Good morning, ladies and gentlemen, and welcome to the ARC Resources Ltd. Q3 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 zero for the operator. This call is being recorded on Friday, November 5, 2021. I would like to turn the conference over to Dale Lewko. 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, Kris Bibby, Senior Vice President and Chief Financial Officer, Lara 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 SEDAR. 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, Dale, 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. Fifth, the 2022 budget announcement. Over the past 12-24 months, we have observed the complexity of the energy environment and the importance of having a reliable and safe source of energy supply. ARC 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 in 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 CAD 3.58 a BOE.
Considering our production is 40% liquids, 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 CAD 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 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 significant value from this effort.
We generated over half a billion dollars or CAD 0.69 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 CAD 0.10 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 complementary value creation tool. Since commencing in September, we have allocated over CAD 200 million of free cash flow to repurchase 20 million shares or approximately 3% of our stock.
Even with the conservative commodity price assumptions, we perceive the intrinsic value of our business to be much greater than the share price, and therefore will continue to utilize the NCIB 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 CAD 1.2 billion-CAD 1.3 billion, of which CAD 1.1 billion is to sustain production, and the balance will be invested in a 80 million cubic feet a day expansion at Sunrise, long lead items at Attachie, and emissions reduction project at Dawson. Our budget is expected to deliver average production of 335,000-350,000 BOE per day.
The Sunrise expansion is one of our highest return opportunities in our portfolio. Supply cost is well below CAD 1 per Mcf. Its emissions intensity is near zero, and it's an excellent supply source for LNG given its proximity to inlet of Coastal GasLink. 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 Attachie.
We plan to invest CAD 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 CAD 600 million, inclusive of the CAD 75 million earmarked for 2022. Once on production, we expect Attachie will generate CAD 250 million of free cash flow at mid-cycle pricing, or roughly CAD 350 million at strip. The 2022 budget and dividend can be funded with cash flow down to $30 a barrel WTI. With strip north of $70 today, there'll be meaningful return of capital component that Kris will talk about.
Before turning it over to Kris, I wanna stress that we 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 have 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 wanna 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 Kris 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. I do wanna 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 onto 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 price above CAD 4.50 per Mcf, or more than CAD 1 above the AECO 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 risks through hedging, but our business is now better positioned to absorb volatility given our balance sheet strength, diversified commodity mix, and our low cost structure. We were able to reduce debt by an additional CAD 158 million 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 CAD 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 optimize our debt structure to better align with our investment grade rating.
We repaid our legacy ARC private notes, senior notes and amended and extended our CAD 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 CAD 1 billion over the long term at our current size. However, the pace of debt reduction will slow in favor of allocating more free cash flow to shareholders. This is a great segue to capital allocation and how we intend to allocate our free cash flow in the future, which has been very topical among the investment community. Foundational to our strategy is a meaningful return of capital component as a part of the total return. To return capital sustainably, you need to reinvest profitably in the business. 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%-80% of our cash flow to shareholders, free 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 Montney. 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. 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 U.S. 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.
With that, I will turn it back to Terry for some closing remarks.
Thanks, Kris. 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 followed by the one 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 polling process, please press the star followed by the two. 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.
Oh, hey, guys. Good morning. Sort of a three-part question here on Attachie, so I'll fire them all out there 'cause 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 River First Nations and the BC government have the preliminary agreement in place, which allows for preexisting permits to move forward here, excluding 20. 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 Attachie, 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 the 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. 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 CAD 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.
Is there any seasonality involved with how you could get going in on the construction for the project?
Perfect, Patrick. Well, it's Terry here. Thanks for the question on Attachie. Let's start with the permitting side, and it is about prudence. If I give a little background, as we've been spending a lot of time talking to First Nations, B.C. government, B.C. Oil and Gas Commission, and everybody is trying to come to the same agreement in that we want to progress activities. It's just about how do we do it in a responsible manner. I have confidence where this is going, and that's why you see us the CAD 75 million in long lead time items. We wanna have a 100% guarantee that we know the regulatory framework going forward.
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. You're right, we do have most of the permits for building the facilities and the pipelines. 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 CAD 600 million. That's, but I have confidence where we're, 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. 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 Attachie. We have everything in place. Our plans are in place with ordering of equipment already happening. We're set up to get going as quick as possible as soon as we get that ruling figured out from the B.C. government in the Blueberry. 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.
Maybe I'll turn it over to Armin more on the cost and the risk on inflation on the CAD 600 million, but I think what we're seeing from the efficiency gains that we are seeing in CapEx, some of those relate back to Attachie too. I think also ordering some of our equipment ahead of time is helping mitigate some of those inflationary pressures. Armin, maybe you have more flavor on that side.
Yes. Thanks, Terry. In terms of the time-sensitive items that you talked about, Patrick, I think the CAD 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. That gives us flexibility in order to be able to advance when the time is right.
