Continuing oil woes fuel Canadian stock market low

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The energy sector was hit with the latest in a string of selloffs, as investors wagered that further losses in battered oil markets will mean more cuts to spending, staff and growth ambitions.

The industry's woes, which began about a year ago as global crude markets weakened, are spreading through much of the commodity-heavy Canadian economy, and that played a role in pulling the broad stock market to its lowest level of the year on Thursday.

The S&P/TSX Capped Energy Index, composed of shares of integrated oil companies, producers and oil field service providers, sank 2.6 per cent. It has fallen to depths not seen since 2004 as markets fret over the industry's ability to generate enough cash flow to maintain output and service debt while U.S. oil hovers precariously just above $40 (U.S.) a barrel. That is down about 30 per cent in less than two months.

"That continued pessimism seems to be metastasizing into other elements of the Canadian equity market," said Les Stelmach, portfolio manager at Franklin Bissett Investment Management. "Whether there are real consequences to other businesses really depends. Certainly from a stock-market perspective, you're seeing that with things as diverse as the REITs [real estate investment trusts], the banks – even telecom, which is usually a place where people go to hide, is selling off."

For the oil patch, investors appear convinced that any recovery is a long way off, especially amid some analysts' predictions that crude could still fall to the low $30s per barrel, equalling the lows of the financial crisis nearly seven years ago. The question is how deep companies may still cut, after months of reductions to work forces, capital spending and dividends.

Notable losers on the day included Athabasca Oil Corp., down 7 per cent; Encana Corp. and Cenovus Energy Inc., down about 3 per cent each; and Crescent Point Energy Corp., sinking more than 4 per cent. At its Thursday close of $14.07, Crescent Point was fetching less than half the value of its last share issue in late May. The company cut its dividend and capital spending last week, blaming the rapid fall in crude prices.

Mr. Stelmach pointed out the company made its tough moves partly in response to investor worries about its unsustainable dividend yield and the potential for debt to pile up, calling the stock's drop since then "patently ridiculous."

"They're in a much better position than many of their peers, and yet the stock has been very weak," he said.

Oil sands producers, which have the industry's highest operating costs, are particularly pressured. Canadian Oil Sands Ltd., the largest interest owner in the sprawling Syncrude Canada Ltd. mining and synthetic crude project, spelled out how it is losing money on every barrel.

In a slide from a corporate presentation this week, the company said Syncrude's operating expenses, maintenance costs, royalties and development capital total $46 per barrel. Add Canadian Oil Sands' expenses, such as interest and overhead, and the break-even climbs to $50.

Despite a glut of supply, oil sands producers such as Syncrude, as well as those that pump steam into the ground so the bitumen flows to the surface in wells, would find it a much more costly and risky proposition to shut off operations, as companies could damage bitumen reservoirs. Meanwhile, they require money to keep flowing.

"[Steam-driven production] and mining are high fixed-cost operations. So you get little benefit from shutting in for short periods of time, because the producer keeps all the costs but now has no revenue," said Samir Kayande, analyst at ITG Investment Research. Producers' other options are to lay off more staff and try to cut costs further by seeking concessions from suppliers, he said.

Some producers of conventional oil have shut off wells this year, a move often seen as a drastic quest for relief when costs are higher than revenue, said FirstEnergy Capital Corp. analyst Michael Dunn.

"We could definitely see some more shut-ins of old, low-rate, high [operating-cost] conventional oil wells. Additionally, capital expenditure for conventional drilling this winter will likely be lower than last winter," Mr. Dunn said. "Asset sales are another option, but arguably not much of an option given the depressed valuations that most assets would likely garner in this market."

Behind the fall in stock prices is an overall swoon in commodities around the world as European demand has weakened and China, previously seen as almost impervious to global market gyrations, has devalued the yuan, raising new questions about the health of its economy. The Bloomberg Commodity Index, a basket of energy, agricultural, metals and soft commodities such as sugar, has fallen below levels of the 2008-09 financial crisis, showing how vulnerable the Canadian economy is to the global turmoil.