Cenovus Energy - Q3 2023

Transcript

Operator (participant)

Good day, ladies and gentlemen, and thank you for standing by. Welcome to Cenovus Energy's third quarter results. As a reminder, today's call is being recorded. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. You can join the queue at any time by pressing star one. Members of the investment community will have the opportunity to ask questions first. At the conclusion of that session, members of the media may then ask questions. Please be advised that this conference call may not be recorded or rebroadcast without the express consent of Cenovus Energy. I would now like to turn the conference call over to Mr. Jason Abbate, Senior Vice President, Investor Relations. Please go ahead, Mr. Abbate.

Jason Abbate (SVP of Investor Relations)

Thank you, operator, and welcome everyone to Cenovus's 2023 third quarter results conference call. Please refer to the risk advisories located at the end of today's news release. These describe the forward-looking information, non-GAAP measures, and oil and gas terms referred to today. They also outline the risk factors and assumptions relevant to this discussion. Additional information is available in Cenovus's annual MD&A and our most recent AIF and Form 40-F. All figures are presented in Canadian dollars and before royalties, unless otherwise stated. We have also posted our results on our website at cenovus.com. Jon McKenzie, our President and Chief Executive Officer, will provide brief comments, and then we'll take your questions. We ask that you hold off on any detailed modeling questions. You can follow up with those directly with our investor relations team after the call.

Please also keep to one question with a maximum of one follow-up. You're welcome to rejoin the queue for any other follow-up questions you may have. Jon, please go ahead.

Jon McKenzie (President and CEO)

Great. And thank you, Jason, and good morning, everybody. I'll start this call with our top priority, which is always health and safety. At our offshore China operations, Liwan 3-1, recently achieved a significant milestone of producing 1 trillion standard cubic feet of natural gas sales with no serious incidents or safety events. This is truly an impressive record of safety. And the comprehensive pre-startup safety reviews conducted at our Toledo and Superior refineries resulted in strong process safety performance throughout the restart of these assets. These achievements underscore the importance of our values and safety commitments in the work that we do every day. And I'm proud of our staff for the hard work and effort that they put into achieving these milestones.

Now, we forecasted earlier this year that we would see strength of our operations and the value of our integrated strategy in the back half of the year. Our third quarter results are a demonstration of that, with both upstream and downstream businesses delivering strong operational and financial results. Our upstream business saw an increase of production to nearly 800,000 BOE per day in the third quarter, and combined with higher commodity prices, we generated an operating margin of about CAD 3.4 billion. In the conventional business, production volumes were impacted by wildfire activity in Q2, but returned to normal rates in the third quarter. Our production increased to over 127,000 barrels per day versus the second quarter number of 105,000 BOE per day.

So I'd again like to thank our staff and contractors that played an integral role in our ability to resume or safely resume our operations following the unprecedented wildfire events. In our oil sands, our oil sands assets continue to perform exceptionally well following the execution of redevelopment programs and the startup of new well pads, both of which support short- and long-term production growth. Production increased over 600,000 barrels per day versus the second quarter number of 305,000 barrels per day. At our Sunrise oil sands production, third quarter production rose 17% to about 55,000 barrels per day. The asset continues to perform well as we apply Cenovus operating processes, including the implementation of redevelopment wells, adjusting well designs and operating parameters.

Now, I expect the oil sands assets to continue their positive performance through the remainder of 2023 and beyond. We'll remain focused on operational reliability and the safe and efficient execution of our growth capital and optimization projects, with the Narrows Lake tieback, Foster Creek steam addition, and new well pads at Sunrise being a few key examples that support short to medium-term growth plans. In our offshore segment, our Asia Pacific assets performed extremely well. The company achieved first gas from the MAC field in Indonesia in September. In the Atlantic, the Terra Nova FPSO has now returned to offshore Newfoundland and is expected to produce first oil in the fourth quarter, while our West White Rose project is also progressing as planned, with approximately 75% of the work completed to date.

