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Investors are looking for bargains among bonds of Canadian oil producers after collapsing crude prices made them the worst performers in the developed world.
The majority of trading in U.S. high-yield energy bonds this month has been in those with below-average prices, and Canadian companies Calfrac Well Services Ltd., MEG Energy Corp., Northern Blizzard Resources Inc. and Teine Energy Ltd. are among those that may continue to benefit, according to a Nov. 13 report from GMP Securities LLC.
"There are great producers that are great opportunities here," John Wilson, who oversees C$6-billion ($5.3-billion) as chief executive officer of Sprott Asset Management LP, said in a Nov. 24 interview at Bloomberg's Toronto office, without naming the securities to which he referred.
Bank of America Merrill Lynch recommended buying oil and gas bonds this month on a view the oil price will recover. New York-based money manager Lehmann Livian Fridson Advisors LLC said the large number of high yield energy bonds trading at distressed levels could spell an "excellent opportunity."
In Canada, fund managers such as Toronto-based Wilson say they're avoiding higher-cost producers focused on the nation's oil sands to guard against the possibility that lower prices are here to stay.
There are a lot of producers who are "just part of the party and don't have as economic assets," Wilson said. "Those are the ones that are going to have a hard time over the next six months."
OPEC Meeting
A Bloomberg News survey showed 20 analysts were evenly divided on whether the Organization of Petroleum Exporting Countries will cut supply to support prices. The 12-member group, which pumps about 40 per cent of the world's oil, meets tomorrow to discuss its official production target of 30 million barrels a day. Canada isn't a member of OPEC.
Coaxing viscous crude from Alberta muskeg or shale formations requires a higher upfront capital expenditure than traditional wells. That means expansion in the oil sands – Canada's fastest growing oil region already accounting for half the country's production – is more dependent on investors' willingness to put up that cash.
The debt of Canadian energy producers has lost 2 per cent since Oct. 15, when the international benchmark grade of crude oil breached a four-year low, according to Bank of America Merrill Lynch data. That's the biggest loss among Group of 10 nations, and the most in the world behind only Brazil, the data show. Average losses in the period were 1.4 per cent. In that time crude has fallen further, with European benchmark Brent touching $76.76 per barrel Nov. 14 and West Texas Intermediate dropping to $73.71 yesterday, both four-year lows.
Selective Purchases
"We have been buying, but we've been selectively buying," Steve Locke, who manages C$20-billion in bonds at Mackenzie Investments, said in a Nov. 13 interview. "Someone who is not capable of producing at say, $60 to $70 per barrel, is going to have trouble making money over the foreseeable future."
The break-even point for about 25 per cent of the nation's oil projects is $80 a barrel of Brent, according to an Oct. 14 report from the International Energy Agency. The threshold for oil-sands projects that use steam to extract crude soaked bitumen is about $85 per barrel of the North American benchmark grade, according to a July report from the Canadian Energy Research Institute.
'Continuous Capital'
"It's that continuous capital expenditure that's going to bite at some point," said Mackenzie's Locke. "You can think about the oil sands or shale plays in that context because in shale you have to drill a lot of holes. Whereas more traditional oil plays, where there's a well sitting there, you can continually tap."
Locke, who also declined to say what he was buying, said he was looking for companies with lower production costs, without too much concentration in the oil sands, and defined assets, like storage facilities that could be worth more than their debt even if production grinds to a halt.
Connacher Oil & Gas Ltd. said this month that cash flow may not be sufficient to cover interest payments on its debt and it will need to get additional funds next year to stay in business.
It was among firms, along with MEG Energy Corp., Athabasca Oil Corp. and Southern Pacific Resources Corp., that credit rater Standard & Poor's named in an Oct. 28 report as having a break-even cost above C$80 per barrel.
'Crude Malaise'
While the S&P report says expansion by investment grade oil-sands firms will still be profitable because of the long lives of the projects, junk-rated companies wouldn't be able to generate positive earnings with North American crude at $80 per barrel.
"You'll see periods where investors will go in and try to pick through the rubble and find names that have been indiscriminately sold," Adrian Miller, the GMP report's author, said in a phone interview yesterday from New York. "You're seeing portfolio managers go in there, doing their work, and finding names that have enough cash and financial resources that will get them to the other side of this crude malaise."