ITEM 1A. Risk Factors
Our business and operations, and our industry in general, are subject to a variety of risks. If any event arising from the risk factors set forth below occurs, our business, financial condition, results of operations, liquidity, the trading prices of our securities and in some cases our reputation could be materially and adversely affected. When assessing the materiality of the foregoing risk factors, we consider several qualitative and quantitative factors, including, but not limited to, financial, operational, environmental, regulatory, reputational and safety aspects of the identified risk factor. The risks described below may not be the only risks we face, as our business, operations and industry may also be subject to risks that we do not yet know of, or that we currently believe are immaterial.
Market Risks
A substantial or extended decline in oil, NGLs or natural gas prices, or a substantial increase in oil, NGLs and natural gas price differentials, could have a material adverse effect on our business, financial condition, results of operations, and the trading prices of our securities.
Our financial performance and condition are substantially dependent on the prevailing prices we receive for the oil, NGLs and natural gas which we produce. Prices for oil, NGLs and natural gasare inherently volatile and fluctuate in response to changes in a variety of factors beyond our control, including:
• volatility and trading patterns in the commodity futures market;
• global economic conditions;
• the level of global oil, NGLs and natural gas inventories;
We also may receive discounted prices for our oil, NGLs and natural gas production relative to certain benchmark prices (such as Brent and WTI for oil and Henry Hub and AECO for natural gas) due to constraints on our ability to transport and sell such production to certain markets. A failure to resolve such regional pricing differentials may result in our continued realization of discounted or reduced oil, NGLs and natural gas prices relative to such benchmarks.
A substantial or extended decline in oil, NGLs and natural gas prices, or a substantial increase in oil, NGLs and natural gas price differentials with respect to certain benchmarks, could result in, among other things, (a) a delay or cancellation of existing or future drilling, development or construction programs; (b) the curtailment or shut-in of production at some or all of our properties; (c) unutilized long-term transportation and drilling commitments; or (d) a decrease in the value of our oil, NGLs and natural gas reserves, each of which could have a material adverse effect on our business, financial condition, results of operations and the trading prices of our securities. Additionally,
32
on at least an annual basis, we assess the carrying value of our oil and natural gas properties in accordance with applicable accounting standards. If oil, NGLs and natural gasprices decline significantly for a sufficient period, the carrying value of our properties could be subject to financial impairment, and our net earnings could be materially and adversely affected.
A pandemic, epidemic or other widespread outbreak of an infectious disease, such as the ongoing COVID-19 pandemic, could materially and adversely affect the operation of our business.
Although we maintain contingency plans to manage the potential workplace impacts of a pandemic, epidemic or other widespread outbreak of an infectious disease, such as the ongoing COVID-19 pandemic, restrictive measures implemented by governments in the jurisdictions in which we operate could prevent our employees, contractors or suppliers from accessing our properties or performing critical services. Such measures may include limitations or prohibitions on cross-border travel, restrictions on large gatherings, stay-at-home orders, vaccine mandates and mandatory closures of “non-essential” businesses. In the event such measures remain in place for an extended period of time, our ability to maintain ordinary staffing levels, secure operational inputs, and execute on portions of our business could be impacted, and if a significant subset of our employees are required to work remotely, we will face an increased exposure to vulnerabilities related to digital technologies and may experience a higher rate of cyber-attacks. Additionally, concerns over the prolonged negative effects of a pandemic, epidemic or other widespread outbreak of an infectious disease, including the ongoing COVID-19 pandemic, on global economic and business prospects may contribute to decreased demand for oil, NGLs and natural gas; increased volatility in capital and commodity markets, including volatility in the prices of oil, NGLs and natural gas; substantial fluctuations in currency exchange rates, inflation rates and interest rates; increased counterparty credit and performance risk; and reduced levels of general investing and consumption.
While the full impact of a pandemic, epidemic or other widespread outbreak of an infectious disease, including the ongoing COVID-19 pandemic, is inherently uncertain, the ultimate impact will depend on several factors, including the location and severity of the virus's spread, the effectiveness and adoption rate of vaccines, the emergence of new or previously unknown variants and the effectiveness of mitigation actions taken by governmental authorities. Any pandemic, epidemic or other widespread outbreak of an infectious disease, including the ongoing COVID-19 pandemic, may reduce our spending and operating plans; reduce the value and amount of our oil, NGLs or natural gas reserves and production; cause substantial fluctuations in our stock price and credit ratings; or otherwise materially and adversely affect our business, financial condition, results of operations, and access to liquidity.
The trading price of our securities, including our common stock, is subject to volatility.
The trading price of our securities, including our common stock, may be volatile. The value of an investment in our securities may decrease or increase abruptly, and such volatility may bear little or no relation to our financial or operational performance. The price of our securities may fall in response to market appraisal of our strategy or if our results of operations and/or prospects are below the expectations of market analysts or stakeholders. In addition, equity and debt markets have, from time to time, experienced significant price and volume fluctuations that have affected the market price of securities, and may, in the future, experience similar fluctuations which may be unrelated to our operating performance and prospects but nevertheless affect the price of our securities. Broad equity and debt market fluctuations resulting from general economic conditions, as well as our ability to meet or exceed market expectations, may materially and adversely affect the trading prices of our securities, including our common stock.
Fluctuations in exchange rates could affect expenses or result in realized and unrealized losses.
We currently have operations in Canada and, as a result, a portion of our revenues and expenses are denominated in Canadian dollars. In addition, our subsidiaries that are domiciled in Canada may hold U.S. dollar denominated assets and liabilities. Fluctuations in the exchange rate between the U.S. dollar and the Canadian dollar may result in realized and unrealized losses, which could impact our revenue and expenses and have a material adverse effect on our business, financial condition and results of operations.
33
Operational Risks
Our ability to operate and complete projects is dependent on numerous factors outside of our control.
We undertake a variety of projects including exploration and development projects and the construction or expansion of facilities and pipelines. Our ability to operate, generate sufficient cash flows, and timely complete projects depends upon numerous factors largely beyond our control. These factors include:
• oil, NGLs and natural gas prices;
• global supply and demand for oil, NGLs and natural gas;
• the ability to secure and maintain financing on acceptable terms;
• legislative, environmental and regulatory matters;
• oil and natural gas reservoir quality;
• the ability to access lands;
• the ability to access water for hydraulic fracturing operations;
• reliance on vendors, suppliers, contractors and service providers;
• changes to free trade agreements;
• prevailing interest and foreign exchange rates;
• royalty and tax rates;
• physical impacts from adverse weather conditions and natural disasters;
• technology failures; and
• accidents.
In addition, part of our corporate strategy is focused on a limited number of Core Assets which results in a concentration of development capital and production. Some of the foregoing risks may be magnified due to the concentrated nature of our development activities and may result in a relatively greater impact on our financial condition and results of operations compared to other companies that may have more geographically diversified operations. Any material delays in a project or project cost overruns could result in delayed revenues and some projects becoming uneconomic, each of which could have a material and adverse effect on our business, financial condition and results of operations.
Our operations involve many risks, some of which could result in unforeseen interruptions and expose us to substantial losses and liabilities, for which our insurance may not fully protect us.
Our business is subject to the operating risks normally associated with (a) the exploration, development and production of oil, NGLs and natural gas and (b) the operation of midstream facilities, including the gathering, transportation, processing, storing and marketing of oil, NGLs and natural gas. These risks include:
• blowouts, cratering, explosions and fires;
• loss of well control;
• encountering unexpected or abnormally pressured formations;
• premature declines of reservoir pressure or productivity; and
34
If any of the foregoing risks were to materialize, we could sustain material losses as a result of:
• injury or loss of life;
While we maintain insurance against some, but not all, of these risks and losses described above, our insurance may not be adequate to cover all casualty losses or liabilities, and our insurance does not cover penalties or fines that may be assessed by a governmental authority. The occurrence of a significant event for which we are not fully insured may have a material adverse effect on our business, financial position and results of operations.
Oil and natural gas exploration, development and production activities involve substantial costs and risks and may not result in commercially productive reserves.
Oil and natural gasexploration, development and production activities involve numerous risks, including the risk that no commercially productive oil or natural gas reservoirs will be encountered. The cost of drilling and completing wells is often uncertain and operations may be curtailed, delayed or canceled, or become costlier, as a result of a variety of factors, including:
• equipment failures or accidents;
• construction delays;
• fracture stimulation accidents or failures;
• adverse weather conditions or natural disasters;
• title defects or restricted access to land;
• lack of available capacity on interconnecting transmission pipelines;
Additionally, our operations involve utilizing some of the latest horizontal drilling and completion techniques as developed internally and by our service providers. Risks that we face while drilling and completing horizontal oil and natural gas wells include the following:
• landing the wellbore in the desired zone within the target formation;
• controlling formation pressures during drilling;
• running casing the entire length of the wellbore;
Our future exploration and development activities may not be successful as a result of, among other things, the risks set forth above and, if unsuccessful, our proved oil, NGLs and natural gas reserves and production would decline, which could have a material and adverse effect on our business, financial condition and results of operation. While all development activities involve these risks, exploratory and extension development activities involve a greater risk of dry holes or failure to find commercial quantities of hydrocarbons.
35
The proved reserves data provided in this Annual Report on Form 10-K is an estimate only and any inaccuracies in the methodology or assumptions underlying our proved reserves estimates could cause the quantity and net present value of our oil, NGLs, and natural gas reserves to be materially overstated or understated.
There are numerous uncertainties inherent in estimating economically recoverable quantities of oil, NGLs and natural gas reserves, including many factors beyond our control. All oil, NGLs and natural gas reserve estimates are uncertain to some degree, and classifications of oil, NGLs and natural gas reserves are only attempts to define the degree of uncertainty involved. For those reasons, estimates of the quantity of oil, NGLs and natural gas economically recoverable from a group of properties and the classification of such oil, NGLs and natural gas reserves, when prepared by different engineers or by the same engineers at different times, may vary substantially. Additionally, estimates with respect to oil, NGLs and natural gas reserves are often based upon volumetric calculations and upon analogy to similar types of reserves, rather than upon actual production history. Oil, NGLs and natural gas reserve estimates based on these methods are generally less reliable than those based on actual production history. Subsequent evaluation of the same reserves based upon production history will result in variations in the estimated reserves and these variations may be material.
Proved reserves data in this Annual Report on Form 10-K and other publications we make publicly available represent estimates only. In general, estimates of our oil, NGLs and natural gas reserves, and the future net cash flows therefrom, are based upon a number of factors and assumptions, including commodity prices, future operating and capital costs, availability of future capital, historical production from the same or similar properties and the assumed effects of regulation by governmental agencies, including with respect to royalty payments, all of which may vary considerably from actual results. Our actual production, revenues, taxes and development and operating expenditures with respect to our proved reserves may vary materially from such estimates.
The estimates of proved reserves included in this Annual Report on Form 10-K are prepared in accordance with SEC regulations. Subject to limited exceptions, oil, NGLs and natural gas reserves may only be classified as proved undeveloped reserves if the wells developing such reserves are scheduled to be drilled within five years after the date of classification. The development timing of our oil, NGLs and natural gas reserves is based upon numerous expectations and assumptions, including the allocation of development capital; anticipated costs to drill, complete and operate our wells; and anticipated commodity prices. Our development expectations and assumptions are subject to change and proved undeveloped reserves may be reclassified to unproved reserves at any time. Additionally, commodity prices used to estimate proved reserves included in this Annual Report on Form 10-K are calculated as the unweighted arithmetic average of the price on the first day of each month within the 12-month period. Significant future price changes can have a material effect on the quantity and value of our proved reserves. The standardized measure of discounted future net cash flows included in this Annual Report on Form 10-K will not represent the current market value of our estimated proved reserves. In addition, these proved reserve estimates do not include any value for probable or possible reserves that may exist, nor do they include any value for unproved undeveloped acreage.
If we fail to find, develop or acquire additional oil, NGLs and natural gas reserves, our reserves and production will decline materially from their current levels.
Our future oil, NGLs and natural gas reserves and production, and therefore our future cash flows, are highly dependent upon our success in developing our current reserves base and exploring for, developing or acquiring additional oil, NGLs and natural gas reserves. Typically, to maintain an oil and natural gas lease in the United States, we are required to drill at least one well that is commercially productive within the primary term of the lease and, once drilled, maintain oil or natural gas production in paying quantities from the lease. If we are unsuccessful in drilling a commercially productive well during the primary term of the lease or, once drilled, in maintaining oil or natural gas production in paying quantities from the lease, we could lose our rights to explore for and develop oil and natural gas under such lease and our right to any oil, NGLs and natural gas reserves associated with the lease. In some cases, the initial commercially productive well will only maintain the lease as to a portion of the lands covered thereby and further oil and natural gas development activities are required to maintain the entirety of the lease.