We'll continue to advance the work for the regulatory dry dock of the SeaRose FPSO that will commence in January in preparation for the startup of the West White Rose project. Now turning to the downstream business, the third quarter results generated much healthier operating margins from the refining and upgrading assets in our portfolio. Overall, our downstream business continued contributed over CAD 900 million in operating margin with favorable crack spreads and FIFO tailwinds. Following a challenging first half of the year, the U.S. manufacturing segment, we delivered on our expectations of getting the last of the refining assets online and running reliably. Following the purchase and startup of Toledo and the commissioning and startup of Superior, crude utilization increased significantly from 70% in the prior quarter to 88% in this quarter.

This is largely due to Toledo having performed well at 90% utilization through the quarter. You also would have seen a sizable reduction in the unit operating costs in our U.S. manufacturing segment, with the majority of our refining assets running at or near full rates in the third quarter, and a reduction in the overall operating costs associated with the startup of Toledo and Superior. At the Superior Refinery, we achieved the safe startup of the fluid cat cracker in early October. While the startup of this unit was delayed, you know, the business unit completed this complex work without compromising the safety of our staff and assets. You will know that the Borger Refinery is now undergoing planned maintenance, which will impact Q4 throughput. We were really pleased with the Canadian manufacturing segment.

Crude utilization was 98% in the quarter, with the Lloydminster Upgrader and Refinery demonstrating strong and stable performance and the ability to capture margins as heavy oil differentials widen. With the seasonally weaker crack spreads and the recent weakness in gasoline cracks, we're focused on optimizing our assets to maximize the economic result. We will continue to build on solid operational execution and reliability we've demonstrated this quarter going through year-end. I'd now like to highlight our corporate and financial performance. In the third quarter, Cenovus delivered approximately CAD 3.4 billion of adjusted funds flow, with both upstream and downstream businesses demonstrating strong performance and contributions to operating margin. Through our base dividend share buybacks and partial payment of common share warrant obligation, we distributed over CAD 1.2 billion directly to shareholders.

In addition, the company's net debt was approximately CAD 6 billion at the end of the third quarter. Long-term debt decreased to CAD 7.2 billion after we purchased CAD 1 billion of notes that were due between 2029 and 2047. We did see an increase in our working capitals compared to Q2, although this was driven by largely higher commodity prices. Looking forward, we remain focused on achieving our CAD 4 billion net debt target and delivering 100% of excess free funds flow to shareholders at that time. So in closing, we believe we've delivered a stronger third quarter in line with our expectations. We're focused on furthering the operational successes that we've achieved in the quarter and continuing to progress both short- and long-term goals of the company. And with that, we're happy to take your questions.

Operator (participant)

Thank you. Ladies and gentlemen, as a reminder, you can join the queue to ask a question by pressing star one. We will now begin the question and answer session and go to the first caller. Your first question is from Dennis Fong from CIBC. Please ask your question.

Dennis Fong (Equity Research Analyst)

Hi, good morning, and thank you for taking my questions. My first one is just around the, I guess, the paydown of the warrant obligation. So, in the quarter, as you highlighted, you did about CAD 600 million. When you think about what's remaining for that, that obligation, as well as your cash returns back going into the fourth quarter, how should we be thinking about, I guess, share buyback cadence, as well as any other considerations you're taking into going into the end of the year around the buyback? Thanks.

Jon McKenzie (President and CEO)

Yeah, I'll turn that question over to Kam to answer. You remember, we did those warrant buybacks, I think, around $22, and we did take the opportunity in the quarter to pay down about CAD 600 million of that. I think there's about CAD 111 million left that we need to pay. I think the deadline is early January. Maybe, Kam, you could talk a little bit about our thinking around share buybacks.

