Headwater Exploration Inc T.HWX

TD Notes

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Q2/23 Commodity Price Deck Update

Only Small Tweaks to Deck; Relative Non-event

TD Investment Conclusion

We are updating our price deck to reflect QTD actuals and expectations for 2023E+, largely based on strip. Key adjustments include: 1) tweaking Brent-WTI 2023E/2024E differentials to US$4.75/US$4.50/bbl (from US$5/bbl); 2) tightening 2024E WCS/WTI heavy differentials to US$14/bbl (from US$15/bbl); 3) dropping 2023E NYMEX to US$2.65/mcf (from US$2.75/mcf), adjusting AECO 2023E/2024E to C$2.70/mcf/C$3.15/mcf (from C$2.75/mcf/C$3.30/mcf); and 4) lowering 2023E NBP/TTF to ~US$13.50/mmBtu (from US$15/mmBtu/US$15.25/mmBtu). Our Q2/23 FFO estimates have increased 4% q/q for our oil-weighted coverage (-34% y/y), but fell 24% q/q for our gas-weighted coverage (-43% y/y).

Oil outlook: Notwithstanding recent Brent/WTI oil price weakness stemming from recession-related global demand concerns, the pace of the China demand recovery emerging from the pandemic, U.S. dollar strength on recent rate hikes (a strong dollar weighs on oil prices), and OPEC+'s relative ineffectiveness in shoring up pricing through additional production-cut announcements, the drivers of our OVERWEIGHT sector stance are largely intact since our last update (note). They include: 1) OPEC+ production remaining well below quotas (~8% short, reflecting limited ability to ramp production) plus 1.66mmbbl/d of additional quota cuts through 2024; 2) very low N.A. crude inventories following SPR releases and slow refills (first 3mmbbl tranche purchased at ~US$73/bbl vs. originally planned US$67-US$72/ bbl); 3) increased Russian supply uncertainty, given Wagner's botched coup attempt (i.e., arguably merits a higher geopolitical risk premium); 4) strong refined product demand offsetting higher utilization, encouraged by above-average crack spreads; and 5) producer reluctance to increase output, given investor pressure to return capital/deleverage, commodity price volatility, and numerous political/regulatory uncertainties.

Natural-gas outlook: Natural-gas supply/demand dynamics have become more balanced, with recent injections largely in line with historical averages after Freeport's restart. Pricing has remained challenged, given the significant storage overhang as a result of previous Freeport downtime and seasonally warmer weather. Total U.S. inventories are 26% above year-ago levels and 15% above the five-year average. Drilling activity has responded to pricing. The U.S. rig count is down 19% since April 28, with meaningful reductions in the Haynesville. In our view, spot pricing remains near the long-term cost of supply, which should continue to drive us towards a more balanced market. That said, we see limited pricing upside in the near term until inventory levels erode and incremental LNG export capacity materializes in 2024/2025.

Key sector positives remain: 1) multi-decade lows on gearing and reinvestment rates; 2) ongoing capital discipline and commitment to shareholder capital returns; 3) largely double-digit 2024E FCF yields; and 4) improving market access with TMX coming online (we estimate mid-2024), supporting 2-4 years WCSB growth, per our estimates (note), followed by LNG Canada Phase 1 in 2026. We are maintaining our OVERWEIGHT sector stance for the Canadian and U.S. energy equities.