Weaker commodity prices are forcing some Canadian oil and gas producers to slash their dividends, and investors should brace for more cuts ahead.
"The market is certainly pricing a number of companies for a distribution cut," warns Mason Granger, an energy-focused portfolio manager with Sentry Investments. "Zargon Oil & Gas and Bonavista Energy are two companies that are likely to [reduce payouts]."
PenGrowth Energy Corp., an intermediate oil and gas company which acquired NAL Energy Corp. in an all-stock deal this year, chopped its monthly dividend by 43 per cent this month to 4 cents a share. Enerplus Corp., challenged by near decade-low natural gas prices, halved its payout in June to 9 cents a share.
When the dividend yield rises to the 15- to 16-per-cent level, such as in the case of Enerplus before its cut, "the market was implicitly telling investors that the distribution is not sustainable," Mr. Granger said. "Enerplus (yielding nearly 8 per cent) may also be forced to cut its dividend again. … Its high gas weighting continues to challenge the sustainability of even the reduced dividend."
While the direction of commodity prices weighs on companies, some firms may be able to avoid slicing payouts by scaling back on capital spending, selling assets or issuing new debt or equity.
Zargon Oil & Gas Ltd., which yields nearly 15 per cent after cutting its monthly dividend to 10 cents a share last fall, "stands out the most" to pay less, he said. "Another dividend cut may be on the table to preserve capital for some of the company's longer-term projects."
Bonavista Energy Corp., which has a heavy exposure to natural gas and little hedging in place to lock in higher commodity prices, is also a candidate for a payout cut, he said. Bonavista recently said it would "continue to closely monitor the current dividend level."
Energy prices have rebounded somewhat after falling precipitously in the spring. Crude oil in New York, which fell to below $78 (U.S.) a barrel last month from $107 in February, has rebounded to the $88 level. Nymex gas futures, which plunged to $1.90 per million British thermal units in April from nearly $14 in 2008, now trade around $3.
"I think we have seen the lows or are in the trough for natural gas," said Jennifer Stevenson, a portfolio manager with GCIC Ltd. and who runs the Dynamic Energy Income Fund. "But we are not back to levels that are robustly economic."
West Texas Intermediate crude will likely trade around $85 to $90 per barrel over the next 12 to 18 months, while investors wait for Europe's debt crisis to be resolved and for global growth to improve, she said.
Penn West Petroleum Ltd., a major conventional oil and gas producer, is another potential dividend cutter, Ms. Stevenson said. The company aims to raise $1-billion from selling assets, but "in markets like this, it can be more difficult."
Investors should be able to rely on firms like Crescent Point Energy Corp., Baytex Energy Corp., Arc Resources Ltd. and Vermilion Energy Inc. to sustain their dividends, she said. Vermilion, an international oil and gas producer, has significant exposure to higher Brent crude oil pricing, but its valuation is "getting a bit rich," she noted.
Robert Bellinski of Morningstar Inc., who had forecast that PenGrowth and Enerplus would cut their dividends, suggested that there could be an encore. "I am not going to say it is imminent, but the potential to cut again is there," he said.
"Commodity prices are still low, and … they have not announced any asset divestitures that would raise cash to fund those dividends, and they have already tapped capital markets this year," Mr. Bellinski said.
"There is certainly the potential to cut back on drilling programs to conserve cash and continue to pay the yield. The problem is that, when you are managing declining assets like oil wells, there is less cash coming into the the door every day if you don't keep drilling."