Kam Sandhar (EVP and CFO)

Thanks, Jon. Hey, Dennis. So, you know, I think, you know, a couple of things I would highlight. First off, you know, Jon alluded to this, but the, the price at which we had transacted on those warrants at obviously a lot lower than where our share price is today. So, you know, we made a very conscious decision to proactively pay that warrant obligation down in Q3, relative to continuing to buy back stock. So I'd say the, the principles around that aren't going to change. You know, we'll continue to look at probably paying down that warrant liability in the fourth quarter. I think given where, you know, even our share price sits today, I think it's not a, not an unreasonable assumption to assume that we would pay the rest of that obligation in Q4.

And then when you think about the rest of the buyback program and, you know, potential for variables, the approach for us has not changed. You know, we're going to continue to test intrinsic value of the share price at a sort of flat $60 WTI price. If we continue to see opportunity in buying back stock, you should see us active in the market. And, you know, the goal is always to fulfill that 50% of excess free funds flow in any particular quarter, either through buybacks or through variable dividends. But, you know, we've been continuing to buy back stock through Q3. You're continuing to see us active in Q4, and I think part of that will also include payment of that warrant obligation.

Dennis Fong (Equity Research Analyst)

Great. I appreciate that color, Kam and Jon. My second question here, or I guess follow-up, is shifting gears a little bit more to the operations side. Appreciate the color that you provided, Jon, on the flexibility of your downstream operations. I just wanted to ask a quick question about Superior and the FCC unit. As I recall, that FCC unit is generally used to help finish gasoline, and that through the third quarter, you were building some intermediate product. How should we be thinking about the opportunity set or how you're going to manage that inventory? Again, just given where gasoline cracks happen to sit at and your ability to maintain flexibility within that particular refinery. Thanks.

Jon McKenzie (President and CEO)

Yeah. I'll let Keith give you a fuller picture on that. But you're exactly right, the FCC unit is a big gasoline-producing asset. You know, and one of the things we always look at is the forward markets and our ability, you know, to move the sales of the gasoline into higher netback periods. And so we're always watching sort of the winter/summer spreads and looking at that with an eye on containment as well. But maybe, Keith, you got some additional thoughts on how we're managing gasoline at Superior in particular.

Keith Chiasson (EVP and COO)

Yeah. Thanks, Dennis. You know, obviously, Superior being the first stop on kind of the mainline system, and the current rate of differentials, you know, it does provide a significant crude advantage and something different than we had online at the end of 2022. So pretty excited to have this asset up and running and fully operational. So we will continue to look at the economics, and obviously, we will make economic decisions on when we run that inventory off. But in today's environment, we're still seeing relatively robust returns to do that.

I think the other thing I'd offer up, Dennis, is we have a, now that we have the integrated network up and running and, and the other assets up and running, we've been moving some of that intermediate inventory to other assets to, to run off those products and, and make finished product, and we've been doing that for, for a period of time. So it's, it's not just that we have to run it through the, the existing asset.

Dennis Fong (Equity Research Analyst)

Great. Appreciate the color. I'll turn it back. Thanks.

Jon McKenzie (President and CEO)

Great. Thanks, Dennis.

Operator (participant)

Thank you. Your next question is from Neil Mehta from Goldman Sachs. Please ask your question.

Neil Mehta (Managing Director and Head of North American Natural Resources Equity Research)

Yeah, good morning, team, and appreciate all the color this morning. Just some early thoughts on, on 2024 capital would be great. I think, you guys do have some interesting growth projects in flight, and so can you help us think about framing, framing this out, recognizing we're going to get a little more clarity out this year, over the next couple of months?

Jon McKenzie (President and CEO)

Yeah, thanks, Neil, and you're exactly right. We are going to come out with a more formal budget release in December. But, you know, what we've been really trying to communicate to the market is that, you know, our capital spending over the next number of years is going to be between CAD 4.5 billion and CAD 5 billion range. So very similar to what you saw in 2023. In 2023, we made a conscious decision to put some capital to work on some growth projects that we have in the portfolio. These are very high return, very efficient projects that we started funding in 2023, and we'll continue to fund through next year and really through the planning period that we're looking at.

