‘Sacrosanct’ dividends on the chopping block as analysts look past oil companies’ Q1 earnings

When executives from Calgary-based PrairieSky Royalty Ltd. announced their earnings on Tuesday, they were hard pressed to say what exactly the future holds for Canada’s beleaguered oil sector.

So far, the company estimated that Canadian oil companies have already cut or shut in about 10 per cent of their production as social distancing and other policies designed to contain the spread of coronavirus extinguished demand and punished oil prices.

But as far as how much more oil production cuts are coming, no one can say exactly.

“So the 10 per cent is the actual number that we’ve seen” of shut ins, said Andrew Phillips, chief executive of PrairieSky. “Twenty per cent is what we’ve been told by industry (to expect in May). My view, and this is my view only, is that it’s going to be significantly higher than that in May.”

The commentary is instructive as earnings season kicks off for oil companies, in part because PrairieSky collects royalties from a variety of companies around Western Canada, making it a bellwether of sorts for the sector. But it also provides a sense of the cloudy conditions under which the sector is operating.

As more companies begin reporting earnings in the coming weeks, analysts will be looking at the results for clues as to how badly the industry has suffered. Cuts to production, dividends and capital expenditures are all expected, given that the price of benchmark grade Western Canadian Select dropped below $4 during the past month, considered far below the break-even point for most companies.

Already, the federal government has announced more than $2.4 billion in aid for the sector.

U.S. West Texas Intermediate (WTI) crude futures for June delivery rose 26.7 per cent, to US$14.66 a barrel on Wednesday, after falling in negative territory for the first time ever earlier this week.

Against that backdrop, the first-quarter results may not reflect the current dire state of the industry, given it covers the period from January to March, and prices remained stable through the end of February. Nonetheless, executives’ commentary about their respective plans is expected to provide a better sense of what lies ahead for the sector.

Cash burns will be immense in the coming period

CIBC

Analysts at Canadian Imperial Bank of Commerce wrote in a note this week that the global supply of oil is so far out of balance with demand, that they expect shut-ins will reduce production in Western Canada by as much as 35 per cent.

“While there are a large number of dividends in Canada that we would normally view as sacrosanct, we do not believe that is true today,” the CIBC analysts wrote. “The reality is that cash burns will be immense in the coming period and temporarily suspending dividends is one of the most logical levers to pull in this environment.”

Analysts at Calgary-based Peters & Co. wrote that many of the largest Canadian producers have “ample liquidity,” which even under the worst-case scenario would sustain them through the end of 2021.

Cutting dividends “would be an obvious source to shore up liquidity if required,” they wrote. It noted Suncor could likely last an additional three quarters, and Canadian Natural Resources Limited could likely last two by cutting its dividend.

Peters analysts added that CNRL may well secure additional credit, or refinance its debt, and projected its liquidity horizon extends past 2024.

They noted Cenovus Energy Inc. has already cut its dividend, and has the highest potential for a lift in valuation if oil prices rise, making it one of their top picks.


Continued lockdowns to protect people from COVID-19 will create a lack of demand for gasoline.

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Even still, the largest U.S. producers may be able to make harder cuts to their production, which would sustain them for longer periods of time than their Canadian peers, according to Peters & Co.

Another measure of the health of Canada’s oil and gas sector will come from the cuts to capital expenditures, including much of the exploratory drilling required to sustain or expand production levels.

The research firm IHS Markit estimated oil producers in Western Canada already have cut $6 billion in planned capital expenditures. It estimated that capex by upstream Western oilsands producers dropped to its lowest level in 15 years — when oilsands production was approximately two-thirds of what it was in 2019.

“The scale of this demand shock is unprecedented,” Kevin Birn, IHS’s vice-president for North American crude oil markets, wrote last week.

Despite the muted share prices, mergers and acquisitions may not be in the cards, given that most companies are in survival mode.

“Moreover, social distancing measures mean that most entities are not in a position to actually complete proper due diligence on any transaction unless they already know it intimately,” CIBC analysts said.

The scale of this demand shock unprecedented

IHS Markit

Among major producers, Suncor Energy Inc., Canadian Natural Resources and Imperial Oil Ltd. are well positioned to ride out the storm, CIBC said. Tourmaline Oil Corp., ARC Resources Ltd. and Prairie Sky were among its mid-cap picks, thanks to their “superior balance sheets and low-cost structures.”

Given the breadth of the budget cuts, oilfields services firms may face the most pain first.

The bank expects Calfrac Well Services Ltd., Ensign Energy Services Inc., Step Energy Services Ltd. and Source Energy Services Ltd., to “trip under the current restrictions at some point in 2020,” given the precarious nature of their covenants, maturity schedule and liquidity in the form of cash on hand and undrawn credit.

“However, as has been the case previously, we believe creditors will provide covenant relief to some of those in need through the downturn,” CIBC analysts noted.

The situation has sparked questions about whether there are fundamental shifts underway in the supply and demand for oil, if, for example, air travel declines or more people work from home after the coronavirus crisis passes.

“We’re not going back to business as usual within the calendar year, that’s for sure,” said Birn, adding that while coronavirus policies may be temporary, “our behaviour and interactions with the world are going to be different on the other side — that is a safe bet.”

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