MEG Energy reports record production, record low net operating costs per barrel, and strong funds flow from operations in third quarter of 2018

All financial figures in Canadian dollars ($ or C$) unless otherwise noted

CALGARY, Nov 1, 2018 /CNW/ – MEG Energy Corp. (TSX:MEG) today reported third quarter 2018 operating and financial results. Highlights include:

• Record quarterly bitumen production volumes of 98,751 barrels per day (bpd) and low steam-oil-ratio (SOR) of 2.2. Annual production is well on-track to achieve 2018 guidance of 87,000 to 90,000 bpd;
• Record low per barrel net operating costs of $4.34, including low non-energy operating costs of $4.38 per barrel;
• Strong adjusted funds flow from operations of $116 million or $0.39 per share, including $88 million of realized net hedging losses. Adjusted funds flow from operations excluding realized net hedging losses totalled $0.68 per share;
• Total cash capital investment of $145 million in the quarter, primarily directed to advance the Phase 2BBrownfield expansion and eMVAPEX pilot;
• Cash and cash equivalents of $373 million; MEG’s covenant-lite US$1.4 billion facility remains undrawn;
• Subsequent to the quarter, MEG executed a binding agreement to access 30,000 bpd of unit train rail loading capacity at the Bruderheim terminal, operated by Cenovus. The term of this agreement is for three years, with a one-year extension at MEG’s option; and
• On October 17, 2018, MEG announced that its Board of Directors (the “MEG Board”) unanimously rejected Husky Energy’s unsolicited bid to acquire the Company and recommended MEG shareholders NOT tender their shares.

“The MEG of today is more robust on every measure. We are entering an exciting period of greater financial strength and flexibility, as the Company reaches a critical inflection point transforming from a net consumer of cash to a generator of significant cash flow, well in excess of future capital investment requirements. Through our world-class asset base and industry-leading technology, the Board and Management remain committed to maximizing value for our shareholders,” says Derek Evans, President and Chief Executive Officer.

“The record high production and record low net operating costs per barrel in the third quarter reflects the successful application of MEG’s proprietary eMSAGP technology on existing wells at Christina Lake Phase 2B. The spending on this phase of the roll-out was substantially completed during the quarter, with lower than expected total costs of $320 million or $16,000 per flowing barrel,” Evans continued. “Our innovative approach to maximizing the value of our steam and achieving among the best-in-class SORs through the application of eMSAGP and eMVAPEX supports our highly efficient capital re-investment, industry-leading cost structure, and enhanced environmental performance. MEG has a pipeline of execution-ready brownfield projects with the potential to double production in the next 10 years.”

Third quarter bitumen production averaged a record 98,751 bpd, a 19% increase relative to the same period in 2017. This strong production growth was achieved as new wells were brought on-stream as part of the Phase 2B eMSAGP implementation. Trending lower for the eighth consecutive quarter, net operating costs per barrel were 28% lower than the third quarter of 2017. The low per barrel net operating costs were supported by higher production volumes, low natural gas prices and strong power revenues.

Pricing and Market Access

MEG achieved strong blend sales realizations of $63.67 per barrel in the third quarter of 2018, 33% higher than the third quarter of 2017. The higher blend sales realization was the result of stronger benchmark crude oil prices, partially offset by wider WTI:WCS differentials in the period. MEG’s bitumen realization averaged $49.58 per barrel, 24% higher than the third quarter of 2017.

“MEG’s diversified marketing strategy allowed the Company to deliver 31% of blend sales into the premium U.S. Gulf Coast market during the third quarter, where the barrels received a pricing uplift of approximately $15 per barrel (net of transportation), relative to sales in the Edmonton market. As a result of this strategy, lower-priced post-apportionment blend sales have been limited to 13% of volumes during the third quarter,” said Evans.