The business of exploring for, developing and acquiring oil and natural gas reserves is capital intensive. Acquisition opportunities in the oil and natural gas industry are inherently competitive, which can increase the cost of, or cause us to refrain from, completing acquisitions. To the extent that cash flows from our operations are insufficient and external sources of capital become limited or undesirable, our ability to make the necessary capital investments to
36
maintain and expand our oil, NGLs and natural gas reserves and production will be impaired. In addition, there can be no certainty that we will be able to find, develop or acquire additional oil, NGLs and natural gas reserves to replace current reserves and production at acceptable costs. Without additions through exploration, development or acquisition activities, our oil, NGLs and natural gas reserves and production will decline over time as the reserves are depleted, which may materially and adversely affect our business, financial condition and results of operations.
Horizontal multi-well pad drilling involves certain risks which may cause volatility in our operating results.
Our operations utilize horizontal multi-well pad drilling. In this type of development, multiple wells are drilled based upon spacing and completions techniques that evolve over time as learnings are captured and applied. Wells drilled on a multi-well pad are generally not placed on production until all wells on the pad are drilled and completed. While the use of this development technique can accelerate the production of our oil, NGLs and natural gas reserves and increase our observed recovery factor from the reservoir, it can also result in production delays as problems with a single well can adversely affect the production of all wells on the pad. Additionally, horizontal multi-well pad drilling increases the risk of unintentional communication or pressure interference between wells which may adversely affect our production. As a result, multi-well pad drilling can both cause delays in our production schedule and result in oil, NGLs and natural gas production below expectations. These delays or production interruptions may reduce our anticipated production volumes from both new and existing wells and this volatility could have a material and adverse effect on our business, financial condition and results of operations.
We are subject to both known and unknown risks and liabilities from acquisitions and any anticipated or desired benefits from such acquisitions may not be realized.
Historically, acquisitions of oil and natural gas properties, including through acreage trades, farm-ins and asset- or corporate-level acquisitions, have contributed to our growth. Acquisition opportunities in the oil and natural gas industry are inherently competitive, which can increase the cost of, or cause us to refrain from, completing acquisitions. The success of any acquisition will depend on several factors and involves potential risks and uncertainties, including, among other things:
• the inability to accurately forecast commodity prices;
• the validity of assumptions about asset- and corporate-level synergies;
• the diversion of management's attention from other business concerns; and
All of these factors, among others, affect whether an acquisition will ultimately generate cash flows sufficient to provide a suitable return on investment. Even though we assess and review the properties we seek to acquire in a manner consistent with what we believe to be industry practice, such reviews are limited in scope, inexact and not capable of identifying all existing or potentially adverse conditions. This risk is magnified when the acquired properties are in a geographic area where we have not historically operated. As a result, the anticipated and desired benefits of an acquisition may not materialize, and this may have a material and adverse effect on our business, financial performance and results of operations.
We are dependent on partners to fund certain projects conducted through joint ventures and partnerships.
Some of our projects are conducted through joint ventures, partnerships or other arrangements, where we are dependent on our partners to fund their contractual share of the project’s capital and operating expenditures. If our partners do not approve their contractual share of capital or operating expenditures, are unable to fulfill their contractual obligations, or suspend or terminate their contractual arrangements with us, the projects may become delayed or we may be forced to absorb additional capital or operating expenditures, each of which may materially and adversely affect the viability of such projects and our business, financial condition and results of operations.
37
These partners may also have strategic plans, objectives and interests that do not coincide, and may conflict, with our plans, objectives and interests. While certain operational decisions may be made solely at our discretion in our capacity as the operator of certain projects, major capital and strategic decisions affecting such projects may require agreement among the partners. While we generally seek consensus with our partners regarding major decisions concerning the direction and operation of a project, no assurance can be provided that future demands or expectations of any party, including our demands and expectations, relating to such project will be met satisfactorily or in a timely manner. Failure to satisfactorily meet such demands or expectations may affect our or our partners’ participation in the operation of such project or the timing for undertaking various activities, which could materially and adversely affect the viability of such project and our business, financial condition and results of operations. Further, we are involved from time to time in disputes with our partners and, as such, we may be unable to dispose of certain assets or interests in certain arrangements if such disputes cannot be resolved in a satisfactory or timely manner.
We do not operate all of our assets, and, in such instances, we may have a limited ability to exercise influence over the operation and development of such assets.
Third parties operate a portion of the assets in which we have an ownership interest, and, in such instances, we may have a limited ability to exercise influence over the operation and development of such assets. The success and timing of our activities on these assets is therefore dependent upon factors that are largely outside of our control. These factors include (a) the timing and amount of capital, operating and maintenance expenditures related to the project; (b) the third-party operator’s expertise and financial resources; (c) the third-party operator’s ability to obtain required approvals from other non-operating partners; and (d) the third-party operator’s selection and implementation of adequate technology and risk management practices. The failure of one or more third-party operators to effectively and efficiently operate assets in which we have an ownership interest could result in the inefficient deployment of capital and the loss of production volumes, each of which could have a material and adverse effect on our business, financial condition and results of operations.
Our customers, counterparties and lenders may be unable to satisfy their contractual or legal obligations.
We are exposed to certain risks associated with our customers, contractual counterparties and lenders. These risks include (a) credit risks associated with (i) customers who purchase our oil, NGLs and natural gas production, (ii) the collection of receivables from our joint interest partners for their proportionate share of expenditures made on projects we operate, and (iii) counterparties to our derivative financial contracts; (b) performance risks associated with the non-delivery, or delayed delivery, of contracted products or services, including the transportation and processing of our oil, NGLs and natural gas production; and (c) liquidity risk in the event one or more lenders under our existing credit facilities are unable to perform their funding obligations. We utilize a variety of mechanisms to limit our exposure to these and similar risks, including requiring letters of credit, prepayments or collateral postings under certain conditions. Despite these mechanisms, in the event a customer, contractual counterparty or lender fails to satisfy their obligations, our business, financial condition and results of operations could be materially and adversely affected.
We retain certain indemnification obligations related to our corporate reorganization in November of 2009.
As part of our November 2009 corporate reorganization that split our predecessor, Encana, into two independent publicly traded energy companies, Encana and Cenovus Energy Inc. (“Cenovus”), Encana and Cenovus each agreed to indemnify the other for certain liabilities and obligations associated with, among other things, in the case of Encana’s indemnity, the business and assets retained by Encana, and in the case of Cenovus’s indemnity, the business and assets transferred to Cenovus. We are unable to predict whether we will be required to indemnify, or seek indemnity from, Cenovus for any obligations and the magnitude of such obligations. Any indemnification claims against us pursuant to the various agreements entered with Cenovus, or our failure to obtain indemnity from Cenovus for any claims we may hold, could have a material and adverse effect on our business, financial condition and results of operations.
38
We may be unable to dispose of certain assets and may be required to retain liabilities for certain matters.
We may identify certain assets for disposition, the proceeds of which could reduce the amount of our existing indebtedness and/or increase the amount of capital available for other business purposes, including shareholder returns and acquisitions. Various factors could materially affect our ability to dispose of the identified assets or complete any announced transactions, including commodity price volatility; the availability of counterparties willing to acquire oil and natural gas assets at prices and on terms acceptable to us; approval by our Board of Directors; associated asset retirement obligations; due diligence; general market conditions; the assignability of any associated contract, joint venture, partnership or other arrangements; and required stock exchange, governmental or third party approvals.
These factors may also reduce the value of our assets or the proceeds of any asset disposition.
We (including our predecessor entities) have retained, or in the future may retain, liabilities or indemnification obligations in connection with certain asset dispositions. While we are unable to predict the magnitude of any retained liabilities or indemnification obligations, any liabilities or indemnification obligations retained could ultimately be material. For example, under state and federal law, once an oil or natural gas well has permanently ceased production of oil or natural gas, the operator of such well is obligated to plug and abandon (“P&A”) the well, decommission production facilities and restore the well site to pre-operating conditions. U.S. state and federal regulations allow the government to call upon predecessors in interest of oil and natural gas leases associated with such well to pay for P&A, decommissioning and restoration obligations (together, “P&A Obligations”) if the current operator fails to fulfill those obligations. If purchasers of any assets previously owned by us or our predecessors (including any offshore wells or facilities), or any successor owners of those assets, are unable to meet their P&A Obligations due to bankruptcy, dissolution or other liquidity issues, we may be unable to rely on our arrangements with them, if any, to fulfill (or provide reimbursement for) those obligations. In those circumstances, the government may seek to impose the bankrupt entity’s P&A Obligations on us and any other predecessors in interest, and such payments could have a material adverse effect on our business, financial condition and results of operations.
Further, certain third parties may be unwilling to release us from guarantees or other credit support provided prior to the disposition of an asset. In those cases, after the asset disposition, we may remain secondarily liable for the obligations guaranteed or supported to the extent that the acquirer of the assets fails to perform their obligations.
Our operations may be affected by indigenous treaty, title and other rights.
Indigenous peoples have claimed indigenous treaty, title and other rights in respect of areas within the United States and Canada. The legal basis of an indigenous land claim is a matter of considerable legal complexity and we cannot predict the impact of such a claim, or the possible effects of a settlement of such claim, with any degree of certainty. In addition, no assurance can be given that any recognition of indigenous rights or claims whether by way of a negotiated settlement or by judicial pronouncement (or through the grant of an injunction prohibiting exploration, development or production activities pending resolution of any such claim) would not delay or even prevent our exploration, development and production activities. If a material claim were to arise and be successful, such claim could have a material and adverse effect on our business, financial condition and results of operations. In addition, the process of addressing such claim, regardless of the outcome, could be expensive and time consuming and could result in delays which could have a material and adverse effect on our business, financial condition and results of operations. For more information on the ongoing BRFN Case refer to Government and Environmental Regulatory Matters under Item 1 and 2 of this Annual Report on Form 10-K.
In addition to the foregoing, we may become subject to various laws and regulations that apply to operators and other parties operating within the boundaries of Native American reservations in the United States. These laws and regulations may result in the imposition of certain fees, taxes, environmental standards, lease conditions or requirements to employ specified contractors or service providers. Any one of these requirements, or any delay in obtaining the approvals or permits necessary to operate within the boundaries of Native American tribal lands, could adversely impact our operations and ability to explore, develop and produce new properties.
Further, in Canada, the province of British Columbia enacted legislation to implement the United Nations Declaration on the Rights of Indigenous Peoples (“UNDRIP”) in the fall of 2019 and the Canadian federal government has followed suit by adopting the UNDRIP Act on June 21, 2021. The UNDRIP legislation adopted by
39
both British Columbia and the Canadian federal government provide frameworks for recognizing the constitutional and human rights of indigenous peoples and aligning their respective provincial and federal laws with the internationally recognized standards of UNDRIP. Both pieces of UNDRIP legislation are at an early stage of implementation and we are unable to predict the total impact of the potential regulations upon our business. Although we do not anticipate any near-term impacts to our business as a result of such legislation, the implementation of the standards of UNDRIP has the potential to increase permitting times and change the processes and costs associated with project development and operations.
Environmental Risks and Risks Associated with Climate Change
We are subject to risks and uncertainties associated with increased Environmental Regulation in all jurisdictions in which we operate.
