A defence Canadian oil producers had against the plunging price of crude is crumbling as hedges expire amid projections that crude will continue to decline.
Hedges that shielded companies such as Crescent Point Energy Corp. and Whitecap Resources Inc. from the full pain of $30 (U.S.) oil are winding down this year and next. Nineteen small to mid-sized producers have an average of 19 per cent of their crude hedged at about $58 a barrel this year, and only 3 per cent at about the same price in 2017, according to data from Canadian Imperial Bank of Commerce. That compares with 27 per cent at $71 for the same companies last year.
"When you look out to next year and beyond and as far as the eye can see," Michael Tran, commodities strategist at Royal Bank of Canada's RBC Capital Markets unit in New York, said in a June 19 phone interview, "producers are fairly naked when it comes to price protection. [They] are fully exposed to oil prices when it hurts the most."
The reduced hedging may prompt companies to accelerate output and costs cuts, including dividends, as the brunt of the downturn hits. "While in 2015 producers still had somewhat of an advantage of hedging on their books, when you roll into 2016 and beyond that's when the pain will be felt," Mr. Tran said.
Oil has plunged to about $28 a barrel in New York, from near $108 a barrel in 2014, as the Organization of Petroleum Exporting Countries raised production to maintain market share amid a surge in North American output. Analysts from Royal Bank of Canada to Credit Suisse Group AG have cut price projections. Morgan Stanley expects Brent crude to average $30 in the third quarter, after reducing forecasts for this year by as much as 51 per cent.
Crescent Point's oil hedges drop to 29 per cent at about $60 a barrel this year, from 44 per cent at $69 last year, CIBC data show. Its gas hedges fall to 30 per cent from 33 per cent. Whitecap's oil hedges fall to 14 per cent this year at $64 a barrel, from 47 per cent last year at $74 a barrel.
Crescent Point is "well protected" with hedges in 2016, Trent Stangl, vice-president of investor relations, said in a phone interview. The company brought costs down 30 per cent last year and the "longer we stay in $30 to $35 environment, the more this cost structure will come down," he said. Hedges put on in 2018 could be brought forward to 2017, should prices stay low until then.
Whitecap has cut its capital budget for this year by more than half to $70-million to cope with lower prices, and has positioned its dividend to be sustainable at $45 oil next year, Chairman Grant Fagerheim said in a phone interview Tuesday.
Selling oil at a lower price may prompt Crescent Point to trim its dividend, Cody Kwong, analyst at FirstEnergy Capital Corp., said by phone from Calgary.
"In this environment, I think the market would take that as a positive note," said Mr. Kwong, who rates Crescent Point as his "top pick." The company is rated "buy" by 18 of 24 analysts, according to data compiled by Bloomberg. The stock has dropped 57 per cent in the past year compared with a 34-per-cent decline for the Standard & Poor's/TSX Composite energy index.
Oil producers with dividends to pay often hedge their oil and gas years in advance to ensure they can make payments, Dennis Fong, a Calgary-based analyst at Canaccord Genuity Corp., said in a Jan. 25 phone interview.
Northern Blizzard Resources Inc. and Pengrowth Energy Corp. are the two most-hedged producers this year among the companies covered by the CIBC data. Pengrowth has 58 per cent of its oil hedged at about $66 a barrel for this year, according to the CIBC estimates. Northern Blizzard will sell 61 per cent of its crude at about $55 a barrel. Next year, Pengrowth's oil hedges drop to 11 per cent at $59 a barrel. Northern Blizzard's also fall to 11 per cent at about $64 a barrel.
Pengrowth's hedging program was put in place in 2013 and 2014 to "ensure cash-flow stability" as the company built its Lindbergh oil sands project, company spokesman Wassem Khalil said in a Feb. 8 e-mail. While the company has oil hedges extending into 2018, "given the current level of oil prices, there is no desire to enter into any additional hedges at this point."
For Pengrowth, the hedges are "a big, big lifeline," Nima Billou, Veritas Investment Research Corp. analyst, said in a phone interview. "They will definitely be able to ride out 2016 because of these hedges."
The industry as whole may have a harder time.
"Those hedges come off in 2017, and with these oil prices continuing to fall, they could be in a difficult positions," Kyle Preston, National Bank Financial analyst, said in a Jan. 15 phone interview.