OIL PRICES HIT $ 40 MARK
Producers brace for more layoffs
Oil prices came perilously close to falling below $ 40 US Wednesday, forcing producers to contemplate more cost- cutting measures at a time of great austerity.
The front- month futures contract in U. S. crude, which expires on Thursday, settled down $ 1.82 US or 4.3 per cent, at $ 40.80 a barrel. It dropped as low as $ 40.46 during the session, its lowest since March 2009.
The plunge came after the U. S. Department of Energy slashed $ 6 off its average oil price estimate this year to $ 49 per barrel, citing increases in global oil inventories.
“We get down to US$ 40 level, companies will have a hard time just to sustain their businesses,” Kyle Preston, analyst at National Bank Financial Inc. said in an interview. “Reality is, if we stay here at US$ 40 or below US$ 40, we are going to see more cuts across the board.”
Adding to the negative sentiment, Citibank analysts said oil retracing its 2008- low of $ 32 per barrel was a “conceivable reality,” especially if capital markets reduce their support of U. S. shale producers.
Canadian oilsands, which have average operating costs of $ 35-$ 40 US per barrel, are already suffering as the heavy oil benchmark Western Canadian Select is trading around $ 25 US per barrel thanks to temporary logistical bottlenecks.
“Canadian heavy producers are already feeling the pain of $ 30 prices,” said Carmen Velasquez, executive director of energy programs at the University of Alberta.
However, a 13 per cent year- todate decline of the Canadian loonie against the American dollar and strong balance sheets of some players mean production shut- ins are not being contemplated, Citibank analyst Christopher Main wrote in a note Wednesday.
“The costs of completely shutting down are high and given the permanence of these decisions and with deferred prices still above cash costs, then oil prices will likely have to breach cash costs for some time in order to see shut- ins,” Main said.
Michael Cohen, analyst at Barclays Capital said Canadian producers have a decision to make as they fetch WCS prices.
They can either “shut- in production and pay the costs associated with closing down and then ramping up production again; or tough it out,” Cohen said in an e- mail.
“We strongly think it is more likely that producers ( especially SAGD production) will tough it out, but we may see extended periods of planned maintenance if the low price environment persists.”
Late last year, as OPEC orchestrated a plan to ease out higher crude prices, Canadian Natural Resource Ltd.’ s influential chairman, Murray Edwards, predicted in November that prices could fall to US$ 30 per barrel.
Nine months later, the industry’s worst fears appear to be coming to pass, leaving many analysts scrambling to revise their estimates and stress- test companies’ financial strength.
Energy companies in the Standard & Poor’s/ TSX Composite Index had an average of 3.1 times more debt than earnings as of their latest quarterly report, the highest ratio in Bloomberg data going back to the middle of 2002. That measure, a gauge of a firm’s ability to repay its obligations with a higher number indicating greater difficulty, has surged this year amid the global oil glut that’s depressed prices and earnings.
Another ratio, measuring how much greater earnings are than interest expenses, plummeted to the third least in a decade at the end of last year, suggesting there’s less money to service the borrowings.
“Prices can remain lower for longer,” warned Patricia Mohr, commodities market specialist at Scotiabank. “Although below US$ 40 per barrel, few operators can remain profitable.”
With oil prices declining more than 50 per cent in less than a year, Canadian oil companies have slashed as much as $ 46 billion in costs in the first half of the year, but it’s unclear whether that’s enough, according to National Bank Financial data.
“At current prices, there would not be many that would be able to sustain without having to do drastic cuts to capital programs, dividends,” said Preston, while noting that US$ 40 prices are not sustainable to maintain global oil production at 90 million bpd.
“At some point, if the industry is not reinvesting, production would decline, and you will need higher oil prices to justify capex,” Preston said.
Others, such as Barclay’s Cohen, believe prices are unlikely to stay at current levels for a long time.
“We continue to believe that a rebound back to the US$ 60 range is likely by the end of this year,” Cohen said, citing U. S. tight oil output declines, stronger than expected global demand, and geopolitical risks in Iraq as possible reasons for an upturn.