New Horizon For Canadian Natural Resources

By bringing its Horizon oilsands project in Alberta into production in February, Canadian Natural Resources (CNQ-T, CNQ-N) thrust itself into the middle of the conversation on how best to play the oilsands.

Once it reaches peak production later this year, Horizon — at current capacity — will turn out 110,000 barrels of oil per day. And while such an amount is attractive to investors in and of itself, the upside of the project is even more fetching.

“The size of Horizon is impressive,” explains Philip Skolnick, an analyst with Genuity Capital Markets. “There are a lot of other phases planned that can take production up to over 500,000 barrels a day.”

And while the production story was also foremost on the mind of Canadian Natural’s president and chief operating officer, Steve Laut, during a recent conference call, the context was slightly different.

Laut said the key to Canadian Natural’s story is its ability to run costs down in what has been a high-cost environment in the oilsands. It has been able to do so, he says, via increased production and technical innovation.

The combination of the two helped the company bring its oil exploration and production costs back down to 2005 levels, despite the price of steel rising by 45%.

Such savings — when combined with better spreads on the sale of its heavy-grade crude compared to light oil, and a good hedge book, brought the company’s first-quarter financials in above expectations on the cash flow side.

Cash flow came in at a strong $1.5 billion, or $2.80 a share, beating the consensus target of $2.33, but down 12% from $1.7 billion last year.

That cash puts the company in a good position to pay down its $2.35- billion line of credit due in October. It paid down $705 million in the last quarter.

But while the market seemed content to focus on strong cash flows, the first quarter did see a 58% cut to profits compared with the same period last year, and earnings of $305 million, or 56¢ a share, were down from $727 million in 2008’s first quarter.

Those tough numbers were no surprise given the fall in oil and gas prices over the period, but while Laut feels the company’s oil business in now in good shape, work still needs to be done on the gas side.

With technological advancements unleashing the vast amounts of shale gas deposits in North America, producers like Canadian Natural have had to watch in pain as the price of natural gas plummeted to around US$3-4 per million BTUs.

To try and compensate for such losses, Canadian Natural — which is the country’s second-largest producer of the commodity behind EnCana (ECA-T, ECA-N) — announced drastic cuts to natural gas development.

While it drilled 70 wells in the first quarter of this year, it plans to drill just 70 more for the rest of the year. Last year, the company drilled 280 natural gas wells — a number that itself was well off from the 900 drilled in 2005.

Laut says well drilling would only increase if gas prices stabilize in the range of US$6-8 per million BTUs. That’s something he doesn’t see happening until 2010 at the earliest.

Overall, however, the cutbacks in natural gas production aren’t expected to do much damage to the company’s bottom line.

That’s because although Canadian Natural is a big gas producer, the company is an even bigger oil producer.

Oil production for the first quarter averaged 330,017 barrels a day, while gas production was 1.37 billion cubic feet a day.

And while it has oil projects in West Africa and the North Sea, it is Horizon, located 70 km north of Fort McMurray, that is drawing the most attention now.

The project was built at the height of the oilsands boom for a total cost of $9.7 billion — 45% higher than planned. Those higher costs have given the company pause with regards to the third and fourth phases of the project, but the second phase, Laut says, will go on.

And while the downturn in oil prices has eased some of the pressures that led to such cost overruns, they could easily return with higher prices.

In anticipation of such an event, Laut called for better organization and co-ordination amongst oilsands players to avoid direct competition for the same services at the same time — a situation that drives up prices by increasing demand.

As for the company’s own culpability in not keeping costs down the first time, Genuity’s Skolnick says it wasn’t alone.

“Its execution, like anyone else in the industry, wasn’t great,” Skolnick says. “It wasn’t specific to CNQ. The project, like any other, was impacted by cost overruns, but they’re still one of the lowest-cost operators overall from a company-wide perspective.”

Genuity has Canadian Natural listed as a buy with a target of $64.

Of 21 analysts polled by Thomson One Analytics, three have the company listed as a strong buy, 11 with a buy, and seven with a hold.

The company was an active participant in the latest market upswing, as its shares were trading in the low $30-range as recently as early March, but closed as high as $63.44 on May 8.

In Toronto at presstime, Canadian Natural Resources shares traded at $57.94 in a 52-week range of $34.19- 111.30. The company has 542 million shares outstanding.