl and 1,000 bbls/d for the fourth quarter of 2015 at an average price of US$64.00/bbl. The company also added Brent fixed price contracts for 2016 of 4,000 bbls/d at an average price of US$65.75/bbl.
  • Cenovus had a realized after-tax hedging gain of $111 million in the quarter, as the company's contract prices exceeded the average benchmark price. Unrealized losses were $108 million after tax in the first quarter, primarily due to the realization of settled positions.
  • Cenovus received an average realized price, including hedging, of $37.66/bbl for its oil in the first quarter. This compares to an average realized price, including hedging, of $71.12/bbl in the first quarter of 2014. The average realized price for natural gas, including hedging, was $3.34/Mcf, compared with $4.47/Mcf a year ago.

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