World's No. 3 Oil Reserves Tested by Rout as Shell Decamps

(Bloomberg) -- When Royal Dutch Shell Plc decided to pull out of the Canadian oil sands, the local producers doubled down with more investment. Crude’s bear market is testing their resolve.

Trailing only Saudi Arabia and Venezuela in proved reserves, the sticky deposits of sand, water, clay and hydrocarbons in the remote boreal forests of Canada are some of the hardest and most expensive to extract. But producers like Cenovus Energy Inc. have vowed to deliver profits at lower prices after spending billions of dollars to buy assets from foreign majors. Now they get a chance to prove it.

“These are large-scale projects that can’t be turned on and off on a dime,” said Dennis Fong, an analyst at Canaccord Genuity Group Inc. “Most would just continue producing even to the point in which we hit the high $20s.”

While U.S. prices haven’t hit near that level yet, they have plunged more than 20 percent from this year’s peak, meeting the common definition of a bear market. On Wednesday, West Texas Intermediate, the U.S. benchmark, was priced below $43 a barrel. Canadian producers say the deep cost cuts they made during the downturn that sent oil plummeting from more than $100 in 2014 provide some resilience to this month’s rout.

In March, Cenovus agreed to buy out ConocoPhillips’ 50 percent stake in the Foster Creek and Christina Lake joint ventures, as well as some other assets, for about $13.2 billion. The acquisition doubled the Calgary-based company’s reserves and production. Canadian Natural Resources Ltd. spent about $9.4 billion this year to buy oil-sands assets from Shell and Marathon Oil Corp.

Oil-sands producers aren’t able to just cut output and wait for prices to recover, as some low-cost drillers have done in U.S. shale plays. Not only do they need to keep producing to pay off large upfront investments, but the deposits also require constant injections of steam to keep the tar-like form of crude they hold fluid enough to flow up to the surface.

The Cenovus deal weakened its balance sheet, prompting the company to tap a credit line, take out a bridge loan and sell shares. The company also said it will sell as much as C$5 billion ($3.8 billion) of assets to pay down the bridge loan. The shares have plunged almost 50 percent since the deal was announced.

The company has turned to hedging to help offset some of the risk of lower prices. In April, Cenovus had 87,500 barrels a day of production hedged at an average minimum of $49.20 a barrel for the remainder of the year, and 50,000 at $49.74 for the first half of 2018. Now the board has approved a plan to hedge as much as 75 percent of output this year and next.

Cenovus has continued to work on cutting costs and says it can cover its dividend and spending with West Texas Intermediate crude at $41. The company expects to get that figure below $40 next year.

More Hedging

Canadian Natural said it has built a “large, diversified asset base” with long-life, low-decline reserves that make it resilient in periods of lower prices. President Steve Laut said last month the company had 67,000 barrels a day of production hedged, but looks at hedging every week and may add more.

The producer also could dial back short-cycle capital spending, tap debt markets, sell royalties or dispose of other assets, such as stakes in Inter Pipeline Ltd. and PrairieSky Royalty Ltd., if oil prices took a prolonged downturn, Canaccord’s Fong said.

Suncor Energy Inc., Husky Energy Inc. and Imperial Oil Ltd., which is 69 percent-owned by Exxon Mobil Corp., have strong financial positions that could help them weather lower prices, Fong said. Plus they have refineries and gas stations that act as a natural hedge against a drop in crude, he said.

Suncor can cover its dividend and its sustaining capital at $40 oil, spokeswoman Sneh Seetal said. The company generated about C$6 billion in cash flow in 2016, when oil averaged just over $40, she noted.

Suncor and its peers have spent the years since crude prices crashed working to drive costs out of their systems and operate more efficiently. Canadian Natural has kept its dividend nearly flat in recent years to help conserve cash during the downturn, and Cenovus trimmed its payout in 2015.

Cenovus expects to continue reducing expenses by using new technology and becoming more efficient, Chief Executive Officer Brian Ferguson said during a presentation to investors Tuesday. The work it already has done to trim its cost structure has given it “flexibility” if oil prices stay low for a longer period, he told reporters afterward.

“We’ve done a very good job of adapting to that and actually being ahead of it,” Ferguson said.

--With assistance from Natalie Wong

To contact the reporter on this story: Kevin Orland in Calgary at korland@bloomberg.net.

To contact the editors responsible for this story: Reg Gale at rgale5@bloomberg.net, Carlos Caminada, Steve Stroth

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