CORONAVIRUS HITS OIL HARD
Demand to see record drop in Q1
As coronavirus brings the world’s economy to a grinding halt, global oil demand is expected to decline by the largest volume on record in the first quarter, dealing another blow to fiscally vulnerable Canadian oil producers.
The coronavirus outbreak in China will cause a demand-side shock to the oil markets that will eclipse the oil-demand contraction seen during the global financial crisis in the last decade, IHS Markit said in a report Wednesday.
The data analysis firm forecast that due to “the unprecedented stoppage of economic activity” in China, first-quarter global oil demand will decline by 3.8 million barrels per day compared with the same period last year.
By contrast, global oil demand declined by 3.6 million bpd during the first quarter of 2009.
“This is a sudden, instant demand shock — and the scale of the decline is unprecedented,” Jim Burkhard, IHS Markit head of oil markets, said in a release.
As Organization of the Petroleum Exporting Countries member countries gathered in Vienna on Wednesday to discuss potential emergency cuts to global oil supply, Citigroup Global Markets commodities expert Edward Morse said in a research note that a cut between 600,000 bpd to 1.5-million bpd appears possible, but cautioned, “this is clearly a wide range.”
The virus’s effect on oil prices to date has been dramatic. The West Texas Intermediate benchmark price has tumbled from roughly US$60 per barrel at the beginning of the year to US$46.78 per barrel on Wednesday.
For Canadian producers, who often receive discounted prices for their crude, the Western Canada Select benchmark was trading at US$32.35 per barrel, or around US$14 below the WTI benchmark.
As the outlook for oil has worsened, Canadian producers are trying to hedge their output at higher prices and also hedge the discount they’re forced to accept for their crude at U.S. refineries.
“We did layer on a couple of additional WCS heavy oil hedges,” Baytex Energy Corp. president and CEO Ed Lafehr said on an earnings call Wednesday, adding that partly as a result of its hedging program the Calgary-based heavy-oil producer “fully expects to be free cash positive in the first half.”
Lafehr said the company would reconsider its capital spending plans in late spring given the gloomy outlook.
“We typically use April and May to recalibrate our views of the macro — what’s going on with pricing and where our cash flow is — and we’ll make calls on our second half program during that time,” Lafehr said.
At the current futures strip for oil prices, Baytex’s debt is expected to be three times larger than its expected cash flow in 2020, up from 2.5 times in 2019, according to analysis from CIBC World Markets.
CIBC data shows that debt-tocash flow ratios for most Canadian oil-weighted producers are expected to rise sharply in 2020 given the outlook and futures market for oil prices.
Bonterra Energy Corp. would own the highest debt-to-cash flow ratio among large and mid-sized oil producers in Canada, at 5.9 times by the end of the year.
The bank expects Husky Energy Inc.’s debt-to-cash flow ratio will more than double, marking it the largest year-over-year increase. At the end of 2019, Husky’s debt was 1.6 times its cash flows, but that number is expected to reach 3.3 times in 2020.
Companies that have aggressively cut costs and repaid their bondholders are expected to fare better.
“A number of the Canadian producers did effectively make hay while the sun shined,” Mark Sadeghian, senior director, corporates at Fitch Ratings said in an interview Wednesday, noting that both Cenovus Energy Inc. and MEG Energy Inc. have aggressively paid down debt in recent months when oil prices were better than now. “Prior to the crash, WCS was at a pretty comfortable place for a lot of producers.”
As new export pipelines out of Canada have been delayed and producers have been hit with production limits by the Alberta government, many companies have spent their money on debt repayment, share buybacks or debottlenecking projects to reduce costs.
“That’s definitely the good news,” Sadeghian said, noting that cost structures are lower for Canadian oil and gas producers than they were previously.
However, as coronavirus wreaks havoc on markets, ratings agencies are watching closely how companies grapple with the commodity price shock. Sadeghian declined to say if Canadian companies would be re-rated.
In a research note published Feb. 26, Eight Capital analysts pointed to Husky and Ovintiv Inc., previously known as Encana Corp., as the larger Canadian producers that will be most challenged if WTI trades at US$45 per barrel.
Smaller oil producers would be under significantly more pressure. “Junior oil names could be under stress given weaker netbacks and balance sheets to start off,” the analysts wrote.
A number of the Canadian producers did effectively make hay while the sun shined.