Thursday, March 10, 2022

Canadian Natural Resources Limited ($CNQ) - Q4 and FY 2021 Results

[Canadian Natural Resources is our third Canadian oil company in the basket with Cenovus and Suncor. See our previous post from November 2021.]

Canadian Natural Resources (CNRL) (NYSE: CNQ) is a bit different than Cenovus and Suncor. For one thing, they don't have any refining or retail businesses, although they do upgrade the bitumen produced by their oil sands. Also, while they are a Canadian oil sands producer, both by mining and in situ extraction, they also have assets in the UK North Sea and Africa offshore (Côte d'Ivoire), plus conventional oil and gas production in Canada, including much more natural gas production than the other two companies.

The current market capitalization of CNQ (at a $60 share price) is US$70 billion, and the enterprise value based on the December 31 balance sheet is about US$88 billion. In the fourth quarter of 2021, CNQ's production was a record 1,314 MBOE/d, including 1,004 Mbbl/d of liquids.

The average price of WTI crude in Q4 was US$77. Free cash flow in the fourth quarter was US$2.7 billion. (Which we define as net income plus depreciation, depreciation, and amortization, less capital expenditures excluding property acquisitions.) Annualized, that is US$10.7 billion, at $77 average oil price. So, that is a 15% pre-tax yield on the current market valuation based on Q4 earnings, which had a much lower oil price than today.

Let's think about this quarter (Q1 2022). Suppose that the price of oil averages US$90, or 17% higher. With 1 million barrels per day of production, back of the envelope, cash flow should increase by US$1.2 billion, or 44%, thanks to operating leverage. 

Proved plus probable (2P) reserves of liquids at the end of the year were 13.6 billion barrels, up from 11.4 billion at the end of 2020. The 2P reserves of liquids grew to 11.6 barrels per share at year end 2021 from 9.6 the year earlier. (So you are paying about US$5 per barrel of proved plus probable reserves of liquids at the current share price, plus an operating cost of about US$24 per barrel for production, royalties, and transportation expenses.)

Some highlights from the Q4 conference call:

  • As evidence of Canadian Natural's long-life, low-decline asset base, 77% of total proved reserves are long-life, low-decline, resulting in our top-tier total proved reserve life index of 30 years and the total proved plus probable reserve life index of 40 years. The net present value of future net revenue before income taxes using a 10% discount rate and including the full company ARO is $120 billion for total proved reserves and $146 billion for total proved plus probable reserves. [Note: this PV-10 value, which implies a $82 share price, was calculated with an oil price strip of $73 per barrel in 2022, declining to $69 in 2026. The PV-10 value with $100+ oil would be far higher.]
  • Returns to shareholders were also significant in the quarter, with approximately $1.4 billion returned through dividends and share repurchases. Per our previously disclosed free cash flow allocation policy, with net debt now below $15 billion, target free cash flow, as defined in the policy, will be allocated 50% to share repurchases and 50% to the balance sheet. This targets to deliver significant increases in shareholder returns as well as continued financial strength.
  • [Y]ear-to-date, up to and including March 2, the company has returned approximately $680 million to shareholders through repurchase and cancellation of 10.5 million common shares and the Board of Directors has approved the renewal and increase of the company's normal course issuer bid. The approval states that during the 12-month period commencing March 11, 2022 and ending March 10, 2023, the company can repurchase for cancellation up to 10% of the public float, subject to TSX approval.

What we like about royalty trusts and long reserve life, slow decline Canadian oil companies is that they both avoid the principal-agent problem that afflicts other types of oil and gas producers with small amounts of reserves. Managements have to buy new reserves in order to keep their jobs, and they typically have the money to do this (whether through earnings or capital raises) when the industry is doing well and valuations are high. 

Hydrocarbon E&Ps with rapidly declining production (shale) have a poor track record of creating long term value for shareholders because of this incentive conflict. They need to buy assets to keep their companies from liquidating (and losing their jobs), but they only have the money to buy assets at the top of the cycle when properties are expensive. The companies that fracked for shale over the past decade managed to transfer almost all of their investors capital (both equity and debt!) to sellers of land and service providers.

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