Investment needed to build reserves and inventory for growth opportunities

Large scale infrastructure investments are relieving the transportation bottlenecks that have curtailed growth in Canada’s oil and gas sector for the last decade, providing opportunity for operators to grow production out of western Canada.

But significant capital investment will be needed by operators to build the reserves and production capacity to take advantage of the opportunity, said Mark Young, senior analyst with Evaluate Energy.

Enbridge’s Line 3 expansion, adding 370,000 bbls/d of incremental oil transport capacity, came on stream in late 2021. The long-awaited 590,000 bbls/d Trans Mountain Pipeline Expansion (TMX) project is expected to be operational by early 2024, and still to come is a potential 90,000 bbls/d expansion of Enbridge’s Flanagan South Pipeline adding capacity to the Gulf Coast.

“This adds up to over 1 million bbls/d of new oil export capacity,” said Young. “It’s obviously a major growth opportunity, particularly for oilsands operators.”

“Linked to this expansion is growing demand for condensate and pentanes plus for diluent,” Young added. “The AER is forecasting demand could reach as high as 938,000 bbls/d by 2030, up one-third from 2022 levels.”

On the gas side, TC Energy’s ongoing expansion of its Alberta NGTL system which will add 3.5 bcf/d of egress, is slated for completion in 2024. LNG Canada Phase 1 and the accompanying Coastal GasLink will require 2.1 bcf/d of new supply in 2025.

Proved Reserves flat as operators focus on sustaining capital

Canada’s top operators will need to shift gears and invest more capital to build the reserves, drilling inventory and production capacity to fill this infrastructure, said Young.

The 69 publicly traded oil and gas operators reported only a 0.2 per cent increase in proved reserves on a barrels of oil equivalent basis in 2022. The same operators added only 81 million boe of 1P reserves last year.

Total oil and liquids 1P reserves declined year over year from 27.1 billion bbls to 26.4 billion bbls. Oilsands reserves declined over 1 billion bbls from 22.57 billion bbls to 21.52 billion bbls.

Natural gas reserves fared much better, with 1P reserves reaching over 51.7 tcf in 2022, up from 47.1 tcf the previous year. Proven gas reserves are up 20 tcf since 2018 as Montney development has expanded.

The expanded access to markets should significantly mitigate the pricing discount applied to Canadian oil and gas production and this will positively impact cash flow, said Kimberly Payne, Audit Partner and Calgary ESG Assurance Leader at KPMG in Canada.

“Will the potential increase in cash flow from reduced discounts on Canadian production result in increased investments in reserves and production growth? That is harder to predict,” said Payne. “More capital in the industry will provide the potential to invest in production growth. It will also allow for increased investment in key ESG initiatives such as carbon capture, reduced water usage and methane emission reductions.”

Oilsands operators repositioning for sustainable growth

Canada’s oilsands operators saw proved reserves decline by 4.8 per cent in 2022. Operators are now optimizing use of current facilities to deliver incremental production growth while ensuring long-term supply is in place for processing and refining operations.

It is more difficult to see a path where large greenfield development in the industry occurs, said Payne. “The regulatory, political, social, and other pressures to prevent new large scale upstream projects is immense. Optimization and enhanced recovery activity and expansion of existing projects seems more likely than the large-scale development seen in the past.”

Getting more out of what we currently have will be a key industry focus, said Payne. “The permitting and approval process is substantially different than large scale new projects. Getting more out of existing resources may not be as glamorous or potentially as profitable as new large-scale projects. However, the risk profile is substantially different.”

Conventional oil and liquids operators extending life of existing reserves while buying future growth

Conventional oil and liquids operators saw a slight decline in 1P reserves in 2022 as they targeted short-cycle projects to take advantage of high oil prices, said Young. But they also continued to invest in capturing more reserves from legacy developments and adding inventory for the future.

The industry has a long history of innovating to enhance production from existing reserves, said Payne. “I don’t see that changing. I am sure there are technologies in development that will continue to prove effective at increasing recovery rates. CO₂ injections are encouraging because of the potential to achieve incremental production while reducing carbon emissions – achieving both with a single effort.”

Natural gas weighted operators increase reserves for LNG, while liquids production climbs

Natural gas operators saw a nine per cent increase in 1P reserves in 2022 compared to the previous year as they focused on delineating their acreage and bringing large pads onto production to capture high commodity prices, said Young.

Like with oilsands operators, large gas producers are looking to build reserves to keep processing facilities full.

Gas weighted operators have focused on liquids production for much of the last five years with condensate prices often trading at a slight premium to WTI, said Young. “Many oil weighted operators buying into plays like the Duvernay and Montney are also primarily producing condensate and light oil. We expect this activity to continue given the condensate premium but with new gas demand from LNG and power generation dry gas targets could see a resurgence.”

Financings down in 2022

Given the high levels of free cash flow among Canada’s public oil and gas operators in 2022 it’s little surprise that financings declined significantly in 2022 compared to the previous year, said Young.

Thirty-nine debt financings were completed for the year with a value of $2.44 billion. Fifty-two equity deals were done with a value of $1.1 billion. This compares $9.4 billion in debt financings and $2.0 billion in equity deals in 2021.

“In 2022 most operators had more than adequate cash flow to fund capital expenditures, pay down debt, and return the remainder to shareholders,” said Young.

ESG performance will add complexity to financing challenges 

Companies will need to seek additional capital to achieve their publicly stated ESG targets. According to KPMG’s annual CEO outlook survey, a fifth of Canadian CEOs say that a lack of budget to invest in ESG transformation is a top challenge. ​

Financial institutions are responding to these capital requirements with investment programs linked to sustainability, where a borrower’s ESG performance will affect their interest rate. ​

Similar considerations apply to equity capital providers. Most institutional investors, including private equity firms, have already embraced ESG as a key factor in their deal-making. ​

“Companies that fail to meaningfully address ESG with actionable strategies and clear reporting will face increased challenges accessing funding,” said Doron Telem, national leader for ESG at KPMG in Canada. “Part of what’s driving this shift is that Canada’s biggest lenders and investors are adopting well-defined ESG mandates and targets, and the compensation of their executives is increasingly tied to delivering on them.” ​

“As financial institutions increasingly make funding decisions based on ESG performance, they will play a key role in shifting the allocation of capital to lower-emitting companies and accelerate their efforts to push for the decarbonization of heavy emitters,” said Telem. “This will quickly begin to impact all businesses and sectors given the interconnected value chains.” ​

Download 2023 Top Operators Report here.

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Editor’s note:

Canadian oil and gas producers reported major increases in cash flows in 2022 as geopolitical uncertainty drove commodity prices to highs not seen in almost a decade. The influx of cash enabled the 69 Canadian headquartered public companies tracked in the 2023 Top Operators Report to continue repairing balance sheets and to increase capital spending, but shareholders were the greatest beneficiaries.

ESG challenges continued to be a priority in 2022, as operators focused on emissions reduction and Indigenous reconciliation.

Cost inflation was a key theme, driven by continued supply chain disruptions, talent shortages, and an oilfield service sector looking to regain operating margins after five difficult years.

Market diversification was another priority, as operators used incremental additions to pipeline infrastructure to access higher value markets.  

The 2023 Top Operators Report reviews the most important trends that emerged in 2022, and how these will shape the business landscape in 2023-2024.

To sort through these challenges, we are leveraging the experience of professional services firm KPMG in Canada.

Data analysts from Evaluate Energy provide context to the stream of information coming from corporate financial reporting, backstopped by subsurface and operational data from geoLOGIC systems and reporting by the Daily Oil Bulletin.

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