Canadian Natural Resources' (NYSE:CNQ) second-quarter net loss of 339 million Canadian dollars ($261.84 million) wasn't entirely unexpected considering the slew of events that caused its oil and gas production to drop 7% from the first quarter. The Canadian wildfires, unexpected pipeline shutdowns, natural production declines, and oil prices that stubbornly remained under $50 per barrel created an extremely challenging environment. What seems particularly alarming is that a 38% drop in cash flow compared to one year ago was a primary contributor to the quarterly losses.
Since maintaining positive cash flow is critical to funding capital expenditures (capex) and paying off debt, it's reasonable to ask if Canadian Natural Resources has a sustainable long-term business plan. Fortunately, the company's cash flows should substantially improve in the long term. Here's why.
Short-term cash flow
Canadian Natural Resources actually increased its cash flow from operations when compared to the first quarter, increasing from CA$657 million to CA$938 million. This was largely a result of a 36% gain in the average price of a barrel of oil, as well as a nearly 19% increase in product sales. Both of the numbers are well off of the numbers from a year ago, though, as product sales decreased almost 27% and cash flows registered CA$1.5 billion.
The reason for the lower cash flows is twofold. First, the company has been experiencing decreased oil and gas netbacks, meaning lower margins between the price of a barrel of oil and the expenses of production. Second, as mentioned, product sales have been down significantly, largely because of decreases in overall production.
At issue with reduced cash flows is the ability to fund capex and pay off debts. The CA$938 million in cash flow from operations in the second quarter, for example, was not enough to cover the CA$1.16 billion in capital expenditures. When cash can't cover operations, a company often has to issue debt, which is exactly what Canadian Natural Resources recently did. Following its second-quarter earnings, the company announced it was issuing CA$1 billion in long-term notes to be used for general core business purposes. Positive cash flow alleviates that need and makes for a cleaner balance sheet.
Long-term cash flow
So the situation reads as extremely dire. Fortunately, it isn't nearly as dire as it appears.
Canadian Natural Resources has two key factors working in its favor. The first is its ability to reduce operating costs. The company managed to save CA$430 million in costs in the first half of 2016 compared to the first half of 2015. Per barrel, cost savings equate to 14% year over year. The company is confident that once oil prices rise, it will be able to maintain these cost reductions, mainly because it operates several projects with low capital exposure and can optimize its drilling programs.
Second, the company is about to tap into a major production opportunity as its Horizon oil sands phase 2 expansion project goes into full production in November. It is spending almost CA$2 billion in capex in 2016 on the expansion, which will add 45,000 barrels of oil equivalent per day (BOE/D) to the company's total production.
In 2017, capex on the third phase of the expansion will drop to CA$1 billion and will add an additional 80,000 BOE/D by the end of the year. In total, Canadian Natural Resources will add 125,000 BOE/D by the end of 2017, with operating costs per barrel expected to be lower than CA$25; capex on the project will drop to almost zero, and the company should have a considerable source of new long-term cash .
Foolish bottom line
Canadian Natural Resources has seen a fairly significant drop in its cash flows from operations, but these appear to be short-term issues. If oil prices rise, it would immediately help alleviate the situation. Regardless, with lower costs of operations and a large source of cash coming on line over the next year and half, the company should begin to turn around its fortunes.
David Lettis has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.