Crude Observations

Time to Buy?

This is one of those abbreviated blog posts because I find myself travelling this week, which is unusual. Even more unusual is that I am travelling with my family somewhere cool instead of acting as the glorified bus driver that I seem to be most days or doing work travel. And, I’m leaving my laptop where it belongs – at the office.


The benefit of the abbreviated blog post is that I can get away with just one subject. And that subject is one that is near and dear to my heart, specifically the state of play for Merger and Acquisition activity in the Canadian energy services space.


First off – let me stop you right there. I know what you are thinking. You’re thinking to yourself commodity price pressure, Canadian energy M&A and an abbreviated blog – hmm, this is the last paragraph in the blog, and if I scroll down all I’m going to get is a depressing rehash of this week’s lousy price action. And you know what? If it was Canadian producer M&A (and we weren’t allowed to mention CNRL), you’d be right. But it’s not. This is energy services and, sorry to say for all you naysayers out there, there is actually a lot of opportunity out there and it’s poised to get more active.


I say this not just in a self-interested way as a practitioner, but also as one who, a few weeks ago, espoused a desire to  change up the dialogue on Canada and stop being so damn negative. Remember the message – if we are trying to sell ourselves as a destination for investment, let’s collectively agree to articulate the many benefits of Canadian firms as M&A targets and why buying into the patch now makes way more sense than waiting another year.


Look, I’m not making this up. I am in fact much more optimistic about the prospects for M&A at this stage of the cycle than I was even 6 months ago.


So why now? It’s not just because I want everyone to be happier and more positive (which I do), there are actually some decently positive things happening this year.


First off, while pretty much everyone has given up on 2019 as a growth year, we have always held the view that 2019 was going to be a second half story – much like 2018 but in reverse.


As you may recall, 2018 started strong and had tremendous momentum until the bad news started piling up with the TransMountain appeal ruling and the unexpected in scale blowout of differentials that led to a complete stop in capex budgets and the year-end collapse in prices.


Well this year we are kind of looking at what seems possible to be a reversal of fortune. There was very little optimism in Q1 and all the forecasting agencies such as PSAC and CAODC are, quite rightly, presenting significant lower drilling numbers for the year. But instead of worsening news or darkening skies like in 2018 (and I say this in full knowledge of where prices are right now), we are likely to see the reverse happen this go around. Do we need $100 oil to have a good year? No, we need $50 to $60 oil, $3 gas and pipelines.


Fortunately, we have a new provincial government that is laser focused on the energy file and we expect some form of decision on the TransMountain Expansion by the end of this month. LNG Canada is well underway, First Nations are lining up to be equity participants in major energy infrastructure and Bills C48 and C69 are, if not headed to scrap heap, about to be subject to major revision. Against this Canadian context, global forces are aligned to manage inventories down via OPEC+ and while global growth is slowing and falling out of sync, the current goldilocks level of oil pricing will keep many Canadian oil companies in the black and flush with cash.


While this cash is most likely to find itself spent as dividends or share buy backs, a lot will, as always, find itself put back in the ground. As it always does. I expect capex budgets to grow as the year goes on rather than contract as they did at the end of last year.


This increase in budgets, positive egress momentum and ongoing profitability will spur M&A activity.


Don’t get me wrong, it’s going to be a long haul but we feel that we are entering what could be a fairly decent M&A cycle in Canada and the United States, particularly with respect to energy infrastructure and land-based drilling and completions execution and technology.


And while the reality is that M&A activity during the downturn has been difficult, it never went away. Many good deals got done in the energy services space and this has the potential to accelerate, in particular for businesses in those areas that for want of a better term have won the “geographic lottery” and are mores specifically located in the active Duvernay/Montney fairway and can actively participate in the coming exploration frenzy that should accompany a closer to completion LNG Canada as we move into 2020 and beyond.


So why now? Well I guess what I’m really saying is that if you are an acquisitive party and have your finger on the pulse of the market, you should be thinking to yourself that right about now is an opportune time to position yourself for the next few years by buying early and having the transition and integration issues sorted out in time catch the lift.


Sectors that we think are of particular interest in this restart of the early part of the consolidation cycle includes completions related businesses such as fracking companies, water and fluid transportation logistics companies, companies providing services around the sourcing and provision of sand, downhole tools, production testing, cementing, surface rental businesses and the like.


On the new drilling side, notwithstanding the number of rigs travelling to the United States to ply their trade, there is still a lot of excess equipment in the market so we will need to wait a bit for that recovery.


On the servicing side, the service rig sector is likely to be in doldrums for a while, but there will be pockets of interest (not sure which, but I have been waiting for the service rig sector to be in play and I’m not giving up). Similarly coiled tubing and snubbing businesses will still have to wait their turn. That said, companies that provide services around ongoing maintenance will always be of interest.


Turning to the infrastructure space, the activity levels here are likely to continue to recover and many companies that do pipeline and facility construction and survived the downturn intact with quality people will start to hit the radar screen of strategic acquirers who may find themselves labour or client starved.


Travelling downstream is where there is likely to be significant activity as the delayed/deferred/restarted/announced major projects such as the Trans Mountain expansion, the Coastal Gas Link and, maybe, Keystone XL heat up, the demand for equipment and manpower is going be intense.


