2022 Top Operators Report: Putting Cash To Work
Editor’s note: The last five years have been a hard ride for Canadian oil and gas producers.
Wild price volatility, a pandemic-induced price crash, ongoing market access issues, oil production curtailment, the rise of the ESG movement, and finally a geopolitical crisis are just some of the challenges industry faced.
The end result of this period of instability is a reinvigorated industry ready to take on the world as the commodity cycle turns once again.
The 2022 Top Operators Report examines the 2017-2021 timeframe, identifying key trends that shaped the present energy landscape and what lies ahead for the 62 Canadian headquartered public operators tracked this year.
To sort through these challenges we are once again leveraging the experience of professional services firm KPMG in Canada to provide insight into the last five years of change and what strategies operators could pursue to thrive in the inevitable turbulence ahead.
Data analysts from Evaluate Energy are providing context to the stream of information coming from corporate financial reporting and other relevant documents. Analysts from geoLOGIC systems ltd. offer context into trends in activity and technology to manage costs.
We’re also tapping into a broad swath of the insights and opinions from industry leaders gleaned from Daily Oil Bulletin coverage.
To download the 2022 Top Operators Report, click here.
A rising tide lifts all boats, and as commodity prices climbed throughout 2021 and into 2022 the fortunes of Canada’s oil and gas sector have risen with them.
Oil prices advanced throughout 2021 to surpass WTI $100/bbl late in the year and despite some volatility have remained above that range for the first half of 2022. Natural gas prices started an upward tilt in the late summer before retreating later in the fall. Since then they have been on a choppy yet consistent rise moving into the summer storage season, with AECO/NGX spot prices hovering around C$6.50 in June.
The sudden and sustained increase in commodity prices has boosted operating cash flow across the board for North America’s oil and gas companies, resulting in record levels of free cash flow, said Mark Young, senior analyst with Evaluate Energy.
But how operators choose to spend this windfall has changed as the dollars continued rolling in during the last year, said Young, who tracks the spending habits of 82 publicly traded North American oil and gas producers (38 Canadian) quarterly using the Evaluate Energy database looking back to 2018.
Record levels of free cash flow continued as the calendar turned to 2022 but, “things felt different in the final quarter,” said Young. Capital spending began climbing, reaching levels not seen since prior to the pandemic. Spending was up 22 per cent compared to the previous quarter.
The fourth quarter was also very different because it saw a noticeable reduction in the percentage of free cash used to repay debt. Debt repayments accounted for just 24 per cent of all cash used in fourth quarter, down from 40 per cent in the third quarter and the first time the figure has dropped below 30 per cent in over a year. “This could be an early indication that the most pressing debt priorities across the industry are being resolved,” he said.
“Shareholders were key beneficiaries instead,” added Young. “Total shareholder returns via dividends and share buybacks made up 26 per cent of total cash used in the final quarter, a meaningful and discernible uptick in cash use in total and in proportion to other uses of cash.”
Canadian oil and gas producers largely align with overall North American trends, with a few exceptions. Canadian oil-weighted operators (excluding oilsands) have been slower to increase capital spending, as they continued to repay debt. Capital spending remained flat between the third and fourth quarter at around $800 million. This is the highest post-pandemic spend for the group but falls short of the pre-pandemic average of just over $1.1 billion per quarter in 2018 and 2019.
“Canadian oil producers were alone in repaying a record amount of debt (C$1.1 billion) in fourth quarter,” said Young.
Capital spending by Canadian gas producers was also relatively flat in the final quarter of 2021 compared to previous quarters. Debt repayments were also flat compared to the rest of 2021.
“The final quarter saw over C$600 million spent on buybacks and dividends for the first time,” said Young, indicating gas operators now have their balance sheets under control.
Oilsands operators are in the midst of tsunami of free cash flow, said Young. Operating cash flow reached $11.4 billion in final quarter of 2021, including changes in working capital. This led to another C$7.3 billion in free cash flow generated by the group of five, and a total of C$25.3 billion for the year.
“This is only around C$4 billion shy of the combined total between the first quarter of 2018 and final quarter of 2020,” said Young
Oilsands operators spent C$3.6 billion in combined buyback and dividend spending in the final quarter. It was the first time that over C$3 billion in cash was devoted to this since the last quarter of 2018.
While Canadian operators restrained capital investment as prices climbed in 2021 the purse strings appear to be opening up in 2022, at least among natural gas producers. Operators flush with cash who have built large resource positions plan on turning the resource into production and reserves to meet what they believe will be growing demand.
