ARC Resources Ltd.

Good morning, ladies and gentlemen, and welcome to the ARC Resources Limited Quarter 3 2021 Earnings Conference Call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you require immediate assistance, please press star 0 for the operator. This call is being recorded on Friday, November 5, 2021. I would like to turn the conference over to Dale Luko. Please go ahead.

Thank you, operator. Good morning, everyone, and thank you for joining us on our third quarter earnings conference call. Joining me on the call today are Terry Anderson, President and Chief Executive Officer, Chris Bibby, Senior Vice President and Chief Financial Officer, Laura Conrad, Senior Vice President Development, and Armin Jahangiri, Senior Vice President Capital Projects. Before I turn it over to our executive team to take you through our Q3 results in 2022 budget, I'll remind everyone that this conference call includes forward-looking statements and non-GAAP measures with the associated risks outlined in the earnings release and our MD&A. All dollar amounts discussed today are in Canadian dollars unless otherwise stated. The press release, financials, MD&A are also available on our website as well as CDAR. Following our prepared remarks, we'll open the line to questions. With that, I'll turn it over to our President and CEO, Terry Anderson. Terry, please go ahead.

Thanks, Gail, and good morning, everyone. I'll keep my opening remarks brief and focused on what I believe is most relevant, which can be summarized in five key points. First being the continual operational excellence of our business. Second, the completion of the seven generations integration. Third, our record production and free cash flow per share. Fourth, the accelerated shareholder returns. And fifth, the 2022 budget announcement. So over the past 12 to 24 months, we have observed the complexity of the energy environment and the importance of having a reliable and safe source of energy supply. ARCA has established itself as a leading provider of that energy and is well positioned to retain that moving forward. Q3 was excellent across the board and really demonstrated the strength of our assets and the best-in-class people that run them. The team continues to build on our 25-year track record of safe and efficient operations. We delivered both record production and free cash flow per share, eclipsing the previous mark set way back in 2006. Our operational momentum is very strong. Continuous improvement and our focus on operational excellence is truly part of our DNA, and we are seeing this materialize again in our results. Production of 354,000 BOE per day was above analyst expectations and we continue to find tangible ways to improve efficiencies and reduce costs. Capital well costs have decreased by greater than 10% year over year, and we anticipate that further efficiencies will offset these inflationary pressures that our industry is facing. I think it's important to step back to realize our operating costs were $3.58 of DOE, and considering our production is 40% liquid, that is an exceptional number. Even though commodity prices are strong, we are still very focused on being a low-cost producer. In addition, we made excellent progress on the integration efforts. Today, we have realized 90% of the $160 million of synergies and are now on pace to exceed that total by year-end, primarily due to greater-than-anticipated capital synergies being realized. We anticipated that the $25 million in capital synergies outlined in April will now double by year-end. It is true that large-scale integrations like seven generations are often difficult to execute successfully. However, the ARC team has worked tirelessly for six months, and the integration is now substantially complete, and we are realizing a significant value from this effort. We generated over a half a billion dollars, or 69 cents per share, of free cash flow in the quarter, approximately 6% of our market cap, which was used to pay down debt, and accelerate capital returns to our shareholders much faster than we anticipated. To this end, we have increased our quarterly dividend by 52% to 10 cents a share. The dividend increase reflects two things. First, our conviction in our business, and second, the greater profitability from fully capturing the synergies. We also put in place an NCIB as a complimentary value creation tool. Since commencing in September, we have allocated over $200 million of free cash flow to repurchase 20 million shares, or approximately 3% of our stock. Even with the conservative commodity price assumption, we perceive the intrinsic value of our business to be much greater than the share price, and therefore will continue to utilize the NCID to create value and per share growth. In addition to the quarter, we released our preliminary 2022 budget, which balances reinvestment with an accelerated return of capital to provide an attractive total return. Next year, the capital budget is $1.2 to $1.3 billion, of which $1.1 billion is to sustain production, and the balance will be invested in an 80 million cubic feet a day expansion at Sunrise, long lead items at Atachi, and emissions reduction project at Dawson. Our budget is expected to deliver average production of 335,000 to 350,000 BUE per day. The sunrise expansion is one of our highest return opportunities in our portfolio. Supply cost is well below a dollar per MCF. Its emissions intensity is near zero, and it's an excellent supply source for LNG, given its proximity to inlet of coastal gas link. Related to that, we recently entered into a long-term supply gas agreement with an LNG Canada participant to deliver 150 million cubic feet a day of gas to the project, which equates to roughly 12% of our corporate natural gas volumes. We also continue to evaluate several measures to extract more profit along the value chain. Our resource depth, financial position, investment grade credit rating, and operating track record of delivering safely on time and on budget make us an excellent partner in these initiatives. Switching gears to Hitachi, we plan to invest 75 million on long lead time items and we have plenty of flexibility to change the pace of spending based on the outcomes of negotiations between the Blueberry River First Nations and the BC government. The total cost of phase one remains at approximately $600 million inclusive of the 75 million earmarked for 2022. Once on production, we expect Hitachi will generate $250 million of free cash flow at mid-cycle pricing or roughly $350 million at strip. The 2022 budget and dividend can be funded with cash flow down to $30 a barrel WTI. So with strip north of $70 today, there'll be meaningful return of capital component that Chris will talk about. Before turning it over to Chris, I want to stress that we can remain committed to building on our leading position as a low emissions producer with top tier governance practices. We are one of the lowest emissions producers in North America, and we've set out to further reduce our scope one and two emissions, both on an intensity and an absolute basis. We've committed to reducing our emissions intensity by 20% and absolute emissions by 70,000 tons of CO2 equivalent by 2025. Our targets are backed by a tangible plan to achieve them, and we continue to look for a viable and concrete path to becoming a net zero producer in the future. Finally, I want to again recognize our entire staff for their efforts in delivering a record quarter safely and efficiently, despite operating in a challenging environment. With that, I'll turn it over to Chris to touch briefly on our financial highlights.

