Expect more Canadian energy producers to increase dividends: Ryan Lewenza
As the oilpatch becomes flush with cash again, numerous energy companies are doling out dividends and share buybacks – paying back investors who have been patient through years of hard times – but at least one company is bucking that trend.
Gear Energy Ltd. announced in its quarterly earnings last week that it will delay returning capital to shareholders until it reaches a net debt target of zero -- and it’s pointing the finger at unhelpful lenders.
“The energy business is all about risk and reward and banking has become more of a risk than it ever was in the past 30 years and we want to make sure it doesn’t nip us in the bud ever again,” said Ingram Gillmore, president and chief executive officer of Gear Energy, in an interview.
Last year was difficult for Gear. One of its lenders withdrew support, forcing the company to find it elsewhere. Gillmore credits ATB Financial and the Export Development Bank with stepping in to help when others didn’t.
“There were some banks certainly that wanted to fix their portfolios and it didn't matter what kind of carnage maybe was in the aftermath of that. So yeah, I would say there is certainly some relationship damage that has occurred over the last 18 months," he said.
As oil prices faltered, smaller oil patch players fell into more precarious positions with their lenders. Banks began to increase the number of borrowing base redeterminations and impose stricter conditions or restrictions on the funds. Additionally, in many cases, risk premiums were applied to lending costs so companies were paying more to maintain their loans.
“The lending model for junior energy in particular is based on reserve values and so you take away that top line revenue and suddenly the lending value just diminishes so drastically so then you're relying on a relationship and so forth to try to coast through to a recovery,” said Gillmore. “For some folks it worked, for other folks it didn't. There are actually multiple companies that sold through the last 12-18 months. I would suspect that not all of them would have preferred that route, but were likely forced into it."
The second factor in Gear choosing to minimize its reliance on lenders is the growing trend of financial institutions reducing their exposure to greenhouse gas intensive industries. In its third quarter release, Gear pointed to the dozens of financial institutions, including Canada’s Big Six banks, that have committed to the Net-Zero Banking Alliance – a pledge to transition to a low-carbon economy by 2030.
Gear doesn’t mince words, writing in its earnings report: “The implications are that this program is designed primarily to target oil and gas producers, seemingly ignoring the material achievements made to date and future emission reduction commitments.”
“Angry, damaged. Is that the right expression? Well, it’s the right impression,” said Dan Tsubouchi, chief market strategist with Stream Asset Financial, in an interview. “Disappointed, resigned, whatever the words are.”
Tsubouchi said many energy players learned the lesson the hard way in the spring when West Texas Intermediate oil prices hovered around US$60 per barrel.
“Prices weren’t great, but they were as solid as a rock, and businesses were very profitable,” he said. “When they saw in the spring that their lines were still being reduced, they realized, ‘Hey you know what? There’s a direction that the financial institutions, globally and the big ones in Canada, are taking and they can see the direction, they just don’t know the timing.’”
“It seems pretty clear to me that all banks, and increasingly Canadian banks, are trying to distance their exposure from kind of emissions intensive [sectors] and in particular, the oil sands,” said Rory Johnston, managing director and market economist at Price Street, in an interview. “I think the trend is secular and I think the trend is global so it’s not surprising to me that the relationships aren’t as friendly or seamless as they once were.”
But Rafi Tahmazian, senior portfolio manager at Canoe Financial, said it’s simply another sign of the changing times for the energy sector.
“Nobody is bitter. We are all focused on how to adapt,” he said in an email. “The banks can't lend if there is no equity market available to offset the risk. These companies are spewing cash now so no new equity is needed, hence [the] debt market fizzles out.”
At current oil prices, Gear Energy predicts it won’t have to wait long to reach its net debt target of zero. The company expects to be at or near that goal in the second quarter of 2022 – close to the timing of its spring borrowing base redetermination. It’s at that point that it expects to reward its shareholders.
“I think Gear is just being rather safe than sorry,” said Tsubouchi. “They’d rather not take the chance that something, even at the great prices, gets taken away. They’re making sure they’re not going to get the rug pulled out from underneath their feet.”