Our operations and properties are subject to numerous existing laws, rules and regulations governing our interactions with the environment that are enacted by U.S. and Canadian federal, state, provincial, territorial, tribal, and municipal governments (collectively, “Environmental Regulations”). Environmental Regulations impose, among other things, restrictions, liabilities and obligations in connection with (a) discharges and emissions of various substances into the environment; (b) the hydraulic fracturing of wells; (c) the handling, use, storage, transportation, treatment and disposal of chemicals, hazardous substances and waste associated with finding, producing, transmitting and storing oil, NGLs and natural gas; (d) the availability and management of fresh, potable or brackish water sources that are being used, or whose use is contemplated, in oil and natural gas operations; and (e) requirements that well sites and other properties associated with our operations be constructed, operated, maintained, abandoned and reclaimed to the satisfaction of applicable regulatory authorities. In addition, certain types of operations, including new exploration and development projects and certain changes to existing exploration and development projects, may require the submission and approval of environmental impact assessments or permit applications. Expenditures required to institute and maintain compliance with new or existing Environmental Regulations can be significant. Failure to comply with Environmental Regulations may result in substantial clean-up and remediation costs arising from damaged or contaminated properties, the imposition of significant fines and penalties by regulators and costly litigation or administrative proceedings. Examples of recently proposed and final Environmental Regulations or other regulatory initiatives include the following:
Emissions - Greenhouse gases (which include, among other things, methane, carbon dioxide, nitrous oxide and various fluorinated gases; “GHGs”) are typically emitted throughout all phases of the oil and natural gas supply chain, including production, transportation, processing, refining and storage operations. Additionally, although beyond our control, end user consumption of oil and natural gas in activities such as power generation and motorized transportation also results in GHG emissions. In the United States, the U.S. Environmental Protection Agency (the “EPA”) has determined that GHG emissions present a danger to public health and the environment and has adopted Environmental Regulations that, among other things, restrict GHG emissions and require the monitoring and annual reporting of GHG emissions from specified sources. For example, in November 2021, the EPA proposed New Source Performance Standard Subpart OOOOb that seeks to impose more stringent methane and volatile organic compound emission standards for new, reconstructed, and modified sources in the oil and natural gas industry. The EPA also proposed New Source Performance Standard Subpart OOOOc, which would create, for the first-time, emission guidelines for existing oil and natural gas sources to be included in individual states’ implementation plans. These Subpart OOOOb and OOOOc standards expand upon previously issued New Source Performance Standards, Subpart OOOO and Subpart OOOOa published by the EPA in 2012 and 2016, respectively. In addition, policy makers at both the federal and state levels continue to propose more stringent Environmental Regulations designed to further limit GHG and other air emissions. Many state and local officials have stated their intent to intensify efforts to regulate GHG and other air emissions, including methane, from the oil and natural gas industry and it is anticipated that the Biden Administration will propose additional Environmental Regulations that may impose new costs on the oil and natural gas industry in an effort to accelerate reductions of GHG and other air emissions from both the production and consumption of energy.
The U.S. and Canadian federal governments, along with several provincial and state governments, have also announced intentions to adhere to certain international protocols regarding GHG emissions and regulate GHGs and certain air pollutants. In addition to federal action, many state, provincial and local
40
officials have stated their intent to intensify efforts to regulate GHG emissions, including methane, from the oil and natural gas industry. These governments are currently developing and/or implementing regulatory and policy frameworks to deliver on their announcements. For example, effective February 19, 2021, the United States officially rejoined the Paris Agreement, an international accord to address climate change through voluntary and non-binding commitments to reduce GHG emissions by signatory nations. Pursuant to its pledge under the Paris Agreement, the United States has committed to reducing its net GHG emissions by 50-52 percent below 2005 levels by 2030. In Canada, the Government of Canada (a) has committed to cutting Canada’s net GHG emissions by 40-45 percent below 2005 levels by 2030 in accordance with its pledge under the Paris Agreement; (b) is gradually raising the federal carbon tax to C$170/tonne CO2e by 2030; and (c) has announced its intention to impose a hard cap on GHG emissions from the oil and natural gas industry, seeking to reduce methane emissions from the oil and natural gas industry by 75 percent below 2012 levels by 2030 and ensure GHG emission reductions are on a pace and scale sufficient to reach net-zero by 2050. We actively participate in certain provincial industrial emission programs offered by both Alberta and British Columbia that allow for the generation of offsets and other rebates to incentivize emission reduction projects and mitigate carbon tax costs.We expect to continue to be able to utilize these provincial programs in the future to migrate our carbon tax costs.
Hydraulic Fracturing Operations- The U.S. and Canadian federal governments, along with certain U.S. state and Canadian provincial governments, continue to review aspects of the scientific, regulatory and policy framework under which hydraulic fracturing operations are conducted. Most of these governments are primarily engaged in the collection, review and assessment of technical information regarding the hydraulic fracturing process and have not provided specific details with respect to any significant actual, proposed or contemplated changes to the hydraulic fracturing regulatory construct. However, certain environmental and other groups have made claims that hydraulic fracturing techniques are harmful to surface water and drinking water sources and continue to suggest that additional Environmental Regulations may be needed to more closely regulate the hydraulic fracturing process. Further, certain governments in jurisdictions where we do not currently operate have considered or implemented moratoriums on hydraulic fracturing until further studies can be completed and some governments have adopted, and others have considered adopting, Environmental Regulations that could impose more stringent permitting, disclosure and well construction requirements on hydraulic fracturing operations or result in an outright ban of hydraulic fracturing in oil and natural gas operations.
Seismic Activity - Some areas of North America are experiencing an increased frequency of localized seismic activity which has been associated with oil and natural gas operations.Although the occurrence and risk of seismicity in relation to oil and natural gas operations is generally very low, it has been linked to the underground disposal of produced water and, in some instances, has been correlated with hydraulic fracturing activities. This has prompted legislative and regulatory initiatives intended to address these concerns. These initiatives have the potential to (a) require additional seismic monitoring; (b) restrict the volume of produced water injected in certain disposal wells; (c) restrict the injection of produced water in certain underground formations; and (d) modify or curtail hydraulic fracturing operations in certain areas.
The cost and effects of complying with existing and emerging Environmental Regulations (including those with respect to emissions, hydraulic fracturing operations and seismic activity) and proposed carbon taxes are not currently anticipated to be material to our operations, however federal, state, provincial and local regulations and programs are either under development or in the early stages of implementation and we are unable to accurately predict the total future impact of such regulations and programs. Increased Environmental Regulations and/or carbon taxes could (a) materially increase our cost of compliance and other operating costs; and/or (b) impede or prevent development of our oil, NGLs and natural gas assets, reducing (i) the amount of oil, NGLs and natural gas we are ultimately able to produce from our reserves and (ii) our overall quantity of oil, NGLs and natural gas reserves. The occurrence of any of the foregoing could have have a material adverse effect on our business, financial condition and results of operations.
41
We are subject to risks and uncertainties arising out of the threat of climate change that could reduce demand for the oil, NGLs and natural gas we produce; increase our operating costs; and limit the areas in which we may explore for, develop, and produce oil, NGLs and natural gas.
Public attention to issues concerning the existence and extent of climate change, and the role of human activity in it, continues to increase, with the oil and natural gas industry receiving heightened scrutiny regarding GHG emissions. Internationally this has resulted in existing and pending international agreements to reduce GHG emissions globally, while in Canada and the United States this has resulted in both national, regional and local legislation and regulatory programs. For example, On January 27, 2021, President Biden issued Executive Order 14008 entitled "Tackling the Climate Crisis at Home and Abroad," directing the heads of various federal agencies, to the extent consistent with applicable law and in consultation with other agencies and stakeholders, to, among other things, (a) assess climate related risks to federal agencies; (b) pause the issuance of new oil and natural gas leases on public lands or in offshore waters pending completion of a comprehensive review and reconsideration of federal oil and natural gas permitting and leasing practices; (c) achieve a carbon-pollution free electricity sector by 2035; (d) procure clean and zero-emission vehicles for federal, state, local and tribal government fleets; and (e) identify and eliminate federal fossil fuel subsidies.Additionally, an increasing number of states, local municipalities and other groups have made claims in federal and state courts against oil and natural gas companies, including Ovintiv, alleging that GHG emissions from oil and natural gas produced by such companies has contributed, and continues to contribute, to climate change. These allegations have included claims of public and private nuisance, trespass, negligence, strict liability and civil conspiracy. Some in the investment community (including, among others, shareholders, bondholders, institutional lenders, investment advisors, pension and sovereign wealth funds and endowments) have also become increasing concerned with the causes of climate change and the role oil and natural gas companies play in any of its purported effects. This has led some in the investment community to shift all or part of their investment or funding allocations away from the oil and natural gas industry and others to modify the terms upon which funding is made available to the oil and natural gas industry. In other instances, it has led shareholders to initiate lawsuits against the directors and management of oil and natural gas companies and/or bring shareholder proposals demanding that oil and natural gas companies increase climate disclosure; change business practices or operations; or appoint new board representation.
If initiatives and actions brought by private parties or additional governmental regulations with respect to climate change intensify, we could experience (a) a reduction in demand for the oil and natural gas we produce and sell; (b) a material increase in our cost of compliance and other operating costs; (c) difficulty in developing our oil and natural gas assets, reducing (i) the amount of oil, NGLs and natural gas we are ultimately able to produce from our reserves and (ii) our overall quantity of oil, NGLs and natural gas reserves; (d) limitations on our ability to access capital markets and raise capital on satisfactory terms, or at all; and (e) costly and time consuming litigation. While we are unable to accurately assess the probability and impact of potential climate change regulations, initiatives and actions, the occurrence of any one or more of the foregoing could have have a material adverse effect on our business, financial condition and results of operations.
Financial and Liquidity Risk
Downgrades in our credit ratings could increase our cost of capital and limit our access to capital, suppliers or counterparties.
Rating agencies regularly evaluate our credit, basing their credit ratings for our long-term and short-term debt securities on a variety of factors, including factors over which we have some control (e.g., our financial strength), as well as factors not entirely within our control (e.g., general macroeconomic trends and conditions affecting the oil and natural gas industry generally). While we currently hold investment grade credit ratings from three of the four major rating agencies, there is no assurance that our credit ratings will not be downgraded in the future, including below investment grade.
Our borrowing costs and ability to raise funds are directly impacted by our credit ratings. A credit rating downgrade may increase the cost of borrowing under our existing credit facilities, limit access to our current commercial paper programs, limit our access to private and public markets to raise short-term and long-term debt capital, and negatively impact our overall cost of capital. Credit ratings may also be important to suppliers or counterparties when they seek to engage in certain transactions. If we experience downgrades in one or more of our credit ratings, we may be required to post collateral, letters of credit, cash or other forms of security as financial assurance for our
42
performance under certain contractual arrangements with various counterparties including marketing, midstream (including gathering, processing and transportation providers), over-the-counter derivative, and construction counterparties. Additionally, certain of these arrangements contain financial assurance language that may, under certain circumstances, permit our counterparties to request additional collateral or require that we terminate transactions based on our credit rating. The occurrence of any of the foregoing could adversely affect our ability to execute portions of our business strategy, including hedging, and could have a material adverse effect on our liquidity and capital position.
Our level of indebtedness may limit our financial flexibility.
As of December 31, 2021, we had outstanding long-term unsecured senior notes of $4,741 million. The terms of our various financing arrangements, including but not limited to the indentures relating to our outstanding senior notes and the credit agreements relating to our revolving credit facilities, impose restrictions on our ability to take a number of actions that we may otherwise desire to take, including incurring additional debt (including guarantees of indebtedness) and selling or creating liens on certain assets.
Our level of indebtedness could affect our operations by:
Our ability to meet and service our debt obligations depends on our future operational performance. General economic conditions; oil, NGLs or natural gasprices; and financial, business and other factors may affect our operational performance. Many of these factors are beyond our control. If we are unable to satisfy our debt obligations with cash on hand, we may attempt to refinance or repay portions of our indebtedness, including with proceeds from a public securities offering or the sale of certain assets. No assurance can be given that we will be able to generate sufficient cash flows to pay the interest on our debt, or that funds from future borrowings, equity financings or asset sales will be available to pay or refinance our debt on terms that we consider favorable. Further, if we incur additional debt to finance asset or business acquisitions, we may decrease our liquidity by using a significant portion of our available cash or borrowing capacity to finance such acquisitions, and such acquisitions could result in a significant increase in our interest expense or financial leverage. The occurrence of any of the foregoing could adversely affect our ability to execute portions of our business strategy and could have a material adverse effect on our liquidity and capital position.
Our risk management activities may prevent us from fully benefiting from an increase in oil, NGLs and natural gas prices and expose us to certain other risks.
We are exposed to, among other things, fluctuations in oil, NGLs and natural gas prices and foreign currency exchange rates. We actively monitor such exposures and, where we deem appropriate, utilize derivative financial instruments and physical delivery contracts to mitigate the potential impact of declines in oil, NGLs and natural gas prices and fluctuations in foreign currency exchange rates. Under U.S. GAAP, derivative financial instruments that do not qualify or are not designated as hedges for accounting purposes are fair valued with the resulting changes recognized in current period net earnings. The utilization of derivative financial instruments may therefore introduce significant volatility into our reported net earnings.
The terms of our various risk management agreements and the amount of estimated production hedged may limit the benefits we receive from an increase in oil, NGLs and natural gas prices. We may also suffer financial loss if (a) we fail to produce anticipated volumes of oil, NGLs and natural gas, particularly during periods of increasing commodity prices; or (b) counterparties to our risk management agreements fail to fulfill their obligations under the agreements, particularly during periods of declining commodity prices. The occurrence of any of the foregoing could adversely affect our ability to execute portions of our business strategy and could have a material adverse effect on our liquidity and capital position.
