With 94 Per Cent Of Rigs Idle, Some Service Companies Won’t Survive Summer: ATB

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With cash flows gutted by disastrously low oil and natural gas prices, producers have slashed capital spending, with severe consequences for some service companies.

That was part of a wide-ranging assessment of the downturn which the Alberta government’s energy banker provided on Wednesday to the annual meeting luncheon of the Canadian Association of Petroleum Landmen (CAPL).

“Capex is falling like a stone.... The value destruction is horrific — 42 rigs running in Canada, six per cent utilization, the lowest rig count since 1999,” said Bruce Edgelow, vice-president of strategic initiatives at ATB Financial. In that job, the veteran banker now spends most of his time managing the provincially owned financial institution’s turnaround group.

“E&P companies have squeezed everybody for cost savings of 20 to 30 per cent,” Edgelow told the well-attended event. ATB says the deep cuts have eliminated profits for many service companies with some firms sacrificing precious liquidity by doing unprofitable work to hold market share.

“These cost cuts are generally unsustainable,” Edgelow said, asking whether companies will be able to find the people they need once the market improves. But some can’t hold out that long.

“Companies and capital providers can only wait out the downturn for so long,” he said, noting lenders were recently forced to put some companies into receivership. In some cases, he said, severely reduced cash flow meant payrolls weren’t being met.

He said the last thing a lender wants to do is put a company into receivership, but it has to protect its investment. But with 94 per cent of Canadian drilling rigs parked, little cash flow is being generated for the huge number of service firms whose fortunes are tied to drilling.

“Certain service companies will not survive through the summer,” Edgelow said, noting some have already succumbed. Probably the biggest casualty was Sanjel Corporation.

“Sanjel, one of our absolute best stories ever — a 35-year Canadian family-owned ... service provider. [Sanjel’s founder] Donald MacDonald is just a prince of a man. And we’re in a CCAA [Companies Creditors Arrangement Act] filing. And that company does not exist as it was four days before the filing.”

It’s unclear how many Sanjel jobs will survive the planned acquisition of assets by privately-held STEP Energy Services Ltd., which is backed by ARC Financial Corp. (DOB, April 5, 2016).

According to its website, Sanjel had about 2,300 employees at 26 field districts, 10 labs, 10 regional maintenance facilities and one training centre. Operating across North America and overseas, Sanjel provided acidizing, cementing, coiled tubing, fracturing and nitrogen services.

Comparing 1980s downturn

By ATB’s count, this is the seventh downturn since 1980. The last price decline of comparable magnitude was in 2008, but the last supply-induced drop in oil prices happened in November 1985.

Comparing the current downturn to the 1980s slump, Edgelow noted producer capital spending is forecast to decline by a cumulative 60 per cent in 2015-16. In 1986-87 the cumulative spending decline was 43 per cent.

In his presentation Edgelow noted that since 1950 oil prices have averaged $45 a bbl in 2015 dollars, and it’s only within the past decade that prices have exceeded $50 a bbl.

So far, Alberta’s jobless rate is lower than in the 1980s. According to ATB, the province’s unemployment rate reached 11 per cent in 1983-84. Last month it was 7.1 per cent, down from a 20-year high of 7.9 per cent during the previous month.

But the jobless rate may rise. Capital spending fell by 43 per cent in 1986 and 1987, according to ATB. The cumulative decline in capital spending in 2015 and 2016 is expected to total 60 per cent.

After the 1980s crash oil prices took five years to recover. It is now 22 months since the current oil price slide began in mid-2014, and the timing of a rebound remains a matter of speculation.

The banker said low interest rates are “the saviour” this time around. In 1981, prime rates were at a historic high of more than 20 per cent. Recently interest rates have been at historic lows with the prime rate currently at 2.7 per cent.

The 1980s downturn occurred amid a period of hyperinflation. Now inflation is persistently low amid fears of global deflation.

‘On what terms?’

