Insights

Canadian operators fought to manage supply costs, protect netbacks in 2023

| By Darrell Stonehouse

After trending upward the last four years, average supply costs across Canada’s publicly traded oil gas operators (excluding integrated operators) declined 5% in 2023 compared to the previous year, from $43.50/boe to $41.20/boe.

Unfortunately, a large drop in royalty payments in 2023 due to lower commodity prices was the major reason for the decline, said Mark Young, Senior Analyst, Evaluate Energy.

Average royalty payments declined by 35% year-over-year as AECO natural gas prices tumbled 54% and Western Texas Intermediate (WTI) oil prices declined 14%.

“Other costs have increased over the last five years,” said Young. “Given the pandemic, supply chain disruptions, service cost inflation, and rising interest rates the sector as a whole has done a good job keeping costs in check.”

“Net royalties, supply costs were up 8.5% year-over-year.”

Changes in three-year average finding and development costs (F&D) over the last five years have been negligible, increasing only 3.5% on a boe basis.

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Operating costs are up 30% since 2019, but declined year-over-year in 2023 from $13.74/boe down to $13.44/boe.

“Transport costs climbed significantly as well, up 46% since 2019,” said Young. “But some of this increase has been driven by shipping to higher value physical markets which paid off in greater realized prices.”

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General & Administrative (G&A) costs increased 30% compared to 2019, but there is no clear trend line over the last five years. Higher labour and compensation costs are likely part of the rise, as is increased investment in digital technologies.

Interest expenses per boe remained relatively stable the last five years, aside from a jump during the pandemic, which has since subsided.

“What we’ve seen with supply costs the last five years, outside of royalties which can have a major impact, is a ramp up beginning in 2022 as high commodity prices drove activity to the limits of oilfield services capacity,” said Young. “In 2023, it looks like cost increases have slowed down and could be normalizing at these new levels.”

Operating netbacks declined along with commodity prices in 2023 but efforts to diversify markets helped lessen the sting on the natural gas side. Average netbacks (excluding hedging) were down 29% on a $/boe basis compared to 2022, when oil and gas prices spiked due to geopolitical uncertainty. Average netbacks were $34.32/boe across Canadian public operators.

“While AECO prices averaged $2.60/mmBtu in 2023, average realized prices were $3.20/mmBtu across operators,” said Young. “That’s a significant premium achieved through their marketing efforts.”

Post-pandemic, netbacks for companies with over 5,000 boe/d of production peaked in the second quarter of 2022, and then trended downward for the next four quarters before recovering slightly in the second half of 2023.

Oil operating costs declined the last two quarters of 2023 as well, with gas operating costs remaining stable.

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Corporate reorganizations drive cost savings at some operators

Some of Canada’s largest operators saw major corporate reorganizations in 2023 in an effort to streamline operations and reduce costs throughout the business.

Undertaking a reorganization is a major change that needs to be well planned, said Shesta Babar, Partner, Management Consulting, People & Change, KPMG in Canada. But under the right circumstances the effort can we worthwhile.

“The first circumstance is when there are significant changes in operations. For instance, a series of acquisitions may necessitate a reorganization to integrate the new entities into the existing structure.”

“The second circumstance is when the company is facing financial difficulties or needs to cut costs. Lastly, reorganizations can be beneficial in response to changes in the market or industry, or to adapt to new technologies or business strategies.”

Re-evaluations of the corporate structure should be completed when significant changes to the overall strategy, technology, service delivery, people, and processes of the organization occur, Babar added.

This evaluation should also be triggered by strategic workforce planning processes, long-term business planning, budgeting, and decisions related to overall service delivery.

“It’s important to note that reorganizations should not be undertaken lightly. They can be disruptive and potentially damaging if not managed properly.”

“Before undertaking a reorganization, operators should conduct a thorough analysis to understand the potential benefits and risks. This ensures that the reorganization will indeed help achieve their strategic objectives.”

Managing supply chains another cost containment tool

Some operators have made a strategic decision to expand their procurement efforts to source materials normally done by service providers. The approach of expanding procurement and sourcing materials like sand for completions by operators has both advantages and disadvantages, said Babar.

“By sourcing materials directly, operators can potentially save money by cutting out the middleperson. This can be particularly beneficial in a time of inflation, as it can help to keep costs down.”

“Direct sourcing also gives operators more control over their supply chain. This can help to ensure that they have the materials they need when they need them, reducing the risk of delays.”

But it also comes with risks, Babar added.

“With direct sourcing comes increased responsibility. Operators will need to manage their supply chains, which can be complex and time-consuming.”

“While direct sourcing can save money, it also exposes operators to the risk of price fluctuations. If the price of sand or other materials increases, this could impact their bottom line.”

Many OFS companies are layering on high-tech value-added services or environmentally beneficial tools, adding to day rates, particularly drilling and completions companies. Operators can ensure they are getting value from these new technologies by implementing several strategies, said Babar.

They can conduct a thorough cost-benefit analysis before investing in any new technology, she added.

This involves comparing the cost of the technology with the potential savings or benefits it could bring.

“For example, if a new technology can increase efficiency and reduce downtime, it could potentially save the operator money in the long run, even if the initial investment is high.”

Operators can seek out independent reviews or case studies of the technology in action. This can provide valuable insights into how the technology performs in real-world conditions, and whether it delivers on its promises, Babar said.

“Finally, operators can monitor the performance of the technology once it is in use. This can help them to identify any issues early on, and to ensure they are getting the maximum value from their investment.”

Operators continue to manage cost of capital

Despite improved cash flows Canadian operators continue to use alternative financing mechanisms to raise needed capital.

These include selling royalty interests and processing infrastructure.

“Royalties and their equivalent have long been used by the industry for various reasons including risk sharing, raising equity without giving up ownership, fund capital programs and for some it is their principal business model,” said Babar.

“This tool in the toolbox will continue to be employed as it can provide rapid liquidity. Granted with cash flows meeting a large amount of capital needs and debt levels reduced — the need to use this tool to create liquidity reduces.”

A few operators have sold infrastructure like gas plants or are building facilities with the intention of selling them with long-term contracts for processing capacity in place. The strategy can have several advantages and risks, said Babar.

“Selling the gas plant can provide immediate capital, which can be used for other strategic investments or to pay down debt. Price realized from the sale is usually higher with long-term contracts.”

“By selling the plant, the company can transfer the operational and market risks associated with running the plant to the buyer. This can be particularly beneficial in volatile market conditions. Selling the gas plant allows the company to focus on its core competencies and potentially improve its overall operational efficiency.”

A big risk is that once the gas plant is sold, the company loses control over that asset. This could limit their ability to make strategic decisions about the plant in the future, she said.

“The company becomes dependent on the buyer for processing capacity. If the buyer fails to fulfil the contract, it could disrupt the company’s operations.

“There is a risk that the gas plant could be undervalued at the time of sale, particularly if gas prices are low or expected to rise. The long-term contracts for processing capacity could also pose a risk if market conditions change and the company is locked into unfavorable terms.”

To find out more on how operators are managing supply costs to improve netback, download your free copy of the 2024 Top Operators Report here.

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