Fracking Ban Threats Seen Hollow in Calfrac Bonds: Canada Credit
Fracking Ban Threats Seen Hollow in Calfrac Bonds
The Plain Dealer/Landov
The EPA said it found traces of fluids used for fracking in drinking water near a Wyoming gas field.
The EPA said it found traces of fluids used for fracking in drinking water near a Wyoming gas field. Photographer: The Plain Dealer/Landov
Calfrac Well Services Ltd. (CFW)’s bonds are outperforming peers as investors bet that U.S. regulators will continue to allow the practice of hydraulic fracturing, which accounts for almost 90 percent of its sales.
Calfrac’s $450 million of 7.5 percent bonds due in 2020 yielded 7.9 percent on Dec. 28, or 625 basis points more than U.S. Treasuries. That compares with a yield of 8.63 percent and a 759 basis-point spread for an index of similar B2-rated U.S. speculative-grade bonds, according to Bank of America Merrill Lynch data.
A boom in gas and oil production using hydraulic fracturing, or fracking, which involves driving fluid into wells to crack rock and boost output, has raised demand for equipment like Calfrac’s 2,500-horsepower pumps. A U.S. Environmental Protection Agency report this month linked the process with groundwater contamination, raising concern it may be banned.
“For the purposes of U.S. energy security, it’s difficult to see how they could ban fracking,” said Kevin Lo, an energy analyst with FirstEnergy Capital Corp. in Calgary, where Calfrac also is based. “It would drive prices up so high it would be excruciatingly painful for the U.S. consumer.”
In the fracking process, water and chemicals under pressure cause rock that holds oil or natural gas to crack, allowing it to flow. The EPA said it found traces of fluids used for fracking in drinking water near a Wyoming gas field. The agency is studying the technique and may “where appropriate” add regulations, according to its website.
Calgary-based Encana Corp. (ECA), owner of the field near Pavillion, Wyoming, denies fracking was responsible for the contamination.
Spreads Widen
Elsewhere in credit markets, the extra yield investors demand to own the debt of Canadian investment-grade corporations rather than the federal government was 183 basis points yesterday, or 1.83 percentage points, compared with 137 basis points on Dec. 31, 2010, according to a Bank of America Merrill Lynch index. Yields fell to 3.39 percent from 3.91 percent.
Canadian 10-year government bonds (G0C0) yielded 1.94 percent, compared with 3.12 percent at the end of last year. The yield touched 1.837 percent on Dec. 16, the lowest level in data compiled by Bloomberg going back to 1989.
The 10-year government securities yielded six basis points more than equivalent-maturity U.S. Treasuries, compared with 32 basis points more on Sept. 5, the most this year, and 17 basis points less at the end of last year.
Canadian employers added 14,300 positions more than they cut in December, according to the median of 14 forecasts compiled by Bloomberg. Statistics Canada is due to release the data on Jan. 6 in Ottawa.
Corporate Bonds
Canada’s corporate bonds (F0C0) have returned 7.8 percent this year, according to the Merrill data. That compares with a 9.6 percent gain by Canadian government bonds. Provincial bonds have returned 11.5 percent, the most since 1997.
The nation’s companies issued C$77.7 billion ($76.1 billion) in debt this year, compared with C$78.8 billion in 2010, a drop of 1.4 percent, Bloomberg data show. Sales of Canadian provincial, municipal and mortgage bonds rose 8.5 percent to C$104.1 billion, from C$95.9 billion.
Merrill’s Canada High Yield Index has returned 2.4 percent this year, the least since 2008, after making 22 percent and 32 percent in 2010 and 2009. The firm’s U.S. High Yield Master II Index is up 4.3 percent this year. The Canadian high-yield index yielded 869 basis points more than federal benchmarks on Dec. 28. The spread was as low this year as 418 basis points in April and as high as 890 in November.
Sales of so-called Maple bonds -- named for the leaf on the nation’s flag to refer to debt raised in Canadian dollars by foreign firms -- totaled C$3.2 billion this year, 33 percent less than the C$4.8 billion sold last year, data compiled by Bloomberg show.
Gas Output
The use of fracking has boosted output from shale formations across North America and led to a natural gas glut that has sent prices tumbling 42 percent this year. The benefits of increased flow make gas production profitable at low prices, raising demand for fracking.
“Calfrac has a very good reputation and good equipment,” said Aniki Saha-Yannopoulos, an analyst at Standard & Poor’s in Toronto. “They’re focusing on gas plays that have a very high rate of return.”
Equipment has been in short supply as explorers seek to tap shale formations in Texas, North Dakota and the U.S. Northeast that require high-pressure fracking. A single frack can require a fleet of more than 100 trucks.
‘Pricing Pressure’
Calfrac said Dec. 8 it will boost its capital spending 10 percent to C$365 million next year to build and refurbish equipment. The company will also spend about C$150 million in the first half as capital projects carried over from this year are completed.
“Investors believe there is a lot of fracking equipment coming on line and that will put pricing pressure on the current operation of projects,” said S&P’s Saha-Yannopoulos. “It won’t be a demand-driven market, it will be a supply-driven market.”
Equipment requirements for fracking vary among formations. In North Dakota’s Bakken and Texas’s Eagle Ford shales, truck- mounted pumps working in concert need to produce as much as 40,000 horsepower, according to data compiled by FirstEnergy. Steady demand for Calfrac’s fleets of equipment means that replacement gear will take up a slice of the new manufacturing.
“Fracking equipment runs 24-7 because of the nature of the activity,” Saha-Yannopoulos said. “The rule of thumb is that equipment gets chewed up by as much as 20 percent every year.”
Safety Questioned
Questions surrounding the safety of fracking, and possible regulation or banning of the practice in the U.S., have weighed on Calfrac bonds, Saha-Yannopoulos said.
In addition to the EPA’s Wyoming study, drilling in Pennsylvania has drawn complaints about drinking-water contamination and drilling wastewater disposal.
Former New York Governor David Paterson put a moratorium on drilling while regulators draft rules planned for completion next year. Ohio is expected to issue rules on well construction early next year, according to Heidi Hetzel-Evans, a department spokeswoman.
“To ban fracturing wholesale would be devastating to the natural-gas community in terms of activity,” FirstEnergy’s Lo said.
Calfrac had about C$493 million in debt (CFW) as of Sept. 30, according to S&P. Natural gas prices have averaged $4.545 per million British thermal units this year compared with $5.8191 in 2010. New York oil futures have averaged $97.41 a barrel this year, a gain of 14 percent.
Spreads on the Calfrac bonds widened 219 basis points this year through Dec. 28, compared with the 223 basis-point average widening of the 300 bonds in Merrill’s B2-rated index.
“What helps Calfrac on the fundamental basis is strength in oil prices,” FirstEnergy’s Lo said. “As long as oil holds at this level there’s a lot of targets to fracture.”
To contact the reporter on this story: Gene Laverty in Calgary at glaverty@bloomberg.net
To contact the editor responsible for this story: David Scanlan at dscanlan@bloomberg.net
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