- Heavy oil producers most at risk with discounts erasing profit
- Canadian economy suffering from weaker oil investment
The Bank of Canada sharpened warnings heavy crude prices are approaching levels that could lead to more production shut-downs, posing another threat to the fragile recovery.
In its quarterly Monetary Policy Report released Wednesday, the bank raised the possibility of prices failing to cover operating costs as one of four risks to its already lukewarm economic outlook. If a large enough part of the industry falls below the threshold, “the resulting negative confidence effects and demand spillovers could weigh heavily on the broader economy,” policy makers said in the report.
The bank predicts oil and gas companies will cut investment by about 25 percent this year, after a 40 percent reduction in 2015. Western Canada Select is hovering around $15 a barrel, down from $54 in June. That’s severely curtailing new oil sands investment and further price declines would test the bank’s forecast.
“The drop in oil and other commodity prices constitutes a significant setback for the Canadian economy, and has set in motion a protracted adjustment process,” Bank of Canada Governor Stephen Poloz told reporters in Ottawa Wednesday. The central bank also held its benchmark interest rate at 0.5 percent.
Prices may fall so low companies won’t even cover their day-to-day costs such as lighting and wages and may force some into bankruptcy, according to the report. The bank’s base case called for the economy to return to full output by the end of next year. That assumes declines in business investment will peak around the middle of this year.
“The lower the price goes the more you concern yourself with what is that
threshold,” Poloz said at the press conference.
To cope with operating in one of the most expensive regions in the world, Canadian oil companies have already made deep cuts to spending and, in the worst cases, have halted production to stem losses. The current price rout is hurting producers of heavy oil the most as the discount to lighter West Texas Intermediate is approaching 50 percent, said Nima Billou, an analyst at Veritas Investment Research Corp.
“It’s a very formidable discount,” he said in an interview from Toronto. “At these prices, no heavy oil production makes money.” Western Canada Select traded traded at $15.68 at 3:42 p.m. New York time. The discount to WTI is about $14.
Credit Suisse Group AG Chief Investment Officer Michael Strobaek expects crude to reach a low of $25 a barrel. It last traded at $29.80. Glencore Plc Chairman Tony Hayward, formerly BP Plc’s chief executive officer, said current price levels are here for some time.
Companies most exposed to heavy oil production such as Baytex Energy Corp., Penn West Petroleum Ltd. and Pengrowth Energy Corp. are most at risk to the low prices, Billou said. Shares of Baytex have fallen 35 percent over the past month, while Penn West is down 33 percent and Pengrowth has lost 29 percent. Over the same period the TSX/S&P energy sub-index has shed 7.7 percent.
The Canadian division of China Petroleum & Chemical Corp., also known as Sinopec, may shut in production, Brian Tuffs, head of the Beijing-based company’s Canadian operations, said Tuesday. Last year, Baytex shut in about 2,400 barrels a day of production while Canadian Natural Resources Ltd. halted 5,700 barrels a day of conventional output.
Baytex spokeswoman Andrea Beblow wasn’t available for comment. Wassem Khalil, a spokesman for Pengrowth, didn’t respond to a request for comment. A spokesman for Penn West wasn’t available.
Oil-sands operators, which are unlikely to shut-in production because of the high costs of restarting, may accelerate maintenance as a way to slow output, said Veritas Investment’s Billou.
“The resource-driven Canadian economy will continue to bear the burden of a low oil price, as significant reductions in capital expenditure in the energy sector have yet to be
entirely offset by other sectors,” said James Dutkiewicz, chief investment strategist at Sentry Investments in Toronto.