May 25, 2021
The Tax Man Cometh
OUR TAKE: Negative. With higher commodity prices and continued producer
capital discipline (which we applaud) we expect several of the companies in our
coverage universe to become taxable, or pay more tax. Consequently, firms that can
generate strong free cash flow and have tax pools to shelter their earnings will have
an advantage. Additionally, companies like MEG, which have top quartile assets and
significant tax pools, could become attractive acquisition targets.
KEY POINTS
Got tax pools? We expect companies with substantial tax pools, especially non-capital
losses, to be protected from cash taxes despite higher commodity prices. However,
companies with more limited tax pools relative to their earnings are likely to see higher
tax bills in the future. In Exhibit 1 we show the change in taxability for those companies that will pay higher tax over the next 5 years. Below is a summary of our findings:
• Unlikely to pay tax. BTE, CPG, MEG, OVV, and WCP have substantial tax pools
and are unlikely to pay cash taxes before 2025. ERF will be taxable, but we do not expect the company to pay material taxes before 2025.
• Becoming taxable. In the next 2-3 years we expect FRU and IMO to start paying cash taxes.
• Currently taxable. CNQ, CVE, PSK, and SU are currently taxable, and we expect
CVE and PSK to pay more tax over time. CNQ and SU’s effective tax rates, which are in the 20%-25% range, are unlikely to change over the next 5 years.
Impact on free cash flow. In the 2021-2025 timeframe we expect taxes to have the
biggest impact on IMO and FRU's free cash flow as these companies will transition from
being non-taxable to being fully taxable (no non-capital loss protection). We estimate
IMO becomes fully taxable in 2023 and FRU in 2024. When these companies become
cash taxable we estimate a 280 and 90 basis point drop in their DAFCF yields as a result of the lower cash flow.
MEG's tax pools have a value of ~$4.50-$5.50/sh. In Exhibit 5 we estimated the
value of MEG's tax pools assuming they were acquired by CNQ or SU through a
corporate acquisition. MEG NAV (just Christina Lake at $60 WTI) is ~$6.00/sh and this
increases to $10.50-$11.50/sh once the tax pools (value to a fully taxable acquiror) are considered.
Implications. Taxes are set to become a significant expense for several companies
with payments ranging from 20%-25% of before tax earnings. Consequently, firms with
strong free cash flow profiles and are sheltered from taxes will have an advantage over
companies that are required to pay tax. Further, firms that have significant tax pools like
MEG and BTE offer incremental value to potential acquirors based on the value of their tax pools.
Tax horizons by company. Given the improvement in commodity prices, we have taken a closer look at
when the companies in our coverage universe will become cash taxable.
CNQ. At $57 WTI the company expects to pay over $1B in cash taxes during 2021. CNQ will continue to be
taxable beyond 2021 and have an effective tax rate in the low-to-mid 20% range. Management does not
expect future capital spending to reduce its taxability.
CVE. 2021 guidance indicates that the company will pay $150-$250M in taxes. Most of these taxes are
being paid on its Asia Pacific earnings. CVE’s 2021 cash tax guidance assumes $46.50/bbl WTI, but
management does not anticipate paying more in cash taxes even at higher commodity prices. We believe
this is due to the contracted pricing on CVE’s Asia Pacific production. Beyond 2021, management expects
cash taxes to increase as the company exhausts its non-capital loss pools.
IMO. At $55 WTI and $18 NYH321, IMO expects to become taxable in 2022 with cash payments starting in
2023. When the company becomes taxable IMO will have an effective tax rate in the low-to-mid 20% range.
Further, IMO’s planned capital spending will not be enough to reduce taxability as the company’s budget
does not include material growth spending.
SU. The company is currently taxable and has 2021 cash tax guidance of $1-$1.3B at $60/bbl WTI. Most of
the company’s cash taxes will be incurred in the downstream and E&P businesses (ie: not oil sands).
Management indicated that SU’s cash taxes will increase to ~$1.5-$1.6B per year in 2022 onwards.
FRU. At $55-$60/bbl WTI, management expects its non-capital loss pools to shelter FRU from taxes for ~3
years. Note that the Canada Revenue Agency is disputing $129M of FRU’s $134M non-capital loss balance.
Once FRU becomes taxable its COGPE pools will help shelter its earnings from taxes. As royalty companies
do not spend capital to develop assets, FRU’s tax pools will be drawn down unless they are replenished by
acquisitions.
PSK. PSK is currently taxable, but its ~$1.2B in COGPE pools help shelter its earnings. Without
acquisitions, PSK’s COGPE pool will be drawn down over time, which will increase the company’s taxes.
Non-taxable companies. We do not expect BTE, CPG, OVV, MEG, and WCP to be taxable by 2025. ERF
expects to pay tax of ~1% of its before tax earnings until 2024. In 2025 ERF’s taxes will increase to 3-5% of
its before tax earnings. Beyond 2025, ERF’s cash taxes will increase to ~10% of its before tax earnings. We
have classified ERF as non-taxable given its modest level of taxability.
Expecting taxes of 20-25% of earnings before tax. In Exhibit 1 we show the forecasted cash taxes for
CNQ, CVE, FRU, IMO, PSK, and SU.