Don't think that the capital budget is going to look much different than what you've seen this year in the CAD 4.5 billion-CAD 5 billion range.

Neil Mehta (Managing Director and Head of North American Natural Resources Equity Research)

That, that's helpful. And then to build off that, can you talk about what some of those key growth projects are in 2024? And, you know, that maybe that higher spend than maybe some were expecting a couple of years ago, some of it's because of differentiated projects, not just because of higher sustaining capital levels. So providing a little more color-

Jon McKenzie (President and CEO)

Yeah.

Neil Mehta (Managing Director and Head of North American Natural Resources Equity Research)

on what those are could be helpful.

Jon McKenzie (President and CEO)

Sure. And again, we've been hopefully clear on differentiating, you know, what we consider to be sustaining capital, and that's the capital to keep production flat and our fixed assets in a safe and stable condition from the growth capital. But again, these projects, you know, we started funding them in 2023, and we'll continue through 2024, 2025 and 2026. But maybe, Keith, you might want to talk about, you know, the big four projects that we've got going on in particular.

Keith Chiasson (EVP and COO)

Yeah, sure, Jon. And thanks, thanks for the question, Neil. You know, I just want to anchor first on, you know, the fact that we looked at investments in these growth projects at the bottom of the cycle, and they all obviously clear the bar and are relatively low capital to get the growth that we're going to be talking about. And we—as Jon indicated, we've kind of kicked these off through the 2023 period, and they'll continue through 2024. But, you know, we're pretty excited about, you know, the Foster Creek, the Christina Lake Sunrise and West White Rose projects, all contributing about, north of 100,000 barrels a day of growth. So, you know, at Foster Creek, we're doing a steam expansion.

We'll be able to kind of wrap that up in the 2025 time period and start ramping up steam and production. That will add about 30,000 barrels a day of production in the 2026-2027 time period. Christina Lake, we've been talking about this one for a little bit, but really it's building a pipeline up into the Narrows resource and bringing that back and processing it at Christina Lake, which is a much different, you know, concept than we had, you know, probably five, six years ago, and a way to access this resource at a much lower capital cost. So by doing that, we'll drop our SORs, and we will see kinda an incremental 20,000-30,000 barrels a day of production at Christina Lake.

Again, that kind of starts ramping up in the 2025 time period and full production kind of in the 2026 time period. At Sunrise, we've been actively working on applying the Cenovus technology since acquiring the asset. You know, we've spent a bit of time with infills and redrills and redevelopment wells this year, and so you're seeing production kinda north of that 50,000 barrels a day. But now we're adding pads. So the last time a pad was added at Sunrise was in the 2017 time frame. So we have a whole pad development program. The first one will be steaming at the back end of 2023 here and through 2024, but we're also adding additional pads.

Through kind of that 2025, 2026 time frame, you can see us fully getting the full utilization of all the steam capacity at the asset, and that should drive our production up into that mid-60s type range. You know, we're kinda gonna see a 15,000-20,000 barrel a day growth at Sunrise. And then, on our East Coast project, the West White Rose project, this is where a bit more capital will be going in, 2024 and 2025 time periods as we finish that project. We're north of 70% complete.

We hit some milestones on our gravity-based structure in the quarter, and you know, we'll be spending 2024 and 2025 to finish construction, tow it offshore, make up the topsides and the gravity-based structure and commence drilling in 2025. So we'll start seeing production growing in 2026 and peaking kinda in that 2028 time frame at about an incremental 45,000 barrels a day. So really excited about the growth projects, you know, the volume it adds at relatively modest or low capital. And to Jon's point, doing all this in that CAD 4.5 billion-CAD 5 billion capital range over the next couple of years.

Jon McKenzie (President and CEO)

Yeah. So, Neil, just-

Neil Mehta (Managing Director and Head of North American Natural Resources Equity Research)

All right, thank you.

