OPEC is keeping oil prices firm for now

But oversupply is looming

A recent SA report noted the OPEC decision Sunday to keep production cuts in place for the time being. The troubling part of the report is that the group is keeping 5.86 million barrels a day off the market.

With almost 6 million barrels a day held back, the market is roughly in balance today. If those barrels were released rather than held back, oil prices would see WTI $40 within weeks. OPEC needs about $80 a barrel to meet its members budgets and the efforts to support price seem almost desperate. That suggests some members may break from the pack.

I see a material risk that the next year or two will suffer significant drops in world oil prices and several Canadian stocks that have bet heavily on firm prices to benefit from record share repurchases are vulnerable to a price collapse. In particular,

MEG Energy - At WCS CDN$40 a barrel (equivalent to US$40 WTI less a $15 discount) MEG EBITDA drops to about CDN$130 million, not enough to carry its debt and fund about CDN$450 million per year of sustaining capital.

Baytex Energy - At similar prices, Baytex EBITDA drops to around CDN$580 million, less than half planned capital outlays. With almost CDN$4 billion of debt, Baytex might face an insolvency issue.

Tamarack Valley - Like Baytex, Tamarack is at risk to a solvency issue at WCS$40 a barrel, with EBITDA falling to the CDN$100 million range.

Majors like Suncor, Canadian Natural Resources, Cenovus and Tourmaline are more or less immune to the risk of lower commodity prices since they have built their balance sheet strength materially in the past few years and in the case of Tourmaline have little exposure to oil prices other than to the extent they reduce the price of condensate.

Lower oil prices will act as an incentive for economic expansion, albeit with a lag. Higher economic activity will rebalance supply and demand of oil over a few quarters as capital plans get cut and demand follows activity higher. Natural gas prices are not exposed to the oil oversupply since there is little cross-fuel switching.

Saturn Oil has a high debt load but a well-planned hedge book and I don’t see a high risk of the company running into trouble if oil prices do fall as mentioned. Trading at a deep discount to intrinsic value, Saturn should weather a downturn quite well.