Editor’s note: Last year, when assembling the 2020 Top Operators Report, the COVID-19 pandemic had shuttered the global economy. Oil demand had been reduced by over 20 million bbls/d and prices were at lows not seen in decades.
The mood of the Canadian industry was grim. After five years of being rocked by wild price volatility the pandemic hit like a knockout punch.
The 2021 Top Operators Report looks back at how Canada’s oil and gas leaders pivoted to meet the challenges of 2020, and how they are positioning their organizations for future success.
Once again, we have tapped into the experience of professional services firm KPMG in Canada to provide insight into what strategies operators could pursue to thrive in the current environment.
The report also features a broad swath of the insights and opinions from industry leaders gleaned from Daily Oil Bulletin coverage, along with commentary from data providers Evaluate Energy and CanOils.
For Jeff Tonken, president and chief executive officer of Birchcliff Energy Ltd., the COVID-19 induced price collapse last spring was a warning bell on the risks of debt in volatile oil and gas markets.
“I started this company 17 years ago and I didn’t like the position of risk we took when commodity prices really fell apart last year. It made me very, very uncomfortable,” Tonken told the Scotiabank-CAPP investors conference early this spring. “So we’ve taken the position that we’re going to pay our debt to zero. We think we can do that sometime by 2024.”
Tonken said it is a prudent approach given the changing dynamics of the market and the sentiment of investors.
“You hear a lot of noise in the market with respect to the banks, with respect to the energy transition, with respect to financial results and we want to find ourselves in a position where we just pay our debt straight down and drive our dividend straight up.”
KPMG national energy leader Michael McKerracher said debt is the largest financial risk facing Canadian operators. The lure of low-interest capital in recent years has resulted in the demise of some very good Canadian operators, he added.
“They accessed cheap U.S. debt that they would refinance and roll forward until they couldn’t. Then they had to give the company away to the debt holders.”
Investors are also looking more closely at debt levels.
“The investment community is going to demand lower debt multiples than in the past.”
The ability to pay down debt means managing other financial risks, said McKerracher. Pricing volatility and the long-term demand growth outlook are two key factors that need to be managed.
Projects with long payout cycles will likely not happen, he said, as industry focuses on smaller projects that optimize cash flow in volatile commodity cycles. This includes investment in oilsands megaprojects.
“I don’t think the industry will initiate the volume of megaprojects we’ve seen in the past,” he said, adding that doesn’t mean an end to production growth. “With in situ, they can do smaller projects.”
With muted long-term demand forecasts, other projects have also been deemed too risky, he added. “In prior years companies have reconsidered and are only advancing projects with the best returns. They have high-graded their assets and many projects on the books will never get built. Projects that are highly capital intensive may also never be built. These are stranded assets.”
Investing in and integrating with downstream refineries proved a successful financial strategy to manage pricing volatility for oilsands operators in recent years. McKerracher said natural gas operators could adopt this strategy as well. Historically, gas producers have built gathering and processing infrastructure only to sell it when prices declined and cash became in short supply.
“Companies are realizing that having control of their products through the value chain improves sustainability,” he said. “They can better control their destiny if they can control their infrastructure.”
Over the years operators have also attempted to manage financial risk via rebalancing production portfolios by increasing oil and gas weighting based on future pricing expectations. McKerracher said he doesn’t believe this is a viable future strategy for any but the largest operators. It’s much better to focus on what operators are good at.
“I don’t know long-term if this is a winning strategy. Oil and gas require different skill sets and you have to be a certain size to play that game. I think developing a long-term strategy and sticking with it will work better for most companies. Expertise and strategy are much more important.”
Andy Mah, president and chief executive of Advantage Energy Ltd., said his company’s focus would remain on gas drilling rather than diverting funds to increase liquids output.
“As the oil prices fell off, we backed off on that a bit and said, ‘Let’s just hold back.’ We went back to drill some wells at our Glacier asset and, given the prices in gas were kind of holding and getting better in the back part of 2020 and we’re continuing to see what I believe is a constructive gas tape going forward, we’ll continue to focus on that,” he said.
“So in order for us to come back to liquids growth, we certainly keep an eye on the liquids pricing going ahead. But I think we’ve seen the volatility in the oil sector, and I think we’ll have a much better picture when we get to the back half of this year, and we’ll decide if we want to put some money there.”
Having a hedging strategy in place can also be key to manage financial risk, said Evaluate Energy senior analyst Mark Young, who recently analyzed hedging results for 72 North American operators for 2020 and early 2021.
“Hedging provided a much-needed glimmer of positivity for North America’s oil producers last year,” said Young. “More than $7 billion was raised in realized hedging gains from settled derivatives in 2020 by the companies we analyzed. This translates to an 11 per cent boost in E&P revenues for the group over the entire year.
“The picture is quite different in early 2021 as many producers have missed out on the recent pricing gains due to conservative hedging strategies. It is hard to criticize any producer that was more cautious when it came to hedging heading into the new year. Instead of gambling on exposure to fluctuating oil prices, the chaos of last year plainly made it a priority for many producers to lock in oil volumes even at new lower market prices via hedging. This provided greater certainty and stability around cash flow.”