Jon McKenzie (President and CEO)

You know what you should be thinking about, just for your model, Neil, you should be thinking kind of in the CAD 2.9-CAD 3 range for sustaining capital and then the residual being growth.

Keith Chiasson (EVP and COO)

Okay. That's really helpful. Thanks. Thanks, Jon.

Jon McKenzie (President and CEO)

Okay. Thanks, Neil.

Operator (participant)

Thank you. Your next question is from Menno Hulshof, from TD Securities. You can ask your question.

Menno Hulshof (Managing Director of Equity Research)

Thanks, and good morning. So I've got a couple of follow-up questions from some of the prior questions. So maybe I'll start with a high-level one on the operational outlook for downstream. Scale of 1 to 10, where do you think you are today on a downstream performance from a pure operational perspective relative to where you'd like to get to? And then where else do you see room for improvement within U.S. refining?

Jon McKenzie (President and CEO)

Well, I'm gonna let Keith answer the specifics on this. But what I, what I would tell you, Menno, is, refining is a core part of our business. You know, we have built a heavy oil value chain that we think has significant value to the shareholders, and we think it's, it's actually quite unique in, in its construct. But our goal is to be as good at running the downstream as we are our thermal assets, and that's not necessarily gonna happen overnight, but that's the trajectory that we're on, and that's where we wanna take this piece of business. Refining and, and upgrading is, is absolutely core to this business.

So, you know, what you'll see from us over the coming years is a continued focus on sweating these assets, grinding out value, not just on the operating side in terms of reliability, throughput, and the like, but also on, on the commercial side of this business, and making sure that we're making all the right decisions and capturing as much margin as, as possible. But maybe I'll, I'll turn it over to Keith. I don't know that he's gonna give you an answer on 1 to 10, but I think he'll give you some indication of where we think we are.

Keith Chiasson (EVP and COO)

Thanks, Menno, and I think I just got some direction. So, you know, basically, you know, you got to think about kind of what the downstream organization has been through. You know, Superior was down for about five years, and we've now safely restarted that refinery and pretty excited about it. Toledo kind of came through an event and then a winter freeze event as well. And the team there has successfully restarted and has ran that refinery reliably since kind of the June time frame. So pretty excited about kind of where we are. I think we do continue to have opportunity, though, and part of that opportunity is around the integrated nature of that value chain.

Now that we're up and running and running reliably, you know, we are actively looking at integration opportunities between Lima and Toledo and ways to capture additional margin. Obviously, having, you know, around 120,000 barrels a day of heavy conversion capacity in today's differential market provides a lot of opportunity and flexibility to capture additional crude advantage at those two refineries. So, you know, you would have seen our unit OpEx drop substantially in the U.S. downstream in the quarter. We're gonna continue to work to grind that even lower over the next several quarters and continue to work on our reliability and continue to improve that.

So, we're not stopping, but we think we have additional opportunity to drive down unit OpEx, improve reliability, and really extract additional margin. But the assets are up and running and performing well today.

Menno Hulshof (Managing Director of Equity Research)

Terrific. Thanks. That was, that was a great rundown. Maybe I'll just circle back on West White Rose. It's 75% complete. You've got CAD 440 million invested on a net basis since, since restart. How is that project generally tracking relative to your internal targets? And given that it's offshore, where do you see the most risk between now and 2026? Is it, is it in the timeline or the budget?

Kam Sandhar (EVP and CFO)

Yeah, Menno, we're pretty happy with where we're at. You know, when we picked up this project, you know, the gravity-based structure had kind of the base of the structure poured, and over the past, you know, 6-8 months, we've finished predominantly finished that gravity-based structure. We have all the necessary contracts in place for the remainder of the project. The topsides are essentially mechanically complete down in Texas, and we're gonna start progressing through the commissioning phase. So all in all, things are lining up. I will remind folks, though, we do have an asset life extension on the Sea Rose FPSO, and that will take about 9 months here in 2024.

