Varcoe: Coronavirus ‘taking the oil market hostage,’ as prices plunge, Canadian firms hunker down

These are precarious times for the global oil industry, leaving the Canadian sector to hunker down amid fresh fears of a new price war erupting.

Benchmark U.S. oil prices tumbled to just US$41.28 a barrel Friday after OPEC and its allies couldn’t strike a deal to slash production. It’s more grim news for an industry struggling with the fallout of the coronavirus, a slowing global economy and weakening demand for energy.

In Canada, some petroleum producers are already battening down the hatches, such as Vermilion Energy chopping its dividend in half on Friday, citing the impact of the virus on oil prices.

“The coronavirus is completely taking the oil market hostage at the moment,” said Michael Tran, RBC Capital Markets managing director, global energy strategy.

“There will be significant pain felt throughout the oil landscape on a global basis…The Canadian energy industry, which historically has been quite resilient, is certainly going to be tested again.”

Benchmark oil prices fell from US$63 a barrel in early January into the mid-$40s earlier this week amid expectations energy demand is gearing down with the spread of COVID-19 to more than 80 countries.

The economy in China has already slowed, air travel is down and stock markets are falling due to the uncertainty.

These factors put intense pressure on the Organization of Petroleum Exporting Countries (OPEC) and its allies to lower output to bolster prices, something it’s done with moderate success since late 2016.

On Friday, an expected deal between the cartel and Russia fell apart, creating more chaos on energy markets. While OPEC openly pushed for an additional production cut of 1.5 million barrel, Russia rejected the idea.

“From April 1, neither OPEC nor non-OPEC (countries) have restrictions” on oil production, Russian Energy Minister Alexander Novak said after Friday’s meeting, according to Reuters.

In turn, West Texas Intermediate crude plummeted to its lowest price since mid-2016.

The failure to reach a deal means more instability is in store in the coming days.

What is less clear is if the fracture between OPEC and Russia spells another prolonged period of instability, jockeying for market share and extremely feeble prices.

“I am not sure there is going to be a price war, but certainly we can’t rule that out,” Ann-Louise Hittle, vice-president of oil research with Wood Mackenzie, said in an interview.

“At this point, it looks as if prices are going to have to fall.”

Even if the coronavirus is brought under control in short order, Wood Mackenzie expects global demand for oil will grow by only 400,000 barrels per day this year, down from the 1.3 million barrels expected at the start of 2020.

If OPEC kingpin Saudi Arabia decides to hold output flat or even trim production, it could lead to more balanced oil markets when demand levels begin to recover from the virus, with prices clawing back up into the $50 level, she said.

However, if a new battle for market share erupts with countries boosting output, “the prices have to fall into the $30s to start to cut into producers who can adjust their production to low prices.”

Analysts say that would squeeze petroleum producers in the U.S. But it would also sideswipe Canadian operators, diminishing cash flow levels and pressuring producers with higher debt.

“It is not a healthy scenario at all. What we have is probably two quarters of oil prices in the $40 range. It’s quite possible … if indeed it’s a price war, you could see it sub-$40,” said Peter Tertzakian, executive director of ARC Energy Research Institute.

“The response is to hunker down and wait it out. The pandemic will eventually resolve itself and the demand will come back.”

However, it’s uncertain how long that will take.

The S&P/TSX Capped Energy Index dropped 6.6 per cent Friday. Shares in Vermilion fell by 18.5 per cent, while Cenovus Energy, Crescent Point Energy and Husky Energy all off by about 12 per cent.

In cutting its monthly dividend, Vermilion cited the emergence of COVID-19 for the decision.

CEO Tony Marino said the virus has “dramatically altered individual, business and government behaviour … and commodity prices.”

Marino doesn’t think the virus outbreak will alter the long-term prospects for the sector. But an oil price recovery seen at the start of the year will be pushed back for an unknown period.

“It’s hard to say what the duration of it will be. My own guess would put it in the medium term,” he added.

“I think of it as setting back the oil price position, to me, at least a year — maybe it’s two years, hopefully not more than that.”

Other companies are also responding.

On Thursday, Canadian Natural Resources trimmed $100 million from its capital budget and said it could cut more, if necessary. Producers such as Tourmaline Oil and Surge Energy have deferred some spending into later in the year.

The uncertainty will also impact the Alberta government, which projects U.S. oil prices will average US$58 a barrel in the new budget year, as it strives to balance the province’s books by 2022-23.

“If there is a major prolonged global downturn, that would obviously affect our plan to get to balance in that timeframe,” Premier Jason Kenney told reporters Friday.

For the province and Canadian energy sector, this is not unfamiliar terrain, with the oil price collapse five years ago, followed by pipeline challenges, weak natural gas prices and investor disinterest.

But the industry is more durable than it was in 2015, having cut staff, squeezed costs, improved efficiency and adopted new technology.

“We are a bit battle-hardened here more than others, but that is not going to save the battle-weary if this lasts,” Tertzakian concluded.

Chris Varcoe is a Calgary Herald columnist.

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