October 11, 2022
Integrated Oil and Senior E&P
3Q Preview - Another Round of Big Numbers
The third-quarter earnings season is set to kick off October 28 with Imperial Oil slated to release its estimated results before market open, followed by Cenovus Energy and Suncor Energy on November 2. The best-positioned producers in the third quarter had an upstream weighting towards synthetic crude oil (SCO), with limited AECO natural gas exposure and/or possess downstream operations given the resilience of elevated crack spreads. Our third-quarter CFPS estimates generally sit below IBES consensus, but may move more into line as formal corporate surveys are released (Exhibit 1).
Third-quarter results for energy producers should continue to showcase their stern capital discipline and allocation of substantial free cash flow towards shareholder returns—particularly share buybacks— and debt reduction. We estimate that Canada’s oil sands weighted majors—CNQ, Suncor, Cenovus and Imperial—generated free cash flow (before dividends) of $10.3 billion in the third quarter, repurchased $4.9 billion of their common shares via normal course issuer bids, and paid/accrued cash taxes (to all jurisdictions) of $2.7 billion. We anticipate healthy downstream refining cash flows (impacted by inventory adjustments) from integrated oil companies including Suncor, Cenovus and Imperial.
Our investment recommendations remain unchanged across the board. Within our coverage, we continue to favour companies that possess focused leadership teams, resilient business models, strong balance sheets and capable/improving execution. Our favorite producer remains Canadian Natural Resources (Global Top 30 and Energy Best Ideas lists) with Suncor Energy (Energy Best Ideas list) our favorite Integrated. Cenovus Energy, Enerplus Corporation (Energy Best Ideas list), Imperial Oil, MEG Energy (our Dark Horse selection) and Ovintiv round out our Outperform roster.
Upstream wise, oil prices fell considerably in the third quarter amid recessionary concerns and government policy-driven volatility. WTI averaged US$92.18—down 15% (US$16.77) sequentially, while Brent fell 12% to average US$98.07. The Canadian dollar depreciated 2% (US$0.01) vs. the US dollar sequentially in the third quarter to US$0.77. Canadian light oil differentials widened on a sequential basis, with Mixed Sweet Blend (Canadian Light) trading at a still narrow discount of US$2.05 to WTI (up from US$0.50 in the second quarter). WTI-WCS differentials widened to US$19.86 in the third quarter, as WCS fell 23% to $94.36 in connection with reduced re-exports from the Gulf Coast amid soft Asian demand and the US SPR release. Conversely, Syncrude’s SCO (as per Bloomberg) averaged nearly $130 during the third quarter—a $9.71 premium to WTI (C$) (versus $7.99 in the second quarter), reflective of its abundant diesel cut. Canadian condensate prices of $115.66 were down 13% sequentially, averaging 96% of C$WTI (vs. 95% in the second quarter as per Bloomberg).
On the natural gas side of the equation, the Russia-Ukraine conflict drove National Balancing Point (NBP) up by 106% (US$17.27/mmBtu) to average US$33.63/mmBtu in the third quarter, while Title Transfer Facility (TTF) rose 94% sequentially to US$58.95/mmBtu. Henry Hub (spot) averaged US$7.95/ mmBtu (up 7% or US$0.54/mmBtu) in the third quarter, while Alberta spot (AECO C) gas prices of $4.28/ mcf fell 41% sequentially amid wide Henry Hub basis differentials of US$4.72/mmBtu, owing to robust production in western Canada and pipeline maintenance on NGTL.
Downstream wise, crack spreads fell modestly in the third quarter. US Midwest cracks fell to US$36.92 (down US$6.67 or 15% vs. the second quarter), while New York Harbor 3-2-1 cracks of US$43.74 were down 22% (US$12.19) on a sequential basis.
Our updated operating EPS/CFPS estimates and one-year target prices are outlined in Exhibit 3. These estimates reflect actual third-quarter commodity prices, disclosed share buybacks, and various fine- tuning adjustments.
Cenovus Energy – Outperform: Special Dividend Coming?
Our third-quarter production outlook for Cenovus of 776,979 boe/d reflects robust Christina Lake production of 245,000 bbl/d, Foster Creek production of 185,000 bbl/d (following a small unplanned outage), Tucker + Lloydminster thermal volumes of 122,000 bbl/d and Liwan production of 41,400 boe/d (net) (including 201 mmcf/d of natural gas at a realization of $13.64/mcf). In the downstream, we anticipate Canada + US refining (pre-tax) operating cash flow of $707 million, including a FIFO inventory loss of about $200 million. Included in our third-quarter outlook is Cenovus’ acquisition of the remaining 50% interest in the Sunrise Oil Sands asset from BP (announced in June), and $420 million in proceeds from its sale of the Husky retail fuels network, announced in November 2021. Our estimates also include $403 million in cash taxes, capital investment of $972 million, and $657 million in share repurchases in the quarter. All said, we peg Cenovus’ third-quarter cash flow at $3.2 billion ($1.67 per share) and free cash flow of $2.1 billion (including A&D). As per our outlook, Cenovus’ net debt (company definition) would sit at about $6.1 billion as of September 30 (before working capital movements). Our analysis suggests that Cenovus may declare a special dividend of $0.15-$0.16 per share commensurate with its third-quarter results to top up its shareholder returns.