IN THE NEWS / Little Upside Seen For Struggling Oil Producers
Cash Crunch: Survival For Many May Hinge On Crude Price Recovery
By Claudia Cattaneo
The Financial Post
Making a call on the fortunes of Canada's oil and gas industry in 1999 is like trying to predict Saddam Hussein's next move.
Circumstances are tough and unsettling -- to the point even the bravest see little upside until oil prices recover.
For many firms, the challenge will be survival, let alone performance, industry observers agree.
West Texas Intermediate crude oil closed at $11.33 a barrel yesterday in New York, about 40% lower than before the commodity started going downhill about 14 months ago because of oversupply and lower world demand.
The collapse shaved 45% off the Toronto Stock Exchange oil & gas subindex since its October, 1997, high, shutting down access to cash and investor interest.
"The key is to have some strength come back to oil prices, getting equity back into the sector so that the drilling can come back," said Tom Ebbern, oil and gas analyst in Calgary with Newcrest Capital Inc.
Natural gas, so far the sector's better half because of the commodity's rosy long-term outlook, is also beginning lose its appeal. With so little cash available for drilling and high storage levels because of the relatively warm winter so far, many natural gas programs are beginning to fall, says Martin Molyneaux, research director at FirstEnergy Capital Corp. in Calgary.
"The shift to natural gas is constrained by opportunity and financial capacity," agrees ARC Financial Corp., a Calgary based energy research and investment firm.
ARC says gas drilling is expected to increase only marginally next year, to about 5,000 wells, up from 4,800 in 1998 -- hardly enough for producers to take advantage of increased pipeline capacity to U.S. markets or to make up for the low oil prices.
Oil drilling has collapsed. ARC says only 3,700 oil wells were drilled in 1998, and 2,500 are projected for next year, down from 8,500 oil wells in 1997.
Meanwhile, increased debt levels, the probable devaluation of oil assets at the end of the year, the prospect of further declines in earnings and cash flow could result in industry credit concerns in 1999, the Dominion Bond Rating Service Ltd. warns in a recent industry study.
Not surprisingly, capital spending -- a key indication of future industry activity and health -- is off sharply, as companies shift their focus to managing their cash, rather than their budgets, said Mr. Molyneaux.
Based on a survey of industry spending plans, ARC estimates capital spending in the sector will be cut a further 6% in 1999 from this year's $13.5-billion, already off from 1997, when the industry spent an unprecedented $18.9-billion.
"Corporate plans for 1999 are extremely fluid and highly dependent on commodity prices, to the point that many companies were reluctant to commit to specific numbers," the firm says.
But Mr. Molyneaux says the micro spending cuts that are containing activity in Canada are also taking place around the world. Eventually, they will lead to a macro oil price recovery.
"With the supply numbers eroding quickly all over the world, but relatively stable demand numbers and some signs of growth out of Asia, we think that by the end of the second quarter you will start to see more balance between supply and demand," he said.
That should result in some uptick in oil prices starting in the second quarter, he said.
Mr. Ebbern is also looking for an oil price recovery by mid-1999, particularly if members of the Organization of Petroleum Exporting Countries send strong signals of a supply cut when they meet in March.
Meanwhile, investors willing to ride the storm will find interesting opportunities among the sector's depressed stock prices.
"It's the kind of atmosphere where potentially you can create a ton of value, when oil prices get back on track," said Mr. Molyneaux.
Mr. Ebbern says larger companies are likely to perform best in this environment, because they are less volatile and more liquid. Among the seniors, he likes Alberta Energy Co. because of its large natural gas production -- it is aiming to be the country's largest producer in 1999 -- and a stable of oil-related opportunities that can be brought back if oil prices start to behave. His 12-month target is $48. The stock (AEC/TSE) closed at $33.80 yesterday, up 20c.
Mr. Ebbern is also enthusiastic about smaller companies focused on natural gas. The advantage of picking small is that stocks are probably as cheap as they can get. Among those he likes Genesis Exploration Ltd., on which he has a target price of $9.50 in 12 months. The stock (GEX/TSE) closed at $5.20 yesterday, down 5c.
Mr. Molyneaux favours Suncor Energy Inc. ahead of other integrated oil companies. Most of its production comes from the oilsands in Northern Alberta. The firm has the best earnings, cash flow, and production outlook, he said. Suncor shares (SU/TSE) closed at $44.45, up 40c.
Suncor will benefit from its inclusion in the new S&P/TSE 60 index, says Peters & Co. Ltd. in Calgary. It has the largest weighting among energy stocks with 1.36%, while it had the smallest weighting in the TSE 35 index, at 0.25%.
Stocks in the new index are expected to gain from buying by index funds and added exposure to international institutional investors, throught its inclusion in an international S&P index of stocks.
At current prices, Mr. Molyneaux is upbeat on Talisman Energy Inc. A senior oil producer with international operations, Talisman could stage a remarkable comeback if oil prices recover. He has a $45 target for the stock in 12 months. The shares (TLM/TSE) rose 70c to $26.20.
Another favourite of Mr. Molyneaux' is Canadian Natural Resources Ltd., a natural gas weighted and lower-cost producer. He has a 12-month target of $45. The stock (CNQ/TSE) gained 10c to close at $22.40.
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