Thanks, Terry, and good morning, everyone. I'll quickly touch on a few additional highlights related to our debt structure and how we think about capital allocation, but I do want to leave a decent amount of time for questions, so I'll be relatively brief, which is a rarity for me, on these comments, and then we can get on to the questions. As Terry mentioned, good operational momentum and strong commodity prices resulted in a record quarter. Along with our low cost structure, our marketing efforts played an important role as we realized a gas print above $4.50 at MCF or more than a dollar above the ACO benchmark. Hedging losses offset some of these pricing tailwinds. The bulk of these positions will be rolling off in 2022. We will continue to manage risk through hedging, but our business is now better positioned to absorb volatility given our balance sheet strength, our diversified commodity mix, and our low-cost structure. We were able to reduce debt by an additional $158 billion in the quarter and by 20% or half a billion dollars since we closed the seven generations transaction in April. As a result, we are now well-positioned to return more of our profits to shareholders. We increased the quarterly dividend, as Terry mentioned, by 52% to a very sustainable level of $0.10 a share per quarter, and we've been active repurchasing our shares through the NCIB. As Terry also mentioned, we've retired approximately 3% of our shares since September. It's worth noting we optimized our debt structure to better align with our investment grade rating. We repaid our legacy ARC private senior notes, and amended and extended our $2 billion credit facility, which collectively lowered our overall cost of debt to approximately 2.4%. Over time, we will continue to reduce debt, ideally targeting roughly $1 billion over the long term at our current size. However, the pace of debt reduction will slow in favor of allocating more pre-funds low to shareholders. This is a great segue to capital allocation and how we intend to allocate our free capital in the future, which has been very topical amongst the investment community. Foundational to our strategy is a meaningful return of capital component as a part of the total return, and to return capital sustainably, you need to reinvest profitably in the business. So we will continue to do both. As we've stated before, once debt's at the lower end of our target range, we will accelerate shareholder returns, and we've now reached that inflection point. As we said in the press release, we intend to return 50% to 80% of our pre-cash flow to shareholders. with the balance earmarked for further debt reduction. The needs of the business are fully met. Capital program and the dividend are sustainable in a low commodity price environment. Our financial position is very strong, and we're very fortunate to have amassed a large drilling inventory in the highly profitable areas of the monotony. While we always look for opportunities to create value externally, the reality is what we've looked at recently does not compete for capital against our internal investment opportunities or buying our own shares. In terms of the method to return capital, the dividend has always been the core mechanism, and that has not changed. And obviously, we've just recently demonstrated that with our dividend increase this quarter. We will now supplement it with share repurchases during periods in which we think it's a sound and profitable investment to do so. The base dividend will grow with our business and is set to be sustainable, such that it can withstand extended periods at the bottom of price cycles, even below $40 US WTI. Our payout is moderate under that scenario so that there's an opportunity for us to continue to grow the dividend and repurchase our shares, which we've obviously been doing so recently. If this changes, we'll continue to evaluate other capital return measures to ensure that we provide our shareholders with the most competitive return possible. And with that, I'm going to turn it back to Terry for some closing remarks.

