The last three years have been an uphill trek for Canada’s oil and gas producers. Persistently low global commodity prices, combined with a series of domestic hurdles including market access, a growing regulatory burden and negative market sentiment, created high levels of investment uncertainty and made it challenging for many operators to survive.
The result of these downward pressures can be seen in this year’s KPMG/Daily Oil Bulletin Top Operators report.
The number of publicly traded Canadian oil and gas companies on the TSX tracked by the DOB has declined by 30 per cent since 2014, and now totals only 72 TSX listed companies.
The TSX Venture Exchange, where smaller companies are listed, fared even worse, falling by over 40 per cent. Market capitalization for TSX-listed companies declined from over $310 billion to around $210 billion from the end of 2014 to the end of 2018.
But it isn’t all bad news, says Michael McKerracher, National Industry Leader for Energy at KPMG.
“If you step way back the industry is getting better,” McKerracher says. “Globally, demand for energy continues to grow, and the Canadian industry is getting better at telling its energy story to the world.”
“There are still over a billion people in the world without electricity,” he points out. “Canadian producers are still among the best producers to meet these needs.”
Domestically, advances are being made to answer market access issues with the recent approvals of the Trans Mountain Pipeline Expansion and LNG Canada export facility.
Oil and gas producers have largely cut costs and cleaned up balance sheets to compete in the current global commodity price environment, with many positioned for growth when market access comes on stream.
“We’re at a bit of a tipping point. You need low costs and a strong balance sheet but you still have to spend money to grow,” he says. “It’s a balancing act for producers.”
What is needed now is stability to bring investors back into the fold. A number of regulatory issues surrounding the project approval process remain unsolved. There are also concerns about high regulatory and taxation burdens. All these factors are making it challenging to understand how current investments will play out in the future.
“Investors put money where there is some comfort they can model future cash flows. If they can’t, they won’t invest.” he says.
What investment there is in the industry is looking for yield, not growth.
“Most companies are using share buybacks or dividend increases. In a down environment this allows access to investors but it’s not a long-term strategy. This is a capital intensive, high decline business that needs investment.”
McKerracher says he is hopeful the federal election this fall will be the last hurdle to create more stability and have investors once again look at Canada as a potential growth area.
“I’m guardedly optimistic,” he says. “Industry needs to take the little successes it has had and build on them. We have to change our sentiment and rebuild our confidence. We need to get our mojo back.”
Oilsands operators will continue to consolidate and vertically integrate
The oilsands sector has consolidated significantly over the last two years as Canadian operators solidified their interest in production from northeast Alberta. This trend will likely continue as operators build the scale necessary to vertically integrate operations further downstream, says McKerracher.
“Vertical integration makes a lot of sense. If you look at 2018 you see that investors are putting money into those companies that are integrated with refineries. If fully vertically integrated, no matter where they are in the commodity cycle, they can take profits out of different businesses and maintain cash flow. Some smaller producers are less able to influence infrastructure and that hurts them from the production to the sales point.”
“You need scale to integrate,” he adds, pointing to more consolidation going forward.
More challenging years ahead for gas producers
While many oilsands operators have the scale and investor confidence to move forward, natural gas is a different story, says McKerracher.
“Natural gas companies are facing greater difficulty. Adding the LNG Canada facility will be a boost for operators.” McKerracher expects the LNG facility to expand quickly to four trains once construction begins. “However, for the near term, gas producers will remain in survival mode as it will remain difficult to reduce Canada’s natural gas glut until an LNG facility is operational.”
“We need two or three LNG facilities. I think we may eventually get two.”
McKerracher says the consortium of Montney and Duvernay region gas producers, who put together a partnership to investigate developing their own export facility, are on the right track.
“I think it’s a great idea. They have hired people with good experience to lead the initiative. The gas is there; they just need the international sales contracts. I think there is a good chance, if they put it all together with the support of the Indigenous communities, they will find financing.”
While awaiting LNG exports, however, he expects investment will flow to the producers with the scale and control of infrastructure to ship production to a variety of markets.
“The junior group that has little control over infrastructure and is stuck selling at AECO. They need market diversification and that’s tough without the control of infrastructure,” he explains.
The tax burden also makes it difficult for smaller oil and gas operators to prosper.
“There’s no big returns to begin with and everyone has their hand out for a piece of it. The more governments can understand the full picture of the whole tax burden and how it is affecting the industry, the better.”
Add the recent Redwater court decision to the mix. Redwater puts regulators saddled with decommissioning costs at the front of the line in insolvency cases before creditors. As a result, banks and other debt financers are taking a close look at company liabilities during credit renewal time.
“The majority of companies can survive Redwater,” he says. “It will cause a little uncertainty in smaller producers. Banks will look closer at asset retirement obligations and could limit reserve-based loans. Smaller companies already at the top of their lines could be in trouble. It could cause some consolidation.”
Desperation in service sector will continue until investment returns
The lack of investment in growing production puts the oilfield services sector in a tough position. “Inefficient service companies are not around anymore,” he says.
Those that remain are providing innovative solutions that drive down costs or drive up production. There is also a demand to work together with customers and others in the supply chain.
“For individual companies to survive they need to build better alliances. Everyone has to be on one page,” he explains. “We’re not as tight as we could be with alliances.”
The lack of investment has led to a number of service companies looking outside of Canada for opportunity. This could have a major effect if investment returns, says McKerracher.
“Our oilfield services are world-renowned. Our Energy Service companies are moving talented people to other places in the world. “It is a real concern for the whole industry when we are losing our young talent!”
McKerracher sums up, “Let’s get our mojo back, build on the little wins, and show the world what the Canadian Energy sector is known for – hard work and resilience!”