More cost-cutting feared as oil nears $40 threshold
Dollar’s slide, strong balance sheets lower odds of production shut-ins
Oil prices came perilously close to falling below US$40 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 US$1.82, or 4.3 per cent, at US$40.80 a barrel. It dropped as low as US$40.46 during the session, its lowest since March 2009.
The plunge came after the U.S. Department of Energy slashed US$6 off its average oil price estimate this year to US$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 US$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 to US$40 per barrel, are already suffering as the heavy oil benchmark Western Canadian Select is trading around US$25 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 shut- ting 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 email. “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.
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.
But Cohen, at Barclays, believes 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.”