Q4/22 Commodity Price Deck Update
Recession Risks Aside, Industry Fundamentals Remain Strong
TD Investment Conclusion
We are updating our commodity price deck to reflect QTD actuals and our expectations for 2023. Key adjustments include: 1) a US$5/bbl reduction in 2023 Brent/WTI prices; 2) a US$4.50/bbl increase in 2023 WCS/WTI heavy differentials; and 3) a US$2/bbl cut in N.A. crack spreads (Exhibit 2). We believe that 2023 will be a less eventful year for the equities, and that stock selection is becoming increasingly important, especially given tighter valuation spreads, and slightly higher, but still attractive multiples, in our view (largely driven by YTD equities outperformance vs. the key oil benchmarks). One investor concern is the impact on global oil demand should the world's major economies slide into recession, although demand has been relatively resilient in past recessions (outlook presentation). Our Q4/22 FFO estimates are down 9% q/q for our N.A. oil-weighted coverage, up 6% for our gas- weighted coverage, and up 24%/38% y/y, respectively.
Oil outlook: Notwithstanding demand concerns and the pullback in Brent/WTI prices, we see numerous potentially bullish indicators. They include: 1) OPEC+ producing 8% below-target quotas in October 2022 (close to the widest gap in its five-year history); 2) low N.A. crude inventories following the 180 mmbbl SPR release (eventually needs to be replenished); 3) global producer reluctance to increase output, given ongoing commodity volatility and political/regulatory uncertainties (including windfall tax risks); 4) the potential impact of the US$60/bbl Russian oil price cap/E.U. embargo; and 5) the potential for 600+ mbbl/d of gas-to-oil switching through winter, in Europe in particular.
Natural-gas outlook: We reiterate our below-strip, but higher-than-historical price outlook for 2023. Through late 2022, U.S. and Canadian natural-gas production reached record-highs, with producers slowly nudging growth expectations higher throughout the year. We estimate that the U.S. is approximately 0.5 Bcf/d oversupplied relative to demand. Meanwhile, U.S. storage levels rose from multi-year lows to levels nearly exactly in line with the five-year average. Looking to 2023, unlike recent years, there are no new U.S. LNG projects scheduled to come on stream. In our view, continued North American gas growth will be regionally constrained until new export facilities are brought on line in 2024/2025.
Key industry positives include: 1) record strong balance sheets, with some companies even transitioning to net cash; 2) reinvestment ratios that likely increase y/y, but remain below historical levels; 3) strong levels of commitment to shareholder capital returns, although most companies have now formalized frameworks, (i.e., likely fewer 'catalysts' in 2023); and 4) although the E&P cost structure is more challenging due to inflation, thus far, we have been pleasantly surprised with the fiscal restraint reflected in 2023 budgets (and inflation expectations embedded therein). We are maintaining our OVERWEIGHT sector stance for the Canadian and U.S. energy equities.