So we will come off station in early January and come back on production in late August or early September. And that extension really is setting us up for kind of the drilling activity that will happen in 2026, and making sure the asset can stay in place to kind of end of life. So, you know, all in all, I would say, it's a big project, but it's trending well, you know, kind of as per our expectations on both cost and schedule.

Jon McKenzie (President and CEO)

Yeah.

Menno Hulshof (Managing Director of Equity Research)

Thanks a lot. I'll turn it back.

Jon McKenzie (President and CEO)

Great. Thanks, Menno.

Operator (participant)

Thank you. Your next question is from John Royall from JP Morgan. Please ask your question.

John Royall (Executive Director)

Hi, good morning. Thanks for taking my question. So just wanted to-

Jon McKenzie (President and CEO)

Good morning.

John Royall (Executive Director)

Clarify one thing on the capital allocation. It sounds like you are including the warrant paydown in your calculation for the 50% allocation. And then, any update you can give us on, you know, potential timing of getting to that floor would be helpful. Thanks.

Jon McKenzie (President and CEO)

Sure. Maybe, we get that question just about every quarter, so why don't I-- Kam, I think you're well-practiced at this one.

Kam Sandhar (EVP and CFO)

Sure. So just on the warrant. So I think, John, I would just highlight, so when you remember the time when we announced the transaction on the warrant purchase, we did remind everybody that the warrant paydown will be included as part of our shareholder framework. So to the extent that we pay that liability down, it will be included as part of that 50% of excess free funds flow that we allocate to shareholder returns. So as John mentioned, we paid CAD 600 million of that through Q3 on top of the CAD 360 million in buybacks we did. And so going to Q4, you should expect us to probably pay that warrant liability completely, the remaining CAD 111 million, with the incremental either going back to share buybacks or variable dividends.

And then on your second question, just around the debt, you know, I think what I would just say is, you know, right now the focus for us, as the team has talked about, is executing the base business, focusing on continuing to progress these growth projects, you know, moving the downstream to continued improvement on reliability and sustained throughput. And, you know, the function of our debt is really gonna be dependent on that and commodity prices. So, you know, I think we'll get there when we get there. I don't, you know, think I can give you a timeline, just given we've seen a lot of volatility in commodity pricing even in the last month or two.

So, you know, the timing is going to move around, but I would tell you the focus is absolutely in getting there as quickly as we can.

Jon McKenzie (President and CEO)

Yeah, and John, I think that's the important piece, we are just operating this business with a focus of getting to CAD 4 billion as quickly and as prudently as we can. You know, one of the things that you can count on us is that we will, you know, continue on that trajectory unimpeded until we get there.

John Royall (Executive Director)

Great. Thank you. Fair enough. And then, you've also, you've talked about being happy, kind of with, your portfolio, as is, but you've also talked about not wanting to be in 50/50 JVs. You still have the one JV on the downstream side that's hanging out there, and your partner has now rolled out an asset sale target. So, how are you thinking about that structure right now with WRB?

Jon McKenzie (President and CEO)

Yeah, you know, we, we've been really clear on that set of assets for years now. And, you know, we have been clear that, you know, we want to own and operate those assets that we see as core. We've been also clear that we are more likely sellers of those assets than buyers of those assets. And we've also been clear there's a fairly healthy bid-ask spread that has persisted through time. So, you know, I don't want to comment on what Phillips is proposing within their portfolio. What we're focused on is running the business and, you know, we're quite happy with, you know, holding that JV through the long term, if that's required.

John Royall (Executive Director)

Thank you.

Jon McKenzie (President and CEO)

All right. Thanks, John.

Operator (participant)

Thank you. Your next question is from Greg Pardy from RBC Capital Markets. Please ask your question.

Greg Pardy (Managing Director and Head of Global Energy Research)

Hey, thanks. Good morning. Thanks for the rundown, guys. You've got lots of capacity on Trans Mountain. Just curious how you're thinking about, timing, but perhaps more importantly, how will your marketing strategy work? So, you know, will you sort of look to sell at the dock, then to tankers, or, or are you looking at something perhaps more, integrated with markets in Asia and so on?

