Ratings agencies weigh in on Canada’s energy outlook

On April 9th, Mizuho’s Head of Ratings Advisory for the Americas, Michael Gorelick, led panel discussions on Canadian upstream and midstream energy companies with a group of senior analysts from S&P, Moody’s, Fitch and Morningstar DBRS during Mizuho’s 6th annual Rating Agency Energy Panel Conference at the Calgary Petroleum Club.  Below we present a few takeaways from these two discussions.
 
Diverging Outlooks for Oil and Gas Prices
 
In recent years, energy markets have experienced significant volatility due to a mix of economic and geopolitical factors. April saw global oil prices approach $90 per barrel, driven by these influences. However, rating agencies are not betting on expectations of sustained high prices. Their price assumptions instead reflect their views of the long-term pricing necessary to support stable global production levels. These assumptions vary among agencies, ranging broadly from $55 to $75 per barrel for WTI over the next few years, with outlooks for Western Canadian Select differentials expected to hold around $12 - $15 below WTI.

In contrast, North American natural gas prices have faced downward pressure. This has stemmed from a warm winter and oversupplied market conditions in Canada, driven by increased production in anticipation of LNG exports with the pending commencement of commercial operations of LNG Canada in mid-2025. While crude prices are currently above long-term assumptions, natural gas prices have persistently lagged. Nevertheless, agencies anticipate normalization for gas markets, with outlooks for AECO ranging from $2.50 to $3.50 per thousand cubic feet of gas in the intermediate term, as demand for LNG exports and a return of more typical winter weather are expected to support the market.  
 
Broadly Stable Ratings for Upstream Companies
 
Among major Canadian upstream energy companies that are in focus for the agencies, ratings have remained stable over the past year with a few notable exceptions. Cenovus, for instance, saw an upgrade from S&P in March, moving from BBB- to BBB, credited to significant debt reduction efforts. This upgrade narrowed the gap between S&P’s rating and those of Moody’s and Fitch, although Morningstar DBRS rates Cenovus slightly higher at BBB (high). Across the peer group, broadly stable ratings reflect supportive oil prices, debt reduction initiatives and robust capital discipline by management teams.
 
Energy Infrastructure Development Boosts Canadian Energy Sector
 
Despite global market uncertainties, Canadian energy firms have been actively constructing energy infrastructure to support burgeoning oil and gas supplies. Notably, LNG Canada, the country’s first LNG export facility is slated to begin operations alongside associated infrastructure, such as TC Energy’s Coastal GasLink pipeline, by mid-next year. Additionally, Trans Mountain Pipeline (TMX), a significant oil pipeline project, commenced operations on May 1st after more than a decade in development. These projects are expected to alleviate transportation bottlenecks, potentially reducing the large price differentials that have recently plagued Canadian oil and gas producers.
 
While agencies expect these projects to generate significant impacts on the industry, their development has been marred by challenges and cost overruns. Citing these difficulties, S&P, Moody’s and Morningstar DBRS commented that they anticipate TMX to be the final major oil pipeline built in Canada. Fitch, however, holds a dissenting view, suggesting that Canadian midstream companies could navigate challenges and develop new infrastructure if demand necessitates.
 
M&A Potential for Canadian Energy Companies
 
Although leading Canadian energy companies have yet to replicate the megadeals undertaken by their U.S. counterparts over the last year, they may be poised for similar transactions in coming years. Rating agencies see Canadian upstream companies as well-positioned for acquisitions following years of debt repayment and additional measures to strengthen credit quality. Analysts suggested that strong oil prices could facilitate bolt-on transactions that complement existing operations. Canadian firms may rely at least partially on debt to fund acquisitions, with panelists commenting they would give issuers around a 12-month window to de-lever, assuming a credible plan is in place to restore metrics to within expected levels for the rating. 
 
For midstream firms, the stability of cash flows relative to upstream counterparts may afford a longer period for deleveraging following acquisitions, although this isn't always the case. Enbridge's recent acquisition of three U.S. natural gas local distribution companies garnered mixed reactions from agencies. Moody’s downgraded the rating to Baa2, citing aggressive leverage and weak distribution coverage metrics, while S&P and Fitch maintained ratings at BBB+. Although Moody’s recognized the transaction’s positive impact on Enbridge's business risk, it deemed resulting metrics too aggressive for the prior Baa1 rating.