During the third quarter MEG doubled rail volumes to 7,800 bpd, with plans to rail approximately 15,000 bpd in the fourth quarter and up to 30,000 bpd by the end of the first quarter of 2019. Subsequent to the quarter, MEG executed a binding agreement at competitive market rates to access 30,000 bpd of unit train rail loading capacity at the Bruderheim terminal, operated by Cenovus. The term of this agreement is for three years, with a one-year extension at MEG’s option. As a mechanism to clear barrels during periods of high pipeline apportionment and reduce exposure to the post-apportionment market, the use of rail enables MEG to maximize the price received on its barrels until additional egress capacity from Western Canada is secured. MEG’s strategic network of North American storage facilities was also used during the third quarter to mitigate differential and apportionment exposure as MEG put barrels into storage.

Transportation costs per barrel for the third quarter of 2018 were 29% higher than the third quarter of 2017. The higher transportation costs reflect the sale of the Company’s 50% share in the Access Pipeline and 100% of Stonefell Terminal, as well as higher per barrel costs associated with the increased use of rail.

“Although differentials are expected to remain challenging in the fourth quarter, we anticipate them to moderate in 2019 as Canadian rail export volumes increase significantly and PADD II refineries come back on line after what has been the largest heavy oil planned turnaround season in the last five years,” added Evans. “In addition, to partially mitigate the financial impact of wider forecasted differentials, MEG plans to reduce its fourth quarter production by 4,000 to 6,000 bpd through advancing a portion of our 2019 scheduled maintenance program into November. Further, we can vary the pace of ramp-up subsequent to the turnaround depending on market conditions. We do not currently anticipate any impact to our previously announced 2018 annual guidance.”

Capital Investment

Total cash capital investment in the quarter was $145 million. The largest area of spending was on the Phase 2B Brownfield expansion, with construction proceeding on-schedule and on-budget. Completion and ramp-up of the project is anticipated in the second half of 2019, bringing total expected production to 113,000 bpd by the end of 2019. Spending on the current application of eMSAGP on Phase 2B was substantially completed in the quarter. Additionally, the Company invested $14 million on the eMVAPEX pilot, including spending on the propane recycling unit, which is expected to be fully operational in the fourth quarter of this year.

Adjusted Funds Flow and Operating Loss

Adjusted funds flow from operations were $116 million in the third quarter of 2018, compared to $83 million in the third quarter of 2017. The 40% increase reflects stronger benchmark crude oil prices and higher sales volumes, partially offset by realized net losses on commodity risk management contracts totaling approximately $88 million. With current cash reserves, higher commodity prices and lower anticipated levels of capital spending in 2019, MEG expects to hedge a substantially lower percentage of barrels in 2019.

The Company recognized an operating loss of $19 million in the third quarter of 2018, compared to an operating loss of $43 million for the same period of 2017. The decrease in the operating loss is primarily the result of higher bitumen realizations, partially offset by realized losses on commodity risk management contracts.

Operational and Financial Highlights

Take-Over Offer from Husky

On October 2, 2018, Husky Energy Inc. (“Husky”) made a formal offer to acquire all of the issued and outstanding common shares of MEG, at the election of each MEG shareholder, for (i) ‎$11.00 in cash or (ii) 0.485 of a common share (“Husky Share”) of Husky for each MEG common share, subject to a maximum aggregate cash consideration of $1 billion and a maximum aggregate number of Husky Shares of approximately 107 million (the “Husky Offer”). The Husky Offer must remain open until January 16, 2019unless otherwise extended, accelerated or withdrawn in accordance with its terms. Based upon the closing price of the Husky Shares on the TSX on October 31, 2018, the current value of the Husky Offer is approximately $9.61 per MEG common share as implied by the exchange ratio.

Upon receipt of the Husky Offer, the MEG Board, operating through a Special Committee, engaged with financial and legal advisors to diligently review the Husky Offer. The MEG Board, on the recommendation of the Special Committee, has unanimously concluded that the Husky Offer significantly undervalues the Company and is not in the best interests of MEG or its shareholders. The MEG Board unanimously recommends that MEG shareholders reject the Husky Offer and not tender their common shares to the Husky Offer. No action is required to reject the Husky Offer.

