A number of Canadian oil sands producers are still trading far below their pre-COVID levels.Todd Korol/Reuters
A rapid rise in the price of Canadian crude is putting investors in an unusual position, prompting them to weigh environmental concerns against the copious cash flows that oil sands producers are now churning out.
Since the start of year, the price of Western Canadian Select, which is heavy Canadian crude, has soared more than 75 per cent to around US$60 a barrel, returning to levels set in the fall of 2014 before energy prices collapsed worldwide. The recent rise tops the gains made by the North American benchmark, West Texas Intermediate, which is up around 50 per cent this year.
With crude prices soaring, analysts expect Canadian oil sands producers to churn out substantial free cash flow in 2021. Canadian Natural Resources Ltd. alone is expected to produce nearly $8-billion in 2021, according to a May estimate from RBC Dominion Securities – and that’s after paying $2.2-billion worth of dividends. Suncor Energy Ltd., meanwhile, is expected to produce $6.4-billion after paying its own dividends.
Investors are starting to notice, and share prices have risen this year. But a number of Canadian oil sands producers are still trading far below their pre-COVID levels. MEG Energy Corp. , for example, closed at $8.91 Tuesday, compared with about $38 a share before energy prices collapsed in 2014.
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Analysts have attributed the persistent market weakness to the ESG era, in which investors are paying more attention to environmental, social and governance issues – and are therefore shying away from owning fossil fuel producers. A push to decarbonize the economy has also made people question just how long oil will be in popular demand.
But some counterarguments could tempt investors to reconsider. For one, oil sands producers are swimming in free cash flow, and the expectation is that they will use the money to boost their dividends. Suncor has targeted increasing its own dividend to around $2 a share in 2025, more than double the current level of 84 cents.
There is also more research being done on future demand for crude – and specifically, for Canadian heavy oil – that contradicts the narrative that the oil sands will soon be stranded assets. To this end, a recent study from CIBC World Markets argued that electric vehicles are “not a death sentence” for all refined products, partly because heavy transport vehicles, such as airplanes, will maintain their demand for heavy oil.
CIBC analysts also stressed that oil sands production is “cost competitive in a world where focus shifts away from supply growth.” Oil sands producers were once seen as uncompetitive relative to rival shale oil producers in the United States, but CIBC estimated that the all-in sustaining costs of the oil sands have fallen to US$25 to US$35 a barrel, compared with U.S. shale at US$25 to US$32.
Oddly enough, oil sands producers have the 2014 energy crash to thank for helping to close that gap.
After crude prices tumbled when Saudi Arabia started flooding the world with oil in September, 2014, “the Canadian energy industry was effectively abandoned,” Stacey McDonald, a director at natural gas producer Birchcliff Energy Ltd. and a former energy analyst at GMP Securities, said in an interview. In the aftermath, “idle engineers, instead of working on growth projects, worked on optimizing current operations. … There was just no other way to survive.”
Over time, the cost of producing a barrel of oil sands crude dropped – and the fervour for U.S. shale oil producers also faded. The new-found American oil attracted scores of producers, and within a few years the market was oversupplied. Many funded their growth with debt, and their highly-levered balance sheets were incompatible with volatile crude prices, leading to multiple waves of bankruptcies.
Many investors also fell out of love with U.S. crude because shale wells have high decline rates, which means the oil per well is produced rather quickly. In the oil sands, analysts stress that decline rates are almost negligible because there is so much crude sitting in the ground.
“Canadian energy companies, especially in the oil sands, can effectively compete against U.S. shale,” Ms. McDonald said.
Current cash flows alone likely won’t be enough to win investors back. Gold miners learned this when the price of bullion soared above US$2,000 an ounce last year, yet many producers’ share prices remained far below their peaks.
To help combat investors’ growing aversion to fossil fuel producers, the largest oil sands producers have started making concrete commitments toward achieving net-zero carbon emissions. In May, Suncor pledged to cut its net-greenhouse gas emissions by one-third to 19 megatonnes annually, down from 29 megatonnes in 2019.
However, the growing frequency of troubling weather events, such as annual forest fires and the recent heat wave that has engulfed Western Canada and the northwest U.S., will make it harder to win investors back.
The push toward electric vehicles also has investors spooked. Canada last week announced it aims to ban the sale of fuel-burning new cars and light-duty trucks starting in 2035. But CIBC’s analysts believe oil sands crude might actually be a relatively safe harbour.
“We view there to be a general misunderstanding of the relative supply/demand for the various grades of crude globally,” they wrote in a recent report, adding that there is “a global undersupply situation in heavier grades with declining volumes from Mexico and Venezuela.”
Although oil demand is likely to fall as the adoption of electric vehicles accelerates, the analysts noted that refiners are likely to retool and hunt for heavy oil to maximize production of jet and diesel fuels. A number of airlines have acknowledged they won’t be able to use biofuels for many years.
The state of global oil supply is also a moving target, and it has burned investors before because the Organization of Petroleum Exporting Countries has historically started pumping more when oil prices started to climb. Crude oil prices hit six-year highs early Tuesday, but then retreated as apparent disagreement among OPEC members raised concerns some countries may loosen restrictions on oil production.
“On its face, the market certainly appears tight in that there is currently more crude being consumed than produced,” Rory Johnston, a market economist, wrote recently in his Commodity Context newsletter. But he worries about OPEC+, which includes Russia, opening its taps again.
He also noted that while oil inventories have dropped significantly relative to 2020, they’re still higher than pre-2014 levels. “Today’s market remains far from healthy,” he wrote.
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Tim Kiladze