E&P Leverage Metrics Trending Higher
While Up, They Are Still Very Low vs. Historical Norms Capital Discipline/Low Growth Narrative Largely Intact
TD Investment Conclusion
In Exhibit 1, we summarize forward-year strip Net Debt/CF (ND/CF) metrics for our Canadian coverage since 2019. In mid-2020, they peaked at an average 8.0x amid an uncertain demand outlook brought on by COVID-19. This metric then hit record lows during 2022 and exited the year at an average 0.2x; certain companies even had line-of-sight to net cash positions. However, since YE2022, WTI spot prices have fallen 15% (2024E forward-curve down 4%), Henry Hub spot natural gas prices are down 46% (2024E forward-curve down 28%), while USMC 321 spot cracks are up 4%. When combined with significant one-time cash tax payments in Q1/23, strip ND/ CF metrics have more than doubled to the current level of 0.5x. However, we still characterize this as very healthy gearing. The key conclusions are as follows:
1. Leverage metrics largely higher due to weaker commodity prices (good reminder of the ongoing importance of capital discipline) and one-time large cash tax bills in Q1/23: In other words, leverage is not up because of more aggressive reinvestment rates and growth aspirations. To this end, we highlight that 2023E peer-average reinvestment rates currently range from 39%-58% on strip (vs. 68%-116% over 2015-2019) while consensus 2023E North American production estimates are down 0.6-2.8% YTD across the various groupings (Exhibit 3).
TMX coming onstream in the H1/24 timeframe could trigger a slight relaxation of current, very conservative growth targets in Canada, in our view, especially for the heavy producers. We continue to believe this expansion should support 2-4 years of WCSB heavy oil production growth based on historical growth rates (note). Beyond this, there is very limited visibility on growth in egress and, as a result, we do not see the industry backing away from current, generous shareholder capital return strategies.
2. Achievement of secondary return of capital (RoC) targets has been pushed out several quarters: Recall, several coverage companies have RoC targets tied to achievement of ND targets. At YE2022, and on strip, we had estimated that several companies would migrate to the next level of capital returns in H1/23. However, weaker commodity prices and outsized Q1/23 cash tax payments, in certain instances, pushed these targets out several quarters.
Focusing solely on the next 12-months, CNQ/CVE should achieve their ND targets in Q1/24 on strip, thereby moving to 100% return of FCF to shareholders, SU in Q4/24, triggering a 75% return of FCF (assuming it acquires TTE's Fort Hills stake, but loses Surmont to COP since it exercised its ROFR—note), BTE to 50% in Q3/23 on closing of the ROCC acquisition, and WCP to 75% in Q4/23 on achievement of <$1.3B ND (including a 26% dividend/share increase).