Another week, another roller-coaster ride for commodity prices, the Canadian dollar and investors. There is currently too much noise and conflicting interpretations of too many news items for anything to comfortably settle and provide a direction in commodity prices. Suffice it to say, we live in uncertain times. However, OPEC leaders say this will be short-lived and sicne they control the taps, who are we to argue?

We have long felt that the second and third quarter of this year are when the real damage of the fall in oil prices was going to hit as asset write-downs, impairment tests and cash flow contractions would be based on a full cycle of low prices and the hedging programs that were in place in mid to late 2014 started to unwind.  As energy and related companies start to release their Q2 results we can see both the extent of the damage and faint glimmers of hope on the horizon. In Canada, the economic fallout from the slowdown in the oilpatch is reflected in the collapsing loonie as the expected benefits of lower energy costs have yet to be reflected in other parts of the country.

From a service company M&A perspective, the current environment presents a significant opportunity for buyers to identify those market leaders that are growing market share through the downturn. Canadian oilpatch companies are nothing if not resilient and are quite often market leaders in a recovery. US based buyers with a longer return horizon will also benefit on a second front through the currency appreciation that will inevitably occur when the markets eventually turn.

But first a little soap-boxy digression.

As noted last week, Nexen had a pipeline leak at its Long Lake oilsands site that released about 31,000 barrels of “emulsion” which is a mixture of produced water, sand and bitumen (note that it is estimated only 1/3 of that emulsion is bitumen). The relatively newly built  pipeline in question had been down for maintenance and then restarted on June 29 so the thought is that it could have been leaking as long as two weeks. While a full investigation is required into why the pipeline in question failed and why the warning systems failed to alert Nexen to the problem, the answer will ultimately be arrived at and the parties responsible will be held to account and punished accordingly.

A second and corollary outcome of this event was the finger-wagging and (in some corners) media commentary about how this was “proof” that pipeline projects such as Energy East, Keystone XL. Northern Gateway and the TransMountain system were disasters waiting to happen. But it seems that any review of this event kind of misses a key element which is that the pipeline that burst is nothing like the pipelines everyone is debating.

Pipelines come in all shapes and sizes and have a multitude of purposes and there are hundreds of thousands of kilometres of pipelines criss-crossing both Canada and the United States. In its most basic form, the oil and gas commodity chain runs from “upstream” (exploration and production) through the “midstream” (gathering and processing) to “downstream” (refining and end-use). Wells are drilled across the producing regions and “tied-in” to larger gathering, processing and upgrading systems which ultimately feed into the large mainline pipleines that are essentially the highways that deliver the commodity across vast distances to end-users.

Tie-ins are smaller diameter pipes because they have lower volumes and the pipelines get to be a larger diameter as product is gathered and volumes increase. The big pipeline projects everyone is always talking about are the last part of this process and probably the safest. In fact, TransCanada’s Keystone system (of which the XL will be a part) safely delivered its 1 billionth barrel of oil last week on its 4300 km network.

The Nexen pipe in question is part of Nexen’s Long Lake integrated oilsands operation, its purpose is to link the company’s SAGD (steam assisted gravity drainage) drilling sites to the plant. The produced water (which comes from steam), sand and bitumen emulsion is at high temperature and relatively high pressure. The emulsion is delivered to the processing facility, the water and sand is separated out and the bitumen is upgraded on-site and the finished synthetic crude is shipped out via pipeline. In many ways, it is part of a closed processing system. Not to downplay the severity of the spill in any way, but this is the failure of a pipeline in an industrial operation, and not comparable to the tranportation pipelines everyone is wringing their hands over. Sometimes, a pipeline is not a pipeline.

Prices as at July 24, 2015 (July 17, 2015)

• It was an ugly week as the price of oil continued to fall – mostly related to ongoing negative news for supply and production
  • Storage posted an increase as imports grew
  • Production decreased ever so slightly during the week in the U.S. but OPEC production numbers continue to expand.
  • The price of oil has now officially entered a bear market, having declined 20% from its recent June high
  • The rig count posted a surprise increase.
• Natural gas held its ground during the week on weather and increased demand

• WTI Crude: $48.15 ($50.81)
• Nymex Gas: $2.778 ($2.882)
• US/Canadian Dollar: $0.7662 ($ 0.7696)

Highlights

• As at July 17, 2015, US crude oil supplies were at 463.9 million barrels, a increase of 2.5 million barrels from the previous week and 92.8 million barrels ahead of last year.
• The number of days oil supply in storage was 27.8, ahead of last year’s 22.6.
• Production decreased to 9.558 million barrels per day from 9.562 with lower 48 and Alaska essentially unchanged
• As of July 17, 2015, US natural gas in storage was 2,828 billion cubic feet (Bcf), which is 3% above the 5-year average and about 28% higher than last year’s level, following an implied net injection of 61 Bcf during the report week.
• Overall U.S. gas consumption increased by 1.5% this week, led by an increase in power-sector consumption of 3.4%
• Oil rig count at July 24 was up to 659 from 638 the week prior.
• Natural gas rigs drilling in the United States fell this past week to 216 from 218.
• As of July 20, the Canadian rig count was up to 190 (25% utilization), 122 Alberta (23%), 32 BC (39%), 34 Saskatchewan (26%), 2 Manitoba (13%)). Utilization for the same week last year was 47%.

Drillbits

• Encana released its Q2 results and on a macro level the results were grim, but some trends appear to be positive. For the quarter, the company posted a loss of US$1.6 billion, including a non-cash impairment charge of $1.3 billion. On an operational basis, the loss was $167 million for the quarter on $181 million in cash flow. The company expects to meet its cash flow targets for the year and its capex program is fully funded. Liquids volumes are increasing as expected and costs are coming down significantly. The company remains active and committed to its four core focus areas – the Eagle Ford and Permian Basin in Texas and the Duvernay and Montney in Canada. Encana appears to be in the right plays at the right time.
• Precision Drilling released results on Tuesday showing a loss of US$30 million for the quarter on revenues of $334 million. Both of these numbers actually exceeded consensus expectations but are significantly behind the same period last year. In its release, the company announced a small expansion in its capex program ($506 million to $546 million). The company is reallocating some assets from the United States to more active basins in Western Canada
• Mullen Group, a provider of oilfield services and trucking/logistics posted revenues of C$284.8 ($313.4 in Q2 2014) and operating income of $46.4 ($52.0) as significant declines in the oilfiled service segment were offset by increases in the trucking/logistics division.
• Oilfiled services giant Halliburton released surprisingly strong results earlier in the week, surprising analysts. While results were significantly lower than in the same period last year, the company reported a profit for the quarter of US$380 million, beating the consensus by about $100 million.