43
The decision to return capital to shareholders, whether through cash dividends, share buybacks or otherwise, and the amount and timing of such capital returns is subject to the discretion of the Board of Directors and will vary from time to time.
Although we currently intend to return capital to shareholders in the form of (a) a base quarterly cash dividend; (b) variable cash dividends; and/or (c) repurchases of our outstanding common stock (commonly known as share buybacks), the amount and timing of these returns of capital to shareholders may vary from time to time. The decision whether to return capital to shareholders, as well as the timing and amount of any return of capital to shareholders, is subject to the discretion of the Board of Directors, which regularly evaluates our proposed capital returns to shareholders and the requirements, if any, under Delaware General Corporation Law (“DGCL”). Additionally, in the case of share buybacks, we may be limited in our ability to repurchase shares of our common stock by various governmental laws, rules and regulations which prevent us from purchasing our common stock during periods when we are in possession of material non-public information. The level of dividends per share of common stock will also be affected by the number of outstanding shares of common stock and other securities that may be entitled to receive cash dividends or other payments.
The amount of cash available to return to shareholders, if any, can vary significantly from period to period for a number of reasons, including, among other things: our operational and financial performance; fluctuations in the costs to produce oil, NGLs and natural gas; the amount of cash required or retained for debt service or repayment; amounts required to fund capital expenditures and working capital requirements; our ability to access capital markets; foreign currency exchange rates and interest rates; any agreements relating to our indebtedness that restrict our ability to return capital to shareholders and the other risks set forth in Item 1A. Risk Factors of this Annual Report on Form 10-K. The trading price of our securities, including our common stock, may deteriorate if we are unable to meet investor expectations with respect to the timing and amount of capital returns to shareholders, and such deterioration may be material.
Regulation and Litigation Risk
We are subject to extensive federal, state, provincial and local government laws, rules and regulations that can adversely affect the cost, manner and feasibility of our business, and increased regulation in the future could increase costs, impose additional operating restrictions and cause delays.
All of our operations are subject to extensive federal, state, provincial, local and other laws, rules and regulations, including with respect to drilling operations; completion operations, including the use of hydraulic fracturing; the production of oil, NGLs and natural gas; the disposal of produced water and other hazardous waste; the gathering and transportation of oil, NGLs and natural gas; the imposition of taxes; royalty payments; environmental matters, including air and water emissions or discharges; free trade agreements; worker health and safety; and conservation policies, including policies related to environmentally sensitive areas and protected species. These laws, rules and regulations may impose substantial liabilities for our failure to comply, including the assessment of administrative, civil and criminal penalties and the issuance of injunctions restricting or prohibiting some or all of our activities in a particular area.
In the normal course of our business, we may be required to make large expenditures to comply with applicable governmental laws, rules, regulations, permits or orders. While we cannot predict the actions that future laws, rules and regulations may require or prohibit, our business could be subject to increased operating and other compliance costs and our operations may be delayed if existing laws, rules and regulations are revised or reinterpreted, or if new laws, rules and regulations become applicable to our operations. Any such increases or delays could have a material and adverse effect on our business, financial condition and results of operations.
We currently are, and from time to time in the future may be, subject to claims, litigation, administrative proceedings and regulatory actions that may not be resolved in our favor.
We currently are, and from time to time in the future may be, subject to claims, litigation, administrative proceedings and regulatory actions. The outcome of these matters may be difficult to assess or quantify, and there cannot be any assurance that such matters will be resolved in our favor. If we are unable to resolve such matters favorably, we or our directors, officers or employees may become involved in legal proceedings that could result in an onerous or unfavorable decision, including fines, sanctions, monetary damages or the inability to engage in
44
certain operations or transactions. The defence of such matters may also be costly, time consuming and could divert the attention of management and key personnel away from our operations. We may also be subject to adverse publicity associated with such matters, regardless of whether such allegations are valid or whether we are ultimately found liable. As a result, such matters could have a material adverse effect on our business, reputation, financial condition, results of operations or liquidity. See Item 3 of this Annual Report on Form 10-K.
The ability of Canadian and other non-resident shareholders to effect service of process or enforce remedies against Ovintiv, its directors, officers, experts, and assets may be limited.
We are incorporated in the State of Delaware and our principal place of business is in the United States. Most of our directors and officers are residents of the United States and many of the experts who provide us with services are residents of the United States. Additionally, most of our oil and natural gas assets and production are located in the United States. It may be difficult for our shareholders in Canada or other non-U.S. jurisdictions (each a "Foreign Jurisdiction") to (a) effect service of process within such Foreign Jurisdiction upon Ovintiv or certain of our directors, officers and representatives of experts who are not residents of the Foreign Jurisdiction (together, “Non-Residents”) and (b) enforce the judgments of courts in an applicable Foreign Jurisdiction against Ovintiv and other Non-Residents based upon liability under the laws of such Foreign Jurisdiction, including the securities laws of any province within Canada.
Tax Risks
U.S. and Canadian tax laws and regulations may change over time, and such changes may result in increased taxes on our business.
From time to time, legislation has been proposed that, if enacted into law, would make significant changes to U.S. and Canadian tax laws and regulations, including those specifically applicable to the oil and natural gas industry (such as the intangible drilling and development costs deduction under U.S. federal income tax law). While we are unable to predict the timing, scope and effect of any proposed or enacted tax law changes, elimination of certain tax deductions, as well as any other changes to, or the imposition of new, federal, state or local U.S. or Canadian taxes (including the imposition of, or increases in, production, severance or similar taxes), could materially and adversely affect our business, financial condition and results of operations. We will continue to monitor and assess any proposed or enacted tax law changes to determine the impact on our business, financial condition and results of operations and take appropriate actions, where necessary.
Additionally, U.S. and Canadian tax authorities could detrimentally change their administrative practices or may disagree with the way we calculate our tax liabilities or structure our arrangements and there are certain tax matters under governmental review for which the timing of resolution is uncertain. While we believe that our current provision for income taxes is adequate, certain tax authorities may reassess our taxes and such reassessments may be material.
Our corporate reorganization in January of 2020 may result in material Canadian and/or U.S. federal income taxes.
On January 24, 2020, Encana completed a corporate reorganization (the “Reorganization”), which included among other things, (a) a consolidation of Encana common stock on the basis of one post-consolidation share for each five pre-consolidation shares; (b) our acquisition of all of the issued and outstanding shares of Encana common stock in exchange for shares of Ovintiv common stock on a one-for-one basis and becoming the parent company of Encana and its subsidiaries and (c) our subsequent migration from Canada to the United States, becoming a Delaware corporation (the “U.S. Domestication”). We continue to carry on the business previously conducted by Encana and its subsidiaries prior to the completion of the Reorganization. The Reorganization and U.S. Domestication involved multiple complex U.S. and Canadian tax issues, including numerous assumptions and estimates of fair market value. While we believe that our analysis and application of both U.S. and Canadian tax laws to the Reorganization was correct, certain tax authorities may challenge our positions which could materially and adversely affect our business, financial condition and results of operations.
45
General Risks
The oil and natural gas industry is highly competitive and many of our competitors have available resources in excess of our own.
The oil and natural gas industry is highly competitive, and many competitors, including major integrated and independent oil and natural gas companies, as well as national oil companies, are larger and have substantially greater resources at their disposal than we do. We compete with these companies for the acquisition of oil and natural gas leases and other properties. Such competition can significantly increase costs and affect the availability of resources, which could provide our larger competitors a competitive advantage when acquiring equipment, leases and other properties.
We also compete with these companies for the personnel, including petroleum engineers, geologists, geophysicists and other key personnel, required to both (a) find, acquire, develop and operate our properties and (b) market our oil, NGLs and natural gas production. The experience, knowledge and contributions of our existing management team and directors to our immediate and near-term operations is of central importance for the foreseeable future. As such, the unexpected loss of services from, or retirement of any, of our key operations or management personnel could have a material adverse effect on our business and results of operation. In addition, the competition for qualified personnel in the oil and natural gas industry means there can be no assurance that we will be able to attract and retain key personnel with the required specialized skills necessary for our business.
We could be adversely affected by security threats, including cyber-security threats and related disruptions.
We have become increasingly dependent upon information technology systems to conduct our daily operations. We depend on a variety of information technology systems to estimate oil, NGLs and natural gas reserve quantities; process and record financial and operating data; analyze seismic and drilling information; and communicate with employees and third-party partners. This growing dependence on technology is accompanied by a greater sensitivity to cyber-attacks and information systems breaches. Unauthorized access to information systems by employees or third parties could corrupt or expose confidential, fiduciary, or proprietary information; interrupt our communications or operations; disrupt our business activities; or interfere with our competitive position. In addition, our vendors, suppliers and other business partners may separately suffer disruptions as a result of such security breaches which may directly or indirectly affect our business activities or our competitive position.
To protect our information assets and systems, we apply technical and process controls, which are reviewed by the appropriate members of senior management with oversight from our Board of Directors. These controls are in line with industry standards and are reviewed annually with peer companies to guide our focus on information security initiatives. However, these controls may not adequately prevent cyber-security breaches and we may not adopt all controls utilized by our peers. As cyber-attacks continue to evolve, we may be required to expend additional resources to investigate, mitigate and remediate any potential vulnerabilities. We may also be subject to regulatory investigations or litigation relating to cyber-security issues.
Although we have not suffered any material losses related to a cyber-security breach to date, there is no assurance that we will not suffer material losses associated with cyber-security breaches in the future. If a cyber-attack were to successfully breach our information or operating systems, we could incur substantial remediation costs and suffer other negative consequences, including exposure to significant litigation risks. The potential for such occurrences subjects our operations to increased risks that could have a material adverse effect on our business, financial condition and results of operations.
Item 1B. Unresolved Staff Comments
None.
46
Item 3. Legal Proceedings
Ovintiv is involved in various legal claims and actions arising in the normal course of the Company’s operations. Although the outcome of these claims cannot be predicted with certainty, the Company does not expect these matters to have a material adverse effect on Ovintiv’s financial position, cash flows or results of operations. If an unfavorable outcome were to occur, there exists the possibility of a material impact on the Company’s consolidated net earnings or loss for the period in which the effect becomes reasonably estimable. See Item 1A. Risk Factors of this Annual Report on Form 10-K, “We currently are, and from time to time in the future may be, subject to claims, litigation, administrative proceedings and regulatory actions that may not be resolved in the Company’s favor”.
In July 2020, the Company received a Notice of Violation (“NOV”) from the U.S. Environmental Protection Agency (“EPA”) and the Utah Department of Environmental Quality, Division of Air Quality (“UDAQ”). The NOV alleges violations under the federal Clean Air Act, the State of Utah’s State Implementation Plan, and the State of Utah’s air quality regulations for the oil and natural gas industry, at certain of the Company facilities located in the Uinta Basin. The Company has exchanged information with the EPA and UDAQ and is engaged in discussions aimed at resolving the allegations. The Company is unable to predict the financial impact of the NOV or the timing of its resolution at this time. Resolution of the matter may result in monetary sanctions of more than $300,000.
For additional information, see Note 27 to Ovintiv’s audited Consolidated Financial Statements under Item 8 of this Annual Report on Form 10-K.
Item 4. Mine Safety Disclosures
Not applicable.
47
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
Market Information
Ovintiv’s shares of common stock are listed and posted for trading on the NYSE and TSX under the symbol “OVV”.
Shareholders
The Company is authorized to issue up to 775,000,000 shares of stock consisting of: (a) 750,000,000 shares of common stock, par value $0.01 per share, and (b) 25,000,000 shares of preferred stock, par value $0.01 per share. As at February 18, 2022, there were 256,769,168 shares of common stock outstanding held by 5,230 shareholders of record, and no shares of preferred stock outstanding.
Capital Return Information
In 2021, the Company paid a quarterly dividend of $0.09375 per share for each of the first two quarters and $0.14 per share for the third and fourth quarters (2020: $0.09375 per share each quarter) and $0.4675 per share annually (2020: $0.375 per share annually). On February 24, 2022 the Board of Directors declared a dividend of $0.20 per share of Ovintiv common stock payable on March 31, 2022 to common shareholders of record as of March 15, 2022. The Company currently pays dividends quarterly to shareholders of record as of the 15th day (or the previous business day) of the last month of each calendar quarter, with the last business day of the same month being the corresponding payment date.
