CIBC NotesEQUITY RESEARCH October 6, 2022 Earnings Revision Energy: Q3/22 Preview & Price Deck Update Higher-for-longer Pricing Underpinned By Capital Discipline Our Conclusion With this publication, we mark to market our commodity price deck and
provide a preview of Q3/22 earnings for the energy sector. Despite looming recessionary concerns, we believe the set up for energy remains attractive for investors. The capital discipline in the sector has provided a boon to free cash flow in this cycle, and has increased shareholder returns that we believe are here to stay. While our price targets remain grounded in modest forward cash flow multiples, we do see room for multiple expansion for Canadian operators given the increased importance of energy security. We expect the pause in equities over the last month will prove to be a key buying opportunity, and we have a more bullish near-term call on natural gas ahead of seasonal demand increasing and recommend investor exposure to the commodity. Our top ideas include: ARX, CNQ, ERF, NVA, SDE, and TOU. Key Points Q3 preview: We sit below consensus on cash flow for most companies
given the timing of this preview and believe consensus estimates may not
fully reflect Q3/22 commodity pricing at this juncture. We sit above
consensus cash flow for FRU, IMO, and VET. We expect 2023 budget
announcements from ARX, BIR, KEL, NVA, PEY, and SDE. We expect
Q3/22 will feature wide variability in price realizations for gas producers, and generally favour producers with limited AECO/Station 2 exposure. Fundamentals for oil price remain relatively strong, but OPEC+
wildcard should be primary focus. Despite oil price weakness through Q3,
we remain relatively constructive on fundamentals given moderating
Strategic Petroleum Reserves (SPR) releases and an eventual reversal to refill withdrawn volumes, in addition to continued capital discipline from
producers. We also saw OPEC+ react to the oil price weakness, suggesting the bloc could look to set a floor in pricing. FIFO-LIFO and impacts to value of inventory could have significant
impact this quarter. Given the significant move lower in oil price, we
estimate FIFO-LIFO adjustments could have a material impact on earnings. Oil price moved by ~US$30 per Bbl from the beginning of the quarter to the end. Given the significant move in pricing, we believe this could drive headwinds for SU and CVE and a tailwind for IMO. Natural gas – bullish/bearish/bullish. We are more bullish than bearish in
the near term given North American storage is poised to enter winter below five-year average levels, and we recommend investors have exposure to natural gas-weighted stocks. We remain cautious on pricing through H2/23 and 2024 as supply should arrive. The LNG demand profile beyond 2025, however, continues to look robust for North America, which should be supportive for pricing.
Crude Oil Outlook
Fundamentals for oil price remain relatively strong, but continued OPEC+ production quota adjustments could provide additional pricing support. The oil price fell ~US$30 through the quarter to ~$US80 WTI given concerns of a recession, additional supply from the Strategic Petroleum Reserve (SPR), demand weakness from China, tighter central bank
policies and rising interest rates. Despite these headwinds, we remain relatively constructive on oil fundamentals given moderating SPR releases and an eventual reversal to refill withdrawn volumes, in addition to continued capital discipline from producers. We also saw OPEC+ react to the oil demand weakness, suggesting the bloc could look to set a floor in pricing. In the medium term, a restart of Chinese demand as the country moves away from its Covid-zero policy, EU embargoes on Russian oil that become effective in December, and potential interruption of Russian supply as western sanctions have driven an exodus of
technology, capital and labour all provide a positive fundamental backstop for oil.
Given the rapidity of the forward curve moving lower, consensus crude oil pricing could come down and put pressure on estimates for Q3/22 (and 2023). Further, headline-driven oil price volatility pushes our focus to companies with integrated exposure and/or high-quality assets which can provide the most consistent returns to shareholders and lower share price volatility.
OECD inventories stand well below the five-year historical range. The world has continued to drawdown physical volumes of both crude oil and refined products globally as logistics of supply were stressed in the first half of this year by a rapid economic restart and western sanctions on Russia. This lower inventory level could provide an upward bias to the
oil price and a buffer if demand growth slows dramatically. The area charts in Exhibit 1 show OECD oil and oil products inventories. Cenovus Energy: We expect Cenovus to achieve its ~$4B net debt floor in Q2/23, allowing the company to increase free cash flow allocation return to shareholders after the dividend to 100%. We estimate Q3/22 free cash flow exclusive of asset acquisitions and on QTD strip
pricing to be ~$2.4B, with net capital spending of ~$931MM. This suggests ~$1.2B in share repurchases based on a 50/50 split. We estimate the upper end of the targeted repurchase price could be ~$30 per share, suggesting buybacks will continue to be the preferred method
of returning cash to shareholders. We will be looking also for an update on the Toledo Refinery given the recent incident and as the company was in the middle of closing an acquisition for the remaining 50% working interest. Given the total share purchases made in the quarter falls modestly below the potential 50/50 allocation level of free cash flow, this
could open up the company to issuing a special dividend.
CIBC's target is $32.00. GLTA