While there are major contractors working on these projects, the real M&A opportunity is with all the sub-contractors and peripheral suppliers and service providers. Add in the major work that TransCanada has planned in the NGTL system and there are not enough people and equipment in Western Canada to do all these projects and any other mid or downstream capex planned by a dozen or so significant players, never mind the ho-hum regular everyday inspection, maintenance and turnaround requirements of an energy sector that produces, processes and transports 4.2 million barrels of oil and 15 Bcf of natural gas a day. I’m not even going to mention all the ongoing investment in petrochemical infrastructure and plants or, sacrilege, renewable energy…


It is worth noting that a lot of Canada’s (and North America’s) major energy infrastructure was built out in the 1960’s and 1970’s. Those pipes are old and require near constant servicing and the anomalies identified and requiring service are not getting any less in number. Mainline pipelines are the lifeblood of major companies like Enbridge and TC Energy, are regulated federally and have mandatory maintenance requirements. In a world of ongoing government and popular oversight of energy infrastructure projects the scope never gets smaller and the penalties for failure are immense.


Companies that provide pipeline inspection, non-destructive testing and integrity management will all be in play now and in the coming years whether they do the actual on the ground physical work, manage and decipher the data or perform critical risk assessment and planning.


One trend that we believe is going to continue as this cycle unfolds is outbound M&A by Canadian companies. The U.S. market has a very strong gravitational pull for Canadian companies and we have a lot of technology and solutions that could have broad application in places like the Permian Basin. With high decline rate, short cycle wells being the bread and butter of U.S. activity, drilling utilization is virtually guaranteed to be a constant in order to keep production up (as long as the money keeps coming!). It is hard for Canadian firms to ignore this, especially when they get the transformational benefit of growing U.S. based cash flow that can open doors to higher purchase price multiples in the long run (no promises BTW). While there is an argument to be made that moving down there now may be too late, is it ever too late to enter a market that is that dynamic?


On the flip side, perhaps those overly aggressive multiples in the United States will serve as a wake-up call to inbound capital to the potential of a Canadian market where companies tend to be less itinerant in terms of staffing, have deeper roots in the community and are still available at a significant discount to similar U.S. firms. What you may give up in immediate growth prospects you make up for in a more realistic multiple and steadier cash flows.


Look, I know I am a hopeless shill for Canada as an M&A destination, but the reality is that there is great opportunity and great companies on both sides of the border. At the end of the day, a recovered and robust M&A market is a good thing all around. To my eyes, Canada is the value opportunity, open for investment and representing a higher potential IRR at this stage of the cycle than the US and way less risky than other jurisdictions.


If you can ignore the short term gyrations in the underlying commodity price, and accept that Canadians as a whole do in fact want to see economic development, it becomes really hard to argue against Canada and Alberta as an investment destination.


Prices as at June 6 (May 31), 2019

  • The price of oil began its recovery this week despite the continuation renewed trade war fears
    • Storage posted an increase week over week
    • Production was up marginally and remains higher than last year this at this time
    • The rig count in the US was down, slightly, while the rig count in Alberta and Saskatchewan improved
  • WTI Crude: $54.07 ($53.37)
  • Western Canada Select: $40.69 ($36.77)
  • AECO Spot : $0.86 ($0.22)
  • NYMEX Gas: $2.33 ($2.452)
  • US/Canadian Dollar: $0.7531 ($0.7401)


  • As at May 31, 2019, US crude oil supplies were at 483.3 million barrels, a increase of 6.8 million barrels from the previous week and 46.7 million barrels above last year.
    • The number of days oil supply in storage is 28.9 compared to 25.8 last year at this time.
    • Production was up for the week at 12.400 million barrels per day. Production last year at the same time was 10.800 million barrels per day.
    • Imports rose to 7.927 million barrels from 6.943 million barrels per day compared to 8.346 million barrels per day last year.
    • Exports from the US fell to 3.298 million barrels per day from 3.347 million barrels per day last week compared to 2.179 million barrels per day a year ago
    • Canadian exports to the US were 3.866 million barrels a day, up from 3.186
    • Refinery inputs rose during the during the week to 16.938 million barrels per day
  • As at May 31, 2019, US natural gas in storage was 1.986 billion cubic feet (Bcf), which is about 240 Bcf lower than the 5-year average and about 182 Bcf higher than last year’s level, following an implied net injection of 119 Bcf during the report week
    • Overall U.S. natural gas consumption was up 4% during the report week
    • Production for the week decreased 1% week over week. Imports from Canada increased 8% from the week before. Exports to Mexico were up 1%
    • LNG exports totaled 33.4 Bcf
  • As of May 31, 2019, the Canadian rig count was up at 103 (AB – 63; BC – 11; SK – 25; MB – 2; Other – 2). Rig count for the same period last year was 182.
  • US Onshore Oil rig count at May 24, 2019 is at 789, down 11 from the week prior.
    • Peak rig count was October 10, 2014 at 1,609
  • Natural gas rigs drilling in the United States was up 2 at 186.
    • Peak rig count before the downturn was November 11, 2014 at 356 (note the actual peak gas rig count was 1,606 on August 29, 2008)
  • Offshore rig count was up 1 to 23.
    • Offshore peak rig count at January 1, 2015 was 55

US split of Oil vs Gas rigs is 80%/20%, in Canada the split is 57%/43%

Trump Watch: Mexico? Seriously? Does this man never buy avocados?

Kenney Watch (new!): Lower taxes, War room in Calgary. This is one busy government.

Crude Observations
Sign up for the Stormont take on the latest industry news »

Recent Posts