On September 9, 2021 the Company announced a new capital allocation framework commencing in the fourth quarter of 2021, where the Company is committed to return 25 percent of Non-GAAP Cash Flow in excess of capital expenditures and base dividends in the form of share buybacks and/or variable dividends at the discretion of the Board. During the fourth quarter of 2021, the Company elected share buybacks under the capital allocation framework.
Although we currently intend to return capital to shareholders in the form of (a) a base quarterly cash dividend; (b) variable cash dividends; and/or (c) repurchases of our outstanding common stock (commonly known as share buybacks), the amount and timing of these returns of capital to shareholders may vary from time to time. The decision whether to return capital to shareholders, as well as the timing and amount of any return of capital to shareholders, is subject to the discretion of the Board of Directors, which regularly evaluates our proposed capital returns to shareholders and the requirements, if any, under DGCL. See Item 1A. Risk Factors of this Annual Report on Form 10‐K, “The decision to return capital to shareholders, whether through cash dividends, share buybacks or otherwise, and the amount and timing of such capital returns is subject to the discretion of the Board of Directors and will vary from time to time”.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
Information concerning securities authorized for issuance under equity compensation plans is set forth in the Proxy Statement relating to the Company’s 2022 annual meeting of shareholders, which is incorporated herein by reference.
48
PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PERSONS
On September 28, 2021, Ovintiv announced it had received regulatory approval to purchase, for cancellation, up to 26 million shares of common stock pursuant to a NCIB over a 12-month period from October 1, 2021 to September 30, 2022. The number of shares of common stock authorized for purchase represents 10 percent of Ovintiv's public float as of September 20, 2021.
During the three months ended December 31, 2021, the Company purchased approximately 3 million shares of common stock for total consideration of approximately $111 million at a weighted average price of $36.18 per share. The following table presents the shares of common stock purchased during the three months ended December 31, 2021.
(1) Includes commissions.
RECENT SALES OF UNREGISTERED EQUITY SECURITIES
None.
49
PERFORMANCE GRAPH
The following performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall information be incorporated by reference into any future filing under the Securities Act of 1933, as amended (the “Securities Act”) or the Exchange Act, except to the extent that the Company specifically incorporates it by reference into such filing.
The following graph compares the cumulative five-year total return to shareholders of the Company’s common stock relative to the cumulative total returns of the S&P 400 and the SPDR Oil & Gas Exploration & Production ETF (“XOP U.S. Equity”). The graph was prepared assuming $100 was invested on December 31, 2016 in the Company’s common stock, the S&P 400 and the XOP U.S. Equity, and dividends have been reinvested subsequent to the initial investment. The graph is included for historical comparative purposes only and should not be considered indicative of future performance.
Comparison of 5-Year Cumulative Total Return Among
Ovintiv, the S&P 400 and XOP U.S. Equity
(US$100 Invested in Base Period)
Item 6. [Reserved]
Not Applicable.
50
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The MD&A is intended to provide a narrative description of the Company’s business from management’s perspective which includes an overview of Ovintiv’s consolidated 2021 results and year-over-year comparisons between 2021 and 2020 results. This MD&A should be read in conjunction with the audited Consolidated Financial Statements and accompanying notes for the year ended December 31, 2021 (“Consolidated Financial Statements”), which are included in Item 8 of this Annual Report on Form 10-K. Discussion and analysis of 2019 results and year-over-year comparisons between 2020 and 2019 results that are not included in this Form 10-K, and can be found in Item 7 of the 2020 Annual Report on Form 10-K.
Common industry terms and abbreviations are used throughout this MD&A and are defined in the Definitions, Conversions and Conventions sections of this Annual Report on Form 10-K. This MD&A includes the following sections:
• Executive Overview
• Results of Operations
• Liquidity and Capital Resources
• Accounting Policies and Estimates
• Non-GAAP Measures
Executive Overview
Strategy
Ovintiv is a leading North American energy producer that is focused on developing its multi-basin portfolio of oil, NGLs and natural gas producing plays as part of its strategy outlined in Items 1 and 2 of this Annual Report on Form 10-K. Ovintiv is committed to growing long-term shareholder value by delivering on its strategic priorities through execution excellence, disciplined capital allocation, commercial acumen and risk management, while driving environmental, social and governance progress. The Company’s strategy is founded on its multi-basin portfolio of top tier assets, financial strength, as well as its core and foundational values.
In support of the Company’s commitment to growing shareholder value, Ovintiv implemented a capital allocation framework in 2021 that outlines increasing returns to shareholders as well as continuing the Company’s progress on debt reduction.
Ovintiv is delivering results in a socially and environmentally responsible manner. Thoughtfully developed best practices are deployed across its assets, allowing the Company to capitalize on operational efficiencies and decrease emissions intensity. The Company’s sustainability reporting, which outlines its key metrics and progress achieved relating to ESG practices can be found on the Company’s website.
Ovintiv continually reviews and evaluates its strategy and changing market conditions in order to maximize cash flow generation from its Core Assets located in some of the best plays in North America. As at December 31, 2021, the Core Assets comprised Permian and Anadarko in the U.S., and Montney in Canada. These Core Assets form a multi-basin portfolio of oil, NGLs and natural gas producing plays enabling flexible and efficient investment of capital that support the Company’s strategy.
Underpinning Ovintiv’s strategy are core values of one, agile, innovative and driven, which guide the organization to be collaborative, responsive, flexible and determined. The Company is committed to excellence with a passion to drive corporate financial performance and succeed as a team.
For additional information on reporting segments and the plays in which the Company operates, refer to Items 1 and 2 of this Annual Report on Form 10-K. For additional information on the segmented results, refer to Note 2 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
51
In evaluating its operations and assessing its leverage, Ovintiv reviews performance-based measures such as Non-GAAP Cash Flow, Non-GAAP Cash Flow Margin, Total Costs and debt-based metrics such as Debt to Adjusted Capitalization, Net Debt and Net Debt to Adjusted EBITDA, which are non-GAAP measures and do not have any standardized meaning under U.S. GAAP. These measures may not be similar to measures presented by other issuers and should not be viewed as a substitute for measures reported under U.S. GAAP. Additional information regarding these measures, including reconciliations to the closest GAAP measure, can be found in the Non-GAAP Measures section of this MD&A.
Highlights
During 2021, the Company focused on executing its 2021 capital plan aimed at maximizing profitability through operational and capital efficiencies, delivering cash from operating activities and using excess cash flows to reduce total long-term debt. Higher upstream product revenues in 2021 compared to 2020 resulted from higher average realized prices, excluding the impact of risk management activities. Increases in average realized natural gas and liquids prices of 91 percent and 90 percent, respectively, were primarily due to higher benchmark prices. Ovintiv continues to focus on optimizing realized prices from the diversification of the Company’s downstream markets.
The Company continued to deliver significant cash from operating activities while reducing its total long-term debt balance. Cash from operating activities of $3,129 million included a net realized loss of $1,362 million on the settlement of commodity and foreign exchange risk management positions and a current income tax recovery of $156 million primarily due to the resolution of prior years’ tax items. The Company used excess cash flows to reduce its total long-term debt balance by $2.1 billion in 2021.
Significant Developments
52
Financial Results
• Paid dividends of $0.4675 per share of common stock totaling $122 million.
• Reduced total long-term debt by $2.1 billion.
• Reported Net Debt to Adjusted EBITDA of 1.4 times.
Capital Investment
Production
Operating Expenses
Additional information on Total Costs items and Total Operating Expenses above can be found in the Results of Operations section of this MD&A.
53
2022 Outlook
Industry Outlook
Oil Markets
The oil and gas industry is cyclical and commodity prices are inherently volatile. Oil prices reflect global supply and demand dynamics as well as the geopolitical and macroeconomic environment.
In 2021, OPEC+ production cuts and increased global demand for oil resulted in upward pressures on oil prices and the tightening of global oil inventories. Oil prices during 2022 will continue to be impacted by the global containment of the coronavirus (“COVID-19”), pace of economic recovery, OPEC+ production levels, and the potential for higher U.S. production.
COVID-19 vaccine rollout/uptake continues to drive optimism, however, emerging COVID-19 variants may impact economic progress while the gradual easing of OPEC+ oil production cuts, the potential for higher U.S. oil production, and macroeconomic risks could contribute to commodity market uncertainty. Since the second quarter of 2021, OPEC+ has gradually increased production in response to increases in oil demand. OPEC+ continues to meet regularly to review the state of global oil supply, demand and inventory levels, and is expected to continue with its planned production increases in 2022.
Natural Gas Markets
Natural gas prices are primarily affected by structural changes in supply and demand as well as deviations from seasonally normal weather. In 2021, supportive weather conditions, limited supply growth from U.S. producers and increased electricity usage contributed to increased drawdowns of natural gas inventory and higher natural gas prices. Natural gas prices in 2022 are expected to be impacted by the interplay between gas production and associated gas from oil production, as well as changes in demand from the power generation sector, changes in export levels of liquified natural gas and impacts from seasonal weather.
Company Outlook
The Company continues to exercise discretion and discipline to optimize capital allocation throughout 2022 as oil demand recovers and the commodity price environment evolves. Ovintiv pursues innovative ways to reduce upstream operating and administrative expenses and expects to benefit from durable cost savings and efficiencies to maximize cash flows.
Markets for crude oil and natural gas are exposed to different price risks and are inherently volatile. While the market price for crude oil tends to move in the same direction as the global market, regional differentials may develop. Natural gas prices may vary between geographic regions depending on local supply and demand conditions. To mitigate price volatility and help sustain revenues, particularly during periods of low commodity prices, the Company enters into derivative financial instruments. As at December 31, 2021, the Company has hedged approximately 80.0 Mbbls/d of expected oil and condensate production and 1,293 MMcf/d of expected natural gas production for 2022. In addition, Ovintiv proactively utilizes transportation contracts to diversify the Company’s sales markets, thereby reducing significant exposure to any given market and regional pricing.
Additional information on Ovintiv’s hedging program can be found in Note 25 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Capital Investment
The Company plans to spend approximately $1.5 billion on its 2022 capital investment program. The majority of this capital program is expected to be allocated to the Core Assets with a focus on maximizing returns from high margin liquids. In 2022, the Company expects to generate cash flows in excess of capital expenditures.
Ovintiv continually strives to improve well performance and lower costs through innovative techniques. Initiatives such as applying Simul-Frac techniques, a process of fracking pairs of wells at the same time instead of a single well, increases operational efficiencies and contributes to well cost savings. Ovintiv's large-scale cube development
54
model utilizes multi-well pads and advanced completion designs to maximize returns and resource recovery from its reservoirs. Ovintiv’s disciplined capital program and continuous innovation create flexibility to allocate capital in changing commodity markets and to maximize cash flows while preserving the long-term value of the Company’s multi-basin portfolio.
Production
Ovintiv is strategically positioned in the current economic environment to maintain a flat liquids production profile while generating cash flows in excess of capital expenditures.
In 2022, the Company expects average oil and plant condensate production volumes of approximately 180.0 Mbbls/d to 190.0 Mbbls/d, other NGLs production volumes of approximately 78.0 Mbbls/d to 82.0 Mbbls/d and natural gas production volumes of approximately 1,450 MMcf/d to 1,500 MMcf/d.
Operating Expenses
The Company continues to benefit from cost savings measures implemented in 2020 which included workforce reductions and operating efficiencies. With rising activity in the oil and gas industry and the recovery of commodity prices, service and supply costs are expected to increase. Ovintiv continues to pursue innovative ways to reduce upstream operating and administrative expenses, and strives to minimize any inflationary pressures with efficiency improvements and effective supply chain management.
Total Costs per BOE is expected to increase for 2022 primarily due to higher production taxes resulting from expected strengthening of commodity prices and higher transportation and processing costs. For 2022, Ovintiv expects Total Costs of approximately $14.75 per BOE to $15.25 per BOE. Total Costs is defined in the Non-GAAP Measures section of this MD&A.
Long-Term Debt Reduction
Ovintiv remains focused on strengthening its balance sheet. Since the second quarter of 2020, the Company has allocated $2,580 million in excess cash flows to reduce its total long-term debt balance, which included proceeds from the Duvernay and Eagle Ford asset divestitures. The Company expects to achieve its Net Debt balance of $3.0 billion in the second half of 2022, assuming commodity prices of $85.00 per barrel for WTI oil and $4.50 per MMBtu for NYMEX natural gas.
In June 2021, the Company redeemed its $600 million, 5.75 percent senior notes due January 30, 2022, and in August 2021, redeemed its $518 million, 3.90 percent senior notes due November 15, 2021. The combined debt redemptions will result in annualized interest savings of over $50 million.
As at December 31, 2021, the Company had no outstanding balances under its revolving credit facilities and U.S. dollar commercial paper programs.
