Falling crude prices threaten to squeeze smaller oil and gas producers: analyst
Spread of coronavirus outside China fans fears that pandemic could do big damage
Smaller oil and gas producers may come under financial duress, resulting in lower dividends and greater debt, if West Texas Intermediate crude hovers around the US$45 level for the rest of 2020 due to coronavirus fears, according to one analyst.
“Junior oil names could be under stress given weaker netbacks and balance sheets to start off … Vermillion (Energy) will surely have to cut its dividend or delve itself deeper into debt in this scenario and we believe Surge (Energy) would also have to make adjustments to outflows to keep leverage in check,” Phil Skolnick, an energy sector analyst at Eight Capital, said in a note this week.
Oil prices tumbled for a fifth day on Thursday to their lowest since January 2019, as further novel coronavirus cases outside China fanned fears that a pandemic could slow the global economy and erode demand for crude.
Brent crude dropped US$1.25, or 2.3 per cent, to settle at $52.18 a barrel, off the session low of US$50.97 a barrel, the lowest since December 2018. West Texas Intermediate (WTI) futures sank US$1.64, or 3.4 per cent to US$47.09, after hitting their lowest since January 2019.
For both Brent and WTI, the spread between December 2020 futures and December 2021, a popular trade used as a barometer for supply expectations, fell firmly into negative territory. Both spreads hit the widest levels since January 2019, signalling erosion in demand could lead to a glut through the end of this year.
U.S. crude has dropped more than 23 per cent since the start of the year as China revealed it was struggling to contain the virus. China is the world’s second-largest consumer of oil and the largest oil importer — any negative impact on demand from the Asian economic giant has massive repercussions for oil prices.
“Many of the Canadian oil companies have hedged their production for the next few months, but less so going into 2021,” said Jeremy Mccrea, an energy analyst with Raymond James Ltd. “But not everyone is hedged and obviously the concern right now is no one knows how quickly the virus will spread and how big of an impact it will have to travel, and world demand.”
According to Eric Nuttall, partner and senior portfolio manager with Ninepoint Partners LP, which manages an energy fund, even the smaller Canadian oil and gas companies have hedged closer to the US$50-US$60 price range, to mitigate against short-term duress.
“To be fair, the balance sheets are relatively strong. Nobody really comes to mind that might not be able to weather low oil prices in the near term,” Nuttall said.
Eight Capital’s Skolnick believes if the coronavirus outbreak had not occurred, oil prices would be at least US$10 per barrel higher than their current levels. “When you really started to see the bottom fall out on oil was the last two days when those new cases hit U.S. and Canada,” he said.
Canadian energy stocks, too, have been battered over the course of the week, as global markets roiled from the prospect of a pandemic.
The S&P/TSX Capped Energy Index was down 20.5 per cent for the year on Thursday afternoon, slightly better than the U.S. S&P 500 Energy Index, which has fallen 23.7 per cent year-to-date.
But Skolnick believes the larger oilsands companies have hedged enough and can generate sufficient free cash flow to weather the storm.
“The bigger ones will be fine, but when you get into the smaller names you might start seeing negative cash flow if this persists,” he said.
On Thursday, Husky Energy Inc. reported a heavy quarterly loss related to a $2.3-billion impairment charge on the company’s oilsands assets. In a statement, Husky attributed the charge to “expectations of lower long-term oil prices and a drop in capital spending.”
Earlier this month, Suncor Energy Inc. also took a writedown on oilsands assets, anticipating lower heavy oil prices for the rest of 2020.
“Canadian oil prices were actually doing rather well, and had broken the US$60 mark because of Permian oil production growth (one of the biggest shale basins in the U.S.) starting to slow. So there was some hope in the oilpatch but that was all taken back by coronavirus,” Mccrea said.
The next shoe to drop is an OPEC meeting next week in Vienna, where the oil cartel and its NONOPEC allies will decide on whether to cut oil production further to stabilize prices. Russia, one of the largest oil producers, still remains undecided on that front.
OPEC supply cuts will be a boon for heavy oil producers in Canada, potentially boosting WTI crude prices.
“Of course it would be beneficial (if OPEC cuts). But look, even if that doesn’t happen, it took oil prices going down below US$30 in 2016 before we started to see Canadian wells being shut in. In a way the Canadian guys have got used to this extreme volatility,” Mccrea said. “The thing is, a lot of the companies who have been through price depressions have sold out or gone bankrupt. The companies remaining are stronger, have paid down debt and are in a better financial position so they can probably weather the storm better than we have seen before.”
The concern right now is no one knows how quickly the virus will spread and how big of an impact it will have to travel, and world demand.