An oil sands facility is reflected in a tailings pond near Fort McMurray, Alta., on July 10, 2012. Energy stocks were down nearly six per cent on the Toronto Stock Exchange as oil prices continued to plunge following last week's five per cent slide.Jeff McIntosh/The Canadian Press
With crude oil prices the lowest in five years, Marc-André Gaudreau says the surest way to profit from the debt of energy exploration and production companies in Canada's oil sands region is if they don't pay it back.
Mr. Gaudreau, who manages $4-billion for Bank of Nova Scotia's 1832 Asset Management unit, is shorting oil sands bonds after the last two months saw the biggest rout in crude since the 2008 financial crisis. He declined to name the companies he's shorting, in which an investor sells a security after borrowing it and hopes to repurchase the asset later at a lower price before returning it to the lender.
Southern Pacific Resource Corp. and Connacher Oil and Gas Ltd. announced last week that they'd hired banks to help raise cash to avoid missing interest-rate payments. Trading in the bonds shows investors expect less than half the principal to be paid back from the energy companies in Alberta's oil sands.
"It would be fair to assume more restructuring in 2015 in the oil patch," Mr. Gaudreau said. "As soon as commodity prices come down, your fixed costs, and even your variable costs, are still there, so you get squeezed. When you get squeezed and you have debt, you just can't service it."
Oil sands companies face some of the highest production costs in the world and are being forced to sell their product at a discount, Mr. Gaudreau said. Producers there need at least $85 (U.S.) a barrel to make money on new projects, according to the Canadian Energy Research Institute.
"For every dollar you're losing in the oil price, the oil sands guys feel it a bit more than everyone else," said Sonny Mottahed, chief executive officer of Black Spruce Merchant Capital Corp., a Calgary-based private merchant banking firm. "A short on some of these things, if that's your view that the commodity is going to stay lower, certainly makes sense."
Southern Pacific, with $432-million (Canadian) of bonds, said last week it had hired Royal Bank of Canada to help address liquidity and capital structure issues after saying it didn't have enough cash to make interest payments. Investors were only offering about six cents on the dollar on Dec. 5 for its January 2018 bonds, according to prices from Industrial Alliance.
Connacher, with about $977-million in debt, said two days earlier that it had hired Bank of Montreal to look at its liquidity and capital structure after saying in November that cash flow may not be sufficient to cover interest payments on debt and it will need to get additional funds next year to stay in business. The company's August 2018 notes were trading at about 40 cents on the dollar, according to data compiled by Bloomberg.
Chris Bloomer, CEO of Connacher, said he can't comment on the financial review or whether the company risks defaulting on its debt. The lower oil price is affecting the entire industry, some more than others, he said.
"Everybody is dealing with the same situation in trying to get their head around it in terms of the short and medium term and what to do about it," Mr. Bloomer said.
Expansion by investment-grade oil sands firms will still be profitable because of the long lives of the projects, while junk-rated companies wouldn't be able to generate positive earnings with North American crude at $80 (U.S.) per barrel, according to a report from Standard & Poor's.
"It's possible that smaller companies that are credit constrained could see their credit profiles weaken in 2015," said Michelle Dathorne, a credit analyst at S&P. "It depends on their ability to attract external liquidity, whether it's through equity infusions through new owners or joint venture partners, or their ability to add leverage on their balance sheet."