Jon McKenzie (President and CEO)

Yeah, I know it's, it's a great question, Greg. It's something we're spending a lot of time on. So I'm gonna turn this one over to Drew, 'cause Drew's right in the middle of this right now.

Drew Zieglgansberger (EVP and Chief Commercial Officer)

Sure. Yeah. Good morning, Greg. Thanks for the question. Maybe to kind of speak on kind of the premise of TMX, we're, we're really pleased that it's still continuing and progressing, and I think even with these latest, you know, route change approvals and whatnot, I think it's still pretty positive that that line is gonna come into service here in Q2. So what you can expect from us is that we're probably gonna get a call on line fill early in the new year. So, you know, with that, we're gonna see a, you know, a working capital build in order to fulfill our kind of volume commitment there. And then how we're thinking about that, you know, being one of the biggest shippers on that line, is that, you know, we're also planning for, you know, some obvious, you know, startup variability.

I mean, a line like that, it's pretty substantive, and getting that operation up and running it to a smooth rate is likely to also take some time. So, you know, we expect, you know, through 2024 to kind of manage that with probably a little bit of bumpiness, in all reality. So, you know, how we're thinking from a marketing strategy is that, you know, we're gonna initially be looking to, you know, secure some, you know, agreements and supply FOB at the dock itself. You know, we're gonna wanna see that get up to a good, stable rate. However, we do have some intention to, you know, get into new markets. It gives us another great tool and a, and a suite, potentially into global markets.

We've obviously got some good connections and access into Asian markets with some of our offshore work over in Indonesia and China. So yeah, we are looking at that as a full suite of a new market access for us. But, you know, we're gonna, you know, do the right thing as we go into 2024, make sure that once they get up and operating, that we can see the reliability of that get there, which I think will take a bit of time. And we'll step ourself into, you know, FOB, going onto the water at some point and accessing those new markets that TMX is gonna allow us all to go after.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay, terrific. That is helpful, and we look forward to hearing more about it as we go. And it's kind of a good segue into, you know, net working capital. I guess question for Kam is, you know, good cash flow generation, obviously, you know, there's headwinds and there's an increase in pricing, as John alluded to. What is the—What does the balance of the year look like? And the reason I ask that obviously is $65,000 question with you guys is, you know, when does the company get to CAD 4 billion? Just curious what your thinking is there.

Kam Sandhar (EVP and CFO)

Thanks, Greg. So just on the working capital, so a couple of things I would highlight. You know, when you look at Q2 relative to where we ended Q3, you know, first off, we did. Remember we did book the liability associated with the warrant purchase, which was that full CAD 711 million. So we drew that down at the end of Q3 for CAD 600 million. So that was partly what drove working capital up in Q3 relative to Q2. The second piece I would just say is, when you look at our inventory, didn't see a lot of change from a volume perspective relative to where we were in Q2, but obviously, prices moved up significantly, quarter-over-quarter, which is the lion's share of the increase that you've seen in the working capital.

But, you know, as we move into the fourth quarter, you know, it's obviously things continue to move around as we look at our marketing strategy on selling our barrels. But, you know, I don't expect a big change, and Drew kind of highlighted the one sort of more structural change that you'll see in Q1 when we add more barrels into the system for the line fill associated with TMX.

Greg Pardy (Managing Director and Head of Global Energy Research)

Okay, understood. Thanks very much.

Drew Zieglgansberger (EVP and Chief Commercial Officer)

Great. Thanks, Greg.

Operator (participant)

Thank you, ladies and gentlemen. As a reminder, you can join the queue to ask a question by pressing star one. Your next question is from Manav Gupta from UBS. Please ask your question.