Thanks, Chris. To close, this quarter was an excellent demonstration of our competitive strengths of our assets and people. Free cash flow and production per share were 25-year records. Operational momentum is strong, and we are at an inflection point to sustainably return more profits and provide an outsized return to our shareholders. With that, I'll turn it back to the operator to open the lines to questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press the star button followed by the 1 on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order that they are received. Should you wish to decline from the pulling process, please press the star, followed by the 2. If you're using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Patrick O'Rourke from ATB. Please go ahead.

Okay, guys, good morning. Sort of a three-part question here on Attachee, so I'll fire them all out there because they are interconnected, and then maybe you can answer them as you see fit. Just wondering here, in terms of the permitting issue and things that are going forward, obviously the Blueberry and the BC government have the preliminary agreement in place, which allows for pre-existing permits to move forward here, excluding 2020. Is sort of the delay here or stepping back and waiting for this to resolve itself, is this more about prudence? I know in the past you said you had mostly all the permits in place for Hitachi, or are you caught up in those 20 permits that were sort of excluded from the agreement? I guess the second thing would be timing-wise, you guys have been very consistent in terms of your sanctioning of projects. They typically come out with a Q3 budgeting process. And we're wondering if this could be sort of a special case here this year where if you do see a full resolution to this issue, could we see a change to the budget mid-cycle here and a sanctioning, you know, essentially effectively when the issue is resolved? And then the third and final question on it is in terms of cost and procurement, Are there any risks on the cost drift or of cost drift on the $600 million here? I know you guys probably, you've done all the engineering, you've done all the procurement, but are there any time-sensitive items in that procurement process there? And is there any seasonality involved with how you could get going on the construction for the project?

Perfect, Patrick. Well, it's Terry here, and thanks for the question on Hitachi. So let's start with the permitting side, and it is about prudence. So if I give a little background, I've been spending a lot of time talking to First Nations, BC government, Oil and Gas Commission, and everybody is trying to come up to the same agreement in that we want to progress activities, and it's just about how do we do it in a responsible manner. So I have confidence where this is going, and that's why you see us the $75 million in long lead time items. But we want to have a 100% guarantee that we know the regulatory framework going forward. And so it is about just stepping back and waiting to make sure that we can drill all the wells that we need to drill to continue producing into this facility. And you're right, we do have most of the permits for building the facilities and the pipelines So for us, it's just being a little, I guess, taking a cautious approach to making sure that everything, we know all the rules of the game before we step into the full 600 million. But I have confidence where everything is going on the negotiations. And it's just a matter of time before this is going to be resolved here because everybody wants it to be resolved. So that's on the permitting side. On the timing side, yes, we could see a change in the budget, and we call this our preliminary 2022 budget. With that in mind, if we get this approval by the end of the year, then we will look at changing our budget in the new year and get going on Apache. We have everything in place from our plans are in place. The ordering of equipment is already happening. so we're set up to get going as quick as possible as soon as we get that ruling figured out from the BC government in the blueberry so mid-year whatever time in the year as soon as we get that comfort we will actually sanction in 2022 we don't have to wait for Q3 I guess is the point and maybe I'll turn it over to Armin more on the cost and the risk on inflation on the $600 million but I think the What we're seeing from the efficiency gains that we are seeing in CAPLA, some of those relate back to ATACHI, too. And so I think also ordering some of our equipment ahead of time is helping mitigate some of those inflationary pressures. But, Armin, maybe you have more flavor on that side.

Yes. Thanks, Terry. So in terms of the time-sensitive items that you talked about, Patrick, I think that the $75 million is effectively just to address that specific question. It really allows us to have all the long lead items ready for a project like that, and so that gives us flexibility in order to be able to advance when the time is right. Cost pressures, I guess, specifically to Attachi, I don't think there's anything unique about that project that differentiates it from the other projects that we are executing. We've seen inflation impact across the board on the price of steel, labor costs, all the other factors. We have estimated that to be about 5% to 7% impact on our overall capital expenditure. But as Terry said, our goal and expectation is to be able to actually offset all of that using efficiency of execution and the continuous improvement initiatives that we see across the board in the company. So Tachi will be just like any other project as far as we can tell. Okay, great. Thank you.

Your next question comes from Travis Wood from the National Bank Financial. Please go ahead.

