The threaded end of one of hundreds of drill pipes is shown in front of the Baytex Energy Ltd.'s Pembina oil rig near Pigeon Lake, Alta., in 2012.Norm Betts/Bloomberg
Sometimes I have to shake my head. Watching investors swarm to buy shares in recent energy financings makes me wonder whether anyone is thinking about the long game.
Since January, Canadian oil and gas producers have sold more than $4-billion worth of new shares to shore up their balance sheets and help fund capital spending. Although some deals have been slower to sell than others, the overarching message has been pretty clear: Investors are happy to buy in.
Using logic to make sense of this will only frustrate you. Baytex Energy Corp., which recently reworked its debt covenants and cut its dividend by nearly 60 per cent in December 2014, launched a $500-million share offering earlier this month and investors devoured it – so much so that the deal size was increased to $550-million in no time.
It all makes me worry that the energy industry is in denial. The consensus seems to be that this is just a temporary blip: Get your hands on some decent stock, and you're bound to make buckets because energy shares were brutally punished when oil and gas prices plummeted.
Call me a fear monger, but it needs to be said: What if the market stays ugly?
Mining investors know just how rough, and long, a downturn can be. When metals prices first tanked, too many industry executives and investors called for a quick rebound – paging Eric Sprott – largely because China's once-roaring economy was thought to be a panacea for any and all market problems. Today copper is less than $3 (U.S.) a pound, and even after rounds and rounds of quantitative easing in three of the world's four largest economic regions – which was supposed to cause hyperinflation, remember? – gold prices haven't pushed higher.
Too many energy investors are thinking along similar lines, which means they haven't realized this recent crash was a classic case of a bubble popping. When crude oil prices first started tumbling, people turned to Saudi Arabia, hoping the Middle East oil barons would solve the problem by curtailing production. It was a knee-jerk reaction.
The truth is, North American companies are the bigger culprits. Since 2011, U.S. producers have roughly quadrupled their production. Energy prices were propped up by resource scarcity; now we're awash in hydrocarbons.
The running joke in the media is that $50 oil didn't convince many chief executives to slash production, so now we have to see if $40 oil will do the trick.
After seven years of wildly volatile markets, you can't really blame anyone for expecting the energy sector to quickly rebound. Even I was in denial. Too many times we've seen wild price swings for an entire industry, only to watch share prices bounce back. Canadian real estate investment trusts are a classic example.
Energy companies are also showing signs of fiscal prudence by quickly tapping investors for new funds and being very clear the money will be used to pay down debt. Many miners mostly shrugged their shoulders for more than a year, convinced the metals markets would recover.
However, this is only early days. What really did the miners in are the tens of billions of dollars they incurred when they were forced to write down the wildly overvalued assets on their balance sheets a few years into the metals crash.
Who's to say energy companies won't suffer the same fate? We've already seen some: Japan's Sumitomo wrote off $1.55-billion in the Permian basin and JPMorgan recently speculated that the Chinese government will have to write off as much as $5-billion worth of its acquisition of Nexen Inc.
The investment bankers who helped sell these shares insist investors have been rather discerning. Cenovus surprised just about everyone when it launched a $1.5-bilion (Canadian) offering, and that deal was slow to sell. Recent financings have also been priced at nice discounts.
A gentle warning to investors: In a prolonged downturn, everything is correlated. Quality names will do better than others, but the miners are proof that even low-cost producers, such as Agnico Eagle Mines Ltd., can suffer – its shares are down 50 per cent from its post-crisis peak.
Personally, I hope the investors who've shelled out billions over the past two months make five times their investments in profit. But here's a sobering thought, something rating agency Standard & Poor's noted last week when commenting on the energy industry's debt profile.
"The one most basic element that would improve the cash flow adequacy and leverage profiles of these companies, and ensure stable credit quality, is out of their control: higher crude oil prices."
Tim Kiladze