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Slowdown’s silver lining Outlook bullish for diversified oil sands’ players, Moody’s report concludes Gary Park For Petroleum News
What might have been the worst of times is turning into more of a blessing as the economic downturn steers the Alberta oil sands towards reduced front-end costs and benefits those with a diverse asset portfolio rather than the one-trick ponies.
A report by Moody’s Investors Service said the future belongs to the large companies backed by a variety of projects (Devon Energy, Canadian Natural Resources and EnCana) as well as those who explore, produce, refine and market (ExxonMobil and Royal Dutch Shell) who are able to withstand oil-price slumps.
The report’s lead author Terry Marshall, a vice president and senior credit officer at the debt rating agency, said the financing woes that have constrained the smaller, pure-play oil sands companies and that could result in more merger and acquisition activity, has an upside because of the resulting slowdown in the frantic pace of development.
“The way development was taking place, at such a breakneck pace, it was not sustainable,” he said.
The deferral or cancellation of projects allows companies to take a closer look at what they are doing and “move forward on a more measured basis,” Marshall said.
Oil sands focus a problem Moody’s said those focused exclusively on the oil sands are vulnerable to problems associated with timely execution of development plans, satisfactory liquidity and ongoing access to capital markets.
“Our recent negative ratings actions on Suncor Energy (prior to its announced merger with Petro-Canada) and Nexen reflect these capital and execution risks,” the report said.
“These companies had built up debt during the construction phases of their projects, but had insufficient cash flow to fully support capital costs and their ratings.
“Canadian Natural Resources, on the other hand, maintained its Baa2 rating despite incurring C$9.7 billion in costs on Horizon Phase I, thanks to its large-scale operations and substantial non-oil sands production base.”
While the oil sands sector remains under stress, it will prosper, but at a more measured pace, Moody’s said.
To that end, projects will be divided into smaller development phases as companies put the squeeze on capital budgets and preserve liquidity, the agency said.
It said that as well as easing cost pressures and forcing companies to abandon high-cost projects, the slowdown should “help check rapid bitumen production growth and allow related pipeline and refining capacity to stay ahead of supply increases.”
Moody’s also said faltering share and oil prices have set the stage for further consolidation and pooling of resources or upstream-downstream joint ventures, such as those by EnCana and ConocoPhillips and Husky Energy-BP.
“Consolidation will benefit the industry and ratings through better staging and sequencing of projects, greater capital efficiency, with only the highest return projects reaching development, reduced competition for labor and resources, and better-controlled development by financially stronger players, diminishing the stress of oil-price volatility,” the report said.
The Canadian Energy Research Institute has already estimated that new investment in the oil sands could tumble this year to C$3 billion from the previously forecast C$23 billion-$28 billion.
When oil slipped below US$40 a barrel, companies such as Petro-Canada, Shell and Canadian Natural, which has suffered from soaring costs resulting from an over-stretched labor pool and inflation in the cost of materials, were forced to rethink their plans as the credit crunch and uncertain energy markets ruled out investing billions of dollars.
“We do not expect to see sustained higher oil prices or significant increases in capital spending until the global economy heals and oil demand rebounds,” Moody’s said.
Call for change in measurement Mike McGee, a senior fellow with Fluor, told a Calgary oil sands and heavy oil technologies conference that capital projects teams should be challenged not just to explain what they have accomplished to date, but “what have you done for me that will make my life easier three to four years from now.”
He suggested the focus should be more on the total cost of ownership of a project rather than whether it is on time and on budget.
McGee said some major projects, despite meeting costs and schedules, fail to deliver expected returns because of startup problems, operating costs and quality that exceeded forecasts or volumes that fell short of expectations.
He said the traditional way of measuring project managers “has got to change if you are going to look for a different result.”
McGee said the ways capital projects teams are measured and rewarded do not promote “operational readiness,” noting that companies often aim for 98 percent reliability without saying how they are going to operate the project, or whether they will invest in a fully trained maintenance force that is reliability-based.
Offering a slightly different take, Robert Mason, manager of investment banking at TD Securities, told the same conference that there is no agreement on how long or deep the recession will be.
“With oil prices coming off like they have and capital costs still fairly high, certainly on a historic basis, the challenges are fairly significant,” he said.
The key questions are how far and quickly capital costs will come down (with some operators estimating there has been a 30 percent fall since mid-2008) and when will sidelined projects be restarted, Mason said.
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