Yeah, thanks. Thanks for taking the question and good work on hosting the conference call. Hopefully you keep these up going forward. I want to stay on Attachee and maybe two parts to this question if I can. First, what do you guys need from these negotiations? What are you expecting out of these negotiations to provide some more certainty and clarity and And then what does that critical path look like for you guys to start to commit incremental capital to Hitachi? And then the last part would be if we see delays into 2022, was there cushion on the on-stream date kind of the back end of 23? Like, do you expect that back on-stream for 2023 changes? even though there potentially is some upfront delays on Apache.

Thanks, Travis, for the questions. It's Terry here again. So as for clarity, we need to see clarity on the permitting authorizations. That's the biggest thing in the negotiations with the BC government and the Blueberry River First Nations is what's the mechanism for these permit authorizations which take into account cumulative effects. And so that's the biggest thing that they are talking about. And there's other finer details, but that's the biggest concern. So we need to make sure we know what the rules are for us when we're permitting activities, what we have to do and make sure that makes sense for our business. So from that perspective, that's what we're looking for is that clarity. And that's what this is really all about is the, the clarity on the permitting authorizations. So that is basically the critical path to everything that we are doing for ATACHI. Everything else is ready to go. We were ready to sanction ATACHI right now if it wasn't for the blueberry and government negotiation issues that we're seeing right now. Otherwise, everything is ready to go. Arm is ready to pull the trigger on this thing tomorrow. So But if it is delayed further into 2022, yes, that will impact the 2023 start time. We still need, whenever we start, ARMA needs at least 18 months to complete the facilities and drill the wells to have everything on stream. So it's basically whenever we sanction, it's 18 months out from then is kind of how you would look at that.

Travis, I would just add, it's Chris here. You know, the way we would see this playing out is when we get that regulatory certainty, we'll circle back with Armin and his team and say, okay, what's your on-stream date? What's the capital you can efficiently deploy in whatever time is left in that year and the following year? And then we'll update the market accordingly.

Okay. That's great color on both of those. Thanks so much, Chase.

Thanks, Armin. Your next question comes from Jeremy McRae from Raymond James. Please go ahead.

Hi, guys. Two questions here. One is, Can you give a little bit more detail with this LNG agreement that you guys signed here? Is there more to come after that? Was this just a little preview of what's possible here? Any other additional clarity on that? And then if you could also provide a little bit more context in terms of the breakdown between the – distribution between buybacks versus potentially special dividends, variable dividends, in terms of 50% to 80% payout to your shareholders.

So, Jeremy, Terry here. I'll take the first one and then throw the second one to Chris. So, on the LNG deal, we can't give much more detail on it, but we can say that it it's advantageous to North American-based pricing is what we got. So from that perspective, we're net positive on this. It's a strategic deal. It's about building long-term relationships. And to your point then, yes, we do believe there's other opportunities out there. And I think for our, just with our Sunrise asset in particular, it is, probably the greenest facility in North America, and it's actually the proximity to the coastal gas link. And it's the reliability of ARC's operations that people are looking for to partner with. And our investment grade, we have enough size to us and the resource. When you add all those up, we're a good partner for long-term LNG agreements like this. So I guess that's about all I can add to slavery to that. And then maybe, Chris, maybe you want to touch on the second question.

You bet. So in terms of buybacks versus dividends, obviously I touched on it in the opening, but we do want to lean on our base dividend as the primary long-term mechanism, but it will be supplemented by the share buybacks just to make sure that we do get into that range of that 50% to 80%. I mean, the market's giving us an opportunity, or we do, is an opportunity with the discounted valuation we see in the market currently. So, you know, we will be spending heavily on that and getting up to our full allotment of our 10% NCIB is what we would anticipate over the remaining eight months that we have left on it. So it's going to be a portfolio approach where it's got a little bit of everything, and that's where we're going to start. And we'll keep moving forward with that as we see throughout the year.

Perfect.

Thanks, guys.

Your next question comes from Aaron Bulkowski from TD Securities.

Please go ahead.

Good morning, guys. Just a follow-up on Jeremy's question. If we assume the regulatory answer to ABC settled and more capital stands at TACHI in 2022 than was outlined in the preliminary budget, does this slow the pace of buybacks and future dividend increases, or does the capex come out of the remaining 20% to 50% of the free cash flow that's allocated to the balance sheet?

