Bond Yields Hint Worst May Be Over in Pummeled Canada Oil Patchby
Investors return as companies shed debt, crude reaches $50
Some ‘made a fortune’ as spreads narrow from February highs
Canadian bond investors are signaling that the worst may be over in the oil patch as yields on the debt of energy producers like Suncor Energy Inc. and Husky Energy Inc. shrink to levels near those before the two-year-plus crude rout took hold.
Though oil prices are less than half what they were in June 2014, they’ve almost doubled from a 12-year low in February to $50 a barrel in New York. Economists now forecast a steady gain to $60 by 2018 amid a shrinking global surplus. The Organization of Petroleum Exporting Countries also gave prices a lift, announcing its first output cut in eight years.
The oil recovery has come too late for some energy companies. But those like Suncor and Husky, which slashed costs and shored up their balance sheets, are now being rewarded by investors.
“Forty-five dollars a barrel still doesn’t work for many North American oil producers, but most bonds are trading as if the issuer will be fine in the long-run,” Bloomberg Intelligence Analyst Spencer Cutter said in an instant message Sept. 23.
The yield that investors demand to hold Suncor’s 6.5 percent bonds due in 2038 over 10-year U.S. government bonds has plunged to 260 basis points from 569 in February. That’s the lowest in more than a year and compares with an average of 275 basis points since December 2013. The spread on Husky’s 3.95 percent bonds due 2022 has shrunk to 112 basis points, the smallest since November 2012, and versus 576 basis points in February.
Yields on energy companies bonds had surged as oil tumbled close to $26 a barrel in February, prices not seen since 2003, from more than a $100 in 2014. The rout will cost Canadian energy companies C$11 billion ($8.3 billion) in losses this year after they lost C$10 billion in 2015, the Conference Board of Canada said in an Oct. 4 report. A total of C$38 billion of investment by the industry has been slashed in two years.
The market capitalization of the 21 largest Canadian oil and gas companies has fallen 19 percent in the past two years, according to data compiled by Bloomberg. Seventeen Canadian energy companies filed for bankruptcy in 2015 and 2016, according to a Haynes & Boone LLP report released Sept. 9
Now, those companies that survived are benefiting from improved oil prices and thirst for yield as central banks from Europe to Japan cut interest rates to stimulate growth. They’ve also benefited from the work done to “shore up” their balance sheets, Manmit Pandori, BMO Capital Markets analyst, said in a phone interview Sept. 23.
Husky scrapped its dividend, cut capital spending and sold assets for total proceeds of C$2.5 billion ($1.9 billion) in 2016. Cenovus Energy Inc., which has also seen spreads tighten, will have cut more than C$1 billion in capital, operating and administrative expenses by the end of the year.
Perhaps no company has done more than Suncor, the country’s largest oil company, which slashed costs even as it invested billions in acquisitions that included Canadian Oil Sands Ltd. The company lowered operating costs by more than a third to under C$24 a barrel, Chief Executive Officer Steve Williams said in a Sept. 7 presentation to analysts in New York.
In June, Suncor offered to repurchase about $1.5 billion of its notes from bondholders to lower its debt load, and earlier this year it issued C$2.9 billion in equity. The company’s Baa1 debt rating, even after a February downgrade, is the highest among its Canadian peers.
“Suncor fares better in the current environment, given the higher rating and their ability to manage in periods that might not be that great,” Pandori said.
Some investors have already profited from the turnaround. A Marret Asset Management Inc. fund that invested in high-quality North American energy company debt has generated a 15 percent return since its Dec. 1 inception. For those who invested in February, they made about a 25 percent return.
“If you went in at the perfect time, you made a fortune,” Barry Allan, the company’s founding partner, said in a phone interview. The fund, which stopped taking cash in May, will be liquidated later this year and its capital returned to investors, he said.
To be sure, there remain headwinds for Canadian oil producers. There’s only so much cost-cutting companies can do, and new production created by investment when oil prices were above $100 is still coming online. Also, the OPEC decision to cut production might prompt increased shale-oil production in the U.S., which could push oil prices down again. The world is “years off” from another bull market in oil it will be “hard” for the price to rise above $55 a barrel, Jeff Currie, head of commodities research at Goldman Sachs, said on Bloomberg TV on Oct. 5.
Still, oil’s rise to around $50 a barrel has allowed companies to hedge, or sell future production, at prices that are economically viable after they cut costs, Matthew Duch, a former money manager at Calvert Investments in Bethesda, Maryland, said.
“Stabilization around $50 allows these companies to continue on,” he said in a phone interview.