A big difference this time around is capital availability.

In the early 1980s capital availability was significantly reduced after Ottawa introduced the National Energy Program which was bitterly opposed by the oil and gas industry.

Today, ATB says more than $10 billion of capital is believed to be available in Canada, including financing from Canadian and U.S. private equity sources and Asian investors.

“But on what terms?” asks Edgelow.

He said: “There’s lots of capital that’s waiting. The challenge is the difference of the bid and the ask, the challenge to get the deals done.”

He warned that Canada is competing for global capital and if the investment climate is less favourable here than elsewhere, Canada will lose out. He cited Royal Dutch Shell plc’s scrapping last October of its Carmon Creek in-situ oilsands project, which had been under construction in the Peace River region, as an example of how uncertainties such as market access hurt Canada’s competitiveness.

According to Edgelow’s presentation, Canada attracted 37 per cent of North America’s oil and gas investments in the 1990s, but now only accounts for 17 per cent. ATB says more Canadian projects have been cancelled or scaled back than elsewhere in the world.

One way this downturn is different is that U.S. shale plays — which weren’t on the radar in the 1980s, but were the prime cause of the current supply glut — can quickly ramp up production when the oil price recovers.

“And when it comes back, it can cause our rebound to be very choppy ... because you can have a production response in a heartbeat,” Edgelow said.

However, there’s much less spare capacity today. During the 1980s downturn OPEC had about 14 million bbls a day of spare capacity — enough to meet about 20 per cent of global demand at the time. Today OPEC’s spare capacity is between one million and two million bbls a day, or roughly three per cent of global demand, according to ATB.

‘Unprecedented headwinds’

Edgelow listed ways the industry has changed since the 2008-09 downturn, and even since 2014 when this slump began.

Canadian producer debt levels entering the 2014 downturn were 50 to 70 per cent higher than in 2008, ATB says, but notes that producer debt levels are generally higher in the U.S. than in Canada.

Even before the current downturn, consolidation was occurring in the E&P sector. According to ATB, the number of juniors has decreased by more than half since 2007. The bank expects the downturn will speed up the pace of consolidation.

In the oilfield services sector, ATB says reduced cash flow has increased the debt ratio to 2.6 times cash flow at year-end 2015, up from 1.6 at year-end 2014.

Changes that occurred since 2014 — which Edgelow called “unprecedented headwinds” — include the election of more left-leaning governments in Alberta and Ottawa, an AECO gas price that this month has been dipping below $1 a gigajoule, increased uncertainty about LNG exports, increased uncertainty over carbon regulations and greater uncertainties over inactive well liabilities. The number of oilsands projects shelved or delayed has also increased since 2014.

“These headwinds have shaken investor confidence, thereby impacting industry access to capital,” Edgelow said in his presentation. “This could be the biggest issue facing producers and service companies over the next few years.”

Edgelow said some of the changes wrought by this downturn are structural, and the industry is unlikely to return to business as usual. For example, how can Western Canada compete with a tsunami of cheap gas from U.S. shale plays?

“We’ve got to pull some permanent costs out of this basin,” he said. “We’ve got to do some things [differently].”

Don’t depend on price recovery

Lenders want companies that run into trouble amid this avalanche of challenges to have not just one plan to deal with the crisis, but three.

“We really encourage companies ... to have a Plan A, B and C [just so] you don’t have all your eggs in that one single basket,” Edgelow said, warning against a single plan banking on a price recovery.

“So we’re asking companies, and asking teams, to have a Plan A and a Plan B and a Plan C that are all executable. All have gateposts, all have guideposts, and we can move towards them.”

The banker praised those who are still working in the industry for finding ways to get things done amid the daily hurdles.

“These are really tough times. ... I applaud you for what you’re doing. ... There’s a lot of stuff that isn’t getting done because we’re still stuck. We’ve not found our way through this. We’re a long way from finding our way through this,” he said.

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