The wild volatility in oil prices simply reflects many variables triggering aggressive price swings these days. By running your own price deck you can simulate worst and best case scenarios for oil and gas stocks particularly when it comes to the dividend payers. You also avoid waiting for the analysts to update their models; they are usually the last guys to refresh the price decks used in their reports.
I bet you can still find reports & company presentations still budgeting $3.00+ AECO natural gas out there
Oil & Gas Price Deck from January 2012
As long as the self-funded growth milestone has not been reached, oil and gas companies will burn through all of their cash flow, tap their credit lines and issue shares for growth. But in times of uncertainty and market fear, some options may no longer be available. In a down cycle, lower commodity prices translate into a smaller cash flow which directly impacts the financial health of an oil and gas company as the gap between income and expense grows.
In the good old days, when realized natural gas prices per mcf where closer to $5 rather than $2, dividend paying E&P companies enjoyed 2 healthy streams of cash flow. At that time, (ok it’s really not that long ago, I was only a couple of years younger) realized oil prices hovered around $70 per barrel, but in conjunction with Natural Gas, the revenue was enough to fund a dividend and grow production some.
Fast forward to 2012, Natural Gas prices are decimated following an unusually warm winter and record production leaving most companies unhedged for 2013 and beyond. As a result of shrinking cash flow, many companies shifted their drill bits to liquids weighted targets. Oil and NGLs became the sole cash generators and that was fine when oil prices hovered around $100 but this level is not guaranteed to hold.
Realized Canadian oil prices have been going through extreme fluctuations reaching under $70 per barrel a few weeks ago and natural gas is nowhere to be seen near $5. Besides the risk of recurring and extended double discounts in Canadian oil prices, an extended ADD scenario in Europe may sink global oil prices quiet easily.
Furthermore, The Saudis are currently pumping extra oil increasing supplies above the current demand level in an environment of slow economic growth. This may end up pushing WTI oil below $80 again in the second half of the year if geopolitical risks dissipate. After all, with elections coming up, the Saudi regime can’t afford to annoy its primary protector in Washington.
The disconnect in Canadian pricing will be resolved with time as new pipelines become operational but in the meantime??weve??seen a scenario where companies reacted to lower prices by cutting capex and dividends and their stock was punished. Hence, your interest in running multiple scenarios using different price decks particularly for determining a companys total payout ratio range you are comfortable with.??While most companies have entered hedges at around $100 WTI, I think using a realized Edmonton Par price of $75 per barrel is realistic for 2012, anything above is extra!
Finally, don’t get caught in lofty price targets based on pie in the sky numbers. The market will punish stocks long before analysts react.??I expect long term oil prices to recover along with differentials to narrow happening as we speak. If youre comfortable investing in companies operating abroad, you can eliminate the double discounts ??by focusing on oil and gas producers realizing international oil and natural gas prices (like Brent pricing for oil.) In the end, running your own deck prepares you mentally??for the quick and sharp downturns because you get to stress test the balance sheet of any stock that interests you.
Do you run your own scenarios when investing in oil and gas stocks?
