Not a lot of optimism for oil prices right now
Markets: Double dip decline takes root
Oilpatch earnings season kicked off last week, with the numbers released by Encana a harbinger of things to come.
The company disappointed investors on a number of levels — declining earnings, cash flow, production and rising debt levels — all of which caused the stock to sink to $10.26 Friday. The pain continued Monday, with Encana hitting $9.53 in intraday trading, a historical low for the company.
And when a research report is published — as it was by CIBC World Markets Monday — saying the company’s future hinges on future asset dispositions for as much as $1.5 billion to get debt levels under control and keep its investment grade credit rating, Encana still has work to do. Given it’s a buyer’s market for oil and gas assets, this isn’t going to be the easiest task to accomplish. And it comes despite the company’s $1.4-billion share issue completed earlier in the year, with the proceeds used to pay down debt.
Its results have set the tone for oilpatch earnings season.
Ever since oil prices collapsed late last year, there were many who believed oil prices would start to strengthen in the latter half of 2015.
But with the nuclear deal involving Iran, production in the U.S. at 9.7 million barrels a day — the highest level since 1971 — and what looks like some difficult times ahead in China as evidenced by continued weakness in the stock markets, there are fewer reasons to expect a price recovery.
The only exception is the potential for an “event” in the Middle East that markedly disrupts both production and export routes.
What seems to have taken root is the dreaded “double dip” of a decline in oil prices.
While Brent reached $69.63 a barrel in May, it has now fallen almost 24 per cent — to $53.33 Monday — while the U.S. benchmark WTI closed at $47.07, down more than 20 per cent in the last six weeks.
If anyone doubted the impact this is having, and will continue to have, on Alberta, a report by Wood Mackenzie released Monday put it in stark perspective.
The current oil price situation has already led to $200 billion US in investment, representing 45 projects and 20 billion barrels in new development being iced by international oil companies. Of those 20 billion barrels, 5.6 billion — or almost 30 per cent — are in the oilsands.
Among the observations made by the Wood Mackenzie study is that at current prices, focusing on costs won’t be enough to push the more expensive projects into achieving an acceptable return on investment.
“We estimate that half of the new greenfield developments still produce sub-15 per cent development IRRs (internal rates of return), which is below most companies’ economic hurdle rate. For most operators, hoping a 10 per cent reduction in capex is sufficient to reach FID (final investment decision) won’t be enough,” stated the report.
That’s because there aren’t many projects that can breakeven at an oil price less than $50 a barrel. Unless the economics of a project are compelling, nothing new is going to move forward.
The current environment is further compounded by an overwhelming lack of certainty, particularly in Alberta, as companies await the outcome of a royalty review and the climate change advisory panel.
All these reasons are giving investors an excuse to sit on the sidelines.
“The marked lack of interest in this space feels an awful lot like what have been other great buying opportunities in the past,” said Mike Dunn, who covers the big cap energy companies for FirstEnergy Capital Corp. “Things are getting more reasonably priced relative to where the futures curve these days, but no one cares about the sector right now. But we know oil prices can’t stay here that long.”
And, as the Wood Mackenzie report said, the deferral of new projects is detrimental to future production growth, the lack of which can whipsaw prices to the upside.
The immediate focus in the coming weeks will be guidance for the winter months, strategies for capital preservation, the vulnerability of dividends and, unfortunately, staffing levels. The question is, at what point do the valuations become compelling enough that investors start to come back into the sector, not to mention companies with the financial capacity becoming active on the acquisition front.
So far there isn’t much movement, and likely won’t be until there is more clarity on the royalty front. But as Dunn pointed out, at some point that negative sentiment is going to change, just as it has in previous commodity cycles.