Canada's integrated oil companies are facing a greater challenge than just plunging crude prices. The coronavirus has sent refined fuel demand plummeting and that removed a retail cushion that provided relief in previous slumps.
The integrated companies, which include Suncor Energy Inc., Husky Energy Inc., Cenovus Energy Inc. and Exxon Mobil Corp.'s Canadian subsidiary Imperial Oil Ltd., face a downturn in demand for gasoline, aviation fuel and diesel amid virus-related travel restrictions that were absent during previous downturns, such as the commodities price collapse in late 2014 and 2015.
Pump prices across Canada collapsed by about 31% from Feb. 25 to March 25. Regular gasoline that had been selling for approximately C$1.13 per liter at the end of February averaged about 78 Canadian cents/liter in late March, according to data compiled by GasBuddy.com.
In the earlier downtimes, Canada's limited competition in the fuel sales sector allowed the companies to keep pump prices, and profits, high. "It's always been kind of a natural hedge, but it's uncertain how that will play out this year," said Mark Oberstoetter, director of research at Wood Mackenzie's Calgary, Alberta, office.
"It's still expected to help somewhat," Oberstoetter said. "It's better than not having that refining, but it's not nearly like the value it was in 2015, because the demand situation for gasoline, jet fuel and everything else is in a high state of flux given the coronavirus, so their refining margins are not perfectly matched to the upstream side right now."
Imperial's Esso and Mobil-branded gas stations, Suncor's Petro-Canada and Sunoco chains, along with Husky and Royal Dutch Shell PLC's self-branded stations, offer the only coast-to-coast gasoline selling networks in Canada. Cenovus refines its crude in the U.S. through a partnership with Phillips 66.
The companies have in the past been able to keep a tight rein on gasoline prices, creating a situation where their downstream sectors made up for losses in the upstream. In 2015, the last time crude prices dropped near their current levels, Imperial saw its downstream net income relatively flat at C$1.59 billion, while its upstream operations posted a loss of C$704 million. Suncor saw its refining and marketing net earnings surge by 34% to C$2.27 billion, while its oil sands and other production units posted a combined loss of C$1.61 billion.
The lack of support from gasoline prices in 2020 prompted analysts at Tudor Pickering Holt & Co. to drop their rating on Imperial stock to "sell" from "hold."
A truck is loaded at the Suncor Energy-operated Fort Hills mine, where production will be reduced in the wake of lower oil prices.
"A robust downstream business for Imperial has historically made up for upstream challenges in a sub-US$30-per-barrel West Texas Intermediate environment," the Tudor Pickering Holt analysts said in a March 18 note. "With the move lower in gasoline, in particular, as demand has been similarly shocked, we see a challenging setup for Imperial as the downstream offers limited ability to offset upstream weakness."
The difficulty for Canada's large integrated companies is that they produce more crude than they refine, and the price of oil sands-derived Western Canadian Select has been hit particularly hard in the price plummet. Prices dropped on the combination of the COVID-19 pandemic and a glut of world production precipitated by a Saudi-Russian feud. The price of the benchmark oil sands blend dipped below US$10/bbl in the week of March 15 to March 22, its lowest-ever price.
Suncor admitted refining returns would not save profits in 2020 as they have in the past.
"It is evident that as a result of significant efforts to limit the impact of COVID-19 through social distancing and having non-essential personnel stay home across many countries around the world, petroleum demand has declined," Suncor said in a March 23 press release that outlined its revised 2020 guidance.
"This is particularly true for jet fuel and gasoline," the company continued. "Product demand in Canada is starting to decline and [that] is expected to continue over the next few quarters. Suncor has begun to adjust refinery utilizations as a result. Due to significant uncertainty, we have not yet updated our guidance in this area, although we anticipate it will be lower."
Suncor said it would take a number of steps to reduce overall upstream production amid the price collapse. The steps include taking one bitumen-production train offline at the Fort Hills mine, a venture it operates with other partners, and deferring the return to service of an in-situ project, where the tar-like crude is steamed out through well pairs. Imperial had already slowed construction of its planned Aspen oil sands project in response to mandatory production cuts imposed by the government of Alberta in January 2019.
Of the two companies, Imperial's production is better aligned with its refining capacity, Wood Mackenzie's Oberstoetter said. "It's pretty close to balanced for them, whereas it's not the case for others," he said.
Cenovus and Husky both operate refineries and sell fuel in the U.S. The dollar in Canada has plunged against its U.S. counterpart since the COVID-19 situation erupted, softening the impact of lower prices for the companies.
However, stiffer competition and a much-larger market have created "brutal" crack spreads that have prompted refiners to begin cutting run rates, the Tudor Pickering Holt analysts said. Crack spreads are a measure of the profitability of refining a barrel of oil. The poor refining outlook, combined with a potentially worsening upstream situation, pushed Tudor Pickering Holt to drop its rating on Cenovus to "hold" from "buy" on March 25.
Recent weak prices for Western Canadian Select at Houston have suggested Cenovus could face "further potential pressure in Western Canada, and little cash flow upside from the exploration and production segment and refining segment as products come under pressure," the analysts said in a note announcing the downgrade.