Canada’s government has been perhaps surprisingly ready to help the country’s ailing oil industry. Interest-only loans, backstopping loans that troubled companies can’t pay have been among the steps taken so far. But they may not be enough. Canada’s oil industry has arguably suffered more than its peers across its southern border or even most producers around the world. Already cheap because of pipeline troubles, Canadian oil slumped to new lows amid the oil price war and the coronavirus pandemic earlier this year. While it has since improved in line with the international benchmarks, it hasn’t improved enough for the comfort of the local extractive industry. And it may drag banks down with it.
Bloomberg reported earlier this month that Canada’s largest banks reported an almost two-fold increase in impaired energy loans over their second quarter due to the oil price plunge and the pandemic. The increase amounted to more than US$1.47 billion (C$2 billion). What’s more, according to the report the country’s top six lenders had boosted their new lending to energy companies jumped by as much as 23 percent during that same quarter.
“Canadian banks’ energy exposure risks are increasing, with oil in a freefall and Canadian oil producers fighting to survive, as cash burn accelerates and liquidity dwindles,” a Bloomberg Intelligence analyst said in April when banks and companies were both bracing for this year’s renegotiation of borrowing bases amid the price plunge. According to Paul Gulberg, if just a tenth of the loans that Canadian banks had on their books at that time went bad, the lenders could lose a collective US$4.40 billion (C$6 billion).
No wonder then that the government is helping. If energy companies fail, they will weigh on banks’ balance sheets when they are already heavy enough: Canada’s top banks have set aside billions to protect themselves from loan impairments, and as elsewhere, they took the respective blow to their earnings.
Yet banks were happy to lend to oil companies before the price slump blow struck. In February, Bloomberg reported that the six biggest banks in the country had increased their loans to the energy industry by 59 percent over the last five years. That was despite their growing investment in clean energy projects and despite the government’s increasing pressure on oil companies for their role in climate change.
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So how have Canadian oil companies been faring in the meantime? Not so well, which is hardly surprising given they were already in dire straits before Saudi Arabia declared a price war on Russia and before the coronavirus turned from a regional epidemic into a global pandemic that crippled demand for oil across the globe.
Like their U.S. peers, Canadian drillers and oil sands miners were forced to cut production to prop up prices, and now Reuters is reporting that they have also started shelving investments in clean energy, to the tune of US$1.47 billion (C$2 billion) so far. And it’s not the small players cutting, it’s the top ones, as they grapple with crisis-caused losses. Cenovus, Canadian Natural Resources, and Suncor have collectively cut some $1.32 billion in green investments, Reuters noted.
In total, Canadian oil firms have cut more than $7.5 billion in spending since the start of the crisis, according to Bloomberg. What’s more, they need between $20 and $30 billion in fresh liquidity to weather said crisis, according to calculations by the Alberta government. There is no way local banks would boost their exposure that much, so the federal government is stepping in with the no-interest loans and backstopping mechanism for existing credit.
“We recognize that the next period of time — months, potentially years — is going to be tough in the oil sector,” said the chief executive of the Business Development Bank of Canada, which started offering oil companies debt convertible into equity earlier this year. The debt scheme will be available for four years, which means nobody expects the industry to rebound anytime soon.
All in all, things are not looking good, not for the oil industry. In addition to the price shock and the demand slump, Canadian oil sands companies specifically have to contend with higher breakevens because their production costs are higher than those of conventional oil. And there is little hope that demand will improve quickly and robustly enough despite the lifting of lockdowns. This means bankruptcies and defaulting loans.
Currently, the share of energy lending on Canadian banks’ books is about 5 percent. This is not a whole lot given they lend a lot more to the real estate and financial services sectors. Besides, not all Canadian oil companies will default on their loans or go bankrupt, of course. But if this state of affairs in the industry persists, banks may become much less willing to keep lending to oil companies at the current rate. They may decide to start shrinking their exposure to the troubled industry. And this will become one more problem for that industry to struggle with.
By Irina Slav for Oilprice.com
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