'Heartburn' for oilpatch this earnings season
Steep discounts, but refiners poised for monster Q4
CALGARY• As Canadian oil producers struggle with severe “heartburn” brought on by record discounts for domestic crude, analysts expect integrated producers to ramp up refining capacity to offset the negative impact of cheap oil.
The country’s largest oil and gas companies begin reporting results on Thursday, at a time when discounts for Western Canada Select crude recently set a record of US$50 per barrel relative to the U.S. benchmark, West Texas Intermediate. AltaCorp Capital data shows the differential between WCS and WTI averaged US$42.32 per barrel on Monday, which is still abnormally large.
Even Canadian light oil production is trading at a wide discount to WTI, with the Edmonton Par blend averaging around US$26 per barrel less than the U.S. benchmark on Monday.
The development is expected to overshadow third quarter results at Canada’s largest oil companies, which are widely expected to post improved earnings and cash flow numbers on the back of increased production, decreased downtime and lucrative refining margins.
“We do not believe that this will be a quarter where earnings prints will be the principal drivers of near-term trading performance of each stock,” CIBC World Markets analyst Jon Morrison, Trevor Bolland and Daniel Chan wrote in a research note.
“Rather the recent blowout in Canadian heavy and light oil (differentials) is causing immense heartburn across the industry and is the big driver of share price performance,” the analysts wrote, adding that they’ll be watching to see if some Canadian producers curtail production as a result.
Indeed, analysts widely expect executives from Suncor Energy Inc., Cenovus Energy Inc., Husky Energy Inc., Imperial Oil Ltd. and Canadian Natural Resources Ltd. will need to explain to investors on earnings calls how they are managing through a period when both Canadian heavy and light oil barrels are trading at large discounts relative to U.S. crude.
“When you think about how vocal they got in the second quarter when we were looking at US$18 per barrel differentials, it’s safe to say that’s going to be the main focus that they’re going to address,” Edward Jones analyst Jennifer Rowland said.
Since major Canadian oil companies last reported earnings, the difference between Western Canada Select and the U.S. benchmark West Texas Intermediate rose from under US$20 per barrel to hit a record of US$50 per barrel and continue to exceed US$40 per barrel — which Rowland said will dominate earnings calls.
Rowland said she expected Suncor, Husky and Imperial to tout their refining businesses, which are “bright spots” for these heavy-oil producers, insulating them from the effects of big discounts and helping them post positive results.
Peters & Co. analysts expect Suncor and Imperial to benefit further in the fourth quarter of this year, given current wide differentials and their ability to process cheap oil.
On the other hand, they noted, “the wider oil differentials will result in some sizable cash flow decreases” for Cenovus and Canadian Natural, whose upstream production is less well covered by refining assets.
To compound the issue, the large integrated producers also have the advantage of better access to Canada’s limited export pipelines.
Companies such as Suncor, Imperial and Husky — with both upstream oil production and downstream refinery assets — have better access to Enbridge Inc.’s Mainline pipeline system between Alberta and the U.S. Midwest refining market, Tudor Pickering Holt and Co. analyst Matt Murphy said in an email.
As a result, he said, those companies are able to “limit the impacts and exposure of apportionment” on the pipeline system while also enjoying higher refining margins.
“The integrateds will also have storage in their marketing businesses as well to take advantage of various arbitration opportunities,” he said, adding that Husky has previously bought discounted oil specifically to boost profits at its refineries.
In the midst of recordsetting discounts for Canadian oil, GMP FirstEnergy analysts Michael Dunn and Robert Fitzmartyn said in a note they expected to see some domestic oil and gas companies curtail production “similar to what we saw in late winter/early spring this year.”
Dunn recently told the Financial Post that Suncor, Imperial and Husky were set up for “monster fourth quarters” given current price discounts.
“Along with a recovery in U.S. Midwest refinery runs and gradually increasing crude-by-rail volumes, we expect differentials to improve from recent levels,” Dunn and Fitzmartyn wrote.
Three major U.S. Midwest refineries — BP plc’s Whiting refinery, Marathon Petroleum Corp.’s Detroit refinery and HollyFrontier Corp.’s El Dorado refinery in Kansas — are all expected to be return to operations in November, which should narrow the discounts, bringing some relief to producers.
Increased crude oil-by-rail shipments are expected to have the same effect.
Edward Jones’ Rowland said she also expected other heavy oil producers to announce longer-term oil-byrail shipping deals on earnings calls when companies begin reporting on Thursday this week.
Oil producers in Canada have exported a record 200,000 bpd on railway cars so far this year and those figures are projected to rise to over 300,000 bpd by yearend.
Cenovus Energy reports third quarter results on Thursday, followed by Cenovus Energy, Canadian Natural and Suncor next week.