The Directors’ Circular, filed on October 17, 2018 by the Board, provides information for MEG shareholders about the Company’s prospects and the MEG Board’s analysis, deliberations and recommendations. The Directors’ Circular is available at www.megenergy.com/RejectHusky and at www.sedar.com. Additional information can be found in the Investor Presentation, which is also available at www.megenergy.com/RejectHusky.

In its Directors’ Circular, the Board describes the reasons for its recommendations. Among other things, the Board notes:

• MEG’s stand-alone plan is worth substantially more than the value proposed to be delivered by Husky in the Husky Offer.
• The timing of the Husky Offer is opportunistic and was timed to deny MEG Shareholders the opportunity to fully evaluate the plans, and experience the value creation of MEG’s new CEO, Mr. Evans.
• In addition to being financially inadequate, the form of consideration offered in the Husky Offer is disadvantageous to MEG Shareholders.
• As the Husky Offer is presently structured, Husky’s existing owners are receiving the lion’s share of the benefits of the combination, many of which Husky has not even acknowledged.

The Special Committee has given its financial advisor, BMO Capital Markets, a mandate to investigate alternative transactions to the Husky Offer. A data room containing confidential information about MEG has been created to help interested parties establish the true value of the Company. MEG will not be providing additional information to the market on the status of the strategic alternatives process until MEG has material developments to disclose.

ADVISORY

Basis of Presentation

MEG prepares its financial statements in accordance with International Financial Reporting Standards (“IFRS”) and presents financial results in Canadian dollars ($ or C$), which is the Company’s functional currency.

Non-GAAP Measures

Certain financial measures in this news release including: net marketing activity, funds flow from (used in) operations, adjusted funds flow from (used in) operations, operating earnings (loss), operating cash flow, cash flow and total debt are non-GAAP measures. These terms are not defined by IFRS and, therefore, may not be comparable to similar measures provided by other companies. These non-GAAP financial measures should not be considered in isolation or as an alternative for measures of performance prepared in accordance with IFRS.

Funds Flow From (Used in) Operations and Adjusted Funds Flow From (Used in) Operations

Funds flow from (used in) operations and adjusted funds flow from (used in) operations are presented to assist management and investors in analyzing performance and liquidity. Funds flow from (used in) operations excludes the net change in non-cash operating working capital while the IFRS measurement “net cash provided by (used in) operating activities” includes these items. Adjusted funds flow from (used in) operations excludes the net change in non-cash operating working capital, realized gain on foreign exchange derivatives not considered part of ordinary continuing operating results, payments on onerous contracts and decommissioning expenditures, while the IFRS measurement “net cash provided by (used in) operating activities” includes these items. Funds flow from (used in) operations and adjusted funds flow from (used in) operations are not intended to represent net cash provided by (used in) operating activities calculated in accordance with IFRS. Funds flow from (used in) operations and adjusted funds flow from (used in) operations are reconciled to net cash provided by (used in) operating activities in the table below.

In this press release, cash flow refers to funds flow from (used in) operations as defined above.

Operating Earnings (Loss)

Operating earnings (loss) is a non-GAAP measure which the Company uses as a performance measure to provide comparability of financial performance between periods by excluding non-operating items. Operating earnings (loss) is defined as net earnings (loss) as reported, excluding unrealized foreign exchange gains and losses, unrealized gains and losses on derivative financial instruments, unrealized gains and losses on commodity risk management, realized gains and losses on foreign exchange derivatives not considered part of ordinary continuing operating results, gain on asset dispositions, contract cancellation expense, onerous contracts expense, insurance proceeds and the respective deferred tax impact on these adjustments. Operating earnings (loss) is reconciled to “Net earnings (loss)”, the nearest IFRS measure in the table below.