Whitecap Resources Inc T.WCP

TD Notes

[retiredcf]

How Would E&P Fundamentals Hold Up If WTI Tracked 2008 Pricing?

TD Investment Conclusion

The recent appreciation in crude prices is the result of multiple years of under- investment in the upstream sector, combined with the return of normalized energy demand. This was further kindled by the Russian invasion of Ukraine that resulted in a near-term supply squeeze as global buyers shun Russian blends. Over the medium term, there is now longer-dated risk that broad and strict global sanctions against Russia will result in a deterioration of Russian crude oil output.

2008 Pricing Scenario — Strong Rally, Followed by a Sharp Decline: For illustrative purposes, in this report, we look at the 2008 WTI price scenario, where crude rallied from the mid-US$60/bbl to set a record price of nearly US$150/bbl, before falling below US$40/bbl during the financial crisis (Exhibit 1). Although many remember the headline-making rise and sharp decline in the oil price, interestingly, WTI ultimately found support near US$80/bbl shortly after bottoming. We focus on the 2008 scenario in this note as this includes a "worst-case" quarter that can be annualized.

The second recent example of oil breaching US$100/bbl is the period between 2011 and 2014, where crude moved up from the mid-$60/bbl range, then hovered near US$100/bbl for a period of three years. It should not come as a surprise to most readers that three stable years near US$100/bbl is positive for the fundamentals of energy equities.

Key Takeaways

• Current Base Dividend Level and Capex Covered Across Entire 2008 Price Cycle: Should WTI track the 2008 pricing scenario, we estimate that current capital-spending assumptions and base dividend levels will consume only 38% of 2022E CF and 49% of 2023E CF. Even if we annualized the worst quarterly result (i.e., Q1/23E), we calculate an average all-in payout ratio of 64%. Similarly, sector average leverage ratios would hover around nil — even under the worst annualized quarter (at US$43/bbl WTI).

• This is in stark contrast to the actual fundamentals during the 2008 period, where the business models of the larger intermediates were vastly different. The income- trust-dominated sector carried significantly higher all-in payout ratios. Ultimately, the downdraft in WTI in 2008 had material side-effects beyond lower realized pricing. Specifically, falling CF resulted in reduced capital spending (resulting in lower production that compounded negative CF revisions). Furthermore, there were significant reductions in unsustainable dividend levels. In many cases, E&Ps were hesitant to reduce dividends quickly, which also resulted in rising absolute debt levels.

   Current Valuations Much Lower than Past Scenario: Before the 2008 downdraft in WTI, valuations were significantly higher than they are today. Specifically, at that time, the sector traded at ~6.0x forward-year EV/DACF (at US$90/bbl WTI, US$9/mcf HH). Today, the sector is trading at ~4.0x 2023E EV/ DACF (at US$65/bbl WTI and US$3.15/mcf HH).