Busting the petrobronc

Debt. It’s not necessarily the worst four-letter word. As matter of fact, in today’s corporate climate, it could be called a necessary evil as the cost of capital upgrades and new projects escalates. But in the financial rodeo that’s the petroleum sector these days, many small to medium-size players are having trouble staying in the saddle. The problem, confirmed by the Canadian Association of Petroleum Producers (CAPP), is that access to capital is drying up.

Figuring out exactly how much debt the petroleum sector is problematic in that Statistics Canada data combine the mining sector with oil and gas extraction. Going into 2008, that industry category carried $43.46 billion in debt, a 44% jump from $30.17 billion at the start of 2007.

Greg Stringham, CAPP Vice-President, Markets and Fiscal Policy, expects the majority of that debt had been accumulated by mining companies because balance sheets in the petroleum sector were in “really good shape” when StatsCan was compiling its latest numbers. “The oil and gas industry’s debt was going ‘way down at that point, because they had enough cash flow to be able to pay off their debts.”

Even so, Stringham said he wouldn’t be surprised if the oil and gas sector, with more than $50 billion in capital investment and $100 billion in annual revenues, revenue, was carrying $30 billion in combined debt.

Any increase, he suggested, is unlikely because “really nothing has been raised in the last three months” by the oil and gas industry on capital markets that he says have “dried up completely.”

Hence the postponement of some projects. “Most of the big oil sands projects that already under construction are going all the way through to completion,” Stringham said. “They’re spending based on cash flow and they had financing that was arranged to be able to carry them through. Others, if they’ve got cash flow that’s coming in, they’re spending their cash flow or investing it very prudently.”

However, there’s another tier of smaller companies which reach out each year, mostly to the equity markets, for financing. They’d drill their planned wells and investors would be paid back. But when that dried up, they turned to debt financing only to see that dry up too because of the credit crunch.

Some have even been told by their banks that their long-standing revolving lines of credit aren’t being renewed, which Stringham said is “really going to hurt.” More than a few have retrenched on their spending and some have cancelled spending outright for the foreseeable future.

CAPP represents a broad spectrum of more than 600 companies with the 150 largest accounting for 96% of Canada’s oil and gas production. The ones being hit hardest financially are likely to be the 300 at the smaller end of that spectrum. “It’s a small percentage of production, but a large number of companies that are being affected,” Stringham said.

Given the break-even costs of oilsands development, Stringham said that at $42 a barrel, oilsands developers are probably covering their operating costs but aren’t getting much, if any, return on capital. “The ones that are expanding are the ones that already have the financing arranged for their projects. . . . but also using money that came off the cash flow they had earlier this year, when it was over $100 a barrel.”

Asked what that bodes for the near term, he said most companies are “living within their means, their cash flow” and the outlook obviously depends on how long and how deep the current situation lasts.

“Most of the big oil sands projects are really built on a 30-to-40-year time line and so while they never believed that prices were going to stay at $130-140 a barrel, I don’t think they believe that they’re going to stay at $42 a barrel either.”

Another factor to consider is that some petroleum projects have experienced overruns due to a relatively strong steel market and a tight labour market. “This slowdown is actually helping to bring some of those costs back down,” Stringham said. “Everybody’s just trying to hold on and weather the storm . . . but if it goes on much beyond the next three or four months, I think you’re going to see some more drastic retrenching.”