Last month, West Texas Intermediate (WTI) oil futures traded negative for the first time in history, largely due to the impact of COVID-19. Despite a rebound in prices, many energy companies will find themselves with liquidity constraints, and Canadian energy companies will be among the hardest hit. What can they do to weather the storm?
- The huge fall in oil prices caused by the COVID-19 pandemic has resulted in excess supply and weakened demand all over the globe. This will hit Canadian energy companies especially hard.
- The extra hardship will be caused as some Canadian energy companies have a breakeven price of $30-$40 per barrel, because additional costs are incurred by upgrading and refining Western Canadian Select (WCS) – the primary oil benchmark in Canada.
- Canadian companies with strong balance sheets will weather the storm better when commuting and travel begin to resume albeit under fresh circumstances.
The energy industry has been hit by a one-two punch in 2020.
First, after a dispute with Russia over production cuts in early March 2020, Saudi Arabia announced it would increase production, leaving the world awash with oil. Less than two days after this announcement, the WHO declared COVID-19 a global pandemic, causing many countries to enter full or partial lockdowns.
With people not commuting or traveling, demand for refined products such as gasoline, diesel, and jet fuel collapsed, causing crude oil storage levels would increase significantly. Year-to-date, crude oil storage at Cushing, Oklahoma, the major trading hub for WTI, is up nearly 74 percent to 64,768M barrels of crude. Storage levels are at 73 percent of total capacity.
The impact on oil in Canada
Over the past 12 months, WCS prices have fallen 65 percent with current prices hovering around $17 per barrel. This has dealt a significant blow to many Canadian energy companies. Other major oil benchmarks have also seen similar declines, however the added pressure facing Canadian energy firms is the cost structure of their assets.
Due to the capital-intensive nature of removing bitumen from the group, some companies require a breakeven price of $30-40 per barrel to cover their operating expenses and ongoing CAPEX programs. The circumstances surrounding the collapse in oil prices and oil demand are posing additional challenges to Canadian energy companies.
In the past, when oil prices had fallen sharply, integrated companies with refining assets were able to generate profits through their downstream business units by selling refined products such as gasoline, diesel, and jet fuel. With weak demand for many finished products, integrated companies are not experiencing the same benefits during this period of low oil prices.
Some non-integrated companies may benefit in a low oil price environment if they have hedged their production. Crescent Point Energy (CPG.TO) have roughly 50 percent of its 2020 production hedged at $75 CAD a barrel, providing the company with revenue certainty and protection against crude oil volatility.
Limited capacity for Canadian oil exports
Oil exports from Alberta are limited to pipeline and rail infrastructure, which adds logistical challenges in bringing the product to market. Due to Canada’s proximity to the United States, roughly 96 percent of Canadian oil exports go south of the border. With limited pipeline and rail capacity to either coast, Canada has limited access to global markets, further widening the spread between WCS and WTI.
Pipelines have been the primary source of crude exports from Canada but limited new capacity has driven significant growth in crude-by-rail exports over the past five years, hitting a record high of 411K barrels per day in February 2020. This represents nearly a threefold increase in crude-by-rail shipments over this five-year period. However, with oil prices falling and a lack of demand, there will likely be a pullback in these shipments in Q2.
What now for Canadian energy companies?
While there has been negative sentiment surrounding the energy industry, demand for crude oil will increase as we start to commute and travel, albeit under new circumstances. Companies with strong balance sheets and the ability to generate positive free cash flow will be able to weather this storm and emerge as leaders in the market.
Meg Energy (MEG.TO), Imperial Oil (IMO.TO), and Suncor Energy (SU.TO) are some examples of Canadian energy companies that have high earnings quality, as measured by the Starmine Earnings Quality Model. The Earnings Quality model is a percentile (1-100) ranking of stocks based on the sustainability of earnings, with 100 representing the highest rank.
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