October 8, 2021
Integrated Oil and Senior E&P 3Q Earnings Preview—Showtime
Our view: The energy sector has experienced a sharp change of fortunes from cash flow famine just a year ago to feast as 2021 closes out. The third-quarter earnings season should showcase this bounty, and is set to kick-off October 27 with Suncor Energy slated to release its results after market close, followed by Imperial Oil (estimated) results on October 29. Our third-quarter estimates sit broadly in- line with IBES consensus for the majority of our coverage group (Exhibit 1). We are above consensus CFPS on Ovintiv, while modestly below on Suncor and Imperial Oil.
Third-quarter results should continue to showcase the free cash flow generative power of producers amid a continually strengthening crude oil and natural gas landscape combined with limited capital investment and moderate cost inflation. Balance sheet deleveraging via debt reduction—a theme throughout 2021—has only accelerated in this environment, which opens the door to bigger shareholder returns including dividends of all kinds and share repurchases. Consolidation activity could accelerate against this backdrop, especially given depressed valuation levels and limited market appetite for organic investment. We suspect that third-quarter conference calls will be punctuated by questions surrounding capital investment, optimal debt levels, royalty rates and the pace of oilfield cost inflation as we move into 2022.
Our investment recommendations remain unchanged across the board. From a Canadian integrated oil, senior and intermediate producer standpoint, we continue to favour companies that possess resilient business models, strong balance sheets and a track record of capable execution. Our favorite producer remains Canadian Natural Resources (Global Top 30 and Best Energy Ideas lists) with Cenovus Energy our favorite Integrated (Best Energy Ideas list). Suncor Energy, MEG Energy and Enerplus Corporation round out our Outperform roster.
Upstream wise, oil prices continued their upward climb in the third-quarter, with WTI averaging US $70.65—up 7% (US$4.61) sequentially, while Brent rose 6% to average US$73.27. Conversely, the Canadian dollar depreciated in the third-quarter, falling 2% to US$0.79. Canadian oil differentials widened on a sequential basis with Edmonton Par (Canadian Light) trading at a US$4.07 discount to WTI (up from US$3.11 in the second-quarter). WTI-WCS differentials widened to US$13.58 in the third- quarter as WCS rose 7% to $71.87 alongside higher benchmark prices. Syncrude’s synthetic sweet prices averaged $87.10 during the third-quarter—a $1.86 discount to WTI (C$) (versus $1.28 in the second- quarter). Canadian condensate prices of $89.21 were up 12% sequentially, averaging 100% of C$WTI (vs. 98% in the second-quarter as per Bloomberg).
The natural gas side of the equation saw dramatic increases in the third-quarter with a 48% increase (US $1.40/mmBtu) in Henry Hub averaging US$4.30/mmBtu. Alberta Spot (AECO C) gas prices of $3.60/mcf rose 17% from $3.08/mcf in the third-quarter (as per Bloomberg). Not to be overlooked, benchmark European natural gas prices (NBP) shot up 82% (US$7.43/mmBtu) to average US$16.45/mmBtu in the third-quarter.
Downstream wise, crack spreads continued their steady climb in the third-quarter. US Midwest cracks increased to US$20.20 (up US$1.07), while New York Harbor 3-2-1 cracks of US$22.45 were up 10% on a sequential basis. Average US refinery utilization rates improved to circa 90% in the third-quarter (vs. 88% in the second-quarter). On balance, we anticipate that LIFO-FIFO inventory adjustments will be favorable but modest in the third-quarter.
Our updated estimates reflect actual third-quarter prices along with various fine-tuning adjustments, and are outlined within this report (Exhibit 3).
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Cenovus Energy – Outperform (Favorite Integrated): Our third-quarter production outlook for Cenovus of 791,200 boe/d reflects Christina Lake production of 232,000 bbl/d, Foster Creek production of 188,000 bbl/d, Tucker + Lloydminster thermal volumes of 142,000 bbl/d and Liwan production of 45,600 boe/d (net) (including 210 mmcf/d of natural gas at a realization of $13/mcf). In the downstream, we anticipate Canada + US refining (pre-tax) operating cash flow of $285 million. Our estimates include $72 million in cash taxes in the quarter, hedging losses of $69 million, and capital investment of $692 million. All said, we peg Cenovus’ third-quarter cash flow at $2.2 billion ($1.09 per share). As per our outlook, Cenovus’ net debt (company definition) would sit at about $10.7 billion as of September 30. In conjunction with its third-quarter results on November 3, it would not surprise us to see the company further define its plan for shareholder returns including potential share repurchases and dividend increases.