Oil, gas sizzle could cool, analysts warn
By DAVID PARKINSON
From Monday's Globe and Mail
Calgary — The party was still on for the Canadian oil and gas sector in the second quarter, but analysts say the music has begun to fade.
Financial results from 14 of Canada's biggest oil and gas companies showed combined profits of $3.27-billion in the quarter ended June 30, up 64 per cent from a year earlier, as Canadian producers continued to benefit from relatively strong prices for crude oil, natural gas and petroleum products. Cash flow in the quarter was a combined $6.15-billion, up 37 per cent. Several major producers, including Petro-Canada, Alberta Energy Co. Ltd., Canadian Natural Resources Ltd. and Nexen Inc., turned in the best second-quarter performance in company history.
"The industry had fantastic results for the second quarter," said David Stenason, an analyst with Scotia Capital Inc. in Montreal. "They met or exceeded our expectations."
However, lurking behind the impressive year-over-year gains was a significant decline from the industry's record first-quarter results, as commodity prices have eroded from their peaks. Profits in the quarter were down 12 per cent from the first quarter, while cash flow slipped 19 per cent. Natural gas-rich companies took the biggest hit, as prices for the fuel on the New York Mercantile Exchange slumped to $3 (U.S.) for a million British thermal units from record levels of more than $10 in late December.
While the second quarter of the year is typically the slowest for oil and gas demand, analysts said the drop in performance from the first quarter goes well beyond seasonal factors, and point to a cyclical downturn for the sector.
"This isn't seasonal as much as structural," said Scott Inglis, an analyst at FirstEnergy Capital Corp. in Calgary. "We've had a material amount of demand erosion."
Analysts said the global economic slowdown is putting a big dent in demand for oil and gas, while the high prices of the past year have also discouraged consumption. They said that with few signs that the economic downturn is near its end, the boom in the energy sector could be reduced to a fizzle over the rest of 2001.
"The third quarter is not looking that rosy. We're going to see earnings down 30-40 per cent from the second quarter," Mr. Inglis said. He added that he expects third-quarter profits to be "flat to down" compared with year-earlier levels. "The third quarter will probably be the weakest quarter in the past seven or eight quarters."
Experts point to falling prices for natural gas and gasoline as two key factors in the muted outlook for energy company earnings.
Analysts forecast that natural gas prices on the New York Mercantile Exchange will average between $3 and $3.50 a million BTUs for the rest of the year, compared with an average of about $6.25 in the second quarter and $9 in the first quarter. The benchmark Nymex contract, for September delivery, closed Friday at $3.04.
"We're probably in a price range now that is sustainable," said analyst Brian Dutton at UBS Warburg Inc. in Toronto.
Meanwhile, lower-than-expected summer demand has driven gasoline prices lower at a time of year when they are usually strong. According to Calgary-based consulting firm MJ Ervin & Associates Inc., Canada's average gasoline price was 63.9 cents (Canadian) a litre as of Aug. 7, down 20 per cent from a record 80.3 cents in mid-May. In the United States, gasoline prices dropped 12 per cent in July alone, according to the International Energy Agency.
While oil and gas companies typically make little profit from retail gasoline sales, the decline in gasoline markets has translated to a much more significant drop in margins at refineries, which enjoyed sky-high profits when the rush was on to build gasoline inventories ahead of the summer driving season.
Analysts said the erosion of refining margins will deal a blow to Canada's integrated producers — Petro-Canada, Imperial Oil Ltd. Shell Canada Ltd., Suncor Inc. and Husky Energy Inc. — whose booming refining businesses helped offset falling natural gas prices in the second quarter.
Crude oil prices have so far held up relatively well despite slowing demand, largely because the Organization of Petroleum Exporting Countries has cut its production by 3.5 million barrels a day, or 13 per cent, so far this year. OPEC recently announced a cut of one million b/d to take effect Sept. 1, which helped prop up falling prices amid slower-than-expected summer demand. Nymex September crude closed Friday at $28.05 (U.S.) a barrel, while OPEC's reference basket of crude oils sat at $24.50 Thursday.
"With the million-barrel cut by OPEC, the market should be firm for the rest of the year," said Vincent Lauerman, an economist at the Canadian Energy Research Institute in Calgary. However, he said OPEC will find it increasingly difficult to keep prices in its target range of between $22 and $28 a barrel if the global economy continues to slow and demand continues to fall.
"The big bogeyman is world demand," he said. "Is it going to slow more? That's the big question mark. We don't think things are going to get much worse, but at the same time we don't expect things are going to get much better."
While analysts agree that some of the shine has come off the oil and gas sector, they insist that the situation is far from bleak. Seasonal demand for both crude and natural gas will pick up in the fourth quarter because of the need to build up stockpiles of heating fuel before winter.
And while demand could fall off once the winter heating push subsides in the first quarter of 2002, most observers expect OPEC to trim production again in the new year to support crude prices. Indeed, prices for both oil and natural gas are likely to remain high enough to keep producers in profits for some time to come.
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