North American oil last traded above $100 (U.S) per barrel on July 30, 2014, and the fallout from the declining price has already hit many companies. As the pain intensifies, shareholders are seeking more information on debt levels, the tolerance of bankers, cost-cutting and hedging programs.Cooper Neill/Reuters
When oil and gas companies begin rolling out third-quarter results this week, investors will be more interested in what executives are planning to do in the future than what they actually did over the past months.
North American oil last traded above $100 (U.S) per barrel on July 30, 2014, and the fallout from the declining price has already nailed many companies. But as the pain intensifies, shareholders are seeking more information on debt levels, the tolerance of bankers, cost-cutting and hedging programs.
Today's low prices mean that just about every decision going forward will have consequences. Companies forced to put assets on the block to shore up balance sheets may have to accept that potential buyers with deep pockets can outlast them, forcing troubled operators to sell projects for less than their perceived worth. Further, while scores of companies are set to renegotiate debt covenants, extending their chances of survival, bankers will be able to extract something in return, like higher interest rates.
Investors monitoring this round of earnings will be weighting the value of all of these types of trade-offs.
"We care more about the future," said Laura Lau, a senior vice-president at Brompton Funds in Toronto. Hedges are a big one on her list. "I expect very little hedging," she said. "I call it locking in defeat."
The average future price for a barrel of oil in 2018 is $55.33, Ms. Lau noted. In 2019, the average rings in at $57.26 per barrel and prices for 2021 reach to around $60 per barrel.
"Sixty dollars – a lot of people view as the magic number for when you can start drilling again," she said. "And we're not to $60 [per barrel] yet for many years."
Impairment charges, also known as write-downs, are expected to litter third-quarter earnings reports. Analysts at Barclays PLC expect Encana Corp. to post a pre-tax write-down of about $2.88-billion, according to a research note. To put that in perspective, the Canadian company's stock market value totalled $7.13-billion on the New York Stock Exchange, the analysts noted in their Oct. 21 report.
They also expect Apache Corp., Chesapeake Energy Corp., Devon Energy Corp., Encana, Newfield Energy Corp. and Southwestern Energy Corp. to collectively post roughly $20-billion in write-downs for the quarter.
"The extent of accounting and reserve write-downs could be magnified as companies re-evaluate future drilling plans," the analysts said. If the plans do not include drilling on proved undeveloped land within five years, those reserves will need to be written down as well, Barclays said. While Barclays' analysis reflects large-cap firms, the same pain will extend to smaller outfits.
Teck Resources Ltd. serves as an example of the extent of potential write-downs. Last week, the Vancouver-based mining company wrote down its 20-per-cent stake in the Fort Hills oil-sands mining project to the tune of $400-million (Canadian). Suncor Energy Inc. leads the $15-billion Fort Hills effort, controlling 50.8 per cent. France's Total SA owns the remaining 29.2 per cent. Suncor has said it is committed to building the mine. Indeed, in September it spent $310-million to buy 10 per cent of Fort Hills from Total. The partners do not expect to produce until late 2017.
While write-downs look ugly, they generally have not been the key to driving down share prices, Barclays said. Investors expect companies to write down assets given the weakness of oil and gas prices over the past 15 months.
Companies may detail further cuts related to their work force, ranging from more layoffs to fewer benefits. Ms. Lau has urged Cenovus Energy Inc. and Encana to ditch their so-called golden Fridays – a policy that allows employees to take off a certain number of Fridays per month with pay.
"We are reviewing all of the company's compensation, benefits and time-off practices to ensure they align with current and anticipated market conditions," Cenovus spokesman Brett Harris said last week.
Encana's Friday policy is safe, according to spokesman Jay Averill. "We recently reviewed our vacation practice, including the first and third Fridays off, and found that the benefit is still a competitive practice across the industry," he said last week.