Canadian oil producers exposed to rout as hedges expire

CALGARY (Bloomberg) -- A defense Canadian oil producers had against the plunging price of crude is crumbling as hedges expire amid projections that crude will continue to decline.

Hedges that shielded companies such as Crescent Point Energy Corp. and Whitecap Resources Inc. from the full pain of $30 oil are winding down this year and next. Nineteen small- to mid-sized producers have an average of 19% of their crude hedged at about $58/bbl this year, and only 3% at about the same price in 2017, according to data from Canadian Imperial Bank of Commerce. That compares with 27% at $71 for the same companies last year.

“When you look out to next year and beyond and as far as the eye can see, producers are fairly naked when it comes to price protection,” Michael Tran, commodities strategist at Royal Bank of Canada’s RBC Capital Markets unit in New York, said in a June 19 phone interview. They “are fully exposed to oil prices when it hurts the most.”

The reduced hedging may prompt companies to accelerate output and costs cuts, including dividends, as the brunt of the downturn hits. “While in 2015 producers still had somewhat of an advantage of hedging on their books, when you roll into 2016 and beyond that’s when the pain will be felt,” Tran said.

Well Protected

Oil has plunged to under $27/bbl in New York, from near $108/bbl in 2014, as the Organization of Petroleum Exporting Countries raised production to maintain market share amid a surge in North American output. Analysts from Royal Bank of Canada to Credit Suisse Group AG have cut price projections. Morgan Stanleyexpects Brent crude to average $30 in the third quarter, after reducing forecasts for this year by as much as 51%.

Crescent Point’s oil hedges drop to 29% at about $60/bbl this year, from 44% at $69 last year, CIBC data show. Its gas hedges fall to 30% from 33%. Whitecap’s oil hedges fall to 14% this year at $64/bbl, from 47% last year at $74/bbl.

Crescent Point is “well protected” with hedges in 2016, Trent Stangl, V.P. of inventor relations, said in a phone interview. The company brought costs down 30% last year and the “longer we stay in $30 to $35 environment, the more this cost structure will come down,” he said. Hedges put on in 2018 could be brought forward to 2017, should prices stay low until then.

Dividend Focus

Whitecap has cut its capital budget for this year by more than half to $70 million to cope with lower prices, and has positioned its dividend to be sustainable at $45 oil next year, Chairman Grant B Fagerheim said in a phone interview Tuesday.

Selling oil at a lower price may prompt Crescent Point to trim its dividend, Cody Kwong, analyst at FirstEnergy Capital Corp., said by phone from Calgary.

“In this environment, I think the market would take that as a positive note,” said Kwong, who rates Crescent Point as his “top pick.” The company is rated “buy” by 18 of 24 analysts, according to data compiled by Bloomberg. The stock has dropped 58% in the past year compared with a 35% decline for the Standard & Poor’s/TSX Composite energy index.

Cenovus Energy Inc, an oil sands producer, said today it had about 24% of its oil output hedged for the rest of 2016 at C$72.31/bbl after adding new positions. The company was 15% hedged for this year at C$80/bbl at the end of 2015, Chief Financial Officer Ivor Ruste said in a conference call in December.

Best-Hedged

Oil producers with dividends to pay often hedge their oil and gas years in advance to ensure they can make payments, Dennis Fong, a Calgary-based analyst at Canaccord Genuity Corp., said in a Jan. 25 phone interview.

Northern Blizzard Resources Inc. and Pengrowth Energy Corp. are the two most-hedged producers this year among the companies covered by the CIBC data. Pengrowth has 58% of its oil hedged at about $66/bbl for this year, according to the CIBC estimates. Northern Blizzard will sell 61% of its crude at about $55/bbl. Next year, Pengrowth’s oil hedges drop to 11% at $59/bbl. Northern Blizzard’s also fall to 11% at about $64/bbl.

Pengrowth’s hedging program was put in place in 2013 and 2014 to “ensure cash-flow stability” as the company built its Lindbergh oil-sands project, company spokesman Wassem Khalil said in a Feb. 8 email. While the company has oil hedges extending into 2018, “given the current level of oil prices, there is no desire to enter into any additional hedges at this point.”

For Pengrowth, the hedges are “a big, big lifeline,” Nima Billou, Veritas Investment Research Corp. analyst, said in a phone interview. “They will definitely be able to ride out 2016 because of these hedges.”

The industry, as a whole, may have a harder time.

“Those hedges come off in 2017, and with these oil prices continuing to fall, they could be in a difficult positions,” Kyle Preston, National Bank Financial analyst, said in a Jan. 15 phone interview.