Additional information on Ovintiv’s long-term debt and liquidity position can be found in Note 15 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K and the Liquidity and Capital Resources section of this MD&A, respectively.
Additional information on Ovintiv’s 2022 Corporate Guidance can be accessed on the Company’s website at www.ovintiv.com.
Environmental, Social and Governance
Ovintiv recognizes the importance of reducing its environmental footprint and voluntarily participates in emission reduction programs. The Company has adopted a range of strategies to help reduce emissions from its operations. These strategies include incorporating new and proven technologies and optimizing processes in its drilling and completions operations, and working closely with third-party providers to develop best practices. The Company continues to look for innovative techniques and efficiencies to help maintain its commitment to emission reductions.
55
As of September 1, 2021, the Company is in alignment with the World Bank Zero Routine Flaring initiative, nine years ahead of the World Bank’s target date of 2030. Ovintiv does not engage in routine flaring by ensuring natural gas gathering infrastructure is in place for all of its producing wells.
As of December 31, 2021, the Company exceeded its targeted 33 percent reduction in methane emissions intensity four years ahead of schedule and achieved a greater than 20 percent reduction in Scope 1 and 2 GHG emissions intensity compared to 2019 levels. In 2022, the Company announced a further GHG emissions intensity reduction target of 50 percent compared to 2019 levels, to be achieved by 2030. This new emissions reduction target is also tied to its annual compensation program for all employees.
Ovintiv is committed to diversity, equity and inclusion. In 2021, the Company developed a new social commitment framework, which is rooted in the Company’s foundational values of integrity, safety, sustainability, trust and respect. The framework focuses on respecting stakeholders, strengthening communities and fostering a culture of inclusion.
Ovintiv remains committed to protecting the health and safety of its workforce. Safety is a foundational value at Ovintiv and plays a critical role in the Company’s belief that a safe workplace is a strong indicator of a well-managed business. This safety-oriented mindset enables the Company to quickly respond to emergencies and minimize any impacts to employees and business continuity. From the onset of the COVID-19 pandemic, Ovintiv established a Pandemic Response Team to continually assess the impact of COVID-19 and develop protocols and procedures to maintain a safe working environment for its staff. Despite the challenges presented by COVID-19, the Company reported its eighth consecutive safest year in 2021.
Additional information on Ovintiv’s ESG practices are outlined in Items 1 and 2 of this Annual Report on Form 10-K, and on the Company’s sustainability website at https://sustainability.ovintiv.com.
56
Results of Operations
Selected Financial Information
Product and Service Revenues
Upstream product revenues $ 7,420 $ 4,044
Service revenues (1) 5 6
Total Product and Service Revenues 10,468 5,509
Gains (Losses) on Risk Management, Net (1,883 ) 507
Sublease Revenues 73 71
Total Other (Income) Expenses 280 333
Net Earnings (Loss) Before Income Tax 1,239 (5,730 )
Income Tax Expense (Recovery) (177 ) 367
(1) Service revenues include amounts related to the USA and Canadian Operations.
Revenues
Ovintiv’s revenues are substantially derived from sales of oil, NGLs and natural gas production. Increases or decreases in Ovintiv’s revenue, profitability and future production are highly dependent on the commodity prices the Company receives. Prices are market driven and fluctuate due to factors beyond the Company’s control, such as supply and demand, seasonality and geopolitical and economic factors. The USA Operations realized prices generally reflect WTI and NYMEX benchmark prices, as well as other downstream oil benchmarks, including Houston. The Canadian Operations realized prices are linked to Edmonton Condensate and AECO, as well as other downstream natural gas benchmarks, including Dawn. The other downstream benchmarks reflect the diversification of the Company’s markets. Recent trends in benchmark prices relevant to the Company are shown in the table below.
Benchmark Prices
Oil & NGLs
Natural Gas
57
Production Volumes and Realized Prices
Production Volumes (1) Realized Prices (2)
Oil (Mbbls/d, $/bbl)
NGLs – Plant Condensate (Mbbls/d, $/bbl)
NGLs – Other (Mbbls/d, $/bbl)
Total Oil & NGLs (Mbbls/d, $/bbl)
Natural Gas (MMcf/d, $/Mcf)
Total Production (MBOE/d, $/BOE)
Production Mix (%)
Oil & Plant Condensate 36 37
Total Oil & NGLs 51 53
Production Change – Year Over Year (%) (3)
Total Oil & NGLs (5 ) (4 )
Natural Gas 2 (3 )
Total Production (2 ) (4 )
Core Assets Production
NGLs – Plant Condensate (Mbbls/d) 48.8 46.3
NGLs – Other (Mbbls/d) 76.2 75.8
% of Total Production 89 84
(1) Average daily.
(2) Average per-unit prices, excluding the impact of risk management activities.
(3) Includes production impacts of acquisitions and divestitures.
58
Upstream Product Revenues
($ millions) Oil NGLs - Plant Condensate NGLs - Other Natural Gas Total
Increase (decrease) due to:
Oil Revenues
2021 versus 2020
Oil revenues increased $1,322 million compared to 2020 primarily due to:
NGL Revenues
2021 versus 2020
NGL revenues increased $1,065 million compared to 2020 primarily due to:
59
Natural Gas Revenues
2021 versus 2020
Natural gas revenues increased $985 million compared to 2020 primarily due to:
Gains (Losses) on Risk Management, Net
As a means of managing commodity price volatility, Ovintiv enters into commodity derivative financial instruments on a portion of its expected oil, NGLs and natural gas production volumes. The Company’s commodity price mitigation program reduces volatility and helps sustain revenues during periods of lower prices. Additional information on the Company’s commodity price positions as at December 31, 2021 can be found in Note 25 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
The following table provides the effects of the Company’s risk management activities on revenues.
$ millions Per-Unit
Realized Gains (Losses) on Risk Management
Commodity Price (1)
Other (2) 1 9 $ - $ -
Unrealized Gains (Losses) on Risk Management (488 ) (204 )
Total Gains (Losses) on Risk Management, Net $ (1,883 ) $ 507
Ovintiv recognizes fair value changes from its risk management activities each reporting period. The changes in fair value result from new positions and settlements that occur during each period, as well as the relationship between contract prices and the associated forward curves. Realized gains or losses on risk management activities related to commodity price mitigation are included in the USA Operations, Canadian Operations and Market Optimization revenues as the contracts are cash settled. Unrealized gains or losses on fair value changes of unsettled contracts are included in the Corporate and Other segment. Additional information on fair value changes can be found in Note 24 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
60
Market Optimization Revenues
Market Optimization product revenues relate to activities that provide operational flexibility and cost mitigation for transportation commitments, product type, delivery points and customer diversification. Ovintiv also purchases and sells third-party volumes under marketing arrangements associated with the Company’s previous divestitures.
2021 versus 2020
Market Optimization product revenues increased $1,584 million compared to 2020 primarily due to:
partially offset by:
Sublease Revenues
Sublease revenues primarily include amounts related to the sublease of office space in The Bow office building recorded in the Corporate and Other segment. Additional information on office sublease income can be found in Note 14 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Operating Expenses
Production, Mineral and Other Taxes
Production, mineral and other taxes include production and property taxes. Production taxes are generally assessed as a percentage of oil, NGLs and natural gas production revenues. Property taxes are generally assessed based on the value of the underlying assets.
$ millions $/BOE
2021 versus 2020
Production, mineral and other taxes increased $120million compared to 2020 primarily due to:
61
Transportation and Processing
Transportation and processing expense includes transportation costs incurred to move product from production points to sales points including gathering, compression, pipeline tariffs, trucking and storage costs. Ovintiv also incurs costs related to processing provided by third parties or through ownership interests in processing facilities.
$ millions $/BOE
2021 versus 2020
Transportation and processing expense increased $114 million compared to 2020 primarily due to:
partially offset by:
Operating
Operating expense includes costs paid by the Company, net of amounts capitalized, on oil and natural gas properties in which the Company has a working interest. These costs primarily include labor, service contract fees, chemicals, fuel, water hauling, electricity and workovers.
$ millions $/BOE
Market Optimization 25 22
Corporate & Other (1 ) (2 )
62
2021 versus 2020
Operating expense increased $20 million compared to 2020 primarily due to:
partially offset by:
Additional information on the Company’s long-term incentive costs can be found in Note 22 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Purchased Product
Purchased product expense includes purchases of oil, NGLs and natural gas from third parties that are used to provide operational flexibility and cost mitigation for transportation commitments, product type, delivery points and customer diversification. The Company also purchases and sells third-party volumes under marketing arrangements associated with the Company’s previous divestitures.
2021 versus 2020
Purchased product expense increased $1,585million compared to 2020 primarily due to:
partially offset by:
Depreciation, Depletion & Amortization
Proved properties within each country cost centre are depleted using the unit-of-production method based on proved reserves as discussed in Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Depletion rates are impacted by impairments, acquisitions, divestitures and foreign exchange rates, as well as fluctuations in 12-month average trailing prices which affect proved reserves volumes. Corporate assets are carried at cost and depreciated on a straight-line basis over the estimated service lives of the assets.
Additional information can be found under Upstream Assets and Reserve Estimates in the Critical Accounting Estimates section of this MD&A.
$ millions $/BOE
Corporate & Other 21 29
63
2021 versus 2020
DD&A decreased $644million compared to 2020 primarily due to:
The depletion rate in the USA Operations decreased $4.10 per BOE compared to 2020 primarily due to the ceiling test impairments recognized in 2020 and the sale of the Eagle Ford assets in the second quarter of 2021. The depletion rate in the Canadian Operations decreased $1.32 per BOE compared to 2020 primarily due to the sale of the Duvernay assets in the second quarter of 2021.
Impairments
Under full cost accounting, the carrying amount of Ovintiv’s oil and natural gas properties within each country cost centre is subject to a ceiling test performed quarterly. Ceiling test impairments are recognized when the capitalized costs, net of accumulated depletion and the related deferred income taxes, exceed the sum of the estimated after-tax future net cash flows from proved reserves as calculated under SEC requirements using the 12‐month average trailing prices and discounted at 10 percent. The 12-month average trailing price is calculated as the average of the price on the first day of each month within the trailing 12-month period.
In 2021, the Company did not recognize ceiling test impairments (2020 - $5,580 million before tax, in the USA Operations). The non-cash ceiling test impairments in 2020 primarily resulted from the decline in the 12-month average trailing prices, which reduced proved reserves.
The 12-month average trailing prices used in the ceiling test calculations were based on the benchmark prices below. The benchmark prices were adjusted for basis differentials to determine local reference prices, transportation costs and tariffs, heat content and quality.
Oil & NGLs Natural Gas
WTI ($/bbl) Edmonton Condensate (C$/bbl) Henry Hub ($/MMBtu) AECO (C$/MMBtu)
12-Month Average Trailing Reserves Pricing (1)
The Company believes that the discounted after-tax future net cash flows from proved reserves required to be used in the ceiling test calculation are not indicative of the fair market value of Ovintiv’s oil and natural gas properties or the future net cash flows expected to be generated from such properties. The discounted after-tax future net cash flows do not consider the fair market value of unamortized unproved properties, or probable or possible liquids and natural gas reserves. In addition, there is no consideration given to the effect of future changes in commodity prices. Ovintiv manages its business using estimates of reserves and resources based on forecast prices and costs. Additional information on the ceiling test calculation can be found in Note 10 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
64
Administrative
Administrative expense represents costs associated with corporate functions provided by Ovintiv staff. Costs primarily include salaries and benefits, operating lease, office, information technology, restructuring and long-term incentive costs.
$ millions $/BOE
Administrative, excluding Long-Term Incentive Costs,
Current expected credit losses 1 1 - -
2021 versus 2020
Administrative expense increased $47 million compared to 2020 primarily due to:
partially offset by:
During 2020, the Company completed workforce reductions as part of a company-wide reorganization in response to the low commodity price environment resulting from the global pandemic and the Company’s planned reductions in capital spending. Additional information on restructuring charges and long-term incentive costs can be found in Notes 21 and 22, respectively, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Other (Income) Expenses
Foreign exchange (gain) loss, net (23 ) 17
Other (gains) losses, net (37 ) (55 )
Total Other (Income) Expenses $ 280 $ 333
Interest
Interest expense primarily includes interest on Ovintiv’s long-term debt. Additional information on changes in interest can be found in Note 4 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
2021 versus 2020
Interest expense decreased $31 million compared to 2020 primarily due to:
65
partially offset by:
Foreign Exchange (Gain) Loss, Net
Foreign exchange gains and losses primarily result from the impact of fluctuations in the Canadian to U.S. dollar exchange rate. Additional information on changes in foreign exchange gains or losses can be found in Note 5 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Additional information on foreign exchange rates and the effects of foreign exchange rate changes can be found in Item 7A of this Annual Report on Form 10-K.