Yeah, good question, Aaron. It's Chris here, obviously. So, you know, when we were designing the framework for our capital allocation, we were certainly mindful of where we were in this process. So it's the latter approach that we know that we have the flexibility with that remaining 20% to 50% that will allow us to continue on the buybacks, continue on our dividend journey. and execute the business and profitably invest in our underlying assets to grow the business and the free cash flow for the long term. So it's the latter of those two, Aaron.

Perfect. Thanks, Chris.

Thanks.

Your next question comes from Elias Foscolis from Industrial Alliance Capital Markets. Please go ahead.

Thanks very much for taking my call. I want to focus a bit on the the new dividend and the sustainability, you kind of peg the dividend to be, or the new dividend to be comfortably funded at 40 WTI and I'll just call it $2 ACO. But I kind of see a third lead to that, which is the LPGs or butane and propane specifically. Are you pricing in what I see as you know, a structural improvement in those prices relative to WTI slash condensate. Just without getting too granular, I think it's important, so any color on that would be appreciated.

Thanks. Thanks, Alex. It's Chris here again, so I'll try to answer that one. You know, we're not changing any material assumptions on it. I mean, clearly propane is is experiencing quite a bit of strength right now. Butane is pricing very strong relative to WTI, but we're not forecasting any material change to those relationships. So really, it is about a stable relationship. You have seen us work hard over the last several years to make sure we do have some exposure to the spot consistency or spot market on the NGL streams, but we're not changing the assumption on the relationship of those values going forward. So we think as long as it stays relatively steady, that's the relationship we're counting on. I mean, it is a relatively small component of our revenue overall, but it is an important component.

Okay. Just maybe sort of another macro question with the potential for ethane cracking. or another ethane cracker in Alberta. Is there some capital projects that might be directed towards feeding a plant like that or not?

I think, you know, at the end of the day, we'll evaluate, you know, there's some vague wording in there, how we will evaluate all the opportunities ahead of us. And, you know, we do like to evaluate things before we commit to anything. So we will look and make sure, like, When we evaluate these things, it's about are we more profitable after the fact or before the fact, and what is the risk that we're absorbing in it? So, you know, I don't have a crisp answer for you. We will or won't do it, but what I will assure you is we will evaluate. We've got a lot of NGL stream that we have available, as well as natural gas that we can put into these types of projects. And fortunately, we have the scale where we do get, you know, approach to at least evaluate these opportunities, and we'll continue to do so.

Great. I'll leave it at that. Thanks very much for the color. Thank you.

Your next question comes from Michael Harvey from RBC Capital Markets. Please go ahead.

Yeah, sure. Good morning, everybody. So I just had a question about the use of free cash. So you kind of mentioned that it's unlikely to be used for M&A. I'm just wondering if you could provide us some details on that. Is it just pure efficiencies that are driving that, so yours are better than others? Are the assets just not available that would be complimentary? Is it pricing, or are you just kind of full up with 7G and your own stuff right now? Just any thoughts from the team and the board on kind of how you guys are thinking about that. Obviously, some mixed views from your peers on that point.

Yeah. Thanks, Michael. It's Terry here. The answer is yes to all of those. I guess when we're looking at the M&A opportunities, we're not looking for large, I guess significant M&A opportunities. We've done the best one that we've seen out there and now we are seeing the benefits of that and you see the extensive free cash flow that we're delivering and and the efficiency gains that we're seeing that we thought we could realize by ARC operating the way ARC operates it. It does not mean that there aren't opportunities smaller in scale that are more bolt-on opportunities that we are looking at. That's always something that we do day in and day out within our teams. But we have such a big resource, and I think it's in my opinion, some of the best resource out there. So that's why we are focused on optimizing our CAQA in particular asset. And it's a huge resource at 180,000 VOE a day of production. And so that's our first step is making sure that's as efficient as it possibly can be. And then we never ever say we're not looking at opportunities, but the bid-ask spread with stronger commodity prices is more challenging right now. And so we don't see the sweet opportunities that were there six to 12 months ago. And so that's more of how we look at it and our view on it. So we are fine with continuing to optimize, taking that free cash flow and giving the majority of that back to our shareholders and earn for the true value of our asset than it is going outside and looking at other opportunities.

Okay, operator, I'm not sure if there's any further questions on there.

Okay. Ladies and gentlemen, as a reminder, should you have a question, please press star followed by one. There are no further questions at this time. Please proceed.

Well, I'd like to thank everyone for joining us this morning. Really appreciate it and appreciate the support as investors. And if you have any further follow-up questions, please don't hesitate to reach out to the team here and we'll be happy to have a chat. Hope everyone has a great day.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.