Canada's top oil sands companies face credit challenges in energy transition

A global transition away from fossil fuel consumption and constraints on Canadian oil export capacity limit the potential for increases in the creditworthiness of Canada's two largest oil companies, according to a top analyst at S&P Global Ratings.

Canadian Natural Resources Ltd. and Suncor Energy Inc., the nation's biggest companies by volume and revenue, respectively, were mentioned in a sweeping review of oil companies released by the rating agency Jan. 25. Canadian Natural saw its BBB rating moved to CreditWatch with negative implications from BBB stable, while Suncor had the outlook on its BBB+ rating lowered to negative from stable.

Michelle Dathorne, S&P Global Ratings director and lead analyst for Canadian oil and gas, said on a Jan. 26 webinar that the potential ratings downside for BBB-rated companies should be limited to one notch.

Oil prices that have improved substantially from lows in 2020 would have to improve even more to sustain Canadian Natural's BBB rating, Dathorne said. Even though the outlook for natural gas is improving, its lower price point would make it difficult to generate the returns seen from crude oil.

"Quite frankly, we would need to have high visibility to a significant improvement in the cash flow and leverage metrics over the near term to support that BBB rating," Dathorne said. "The forecast that we currently have, with our current price assumptions, provides little visibility or little likelihood of that being the outcome of the upcoming CreditWatch resolution review."

Governments across the globe, including Canada's, have set aggressive emissions reductions targets that largely depend on reductions in the use of fossil fuels to meet their goals. One of the first actions U.S. President Joe Biden took upon assuming office earlier this month was to commit that nation to the Paris Agreement on climate change. The U.S. is the biggest consumer of Canada's oil output, particularly heavy and upgraded crude from the oil sands region where Canadian Natural and Suncor are the biggest producers. Biden also canceled a key permit for TC Energy Corp.'s Keystone XL oil pipeline project, an action that will limit Canada's ability to grow exports over the next decade.

"President Biden's decision to revoke the Keystone [XL] approval is first and foremost something he has signaled he intended to do, so the fact that he did it is no surprise," Dathorne said. "We have been dealing with the reality of insufficient pipe capacity out of Western Canada for a number of years, and you've seen its impact in the reduction or the elimination of any potential growth in crude oil and by crude oil I mean heavy oil production growth for the foreseeable future."

The cancellation of the Keystone XL permit continued "a structural disadvantage for Canadian producers," Dathorne said. A lack of sufficient pipeline space has limited Canadian heavy oil flows to the high-value market of the U.S., prompting producers to use more-costly rail shipping, which in turn lowers profitability.

"The commodity price outlook that we currently have will erode profitability for Canadian producers if they have to turn increasingly to rail given the incremental cost of rail relative to pipe transport," Dathorne said.

This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings.