With crude prices now under $50 per barrel and both West Texas Intermediate and Brent having lost over half of their value in the last six months, Canada’s energy patch is being hit hard. But there are a number of analysts claiming the price crunch may be short lived with prices well below the breakeven price for a number of U.S. shale oil producers.
However, I believe this may be premature with no signs of production diminishing anytime soon and the world’s top global producers of crude continuing to pump oil at record volumes.
What is the outlook for crude prices?
Over the last five years U.S. crude production has surged 39%, while Canadian crude production grew 14% by for the same period and there are signs production growth will remain steady. Furthermore OPEC producers, particularly Saudi Arabia, are determined to maintain production as a means of driving higher cost unconventional oil producers out of business and regain market share.
This ongoing production growth continues to drive the global supply glut which is pushing crude prices ever lower. But it has seen many analysts speculate that the Saudis have U.S. shale oil producers firmly in their sights and with the price of crude now under the breakeven price for many operations, production will wind down and prices will rebound.
But with Canadian oil sands having some of the highest breakeven costs in the oil industry, it is likely the energy patch will be affected first.
While the U.S. shale oil industry has breakeven costs ranging between $48 and $68 per barrel, Canadian oil sands projects have far higher breakeven costs. Typically, they range between $53 for legacy projects to $90 per barrel for new projects. With the North American benchmark price, West Texas Intermediate (WTI), now only at $46 per barrel many of these projects are operating at a loss.
It is also appearing increasingly unlikely that U.S. shale oil production will wind down as quickly as some analysts believe, with many wells still profitable at current prices. Furthermore, a number of producers are increasingly willing to gamble on higher prices or risk taking a loss because stopping and then restarting production can be a costly process.
For these reasons, I expect to see the global oil supply glut continue for the foreseeable future, potentially keeping prices under US$65 per barrel for the remainder of 2015.
What does this mean for Canadian investors?
The key takeaway for investors is the vulnerability of oil sands operators, particularly those with high operating costs and weak balance sheets. One company that stands out as being particularly vulnerable is Canadian Oil Sands Ltd. (TSX:COS) with production outages and high maintenance costs weighing heavily on its ability to grow production and remain profitable. This is even of greater concern, with the company having predicated its 2015 guidance on an average WTI price of $75 per barrel for 2015, which is 39% higher than the current price and unlikely to be seen anytime soon.
However, the larger integrated oil majors with their diverse portfolio of conventional and unconventional oil assets coupled with the ability of their refining operations to offset lower crude prices and wider price differentials are well set to weather sustained softness in crude prices.
One Canadian integrated energy major I believe is well positioned is Canadian Natural Resources Ltd. (TSX:CNQ)(NYSE:CNQ). This is because it has a solid balance sheet with a low level of leverage and considerable liquidity. It is also well positioned to minimise the impact on earnings with 2015 production forecast to rise 9%, despite expenditures being cut by 30%.
More importantly for investors, at a time when many oil companies are slashing dividends along with capital expenditures, Canadian Natural Resources, which yields a solid 2.8%, appears sustainable with a payout ratio of a mere 31%. This leaves plenty of fat in its bottom line to weather significantly lower crude prices while continuing to reward patient investors until crude prices rebound.