Cost pressures, I guess, specifically to Attachie, 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%-7% impact on our overall capital expenditure. 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. Attachie 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 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 wanna stay on Attachie 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 then what does that critical path look like for you guys to start to commit incremental capital to Attachie? 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 2023?
Like, do you expect that on-stream for 2023 changes, even though there potentially is some upfront delays on Attachie?
Hey, thanks, Travis, for the questions. It's Terry here again. 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. That's the biggest thing that they are talking about. There's other finer details, but that's the biggest concern. 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. From that perspective, that's what we're looking for is that clarity. That's what this is really all about is the clarity on the permitting authorizations.
That is basically the critical path to everything that we are doing for Attachie. Everything else is ready to go. We were ready to sanction Attachie. Well, 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. Armin's ready to pull the trigger on this thing tomorrow. But if it is delayed further into 2022, yes, that will impact the 2023 start time. Whenever we start, Armin needs at least 18 months to complete the facilities and drill the wells to have everything on stream. 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 Kris 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?" Then we'll update the market accordingly.
Okay. That's great color on both those. Thanks so much, Chris.
Thanks.
Your next question comes from Jeremy McCrea from Raymond James. Please go ahead.
Yeah. 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? If you could also provide a little bit more context in terms of the breakdown between the distribution between, you know, buybacks versus potentially special dividend, variable dividends in terms of the 50%-80% payout to your shareholders.
Jeremy, Terry here. I'll take the first one and then throw the second one to Kris. On the LNG deal, we can't give much more detail on it, but we can say that it's advantageous to North American-based pricing is what we got. From that perspective, we're net positive on this. It's a strategic deal. It's about building long-term relationships. To your point then, yes, we do believe there's other opportunities out there. I think, 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 GasLink, and it's the reliability of ARC's operations that people are looking for to partner with. When you
Our investment grade, we have enough size for us and the resource. When you add all those up, we're a good partner for long-term LNG agreements like this.
I guess that's about all I can add some flavor to that. Maybe Kris, you wanna touch on the second question.
You bet. In terms of, you know, buybacks versus dividends, obviously I touched on it in opening, but you know, we do wanna lean on our base dividend as the primary long-term mechanism, but it'll be supplemented by the share buybacks just to make sure that we do get into that range of that 50%-80%. I mean, the market's giving us an opportunity, or we view as an opportunity with the discounted valuation we see in the market currently. 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, I think, the remaining 8 months that we have left on it.
It's gonna be a portfolio approach where it's got a little bit of everything, and that's where we're gonna start, and we'll keep moving forward with that as we see throughout the year.
Okay. Perfect. Thanks, guys.
Your next question comes from Aaron Bilkoski from TD Securities. Please go ahead.
Good morning, guys. Just to follow up on Jeremy's question. If we assume the regulatory answer in BC is settled and more capital spent at Attachie 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%-50% of the free cash flow that's allocated to the balance sheet?
Yeah, good question, Aaron. It's Kris here, obviously. You know, when we were designing the framework for our capital allocation, we were certainly mindful of where we were in this process. It's the latter approach that we know that we have the flexibility with that remaining 20%-50% that will allow us to continue on the buybacks, continue it 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. It's the latter of those two, Aaron.
Perfect. Thanks, Kris.
Thanks.
Your next question comes from Elias Foscolos from iA Capital Markets. Please go ahead.
Thanks very much for taking my call. I wanna focus a bit on the new dividend and the sustainability. You kind of pegged the dividend to be, or the new dividend to be comparably funded at $40 WTI, and I'll just call it $2 AECO. But I kind of see a third leg 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/condensate? Just without getting too granular, I think it's important. Any color on that would be appreciated.
Thanks. Thanks, Elias. It's Kris 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 experienced 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. Really, it is about a stable relationship. You have seen us, you know, work hard over the last several years to make sure we do have some exposure to the spot market on the NGL streams, but we're not changing the assumption on the relationship of those values going forward. We think as long as it stays relatively steady, it is. 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. You know, we do like to evaluate things before we commit to anything. 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. 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.
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. Just had a question about the use of free cash. You kinda mentioned that it's unlikely to be used for M&A. Just wondering if you could provide us some details on that. Is this pure efficiencies that are driving that, so yours are better than others? Are the assets just not available that would be complementary? Is it pricing or are you just kind of full up with Seven Generations and your own stuff right now? Just any thoughts from the team and the board on kinda 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. Like, 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. You see the extensive free cash flow that we're delivering 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.
We have such a big resource and, I think, it's in my opinion, some of the best resource out there. That's why we are focused on optimizing our Kakwa in particular asset. It's a huge resource at 180,000 BOE a day of production. That's our first step is making sure that's as efficient as it possibly can be. We never ever say we're not looking at opportunities, but the bid ask spread with a stronger commodity prices is more challenging right now. We don't see the sweet opportunities that were there 6-12 months ago. Probably that's more of how we look at it and our view on it.
We are fine with continuing to optimize, taking that free cash flow and giving the majority of that back to our shareholders in return for the true value of our asset rather than 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. 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.