MARKET ACTIVITY/TRADING NOTES FOR DAY ENDING WED., JANUARY 14, 1998 (2)
HEADLINE STORY
The Globe and Mail
The Oil Patch's Brutal Math
Everyone knows that what goes up has to come down, but does it have to come down so darn fast? Even seasoned oil patch watchers have been amazed by just how quickly things have gone from being exceptionally great to being absolutely rotten, thanks to a stunning freefall in the price of crude oil. As one industry player put it recently, the oil and gas sector has gone through almost an entire business cycle in only a year and a half. "We've gone from the penthouse to the outhouse," one oil patch chief executive officer told Reuters News Agency.
Last January, the price of West Texas intermediate crude was trading on the New York Mercantile Exchange at north of $26 (U.S.) a barrel, up from about the $20 range in the middle of 1996, and oil producers everywhere were awash in cash flow. That in turn drove stock prices higher, and helped fuel the unprecedented wave of takeovers and equity financings in the oil patch last year. Everyone knew that $26- or even $25-a-barrel oil couldn't last, but expectations of $20- or $21-a-barrel prices were fairly widespread. No one predicted a massive fall-off.
For one thing, the re-entry of Iraq into the world oil market as part of an "oil-for-food" deal, one of the factors that is being blamed for the recent price drop, had been under way for more than a year and was largely taken for granted (or so it seemed). By the middle of last year, another factor -- a 10-per-cent increase in production by OPEC -- was also pretty much a fait accompli. The only real wild card since the middle of last year has been the collapse of the Asian market, and the fear that has spawned about a corresponding slump in demand for crude oil.
After trading between $19 and $23 for the better part of the year, the oil price fell off a cliff in October. It has since bumped and tumbled down to a low of $16.30, lower than it has been since April of 1994, when it hit $16.26. In that year, however, just getting as high as $16 was cause for joy, since the price got as low as $13.88 in February. Things aren't that bad right now because many companies can still make money with $16.50 oil, but there is no question that high-cost producers and those with a lot of debt will find it harder to make ends meet.
The situation is made even more severe by the speed at which oil prices have plummeted. In most cases, when the oil price falls by such a huge margin -- more than 25 per cent in just the past few months -- the drop takes place over a longer period of time, and companies can adjust their drilling programs and spending requirements gradually. At the moment, however, many producers are committed to exploration programs laid out back when oil prices were a lot more attractive.
In addition, much of the industry is still dealing with the effects of higher costs for drilling rigs, land and services, costs that climbed steadily last year as high crude prices fuelled a frenzy of exploration and drilling. From the level of $6.50 (Canadian) a barrel in 1995, average "finding and development" costs for the industry soared to the $9-a-barrel range last year, according to a study by FirstEnergy Capital. The effect of those costs started hurting the profit margins of even senior producers such as Renaissance Energy last year, and that kind of harsh arithmetic isn't likely to get any better with oil prices dropping the way they have.
Even a small change in the price of crude can make a dramatic difference in cash flow. Gulf Canada says its operating cash flow rises or falls by $27-million for every $1 (U.S.) change in the price of oil, implying that it has fallen by about $175-million (Canadian) since October. Canadian Natural Resources says its cash flow increases or decreases by $17.6-million for every $1 (U.S.) change.
These kind of equations haven't been lost on investors, obviously. After steaming ahead for most of last year to a record high of more than 8,000 in October, the TSE oil and gas subindex has tumbled more than 2,300 points -- or close to 30 per cent. In fact, it has fallen more than 10 per cent just since January, and is now lower than it has been since the fall of 1996.
At this point, some analysts are saying the market has overcorrected, and that many companies look cheaper than they have in more than a year. Talisman Energy is down more than 35 per cent from October, while Canadian Natural Resources is down 40 per cent. Gulf Canada is off almost 42 per cent, perhaps in part because it carries more debt than other producers. Ranger Oil has fallen close to 44 per cent, and is cheaper than it has been since early 1996.
Although oil price forecasts must always be taken with a grain of salt, especially when they come on the heels of such an unexpected plunge, most analysts expect the crude price will stabilize somewhere around the $20 range this year. That means the selloff of oil stocks has almost certainly been overdone. Still not convinced? Then you'd be better off taking FirstEnergy's advice -- stick to companies with exposure to natural gas, which at the moment looks to have more upside.
FEATURE STORY
Canadian Oilpatch Ripe For Plucking
Report Says U.S. Energy Firms Seeking Acquisitions
Calgary Herald
Conditions are ripe for U.S. companies to make significant acquisitions in the Canadian oilpatch, according to a brokerage firm report obtained confidentially by the Calgary Herald.
The report highlights four factors making Canadian oil and gas companies more attractive to U.S. suitors:
- The Canadian dollar at 12 year lows.
- The relatively under-drilled Western Canadian Sedimentary Basin.
- Low share values.
- The upside presented by natural gas pipeline expansions to the U.S. that open beginning this November.
Authors of the report refused to comment, but some other analysts agreed with findings of the study.
"The trend is definitely in place. The industry will be a lot smaller at this time next year because of the consolidation, which will involve some U.S. players," says industry analyst Ken Faircloth of Goepel Shields & Partners, pointing to the acquisition last fall of Chauvco Resources by Pioneer Natural Resources.
Citing the loss in value of more than 12 per cent in the Toronto Stock Exchange's oil and gas index since the beginning of the year, Faircloth says companies may be more willing to consider merger or takeover opportunities.
"With higher debt to cash flow levels because of lower commodity prices, capital expenditure programs and production levels, some companies will find themselves in tough situations which they won't be able to get out of," says Faircloth.
" I wouldn't be surprised to see more of the types of joint ventures similar to the alliance announced yesterday by Chesapeake Energy and Ranger Oil to develop the Helmet area of northeast B.C.," says Doug Monaghan, analyst with Scotia Capital Markets in Calgary.
But Monaghan doesn't think that the lower valuations will pull in some bigger U.S. players.
"The bigger companies are more interested in the higher impact overseas plays," he said Wednesday.
"I am not seeing any evidence of increased interest by U.S. players in Canada," says Bob Hinckley of Merrill Lynch in New York.
Hinckley says most independent oil and gas companies prefer to stay in familiar territory, exploring and producing in the Gulf of Mexico and the U.S. Gulf coast.
"With currently available technology, companies can go back into old wells and go deeper or drill in previously untouched areas such as drill faults," he says. "Most companies look at Canada as a rather mature basin, especially on the oil side."
But statistics suggest otherwise.
The study shows drilling density in the U.S. basin is more than five times that of the Western Canadian basin, at four wells per square mile versus Canada's 0.7 wells.
|
