Income-growth oil firms forced to pick drilling or dividendsMore from Dan Healing, Calgary Herald Published on: February 11, 2015 | The growth-plus-income business model adopted by a host of Calgary oil and gas companies and popular with retired investors who want regular cheques with their energy stocks is in trouble, brought down by oil prices that are forcing companies to choose between paying dividends and drilling wells. Or surviving, in some cases. Earlier this week, Long Run Exploration Ltd. announced that its dividend, halved in December to 1.75 cents per share per month from 3.5 cents, would be suspended after the February payments are made. Fellow Calgary intermediate Lightstream Resources Ltd., having cut its monthly dividend from four cents per share to 1.5 cents in December, suspended it entirely in January; Spyglass Resources Corp., a small intermediate formed with an income-growth mandate from three juniors in early 2013, announced it would suspend its 1.5-cent-per-month payouts in December; Trilogy Energy Corp. eliminated its dividend in December. “It’s something you don’t do lightly,” Bill Andrew, chairman and chief executive of Long Run, said in an interview Wednesday. “You set the company up to appeal to investors who want some yield and want some income and then — on a temporary basis — you’re taking that away from the very audience you wanted to attract. You’re saying, ‘We’re not putting on the show you want to see,’ because the survival instinct becomes more important than having the company perfectly set up to appeal to those investors.” He said those investors, some of whom are retirees on fixed incomes, have let him know directly through phone calls and through stock trades that they are not happy. After announcing the dividend cut Monday evening, Long Run shares fell nearly 15 per cent on Tuesday and remain near their 52-week lows. In a research note Wednesday, analyst Jeremy Kaliel of CIBC World Markets said he expects to see more payout and capital spending cuts as several dividend-paying intermediate and junior exploration and production companies roll out fourth-quarter 2014 financial results over the next few weeks. “We expect continued capex and dividend reductions to be a key theme at year-end reporting as divcos move to protect their balance sheets (while investors evaluate downside protection as they pick their horses to ride a potential recovery in the commodities),” the report says. “We expect further reductions in capex in Q4 results from Baytex, Bonavista, Crescent Point, Enerplus, Journey, Northern Blizzard, Peyto, and Vermilion. In addition, barring a recovery in commodities, we will be watching Baytex and Enerplus for potential dividend cuts.” In an interview, he said the sector will survive for the same reason that energy trusts were popular before most of them were converted following federal tax changes. “Because of the demand for income products, I think you’re seeing the choices that growth-plus-yield companies are making,” Kaliel said. “Most of them chose to cut growth capex first and, if they can’t provide both, they reduce the growth component first and then dial back the yield side of the equation.” Analyst Thomas Matthews, who covers Saskatchewan oil and gas producers for AltaCorp Capital, agreed low oil prices are forcing companies to choose between dividends and capital spending. High debt levels make the choice even more difficult. “In the case of Lightstream, you cut the dividend completely to maintain what you can of production,” he said, adding the company’s level of debt makes it unlikely it will be able to afford to reinstate its dividend anytime soon. “For Crescent Point, they’ve said, ‘We’re not cutting the dividend at all,’ and they’ve been pretty adamant about it. But if you look at their 2015 capex, it’s pretty barebones. If you look at their production guidance for 2015, it’s pretty much flat.” He added many companies have deliberately cut capital spending deeper than necessary in the first half of the year to avoid producing finite resources into a low price market, preferring to ramp up when prices recover. Neither Matthews nor Andrew think the income-growth model is permanently broken. But its recovery, like its recent setbacks, depends on commodity prices. AltaCorp expects benchmark West Texas Intermediate crude to average $48 US per barrel in the first half, improving to $55 in the third quarter and $61 in the fourth. Matthews said he doesn’t expect anyone who has cut a dividend to reinstate it until prices are well above $70 per barrel. Andrew pointed out that when Long Run adjusted its budget in December, the reduced dividend was based on a forecast crude price of $70 and a natural gas price of over $3 per thousand cubic feet. The company currently produces about 35,000 barrels of oil equivalent per day, about 56 per cent natural gas. “I think as oil creeps back up, over $65, over $70, at that point you would start looking at whether it makes sense to start putting some dividend back in,” he said. “The difficulty is that at $50, you have precious little cash coming in and you really can’t afford a dividend. You add $20 to the price and it really changes things.” Dividend cuts are never popular but a report from CIBC researcher Jeff Evans published last week indicates it isn’t necessarily the end of the world. The reported noted that stock prices often outperform the market nine to 12 months after a reduction in dividend is announced. “Our research suggests that dividend reductions in the materials sector have been the most strongly ‘rewarded’ historically, although energy stocks also show reasonably strong post-cut performance,” the report says. “In both the energy and materials sectors, cutters tend to be placed in the penalty box for one to two months post-cut, after which they generally begin to steadily outperform the market. As the recent wave of cuts occurred in December and January, we are now entering the ‘sweet spot,’ where relative returns have (historically) begun to accelerate.” The study analyzed all companies that were members of the S&P/TSX composite index at any point in the past 15 years.