Following the completion of the corporate reorganization and U.S. domestication in the first quarter of 2020, the U.S. dollar denominated unsecured notes issued by Encana Corporation from Canada were assumed by Ovintiv Inc., a company incorporated in Delaware with a U.S. dollar functional currency. Accordingly, these U.S. dollar denominated unsecured notes, along with certain intercompany notes, no longer attract foreign exchange translation gains or losses.
2021 versus 2020
Net foreign exchange gain was $23 million compared to a loss of $17 million in 2020 primarily due to:
partially offset by:
Other (Gains) Losses, Net
Other (gains) losses, net, primarily includes other non-recurring revenues or expenses and may also include items such as interest income, interest received from tax authorities, transaction costs relating to acquisitions, reclamation charges relating to decommissioned assets, gains on debt repurchases, government stimulus programs and adjustments related to other assets.
Other gains in 2021 includes interest income of $14 million primarily associated with the resolution of prior years’ tax items.
Other gains in 2020 primarily included gains of $30 million relating to the repurchase of the Company’s fixed long-term debt on the open market and interest income of $5 million.
66
Income Tax
Current Income Tax Expense (Recovery) $ (156 ) $ (14 )
Deferred Income Tax Expense (Recovery) (21 ) 381
Income Tax Expense (Recovery) $ (177 ) $ 367
Effective Tax Rate (14.3% ) (6.4% )
Income Tax Expense (Recovery)
2021 versus 2020
In 2021, Ovintiv recorded an income tax recovery of $177 million compared to an income tax expense of $367 million in 2020, primarily due to the resolution of prior years’ tax items and the change in valuation allowances.
Deferred income tax assets are routinely assessed for realizability. During the year ended December 31, 2020, the Company determined, after weighing both positive and negative evidence, that a valuation allowance should be recorded to reduce the associated deferred tax assets in the U.S. and in Canada. Accordingly, a valuation allowance of $568 million was recognized in Canada related to prior years’ deferred tax assets during the year ended December 31, 2020. As at December 31, 2021, the Company continues to be in a cumulative three-year loss position in both the U.S. and Canada and as such, continues to recognize the valuation allowance against net deferred tax assets. The cumulative three-year losses and uncertainty in the timing as to when the realization of deferred tax assets will occur, is significant negative evidence to overcome, and consequently, it is more likely than not that the deferred tax assets will not be realizable. However, if market conditions continue to improve, it is possible that a portion of the valuation allowance in Canada may be reversed within the next 12 months.
Effective Tax Rate
The Company’s annual effective income tax rate is primarily impacted by earnings, changes in valuation allowances, amounts in respect of prior periods, state taxes, income tax related to foreign operations, the effect of legislative changes, and tax differences on divestitures and transactions.
The Company’s effective tax rate was (14.3) percent for 2021, which is lower than the U.S. federal statutory tax rate of 21 percent primarily due to the resolution of prior years’ tax items and the change in valuation allowances.
The Company’s effective tax rate was (6.4) percent for 2020, which is lower than the U.S. federal statutory tax rate of 21 percent primarily due to valuation allowances recorded relating to net losses arising from ceiling test impairments and an increase in the valuation allowance of $568 million in Canada related to prior years’ deferred tax assets.
The determination of income and other tax liabilities of the Company and its subsidiaries requires interpretation of complex domestic and foreign tax laws and regulations, that are subject to change. The Company’s interpretation of tax laws may differ from the interpretation of the tax authorities. As a result, there are tax matters under review for which the timing of resolution is uncertain. The Company believes that the provision for income taxes is adequate.
Additional information on income taxes can be found in Note 6 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
67
Liquidity and Capital Resources
Sources of Liquidity
The Company has the flexibility to access cash equivalents and a range of funding alternatives at competitive rates through committed revolving credit facilities as well as debt and equity capital markets. Ovintiv closely monitors the accessibility of cost-effective credit and ensures that sufficient liquidity is in place to fund capital expenditures and dividend payments. In addition, the Company may use cash and cash equivalents, cash from operating activities, or proceeds from asset divestitures to fund its operations or to manage its capital structure as discussed below. At December 31, 2021, $188 million in cash and cash equivalents was held by Canadian subsidiaries. The cash held by Canadian subsidiaries is accessible and may be subject to additional U.S. income taxes and Canadian withholding taxes if repatriated.
The Company’s capital structure consists of total shareholders’ equity plus long-term debt, including any current portion. The Company’s objectives when managing its capital structure are to maintain financial flexibility to preserve Ovintiv’s access to capital markets and its ability to meet financial obligations and finance internally generated growth, as well as potential acquisitions. Ovintiv has a practice of maintaining capital discipline and strategically managing its capital structure by adjusting capital spending, adjusting dividends paid to shareholders, issuing new shares of common stock, purchasing shares of common stock for cancellation, issuing new debt and repaying or repurchasing existing debt.
($ millions, except as indicated) 2021 2020
Cash and Cash Equivalents $ 195 $ 10
Available Uncommitted Demand Lines (2) 300 269
Issuance of U.S. Commercial Paper - (352 )
Long-Term Debt, including current portion $ 4,786 $ 6,885
Total Shareholders’ Equity (3) $ 5,074 $ 3,837
Debt to Capitalization (%) (4) 49 64
Debt to Adjusted Capitalization (%) (5) 27 37
The Company has access to two committed revolving U.S. dollar denominated credit facilities totaling $4.0 billion, which include a $2.5 billion revolving credit facility for Ovintiv Inc. and a $1.5 billion revolving credit facility for a Canadian subsidiary, both maturing in July 2024. The Credit Facilities provide financial flexibility and allow the Company to fund its operations or capital program. At December 31, 2021, there were no outstanding amounts under the revolving Credit Facilities and the Company continues to have full access to its Credit Facilities.
During the fourth quarter of 2021, Ovintiv’s credit rating was upgraded to investment grade by one of its credit rating agencies driven by Ovintiv’s significant debt reductions and improved commodity price assumptions used by the rating agency. As a result of the upgrade, most of Ovintiv’s credit ratings are investment grade.
Depending on the Company’s credit rating and market demand, the Company may issue from its two U.S. CP programs, which include a $1.5 billion program for Ovintiv Inc. and a $1.0 billion program for a Canadian subsidiary. As at December 31, 2021, the Company had no commercial paper outstanding under its U.S. CP programs and continues to have full access to its U.S. CP programs.
The Credit Facilities, uncommitted demand lines, and cash and cash equivalents provide Ovintiv with total liquidity of approximately $4.5 billion. At December 31, 2021, Ovintiv also had approximately $36 million in undrawn
68
letters of credit issued in the normal course of business primarily as collateral security, related to transportation arrangements and to support future abandonment liabilities.
Ovintiv has a U.S. shelf registration statement and a Canadian shelf prospectus, under which the Company may issue from time to time, debt securities, common stock, preferred stock, warrants, units, share purchase contracts and share purchase units in the U.S. and/or Canada. At December 31, 2021, $6.0 billion remained accessible under the Canadian shelf prospectus. The ability to issue securities under the U.S. shelf registration statement or Canadian shelf prospectus is dependent upon market conditions and securities law requirements.
Ovintiv is currently in compliance with, and expects that it will continue to be in compliance with, all financial covenants under the Credit Facilities. Management monitors Debt to Adjusted Capitalization, which is a non-GAAP measure defined in the Non-GAAP Measures section of this MD&A, as a proxy for Ovintiv’s financial covenant under the Credit Facilities, which requires Debt to Adjusted capitalization to be less than 60 percent. As at December 31, 2021, the Company’s Debt to Adjusted Capitalization was 27 percent. The definitions used in the covenant under the Credit Facilities adjust capitalization forcumulative historical ceiling test impairments recorded in conjunction with the Company’s January 1, 2012 adoption of U.S. GAAP. Ovintiv does not expect the current COVID-19 pandemic to impact the Company’s ability to remain in compliance with its financial covenants under the Credit Facilities. Additional information on financial covenants can be found in Note 15 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
69
Sources and Uses of Cash
During 2021, the Company primarily generated cash through operating activities and divestitures. The following table summarizes the sources and uses of the Company’s cash and cash equivalents.
Sources of Cash, Cash Equivalents and Restricted Cash
Cash from operating activities Operating $ 3,129 $ 1,895
Proceeds from divestitures Investing 1,025 89
Net issuance of revolving long-term debt Financing - 252
Uses of Cash and Cash Equivalents
Capital expenditures Investing 1,519 1,736
Acquisitions Investing 11 19
Net repayment of revolving long-term debt Financing 950 -
Repayment of long-term debt (1) Financing 1,137 272
Purchase of shares of common stock Financing 111 -
Dividends on shares of common stock Financing 122 97
Other Financing/Investing 119 287
Increase (Decrease) in Cash, Cash Equivalents and Restricted Cash $ 185 $ (180 )
(1) Includes open market repurchases in 2020.
Operating Activities
Net cash from operating activities in 2021 was $3,129 million and was primarily a reflection of the impacts from higher average realized commodity prices, partially offset by the effects of the Company’s commodity price mitigation program and changes in non‐cash working capital.
Additional detail on changes in non-cash working capital can be found in Note 26 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Ovintiv expects it will continue to meet the payment terms of its suppliers.
Non-GAAP Cash Flow in 2021 was $3,209million and was primarily impacted by the items affecting cash from operating activities which are discussed below and in the Results of Operations section of this MD&A.
2021 versus 2020
Net cash from operating activities increased $1,234million compared to 2020 primarily due to:
partially offset by:
70
Investing Activities
The Company’s primary investing activities are capital expenditures, divestitures and acquisitions, and are summarized in Notes 2 and 9 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
2021 and 2020
Net cash used in investing activities in 2021 was $525million primarily due to capital expenditures, partially offset by proceeds from divestitures. Capital expenditures decreased $217 million compared to 2020 due to the Company’s reduced capital program in response to the volatile market conditions that commenced at the end of the first quarter of 2020 as well as the Company’s drive to maintain capital discipline while maximizing efficiency gains.
Acquisitions in 2021 were $11 million (2020 - $19 million), which primarily included property purchases with oil and liquids rich potential.
Divestitures in 2021 were $1,025 million, which primarily included the sale of the Eagle Ford assets in south Texas and Duvernay assets in west central Alberta, totaling approximately $1.0 billion, after closing and other adjustments, as well as certain properties that did not complement Ovintiv’s existing portfolio of assets. Divestitures in 2020 were $89 million, which primarily included the sale of certain properties that did not complement Ovintiv’s existing portfolio of assets.
Financing Activities
Net cash used in financing activities has been impacted by the Company’s strategy to enhance liquidity, strengthen its balance sheet by repaying or repurchasing existing debt, and returning value to shareholders through the purchase of shares of common stock and paying dividends.
2021 versus 2020
Net cash used in financing activities in 2021 increased $2,213 million compared to 2020. The increase was primarily due to a net repayment of revolving long-term debt in 2021 of $950 million compared to a net issuance in 2020 of $252 million, higher repayment of long-term debt associated with the early redemption of the Company’s senior notes ($865 million) and shares of common stock purchased under the 2021 NCIB ($111 million) as discussed below.
From time to time, Ovintiv may seek to retire or purchase the Company’s outstanding debt through cash purchases and/or exchanges for other debt or equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, the Company’s liquidity requirements, contractual restrictions and other factors.
The Company’s long-term debt totaled $4,786 million at December 31, 2021. There was no current portion of long-term debt outstanding at December 31, 2021. The Company’s long-term debt at December 31, 2020 totaled $6,885 million, which included the current portion of $518 million. In June 2021, the Company redeemed its $600 million, 5.75 percent senior notes due January 30, 2022, and in August 2021, redeemed its $518 million, 3.90 percent senior notes due November 15, 2021. The combined debt redemptions will result in annualized interest savings of over $50 million. As at December 31, 2021, the Company has no fixed rate long-term debt due until 2024 and beyond.
Since the second quarter of 2020, the Company has allocated $2,580 million in excess cash flows to reduce its total long-term debt balance, which includes proceeds from the Duvernay and Eagle Ford asset divestitures. The Company expects to achieve its Net Debt balance of $3.0 billion in the second half of 2022, assuming commodity prices of $85.00 per barrel for WTI oil and $4.50 per MMBtu for NYMEX natural gas.
