Tough times lie ahead for Canada’s oil patch

In the long history of Canada’s E&P sector, there have been few periods when the outlook for Canadian producers has been as miserable as it is in 2016. Coming off a year that saw the Toronto Stock Exchange’s main energy index fall close to 30%, amid reduced spending and layoffs, opportunistic fear-mongering continues, as does the ridiculous and damaging demonization of pipelines, much of it within Canada.

For a country that prides itself on its ability to overcome adversity through cooperation and collaboration, the tough economic times have exposed deep-seated, east-west divisions in Canada, and the cynicism of local politicians claiming that they do not sufficiently benefit from the pipelines that pass through their communities.

Pipelines have become the poster child for Canadian oil patch malaise, but even if any of the recently proposed projects were to be constructed, they would do little to alleviate the issues confronting producers. For example, Canadian heavy crude blends were trading at a discount of more than 50%, compared to the WTI benchmark in early 2016, which means that the Western Canada Select benchmark was at US$13.25/bbl, its lowest level since the benchmark was introduced in 2004.

Much like the rest of Canada, activity has quieted down considerably in the Alberta portion of the Montney shale over the last 18 months. Photo: Encana Corporation.

Oil sands producers have hunkered down for the long haul. They hope that dismal world oil prices improve, and that the broader conversation shifts to all the things being done right in Alberta, at the policy and regulatory level, rather than the much smaller percentage of things that need improvement.

As is often the case when times are the worst north of the 49th parallel, the Canadian dollar’s nosedive (in lockstep with poor oil prices) provides the only respite to a beleaguered industry. In fact, the Canadian dollar fell to slightly more than 68 U.S. cents in late 2015, its lowest level since 2003. The low Canadian dollar benefits the export-driven oil and gas industry, which still ships substantial volumes of oil and gas south to U.S. customers, despite the recent resurgence of U.S. domestic oil production.

Alberta, home to the majority of Canadian production, including the massive oil sands deposits, has been hit particularly hard by the downturn. The provincial employment rate has fallen below the national rate for the first time since 1988, as an estimated 35,000 Alberta workers lost their jobs in 2015.

And as goes the oil patch, so go government revenues, particularly in Western Canada. Deficit spending is the order of the day, as royalty revenues, corporate taxes and land sale proceeds also have plummeted in concert with oil and gas prices.

In an effort to counter the anti-pipeline rhetoric, new governments in Alberta and Ottawa have unveiled policies to combat climate change, hoping that improving Canada’s reputation on that front may reduce opposition to building new pipelines, whether they are north or south of the U.S. border.

No one will know if these efforts would have changed U.S. President Obama’s staunch opposition to TransCanada’s Keystone XL project, which he vetoed one final time in late 2015. In response, TransCanada said, “misplaced symbolism was chosen over merit and science.” In January, the Calgary-based company filed a federal lawsuit, based on the premise that the President does not have the authority to prevent the pipeline’s construction, and that the denial was a violation of the North American Free Trade Act. The company is seeking to recover more than US$15 billion in costs and damages.

However, the efforts to reduce greenhouse gases don’t seem to be resonating with Canadians, so it remains to be seen if anyone outside Canadian borders knows or cares. Opposition within Canada to Enbridge’s Northern Gateway project remains, despite its approval almost two years ago by the National Energy Board (NEB), the federal regulator, subject to 209 conditions. Nonetheless, it appears less and less likely that Northern Gateway will ever get off the drawing board, as newly minted, Liberal Prime Minister Justin Trudeau recently stated that his government plans to formally implement a moratorium on crude oil tanker traffic on B.C.’s north coast, effectively killing the pipeline. Northern Gateway is designed to open up Asian markets to Canadian crude, and oil tankers are a necessary component.

The federal government also has unveiled interim guidelines for environmental assessments that are expected to further delay decisions on TransCanada’s proposed Energy East pipeline, and Kinder Morgan’s Trans Mountain pipeline expansion. The government said that the new requirements are critical to restoring public faith in the assessment of major energy projects.

