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Oil glut to weigh on energy-sector earnings season

Pipes that carry various liquids from their MacKay River pad in the oil sands in Fort McMurray Alta, on Monday June 12, 2017.

JASON FRANSON/THE CANADIAN PRESS

Sub-$50 oil and questions about the need for new heavy oil pipelines will dominate this Canadian energy-sector earnings season.

The West Texas intermediate price drop into the low $40s (U.S.) a barrel in June has hammered any vestigial optimism in Canada's oil patch. The S&P/Toronto Stock Exchange energy index had been making gains to the end of last year as some of the world's largest crude producers made targeted production cuts and oil prices climbed out of a two-year hole. Oil producers had penned 2017 budgets with prices of $50-55 a barrel in mind.

But the oil glut has ramped up again in recent months and prices are forecast to remain 10 per cent below those estimates well into 2018. Per-barrel-prices are being pushed down by concerns about OPEC's ability to deliver further cuts alongside surging North American production. The Canadian energy index has dropped about 16 per cent since the beginning of this year.

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Canadian energy-sector second-quarter reporting begins Friday with Encana Corp. and Husky Energy Inc. Looking forward, companies are likely to touch on paring back activity or other spending for the back end of the year, according to Dan Tsubouchi, chief market strategist of private-equity group Stream Asset Financial Management LP.

"To me, it's almost impossible for an E&P company to not cut the budget," he said. To keep the budget as is, "they would have to put in big hedging in last year, or early this year. And they would have to believe the price dip is temporary."

A CIBC report Friday said there has yet to be any major pullbacks, despite the lower prices and corporate messaging remains on track for steady further drilling ramp-up. But even as producers have slashed costs and generated cash flow at low prices, Mr. Tsubouchi said oil companies are facing mounting challenges.

Share prices are down as capital shifts south of the border, or abroad. An interest-rate hike is helping to boost the Canadian dollar, to the detriment of Canadian oil and other exports. The price for Alberta-benchmarked natural gas has dropped by about 20 per cent from the beginning of the year. Given these fundamentals and a fresh memories of insolvencies and soured loans in the sector, few want to borrow or lend cash.

"They are being hit on everything. It is impossible for boards to ignore," Mr. Tsubouchi said.

Late in the month, all eyes will be on TransCanada Corp.'s July 28 conference call. Investors will be looking to whether executives will shed any light on shipper commitments for its Keystone XL pipeline – a project designed to move hundreds of thousands of barrels of heavy oil daily to refineries on the U.S. Gulf Coast. The Trump administration has given its blessing to the project. With oil sands output set to ramp up by 300,000 barrels a day this year and another 380,000 in 2018, it would seem like a given that shippers would want to sign on.

But Keystone XL is still opposed by environmentalists, and some Indigenous groups and landowners, and has yet to clear regulatory hurdles in Nebraska. Next month, the state's Public Service Commission will hold what will be closely watched hearings on the public benefits of the project.

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Still, it's likely oil prices, even more than antipathy, will determine the fate of the pipeline. The Wall Street Journal reported last month that shippers are hesitant about signing long-term contracts in an era of plentiful oil.

Some Canadian firms see rising U.S. oil production as a signal they need to get their own increasing production to overseas markets. Kinder Morgan Inc.'s Trans Mountain expansion, to bring Alberta oil to the West Coast for export, faces stiff political opposition in British Columbia but is still seen as the most likely of the proposed major pipeline projects to come to fruition.

The situation for Canada's oil field service sector also remains fraught. In Alberta, drilling was up 114 per cent from lows in 2016 compared with the first four months of 2017. But the recent drop in commodity prices will again raise questions about the 2017-18 winter drilling season.

Eric Nuttall, a portfolio manager with Sprott Asset Management LP, said he remains positive on Canadian pressure pumpers, such as Trican Well Service Ltd. – the largest holding of the Sprott Energy Fund. He said with a lack of new equipment and labour, demand for fracking and associated services will remain tight.

However, Mr. Nuttall – once an ardent booster of Canadian energy – has a significantly more dour outlook when it comes to the broader oil and gas sector. He said he sold all his Canadian exploration and production company holdings in February. Policy moves such as carbon taxes and caps on greenhouse gas emissions in the oil sands – and governments in Alberta, Ottawa, and now British Columbia he views as unfriendly to the industry – helped cement the decision.

"It was just growing exhaustion … Having to worry about takeaway capacity on gas, takeaway capacity on oil," Mr. Nuttall said in reference to industry concerns about the ability to build or expand exportable pipelines.

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"I can go south of the border and get the same exposure to the commodity, and not have to deal with any of that."

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