Montney operator Kelt Exploration Ltd. plans to increase production by 48 per cent in 2022, bringing average production to over 31,000 boe/d.
“This growth will be accomplished without taking on additional debt,” said Sadiq Lalani, Kelt’s vice-president and chief financial officer.
Kelt has around 540 net sections of Montney lands in Alberta and B.C., along with 113 net sections of Charlie Lake lands.
“The reason this Montney play is such an exciting play and people covet the play is because there are so many different layers within the Montney that it is almost like having three or four times the amount of land because you are able to drill three or four different horizons on the same section of land,” said David Wilson, president and chief executive officer. “I think as time goes on, people will start giving companies with big inventory and big resource credit for that and you’ll see it in the stock price.”
Jonathan Wright, president and chief executive officer of NuVista Energy Ltd., said his company is also returning to growth. NuVista purchased assets in the Pipestone field from Cenovus Energy Inc. in 2018, with a commitment to expand processing facilities as part of the deal. The pandemic put those plans on hold, keeping production relatively flat for about 1.5 years.
Peyto Exploration & Development Corp. is taking a more measured approach.
“We have some debt repayment plans to de-risk the balance sheet a little bit and get our debt into the right place, and we also have some capital investment plans that’ll deliver some growth of probably 10 per cent this year,” said company president and chief executive officer Darren Gee.
Current economics for investing capital in the field “are fantastic” for creating cash flow-generating assets that not only pay out quickly, but have years of future returns built into them, he said.
While his inclination for 2023 and beyond would be to invest as much as possible into growth, Gee suggested that there are clear limits to doing so, notably the availability of people and equipment. For Peyto, any excess cash it receives in the near-term would not necessarily go towards eliminating debt, but shareholder returns will be important.
Canadian oil producers are more cautious about capital spending plans going forward, choosing instead to continuing to eliminate debt and then returning capital back to investors.
Baytex Energy Corp. is on track to meet its debt targets in early 2023, which will provide options on how it spends cash flows.
MEG Energy Corp. is in a similar position. The company completed or announced repayment of about $499 million of outstanding indebtedness during the first quarter of 2022. The company is targeting net debt of $600 million.
“We spent a lot of time thinking about that net debt floor,” said Eric Toews, chief financial officer, earlier this year. He said the $600 million floor, when coupled with MEG’s credit facility structure, provides liquidity if needed that is unencumbered by covenants up to C$400 million. Further, he added, in terms of debt-term structure, the first maturity is 2029, which is “well out into the future” for the company.
“The third piece, which I think is important, is the ability to actually refinance that debt when it comes due — that US$600 million. We think at that level, given the credit quality of MEG, we won’t have an issue in rolling that debt, whether that’s in the capital markets, whether that’s in the bank market, or wherever that market is. And so, from that perspective, we feel very comfortable that it’s a sort of ‘bullet-proof’ debt number.”
David Hughes, vice-president of investor relations, Imperial Oil Limited, said that early on during the COVID-19 downturn, companies either dramatically reduced or eliminated dividends out of necessity. As conditions improved in late 2021 and 2022, many companies have been aggressively increasing returns, rewarding shareholders for their patience.
Political risk also leads to investors favouring returns, according to Hughes, as the regulatory processes can tie up capital for years. “That’s a concern, and that’s where we were starting to see some of the capital flight out of Canada, probably, three or four years ago. On top of that, there are broader political risks with all the uncertainties. Whether it’s the clean fuels regulation or carbon taxes, there’s still a lot of uncertainty around that and where that leads us.”
Industry requires certainty, he said. In the absence of it investors would prefer to see returns rather than risk capital on something uncertain. “There is a concern about the energy transition movement and what that means potentially for security of some of these investments going forward,” Hughes said, adding oilsands production in particular is a long-term business requiring massive capital investments that play out over decades.
However, he noted, there are also opportunities for firms to significantly reduce their emissions profile and thus drive value for shareholders in the current environment.
In general, suggested Hughes, there are “some pretty impressive moves” on the part of companies to return cash through dividend policy or repurchasing shares. It is also important to be mindful of the capital requirements for the energy transition. “There is either a lot of technology that is potentially available now or is in the process of being commercialized, and it’ll require some pretty material capital investment as we move forward towards 2050.”
He added: “I think we’re going to see ourselves shift in the not-too-distant future back towards capital investment. The interesting or challenging thing will be trying to strike the right balance. Certainly, when you look at performance today, there’s a tremendous amount of free cash being generated, and that would suggest there is a capacity to do both right now. That’s the big shift we’ll see coming.”
To download the 2022 Top Operators Report, click here.