The NEB, itself, has been under fire for its convoluted approval process, and was recently censured by Canada’s Auditor General, for not tracking the implementation of NEB-imposed conditions on pipeline approvals, and failing to adequately follow up on regulatory compliance deficiencies. For its part, the NEB accepted the report’s findings, and indicated that it already has taken steps to address the concerns.

Canadian wells drilled, 2004–2016

Meanwhile, TransCanada’s proposed C$15.7-billion Energy East pipeline, which would transport 1.1 MMbpd of Alberta crude through Quebec to East Coast refineries, supplanting imported sources of crude, also appears to be facing an uphill battle on its home turf. A group of Quebec mayors—despite having no role in the approval process, nor regulatory expertise or oversight—has come out in opposition to the pipeline, saying it could contaminate the waterways, wetlands and agricultural areas that it crosses in Quebec.

Their opposition sparked some acrimonious response from Western politicians, including Saskatchewan Premier Brad Wall, who posted an infographic that showed the dollars received in the west (zero) from the controversial federal program of annual equalization payments, compared to the $10 billion paid to Quebec in 2015. “This is a sad day for our country, when leaders from a province that benefits from being part of Canada can be this parochial about a project that would benefit all of Canada, including these Quebec municipalities,” stated Wall on his Facebook page.

Wall also has proposed that the feds fund a program that would hire laid-off workers to abandon dormant wells that are no longer capable of producing oil or gas. At a cost of C$156 million, the program would create 1,200 jobs to reclaim and abandon about 1,000 wells in Saskatchewan over two years.

The industry received some good news early in 2016, when the Alberta government left royalty rates as is, following an extensive review of the province’s royalty framework. Unlike the last review conducted in Alberta, in 2007, under Premier Ed Stelmach—a controversial and acrimonious process that led to changes that were subsequently repealed—this process was greeted with cautious optimism, and the response has been largely favorable. The new framework also introduces changes, starting in 2017, which simplify the royalty structure by covering all types of wells under the same rate.

In response to the grim outlook, producers have announced severe spending reductions, further deepening Canada’s economic malaise. As a result, drilling has fallen to levels not seen for decades, and the outlook for 2016 is equally grim. World Oil’s survey results bear this out, indicating that regulators and industry observers across the country expect drilling to fall by a further 15%–19% this year. Government land sale revenues are also expected to fall again in 2016.

Spending continues to fall, as some plans that were revised downward in late 2015 have been cut again in early 2016. Following a reduction of more than $3 billion in 2015, Canadian Natural Resources Ltd. (CNRL) recently announced that it would cut 2016 spending to C$4.5–5.0 billion, including almost C$2 billion for its Horizon oil sands mine expansion.

Husky Energy has announced a further US$800-million cut from its initial 2016 spending program, down to $2.1–2.3 billion. Encana has cut its spending to three-quarters of 2015 levels, to US$1.5–1.7 billion, and also will reduce its annual dividend. Cenovus plans to decrease spending by almost 20%, to C$1.4–1.6 billion, and expects production to remain flat.

Meanwhile, Crescent Point Energy has announced that it will spend C$950 million to C$1.3 billion, compared to $1.45 billion in 2015; Seven Generations Energy will reduce its spending by about 20%, to C$900–950 million, and ConocoPhillips has slashed its 2016 Canadian budget 30%, to US$800 million.

The volatility in the Canadian market did not translate into an upswing in mergers and acquisitions (M&A’s) in 2015, but this year kicked off with a blockbuster deal focused on Alberta’s oil sands deposits. According to Sayer Energy Advisors, there was C$15 billion of M&A activity last year, versus $49 billion in 2014. Within last year’s total, some $9 billion was from property deals.

As conditions worsen, more and more companies will be vulnerable to takeovers, or may look to dispose of assets to improve their bottom lines. The select few companies that are positioned to be buyers should have ample opportunity to bolster their portfolios.

