Milan Cacic
September 20, 2022
IF OIL PRICES ARE DOWN, WHY DO THE COMPANIES LOOK SO CHEAP?
Despite the volatility that we’re seeing with energy prices, oil and gas companies are continuing to generate large free cash flow yields. They also appear to be sticking to their guns with regard to increasing dividends, paying down debt and buying back their stock as opposed to increasing production. As a matter of fact, it appears that most Canadian oil and gas companies can be debt-free by Q1 2023 if they decide to use their cash flow to pay down debt as opposed to paying out dividends or buying back their stock.
OPEC announced a few weeks ago that they were going to increase production by 100,000 barrels a day. However, the group seems to have struggled to meet its August and September increases. This is likely due to underinvestment in production related areas. Russia, who has their hands full right now, is also unlikely to be able to increase production in the future as it is likely that oil and gas cash flows are going to fund the war as opposed to increasing production.
I should also point out that the European Union oil sanctions on financing, shipping and insurance come into effect on December 5. Although I don't think this will have a material impact as oil from Russia appears to be finding its way into China and India, regardless of the sanctions in place.
HAS THE BIDEN ADMINISTRATION PUT AN $80 FLOOR ON THE PRICE OF OIL?
In March, the Biden administration committed to sell 180 million barrels of oil, or 1 million barrels per day over six months from the "Strategic Petroleum Reserves" (“SPR”). These sales will be coming to an end soon. The administration also hinted that they would like to buy back the barrels they sold, which by law they have to do to refill the SPR, at $80 per barrel. The Saudis have also hinted that they will do what they need to do to protect the price of oil at $90 a barrel.
If you take both the Saudis and the Biden administration on their word, it appears that they’ve set a floor on the price of oil at $80 per barrel. Combine this with a fact that demand is currently back to pre-Covid levels and supply continues to lag. Canadian and US oil and gas companies do not appear to be increasing production. As you can see from the chart below, the number of rigs drilling for oil and gas has dropped for the last two weeks and is back down to June levels.
One cautious note that we must remember is if the Federal Reserve continues to increase rates at the current pace and we go into a hard economic recession, demand for oil will drop and the price of oil will likely drop as well. Either way, we are setting up for a very interesting Q4 2022 for oil and gas companies. We remain overweight in oil and gas securities in our models.
Source: Baker Hughes Crude Oil Rigs Summary, Baker Hughes Company, Trading Economics, September 2022
I have also included a piece from our CIBC Economics Team entitled "You take the high road; they'll take the low road".
If you have any questions, please feel free to give us a call at any time.
Have a great weekend.
Milan