We’ve transitioned from an era of peak oil to one of abundance, where energy cost deflation remains the name of the game. In this environment, competition between energy sources and individual producers has intensified, forcing the sector to cut costs relentlessly and throughout the value chain—from the wellhead to the burner tip.
Although concerns about the gas-to-oil ratio in the Midland Basin emerged during second-quarter earnings season, this play, the Delaware Basin and the STACK in central Oklahoma offer exposure to multiple oil-and-gas-bearing formations—a major source of cost savings. The best operators will exploit these stacked resources using the same surface facilities, from gathering lines and processing plants to water-handling infrastructure and proppant storage units.
These plays have attracted the most drilling activity during the recent up-cycle, benefit from legacy takeaway capacity out of these basins, and have fueled a midstream construction boom to support additional throughput volumes and exports. In some instances, marine terminals initially built to serve producers in the Eagle Ford Shale will be repurposed to handle volumes from the Permian Basin.
Whereas mergers and acquisitions in the US shale patch have focused on asset deals in the Permian Basin and Oklahoma’s STACK play, Suncor Energy (TSX: SU, NYSE: SU), Canadian Natural Resources (TSX: CNQ, NYSE: CNQ) and other major players have driven consolidation in Canada’s oil sands—a long-lived resource that exhibits a shallow decline rate and generates significant cash flow after a capital-intensive start-up phase.
These operators have also resumed previously approved projects that were paused when oil prices collapsed. Suncor Energy’s Fort Hills project, for example, is expected to come onstream by year-end.
However, Canadian energy prices tend to trade at a discount relative to their counterparts south of the border because of competition from increasing US oil and gas production and insufficient takeaway capacity.
Western Canada Select crude oil, for example, trades at a more than $11 discount to WTI and a $9 haircut to the heavy Maya crude oil that Mexico exports to the US.
Meanwhile, one-month natural gas futures at the AECO hub in Canada fetch about $1.90 per million British thermal units (mmBtu), compared to about $3 per mmBtu at the Henry Hub in Louisiana.
These lower price realizations have forced Canada’s energy complex to operate relatively conservatively and focus on reducing costs.
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Elliott and Roger on Mar. 31, 2020
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