Manav Gupta (Executive Director and Senior Equity Research Analyst)

Thank you, guys. A little bit of a macro question here. We have seen some widening of WCS here. Can you help us understand what's exactly going on? And then where do you see this spread once, as you said, TMX does come online in 2Q? If you can help us understand some of those things.

Drew Zieglgansberger (EVP and Chief Commercial Officer)

Sure. Good morning, Manav, it's Drew. Yeah, great question. As you've alluded to, you know, the crack or the diff has widened here, and that was not unexpected. You know, we've had some incremental growth come out of the basin here over the course of this year, and, you know, with you know, with condensate pricing and whatnot being quite attractive, people are really moving a lot of sales volume. So, you know, we expected this to widen out, and as I alluded to, with TMX coming on, I think, you know, in the near term, people also probably saw some of those potential delays and construction issues that have kind of come out as of late.

I think people probably shifted some of their positions on timing, but, you know, we fully expect as the line fill even starts here early in the new year, I think you'll start to see things already start to head down the path of tightening back up. And then as it comes into full operation into Q2 sometime, you know, we do expect in the second half of next year for it to kind of tighten back up to, you know, what we saw when we had some egress space here earlier this year and late last year. So, you know, we would expect it to come down substantially from where it is, probably in the order of, you know, half of what we're seeing today.

But, you know, that probably won't show itself till it's actually up and operational and probably gets through some of its bumpiness as it starts up.

Jon McKenzie (President and CEO)

Yeah. You know, Manav, I'd say one of the big differences this year from last year, and we certainly saw differentials widen last year when we had the, you know, the Keystone outage and the like. But, you know, with the upstream, or sorry, with the downstream, you know, up and running and performing the way it is, does insulate us from a lot of those wider spreads that we were exposed to last year. So while at, you know, a corporate level, we'd still like to see narrower spreads, you know, we're much less exposed to that kind of widening through the fourth and first quarter of this year than we were last year. So we're again, really pleased to have those refining assets up, running, and performing well.

Manav Gupta (Executive Director and Senior Equity Research Analyst)

Perfect. I'm going to ask a follow-up question. Based on the response you provided to John, I got a whole bunch of questions on my Bloomberg, so I'm going to follow up on this. As it relates to those two assets, sir, is it more of a case of a price, or is it more of a case that you always thought of Toledo as a core asset you want to operate and these two don't actually fit that picture? Which one is it more, is it price or is it more of they, they don't fit-

Jon McKenzie (President and CEO)

No.

Manav Gupta (Executive Director and Senior Equity Research Analyst)

Your action? Yeah.

Jon McKenzie (President and CEO)

You know, what I want to tell you is Toledo is an absolutely core asset for us. It consumes 90,000 barrels a day of heavy, and it consumes the molecules that we produce inside our upstream. It consumes Christina Lake, and it consumes Sunrise heavy oil and provides us insulation against heavy oil differentials and location differentials. So it's an absolutely core asset for us and a key piece of infrastructure. What I don't want to do is give anybody the impression that we're doing anything other than focusing on our base business right now and our core set of assets that we have. Our intention is to continue to, you know, build on the operating momentum we have, drive our debt down to CAD 4 billion, move to 100% shareholder payout.

That is our focus right now. And I understand there's rumors swirling, but, you know, they shouldn't be.

Manav Gupta (Executive Director and Senior Equity Research Analyst)

Thank you. Congrats on a great quarter, and good to see downstream make a material big contribution. Thank you, sir.

Jon McKenzie (President and CEO)

Yeah, thank you very much. Appreciate the questions.

Operator (participant)

Thank you. Once again, as a reminder, you can join the queue to ask a question by pressing star one. There are no further questions. That concludes our question and answer session. I will hand the call back to Mr. McKenzie for the closing remarks.

Jon McKenzie (President and CEO)

Okay. Well, thank you very much, everybody. We certainly appreciate your interest in the company and wish you the best, and we'll talk to you again in the new year. Thank you.

Operator (participant)

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect.