Canada's oil and gas industry is closely watching the trend in receiverships, as companies — especially smaller ones — struggle with low oil and gas prices and reluctant investors.
"There are a fair number of them out there, and there are a fair number of them pending" Alan Tambosso, president of Calgary-based Sayer Energy Advisors told CBC News. Sayer advises clients on oil and gas mergers and acquisitions.
Exact numbers are difficult to compile. While firms that trade on the public markets must disclose the information by law, there's no way to know how many companies backed by private investors have failed, short of rummaging through court records.
The banks are known to have pushed five or six firms into forced liquidation so far this year, about the same number of all of 2011 and last year, and twice the number for all of 2010.
'We think there are more companies that are on the edge financially' —Oil patch adviser Alan Tambosso
But it's well short of the couple of dozen that sought protection from creditors or were pushed into receivership in 2009.
"We think there are more companies that are on the edge financially," said Tambosso, "but as far as the trend goes, it’s not any worse than some of the bad years we’ve had recently."
The firms that have failed so far this year had debt levels that ranged from $2 million to $25 million.
"It’s obviously a bit of a disturbing trend," says Doug Porter, deputy chief economist at BMO Nesbitt Burns. "I wouldn’t say it’s shocking, though, given the confluence of factors we’ve had in recent years."
With oil prices above $93 US and the Dow making new, all-time highs, it might not make sense to some people that the Canadian industry is facing its challenges.
But natural gas prices have been low for years, as technology has opened up formations that couldn’t be exploited before, flooding North American markets with supply.
Investors harder to find
Oil prices have been constrained as pipeline bottlenecks in the U.S. produce a glut at a major pricing point on the continental transportation system at Cushing, Oklahoma, and prevent Canadian firms from getting world prices.
"Pipeline capacity is beginning to hurt the sector, I think that’s weighing," said Porter.
And the recent rise in major U.S. stock market indices may not be showing it, but many firms in the higher risk oil and gas sector are finding it hard to line up investors.
"In the market we’re in today, with the equity markets being effectively closed, there’s not a lot of capital available," says Tambosso.
Part of the problem was the relative ease getting into the oil and gas business just a few years ago.
Just put together a management team, get financing from the public markets or private investors along with bank debt and get lease rights to some potential production properties. Unlike mining, manufacturing or even farming, which take much longer before producing a return, in oil and gas, it was possible to start paying back investors in a year.
But then equity markets went soft, and companies, unable to sell more shares at a decent price, ran up debt as interest rates hovered at historic lows, debt that ballooned as commodity prices stayed stubbornly low.
Tambosso doesn’t blame the lenders for the failures so far this year.
Often, he says, the problem is that management’s view of what an undeveloped oil or gas property that it has put up for sale is really worth departs from the market reality.
Management, which a sees the potential development value, holds out for an impossibly high offer and the only possible result is receivership.
"If the company goes into receivership, the emotional attachment to the asset and the upside is off the table," says Tambosso, allowing the bank to have properties auctioned off and recover what its owed, which may often amount to the market price of the assets anyway.
"The banks aren’t in the business of putting people out of business," he said. "They’re not interested in lending (companies) money and then putting them into receivership. (Those are) their customers."
He believes the banks have been patient, but four years of low natural prices —although both gas and oil prices seem to have made some recovery recently— have cut into cash flow falls at the same time as properties produce less oil and gas.
"After two or three years of prolonged low natural gas prices, the banks have reached the point where they realize with some companies that if they don’t do something soon, then they may be at risk of not recovering their investment."
Asset sales surpassed $14B in 2012
So companies are selling off assets or looking for outright buyers, and doing it quietly, to avoid pushing prices down as much as possible.
"Many companies, particularly publicly-traded entities, will be quietly shopping for purchasers or for merger candidates," Tambosso said in a commentary released Jan. 30.
The value of asset sales in the Canadian oil patch surpassed $14 billion last year, the second highest level in 10 years, and Tambosso expects to see that continue this year as firms try to find funds to invest in exploration and developing new production.
But capital spending is still at its lowest level in years, reflecting a drop off in cash flow and earnings.
In February, Statistics Canada reported the oil and gas extraction sectors watched their profits plummet by 22.7 per cent in the fourth quarter of 2012, the sixth consecutive period of decrease.
And as the hundreds of exploration and production companies in the industry struggle, so to the service companies they contract with to drill their wells for them and to provide other services.
Typical of that, last week Calgary-based Total Energy Services blamed a slowdown in activity for a 55 per cent drop in fourth-quarter net income to $10.5 million and a fall of 19 per cent in revenue, to $78.4 million from the same period a year earlier.
As the industry's growth remains muted, that will have trickle-down effects in the overall economy, in trade and in income tax revenue for Ottawa and royalty payments, especially in Alberta.
"I think there’s no two ways about it, that the energy sector and oil production in particular had been the main driver for the relative outperformance of the Canadian economy, not just over the past few years, but I’d say for the past decade," Porter says.
"I would say it’s still the workhorse for trade, though. Last year, we had our second largest trade surplus on record in the energy trade sector alone, and that’s really one of the few points of strength that we’re seeing for overall Canadian trade at this point."