The booming fossil fuel industry

Over the next few weeks, oil and gas companies will be reporting their third quarters and give projections based off of the existing strip pricing.

For gas producers, winter gas prices appear to be headed to around CAD$5/GJ (AECO pricing), while if you can get the stuff onto a tanker and ship it to Japan or Korea, it’s going for about US$35/mmBtu (one million BTUs is about 1.06 GJ).

The spot oil price has also gone up about US$10 since the last slew of quarterly reports.

The first shot that was fired was on October 14 when Whitecap Energy (TSX: WCP) announced its 2022 capital plans and projections. In addition to ramping up production mildly (from 111k boe/d to 122), at a US$70 WTI price (note that spot crude is US$83 as I write this), they anticipate generating $911 million in free cash flow, and this is after capital expenditures and accounting for some idiotic hedges that will result in some considerable losses.

Let’s focus on the $911 million in free cash flow. At the end of Q2-2021, WCP had $1.3 billion in outstanding debt, and a market cap of $4.8 billion. This works out to a 15% return.

Others in the Canadian energy complex have similar metrics.

De-leveraging has been the focus of all of the companies – I suspect they are getting concerned that the banks and financial institutions are going to be pressured to “defund” or put pressures on their credit lines (a “climate surcharge”, etc.). Debt financing can be focused on bond issuances rather than relying on lines of credit.

In the case of Whitecap, as their dividend payout rate is very low, if they keep on their existing track they will be able to eliminate most, if not all, of their line of credit by the end of 2022. Out of the $1.3 billion in debt they have at June 30, 2021, $740 million is bank debt and $595 million are in senior secure notes – $200 million maturing in January 2022, May 2024 and December 2026.

The even rosier news for the industry is the lack of material capital investment in the sector. This gives huge incumbency advantages for the existing players. Traditionally at this phase of the boom-and-bust cycle, you would hear companies pouring billions of dollars in extra capital spending, but companies today are being very cautious. While market valuations would suggest that this pricing level is temporary, I would bet against that. Although prices will never move in straight lines in the short term, the overall trend is quite positive.