Business·Analysis

Energy sector suffers a stunningly bad day

The week got off to a thoroughly depressing start for the oilpatch, as oil slipped below $38 US a barrel for the first time in six years. What does sub $40 oil mean for an energy sector that has already taken a beating over the past year?

It's very difficult to make money at $37 a barrel

Oilsands producers struggle to break even with oil at $37 US a barrel. (Jeff McIntosh/Canadian Press)

The week got off to a thoroughly depressing start for the oilpatch, as oil slipped below $38 US a barrel for the first time in six years, as the realization sank in that OPEC was not going to pull back on production. Some members, in fact, are looking to pump more oil into a world that is awash in it.

I can think of, in 25 years, a day in 2008 that might have been as stunning.—Rafi Tahmazian, Canoe Financial

West Texas Intermediate oil closed at $37.65 US per barrel. The energy sub-index of the Toronto Stock Exchange lost six per cent, with some smaller companies dropping as much as 13 per cent in one trading session. This is a sector that lost a collective $1.5 billion in the first half of this year and has laid off 40,000 people. It raises the question of just how much more it can take.

"I can think of, in 25 years, a day in 2008 that might have been as stunning," said Rafi Tahmazian, a portfolio manager with Canoe Financial. "But that had nothing to do with the industry specifically, it was the broader market. This one has a lot of fundamental issues behind it, in energy."

Too much oil

The one overriding fundamental issue is well-established: There is too much oil being produced.

"We are over-supplied anywhere between 1.2 and 1.7 million barrels a day," said Nick Lupick, an energy analyst with Altacorp capital. 

It's a game of chicken. OPEC members are currently producing 31.5 million barrels a day. Russia has increased production as well, setting a record in October. Neither the cartel nor Russia will agree to cutting production.

Meanwhile, the new swing producer, the United States, is decreasing production, approximately 265,000 barrels a day between April and August, simply not enough to make a dent in the oversupply picture.

"We want them to do this cut for us," said Tahmazian. "But what we want is irrelevant, we're not in control."

Canada not in control

As a small producer, Canada has no control over the price of oil and doesn't really have the ability to make large-scale production cuts.

Production of conventional oil dropped by eight per cent in Alberta in the summer quarter, but that amounted to only 56,800 barrels per day. The lion's share of production comes from the oilsands, where production tends to be locked in once it starts up. 

But at $37 a barrel, it's the rare company that is making a profit in the oilsands.

"You need to be a top-tier company, with industry-leading costs, but even then at $38, it starts to get very marginal," said Lupick.

The large oilsands companies for the most part have strong balance sheets. Imperial, Canadian Natural, Suncor, Husky and Cenovus can all hold out for some time with oil prices this low, either because they refine and sell gasoline or have a tight handle on costs.

"These are the companies, from a longevity standpoint, there's no risk to any of them going bankrupt," said Lupick.
Dwayne Roy is a foreman with junior Gear Energy. Gear's shares dropped 16 per cent in trading on the Toronto Stock Exchange on Monday. (Dan Riedlhuber/Reuters)

Juniors hit hardest

The smaller the company, the more difficult the day it was on Monday in the markets. There is some real concern about viability in a long-term low price environment, particularly when companies are facing new costs from Alberta's climate change plan and a likely change in Alberta's royalty structure that is set to be introduced before the end of the year.

Tahmazian is calling for some stimulus to the sector.

"Find ways to keep the jobs in the industry; find ways to make sure that we keep the sector in some kind of health, that the companies can continue to find some ways to spend. We can't afford to be in this environment for very long." 

Recovery a year away

The best guess among oil forecasters is that a recovery will come in the second half of 2016, when a decrease in rig counts in the United States will finally translate into larger drops in production and when demand will continue to increase. The hope is that then OPEC will finally see that production is easing and take its foot off the pedal.

There's generally agreement that oil cannot remain under $40 in the long term, simply because spending around the world has been pulled back enough that production will grow slowly, or even decline in the coming years.

"You could very easily see that start to emerge," said Lupick. "And have a supply gap in the  2018-2019 time frame, at which point there's no way we're going to be in the mid-30s."

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