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Morningstar | The Heavy Oil Discount Weighs on Canadian Natural Resources

No-moat Canadian Natural Resources’ fourth-quarter upstream operations seemed to be hit harder by the widening of the heavy oil discount than peers. On average, heavy oil discount realizations fell 85% from the third quarter despite only a 40% decline in average Western Canadian Select pricing. Price realizations for the quarter were lower than we expected, but there is room for optimism. Thus far, the first-quarter heavy oil discount has averaged $11 per barrel, down significantly from the fourth-quarter average of $34/bbl.

Canadian Natural reported fourth-quarter production of 1.08 million barrels of oil equivalent per day, which was more or less in line with our expectations. Production was up 2% from third-quarter levels and 6% from the year-ago quarter, driven by the completion of the Horizon Phase 3 expansion. Looking to 2019, the company expects first-quarter production in the range of 1.00-1.07 mmboe/d and full-year production in the range of 1.030–1.12 mmboe/d, both of which are in line with our expectations.

The company continues to make progress on its oil sands expansion projects. First oil at the 32 mbbl/d Primrose project is expected by the end of the year. The 40 mbbl/d Kirby North project remains on track to produce first oil during the third quarter, but Canadian Natural has flexibility to delay production if market conditions warrant. Outside of these projects, future growth looks uncertain for Canada’s largest producer.

We intend to incorporate Canadian Natural's fourth-quarter results into our model shortly, but for now, we are maintaining our $34 (CAD 45) fair value estimate and no-moat rating.

The company continues to return capital to its shareholders and announced a first-quarter dividend of CAD 0.375 per share, which represents a 4.2% annual yield. Canadian Natural also repurchased almost 11 million of the company’s shares for CAD 409 million in proceeds. As a reminder, with limited growth opportunities, Canadian Natural’s board announced a policy to continue to buy back shares and reduce debt. On an annual basis, Canadian Natural will allocate 50% of its residual free cash flow, which is free cash flow after budgeted capital expenditures and dividends, to share repurchases and the remaining 50% to reducing debt. The company intends to reduce its leverage to 1.5 times trailing EBITDA and absolute debt to CAD 15 billion.

For a detailed look into Canadian crude market and pipeline trends, please refer to our January Energy Observer, "Pipelines Are Canada’s Lifelines.”