The new year kicked off with the completion of a hostile takeover-turned-friendly, a deal first announced in late 2015. In mid-January, Suncor Energy and Canadian Oil Sands (COS) reached an agreement for Suncor to acquire COS in a stock-and-debt deal worth approximately C$6.6 billion. The new offer values COS stock at a premium of 17% over the company’s stock price at previous close. Suncor also has suggested that it will be looking at other acquisitions in this buyer’s market.

DRILLING

Not surprisingly, drilling fell precipitously in 2015, and with oil prices in freefall, operators shifted their focus slightly. According to Daily Oil Bulletin (DOB)records, of the 5,394 wells drilled last year, about 64%, or 3,461, were estimated to be oil wells, compared to more than 72% of the total in 2014. By comparison, the Canadian Association of Petroleum Producers (CAPP) includes dry holes and service wells in its estimate of 6,279 wells in 2015. Among productive wells, CAPP said that 3,189 wells, or 67%, were oil producers. The remaining 1,590 producers, or 33%, were gas wells. Another 1,500 wells were dry or drilled for service purposes.

On a percentage basis, the DOB’s number of gas wells increased to over 25% of the total in 2015, versus just under 20% the year before. Overall, drilling plummeted almost 52%, from the 11,170 drilled in 2014. The CAPP figures show a drop of 45% from 11,333 in 2014. Exploratory drilling, said DOB, dropped to 434 wells in 2015, just 8% of the total, versus 997 the year before.

The one trend that continued upwards last year was the average length of wells. Total meters drilled, said DOB, fell 45%, to 13.74 million in 2015, compared to 25.16 million in 2014. CAPP puts the figure at 14.24 million m.

In Alberta, DOB said drilling dropped 56% to 2,822 wells, versus 6,444 in 2014. The Alberta Energy Regulator’s preliminary estimate of 2015 drilling is 3,509 wells. In Saskatchewan, DOB said there were 1,818 wells drilled, a 49% drop from 3,559 drilled the year before. Official provincial data show 1,905 wells. To the west, the downturn wasn’t as severe in British Columbia. DOB estimates that 535 wells were drilled, a 23% decrease compared to the 691 in 2014. Official provincial figures show 476 wells. Meanwhile, DOB put Manitoba’s drilling at 219 wells (down 53%), but the province claims 295 as the figure. In East Canada, CAPP estimates that nine wells were drilled offshore Newfoundland during 2015, with seven wells (including one offshore Nova Scotia) predicted this year.

For the year ahead, the Canadian Association of Oilwell Drilling Contractors (CAODC) is predicting that national drilling will fall to 4,728 wells drilled, a 12% decrease from 2015’s number, and 58% lower than 2014. CAODC forecasts a 22% rig fleet utilization rate for 2016, and estimates that over 28,000 jobs will have disappeared from the drilling sector since 2014. Meanwhile, the Petroleum Services Association of Canada (PSAC) is slightly less bullish, predicting that 4,900 wells will be drilled in 2016, a 9% decrease. PSAC based its predictions on an average WTI benchmark price of US$38/bbl, a natural gas price of C$2.50/Mcf and an average Canadian dollar value of US$0.72. CAPP predicts an 18.7% drop, to 5,107 wells.

LAND SALES

And, just in case, there was any doubt as to the current state of Canada’s oil patch, land sale revenues declined drastically in 2015, plunging 65% to C$376 million, versus $1.1 billion in 2014, and substantially behind the record $5 billion collected in 2008.

Alberta collected the highest total, $299 million, down almost 40% from last year’s $494 million. British Columbia garnered $18 million, down an astounding 95% from $383 million in 2014, and narrowly surpassing the lowest total collected since 1982, when it took in just under $17 million.

Saskatchewan also saw its revenues fall dramatically, to $56 million, dropping 71% from $198 million in 2014. Finally, Manitoba took in $2.2 million in 2015 (compared to $1.6 million in 2014).

Land inventories are one of the most consistent indicators of future drilling activity; the decrease in land sale volumes indicates that, although there are some positive signs in Canada, it would be premature to suggest that any sort of recovery is imminent.