2020 Top Operators Report: Size Matters, But Agility And Ability To Pivot Just As Important To Manage Market Volatility
Canada’s oil and gas industry is at an inflection point. After five years of wild price volatility, market access issues, and other challenges, it now finds itself in the midst of a pandemic that has driven demand to lows not seen in decades.
This year’s Daily Oil Bulletin Top Operator report reflects the great uncertainty facing the oil and gas sector and tries to make sense of what the industry and successful operators in the post-pandemic future will look like.
To do so, we made some changes to the Top Operator format.
Rather than comparing year-over-year data, in some instances our CanOils analysts compared first quarter 2019/2020 data to measure the impact of the early stages of the COVID-19 pandemic.
We also tapped into the experience of professional services firm KPMG to gain insight into what strategies operators and service companies could pursue to survive and thrive through the difficult days ahead.
Further, we leveraged the reporting power of the Daily Oil Bulletin staff and its ongoing coverage of the industry over the last four months to capture the industry’s response to the pandemic and its future outlook.
Which companies are best positioned to weather the COVID-19 storm and emerge strong on the other side?
“Larger and integrated companies will survive and prosper. We have already seen they can raise capital in tough times,” says KPMG’s national energy leader Michael McKerracher. “There will always be a spot for specialty E&P companies in smaller profitable plays and basins. The smaller juniors are at risk. The junior of the future will have more production, specialized skills, and may even be internationally focused. “
The integrated business model, with operators owning production, refining, and even retail assets has stood the test of time, he says. When heavy oil differentials exploded prior to the Alberta government limiting production in 2018, Canada’s integrated operators were some of the few companies that remained profitable.
Suncor Energy Inc. president and chief executive officer Mark Little says being a large integrated company has worked well, and he expects that to continue through the current downturn.
“Throughout the North American shale boom and the subsequent oil price collapse and the Fort McMurray fires … we demonstrated the importance of financial discipline through our ability to significantly scale-down costs,” he said.
“And now, looking forward from today, we have confidence that we have taken the right measures to ensure Suncor will continue to weather the storm. Suncor's competitive advantages of an integrated physical connection to the consumer, sophisticated marketing, logistics and infrastructure capabilities and always maintaining our financial strength will allow us to emerge stronger than ever.”
Scalability is one of the key advantages large producers have in dealing with market volatility, he explains. When prices drop, large producers can cut capital expenditures, focus on their best assets, and shut-in less economic production.
Canadian Natural Resources Limited provides an example of this scalability. Following the price collapse CNRL cut its capital budget by $280 million, bringing its total cut to $1.37 billion compared to its original 2020 spending plans.
CNRL is reducing well servicing activity and shutting- in higher cost production at its conventional oil operations. It is temporarily lowering production at its thermal oilsands assets.
“So what we did is go through the year looking at all items and asking what is potentially deferrable and what is not even really needed in this type of environment,” explains president Tim McKay.
Having a balanced portfolio between oil and gas can also help in challenging times, says McKerracher. He points to the 2009 separation of the Encana Corporation into two companies—oilsands company Cenovus Energy Inc. and natural gas company Encana—as an example of what can happen when companies put their eggs in one basket. Both companies saw valuations decline and ultimately moved to increase their gas and oil holdings, respectively, to improve their viability.
“Being more balanced can flatten out some of the cycle. It gives you the ability to change focus but you have to be big enough to afford to have the specialties in each commodity,” he says.
Larger gas-weighted producers are leveraging the scalability and diversity of their assets to manage market volatility. As gas prices eroded in the first quarter of 2020, Peyto Exploration and Development Corp. decided to slow its winter drilling program and defer some capital expenditures.
“Then in March, of course, the oil price crashed on the demand impact due to COVID-19, and we had the price war between Russia and Saudi Arabia, where they were threatening to flood the market with a whole bunch of production,” says company president and chief executive officer Darren Gee. “We had to completely reassess our drilling plans for the year in light of the impact to our economics that those commodity prices brought.”
With liquids prices declining and natural gas prices enjoying an uptick, Peyto shifted focus from its more liquids-rich Cardium opportunities back to its leaner Spirit River opportunities.
While large companies can leverage scalability to manage volatility, smaller companies need to be agile to manage market gyrations, says McKerracher.
Privately owned Westbrick Energy Ltd. takes a seasonal approach to its production, concentrated in the Rocky Mountain House and Drayton Valley areas of Alberta.
In the November through April period, it ramps up gas production to as much as 30,000 boe/d, with production being reduced to one-third of that during the summer. It’s an approach that has allowed the company to remain profitable in a difficult environment for gas prices.
Other small companies are looking international to survive and thrive, says McKerracher. “There are a number of basins around the world not exploited or commercialized. There is real value to be captured in these international jurisdictions. We have some of the best technologies in [the] world in exploration and production and can take expertise to other locales. That’s where the junior space will survive and prosper in the international realm.”