In support of the Company’s commitment to growing shareholder value, Ovintiv announced a new capital allocation framework in the third quarter that outlines increasing returns to shareholders as well as continuing the Company’s progress on debt reduction.
For additional information on long-term debt, refer to Note 15 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
71
Dividends
The Company pays quarterly dividends to common shareholders at the discretion of the Board of Directors.
($ millions, except as indicated) 2021 2020
Dividend Payments $ 122 $ 97
On February 24, 2022, the Board of Directors declared a dividend of $0.20 per share of common stock payable on March 31, 2022 to common shareholders of record as of March 15, 2022. This represents an increase of about 43 percent to the annualized dividend payment.
Normal Course Issuer Bid
On September 28, 2021, Ovintiv announced it received regulatory approval to commence a NCIB that enables the Company to purchase, for cancellation, up to approximately 26 million shares of common stock over a 12-month period from October 1, 2021 to September 30, 2022. The number of shares authorized for purchase represent approximately 10 percent of Ovintiv’s issued and outstanding shares of common stock as at September 20, 2021. The Company is funding the NCIB through its new capital allocation framework as discussed above. In 2021, the Company purchased for cancellation, approximately 3.1 million shares of common stock for total consideration of approximately $111 million.
For additional information on the NCIB, refer to Note 18 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Material Cash Requirements
Ovintiv’s material cash requirements include various contractual obligations arising from long-term debt, operating leases, risk management liabilities and asset retirement obligations which are recognized on the Company’s Consolidated Balance Sheet. The Company expects to fund long term material cash requirements primarily with cash from operating activities.
Interest payments include scheduled cash payments on long-term debt, finance leases and other obligations. Additional information can be found in Notes 15 and 14 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Operating leases include drilling rigs, compressors, office and buildings, certain land easements and various equipment utilized in the development and production of oil, NGLs and natural gas, as well as The Bow building. The Company has subleased approximately 50 percent of The Bow office space under the lease agreement. Additional information on leases can be found in Note 14 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Risk management liabilities represent Ovintiv’s net liability positions with counterparties. The majority of the Company’s risk management positions are expected to be settled by the end of 2022. Additional information can be found in Note 25 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Contractual commitments relating to transportation and processing commitments, and drilling and field services can be found in Notes 14 and 27 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Further to the commitments discussed above, Ovintiv also has various obligations that become payable if certain future events occur relating to take or pay arrangements and guarantees on transportation commitments resulting from completed property divestitures as described in Notes 20, 25 and 27, respectively, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
72
In addition, the Company has obligations to fund its defined benefit pension and other post-employment benefit plans, as well as obligations to fund the disposal of long-lived assets upon their abandonment as described in Notes 23 and 17, respectively, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Other than the items discussed above, there are no other transactions, arrangements, or relationships with unconsolidated entities or persons that are reasonably likely to materially affect the Company’s liquidity or the availability of, or requirements for, capital resources.
Contingencies
For information on contingencies, refer to Note 27 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
73
Accounting Policies and Estimates
Critical Accounting Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make informed judgments and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses. For a discussion of the Company’s significant accounting policies refer to Note 1 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K. Changes in facts and circumstances or additional information may result in revised estimates, and actual results may differ from these estimates. Management considers the following to be its most critical accounting estimates that involve judgment. The following discussion outlines the accounting policies and practices involving the use of estimates that are critical to determining Ovintiv’s financial results. Changes in the estimates and assumptions discussed below could materially affect the amount or timing of the financial results of the Company.
Description Judgments and Uncertainties
74
Description Judgments and Uncertainties
75
Description Judgments and Uncertainties
76
Non-GAAP Measures
Certain measures in this document do not have any standardized meaning as prescribed by U.S. GAAP and, therefore, are considered non-GAAP measures. These measures may not be comparable to similar measures presented by other issuers and should not be viewed as a substitute for measures reported under U.S. GAAP. These measures are commonly used in the oil and gas industry and by Ovintiv to provide shareholders and potential investors with additional information regarding the Company’s liquidity and its ability to generate funds to finance its operations. Non-GAAP measures include: Non-GAAP Cash Flow, Non-GAAP Cash Flow Margin, Total Costs, Debt to Adjusted Capitalization, Net Debt and Net Debt to Adjusted EBITDA. Management’s use of these measures is discussed further below.
Non-GAAP Cash Flow and Non-GAAP Cash FlowMargin
Non-GAAP Cash Flow is a non-GAAP measure defined as cash from (used in) operating activities excluding net change in other assets and liabilities, net change in non-cash working capital and current tax on sale of assets.
Non-GAAP Cash Flow Margin is a non-GAAP measure defined as Non-GAAP Cash Flow per BOE of production.
Management believes these measures are useful to the Company and its investors as a measure of operating and financial performance across periods and against other companies in the industry, and are an indication of the Company’s ability to generate cash to finance capital programs, to service debt and to meet other financial obligations. These measures are used, along with other measures, in the calculation of certain performance targets for the Company’s management and employees.
($ millions, except as indicated) 2021 2020
Cash From (Used in) Operating Activities $ 3,129 $ 1,895
(Add back) deduct:
Net change in other assets and liabilities (39 ) (173 )
Net change in non-cash working capital (41 ) 139
Current tax on sale of assets - -
Divided by:
Non-GAAP Cash Flow Margin ($/BOE) $ 16.46 $ 9.69
(1) 2021 includes restructuring costs of $14 million (2020 - $90 million).
77
Total Costs
Total Costs is a non-GAAP measure which includes the summation of production, mineral and other taxes, upstream transportation and processing expense, upstream operating expense and administrative expense, excluding the impact of long-term incentive, restructuring and legal costs, and current expected credit losses. It is calculated as total operating expenses excluding non-upstream operating costs and non-cash items which include operating expenses from the Market Optimization and Corporate and Other segments, depreciation, depletion and amortization, impairments, accretion of asset retirement obligation, long-term incentive, restructuring and legal costs, and current expected credit losses. When presented on a per BOE basis, Total Costs is divided by production volumes. Management believes this measure is useful to the Company and its investors as a measure of operational efficiency across periods.
($ millions, except as indicated) 2021 2020
Deduct (add back):
Market optimization operating expenses 3,148 1,608
Corporate & other operating expenses (1 ) (2 )
Depreciation, depletion and amortization 1,190 1,834
Accretion of asset retirement obligation 22 29
Long-term incentive costs 132 31
Restructuring and legal costs 34 90
Current expected credit losses 1 1
Divided by:
(1) Calculated using whole dollars and volumes.
Debt to Adjusted Capitalization
Debt to Adjusted Capitalization is a non-GAAP measure which adjusts capitalization for historical ceiling test impairments that were recorded as at December 31, 2011. Management monitors Debt to Adjusted Capitalization as a proxy for the Company’s financial covenant under the Credit Facilities which require debt to adjusted capitalization to be less than 60 percent. Adjusted Capitalization includes debt, total shareholders’ equity and an equity adjustment for cumulative historical ceiling test impairments recorded as at December 31, 2011 in conjunction with the Company’s January 1, 2012 adoption of U.S. GAAP.
($ millions, except as indicated) December 31, 2021 December 31, 2020
Long-Term Debt, including current portion $ 4,786 $ 6,885
Debt to Adjusted Capitalization 27% 37%
78
Net Debt and Net Debt to Adjusted EBITDA
Net Debt and Net Debt to Adjusted EBITDA are non-GAAP measures whereby Net Debt is defined as long-term debt, including the current portion, less cash and cash equivalents and Adjusted EBITDA is defined as trailing 12-month net earnings (loss) before income taxes, depreciation, depletion and amortization, impairments, accretion of asset retirement obligation, interest, unrealized gains/losses on risk management, foreign exchange gains/losses, gains/losses on divestitures and other gains/losses.
Management believes these measures are useful to the Company and its investors as a measure of financial leverage and the Company’s ability to service its debt and other financial obligations. These measures are used, along with other measures, in the calculation of certain financial performance targets for the Company’s management and employees.
($ millions, except as indicated) December 31, 2021 December 31, 2020
Long-Term Debt, including current portion $ 4,786 $ 6,885
Less:
Cash and cash equivalents 195 10
Add back (deduct):
Depreciation, depletion and amortization 1,190 1,834
Accretion of asset retirement obligation 22 29
Unrealized (gains) losses on risk management 488 204
Foreign exchange (gain) loss, net (23 ) 17
(Gain) loss on divestitures, net - -
Other (gains) losses, net (37 ) (55 )
Income tax expense (recovery) (177 ) 367
Net Debt to Adjusted EBITDA (times) 1.4 3.1
79
Item 7A: Quantitative and Qualitative Disclosures About Market Risk
The primary objective of the following information is to provide forward-looking quantitative and qualitative information about Ovintiv’s potential exposure to market risks. The term “market risk” refers to the Company’s risk of loss arising from adverse changes in oil, NGL and natural gas prices, foreign currency exchange rates and interest rates. The following disclosures are not meant to be precise indicators of expected future losses but rather indicators of reasonably possible losses. The forward-looking information provides indicators of how the Company views and manages ongoing market risk exposures.
COMMODITY PRICE RISK
Commodity price risk arises from the effect fluctuations in future commodity prices, including oil, NGLs and natural gas, may have on future revenues, expenses and cash flows. Realized pricing is primarily driven by the prevailing worldwide price for crude oil and spot market prices applicable to the Company’s natural gas production. Pricing for oil, NGLs and natural gas production is volatile and unpredictable as discussed in Item 1A. “Risk Factors” of this Annual Report on Form 10-K. To partially mitigate exposure to commodity price risk, the Company may enter into various derivative financial instruments including futures, forwards, swaps, options and costless collars. The use of these derivative instruments is governed under formal policies and is subject to limits established by the Board of Directors and may vary from time to time. Both exchange traded and over-the-counter traded derivative instruments may be subject to margin-deposit requirements, and the Company may be required from time to time to deposit cash or provide letters of credit with exchange brokers or counterparties to satisfy these margin requirements. For additional information relating to the Company’s derivative and financial instruments, see Note 25 under Item 8 of this Annual Report on Form 10-K.
The table below summarizes the sensitivity of the fair value of the Company’s risk management positions to fluctuations in commodity prices, with all other variables held constant. The Company has used a 10 percent variability to assess the potential impact of commodity price changes. Fluctuations in commodity prices could have resulted in unrealized gains (losses) impacting pre-tax net earnings as follows:
(US$ millions) Increase Decrease
FOREIGN EXCHANGE RISK
Foreign exchange risk arises from changes in foreign exchange rates that may affect the fair value or future cash flows of the Company’s financial assets or liabilities. The following table presents the foreign exchange rates for the respective years ended December 31.
Foreign Exchange Rates (C$ per US$1)
As Ovintiv operates primarily in the United States and Canada, fluctuations in the exchange rate between the U.S. and Canadian dollars can have a significant effect on the Company’s reported results. The table below summarizes selected foreign exchange impacts on Ovintiv’s financial results when compared to the same periods in the prior years.
$ millions $/BOE $ millions $/BOE
Increase (Decrease) in:
Capital Investment $ 21 $ (6 )
Transportation and Processing Expense (1) 55 $ 0.28 (7 ) $ (0.04 )
Depreciation, Depletion and Amortization (1) 30 0.15 (4 ) (0.02 )
(1) Reflects upstream operations.
80
Foreign exchange gains and losses also arise when monetary assets and monetary liabilities denominated in foreign currencies are translated and settled, and primarily include:
• U.S. dollar denominated financing debt issued from Canada
• U.S. dollar denominated risk management assets and liabilities held in Canada
• U.S. dollar denominated cash and short-term investments held in Canada
• Foreign denominated intercompany loans
To partially mitigate the effect of foreign exchange fluctuations on future commodity revenues and expenses, the Company may enter into foreign currency derivative contracts. As at December 31, 2021, Ovintiv has entered into $400 million notional U.S. dollar denominated currency swaps at an average exchange rate of C$1.2848 to US$1, which mature monthly throughout 2022.
As at December 31, 2021, Ovintiv did not have any U.S. dollar denominated financing debt issued from Canada or foreign denominated intercompany loans that were subject to foreign exchange exposure.
The table below summarizes the sensitivity to foreign exchange rate fluctuations, with all other variables held constant. The Company has used a 10 percent variability to assess the potential impact from Canadian to U.S. foreign currency exchange rate changes. Fluctuations in foreign currency exchange rates could have resulted in unrealized gains (losses) impacting pre-tax net earnings as follows:
(US$ millions) 10% Rate Increase 10% Rate Decrease
Foreign currency exchange $ (32 ) $ 39