Canada's independents expect tough year

Canadian independents are bracing for an uncertain year in the face of low oil prices that have chilled earnings, drilling activity, and spending plans.

One bright spot was the arrival in late December of below-zero temperatures in many parts of Canada and the U.S. That bumped demand and prices for natural gas after temperatures had remained unseasonably high well into the prime heating season.

Low oil prices through most of 1998 triggered a negative chain reaction in Western Canada's oil sector. Companies scrambled to cut costs. There was a wave of merger and acquisition (M&A) activity, while many companies tried to balance high debt loads with declining cash flow and sparse equity financing.

Operators retooled plans during the year to switch their exploration and development efforts to gas from oil. The ratio of drilling projects is now about 60-40 in favor of gas, a reversal of the previous ratio.

1998 results

Nickle's Oil and Gas Statistics Quarterly reported at yearend that more than 45% of Canadian oil and gas producers lost money in the first 9 months of 1998. It said net income in the industry fell drastically to $399 million (Canadian) from $2.5 billion for the same period in 1997.

Independents took most of the hit, while integrated companies such as Imperial Oil Ltd. and Petro-Canada were partially shielded by steady gasoline prices.

FirstEnergy Capital, a Calgary-based securities firm, estimates the oil industry will see about a 35% decline in cash flow in 1998 to about $7 billion from $10.6 billion in 1997. Based on a 100-company survey, FirstEnergy estimated that total earnings for the group in the past year will be about $500 million, 78% below 1997 earnings. That is the lowest total since 1992, when earnings were $360 million.

The Alberta government revised its crude oil revenues forecast for the current fiscal year downward to $483 million from an earlier estimate of $644 million, as income from royalties and land sales declined.

The Canadian Association of Oilwell Drilling Contractors (Caodc) reported in early December that 267 rigs were active, the lowest number since December 1992, when 209 units were operating. The rig count dropped to 236 units near yearend.

The drilling association recently forecast 10,200 wells would be drilled in 1998, but the final tally is now expected to fall below that number. That compares with earlier estimates for 1998 of 13,500 wells, contingent on higher prices, and a record total of 16,488 wells drilled in 1997.

Caodc says that, in 1998, 40% of drilling activity took place in the first quarter. But that is expected to fall to 30% in the first quarter this year, as companies cut capital spending. Heavy oil was the hardest hit in the upstream sector, as prices for heavier grades fell by more than 40%. More than 80,000 b/d of heavy oil production was shut in by summer, and companies continued to scale back operations.

M&A activity

Oil prices and a weak Canadian dollar also spawned strong merger and acquisition activity and asset sales in the Canadian oil industry in the past year. Much of the buying was done by U.S. companies looking for bargain prices and to position themselves to take advantage of natural gas sales as Canada's export pipeline capacity expands.

Acquisitions totaled more than $7.4 billion. The largest takeover was a $3.7 billion purchase of Norcen Energy Resources Ltd. by Union Pacific Resources Co.

Large deals included: a $1.1 billion purchase of Tarragon Oil & Gas Ltd. by Marathon Oil Co., a $725 million takeover of Pinnacle Resources Ltd. by Renaissance Energy Ltd., an $890 million purchase of Northstar Energy Corp. by Devon Energy Corp., and a $222 million takeover of Barrington Petroleum Ltd. by Sunoma Energy Corp.

Industry observers expect the M&A activity to continue in 1999. Debt loads and market conditions have also prompted companies to focus on strong revenue-generating assets and slim down in other areas. A number of companies, including Gulf Canada Resources Ltd., Canadian Occidental Petroleum Ltd., and Renaissance Energy, have sold off non-core oil and gas assets in Western Canada and elsewhere.

A look ahead

Many companies are trimming capital spending by 10-35% for 1999. PanCanadian Petroleum Ltd., one of the largest independents, will cut capital spending by 25% in 1999 to $650 million from $870 million in 1998. Its capital budget at the start of 1998 was more than $1 billion. The company will still drill a projected 1,000 wells this year, with most targeting natural gas.

Ranger Oil Ltd. announced a 30% cut in capital spending, and Anderson Exploration Ltd. will cut by 35%.

The bright spot for Canadian companies going into 1999 is the possibility of strong natural gas sales as winter hits and as increased pipeline capacity to export markets comes on stream. With a cold snap in the final week of December, spot prices for gas at the AECO-C hub in southern Alberta increased to $2.63/Mcf from prices as low as $1.17 early in the month.

Verne Johnson, president of Ziff Energy Group, Calgary, said the price jump is welcome but warned that a long spell of cold weather will be needed to maintain prices because of high storage levels in the U.S. and Canada.

Many Canadian independents had already used price hedging earlier in the year to lock in prices of up to $3/Mcf for gas, Johnson said. Analysts are forecasting an average price for Canadian gas in 1999 of $2.10-2.25/ Mcf.

The Canadian Gas Association estimated that Canadian storage facilities were 92% full in mid-December and said a prolonged cold spell would be needed to reduce supplies.

Companies also expect that increased export capacity, through expansions of the TransCanada Pipelines Ltd. and Northern Border pipeline systems and completion of the Alliance Pipeline project to Chicago in 2000, will improve prospects for gas producers.