How to invest in sub-US$40 oil.
We are at a price point that will not enable future demand and so we are confident (of recovery)
Canadian oil and gas investors’ worst nightmare came to pass in 2015 as crude oil prices spiralled down with each passing month, but some believe it may have hit rock bottom.
“Both the oil and gas commodities have been absolutely decimated,” said David Taylor, who manages the half- billion dollar IA Clarington Focused Balanced Fund based in Toronto.
“When you take a look at some of the lowest cost producers with the best assets in the best jurisdictions, and if these companies can’t make money in this commodity scenario, then you know you have got to be close to the bottom.”
West Texas Intermediate hit a six- year low to US$ 33.98 per barrel this week, with the Canadian heavy benchmark trading at an even lower US$ 31.32 per barrel.
Citigroup Inc. says crude could fall into the US$ 20s if inventories rise further, while Goldman Sachs Group Inc. also warns of “high risks” of a further decline. But analysts are hopeful that fundamentals point to a recovery in the next year.
“We are at a price point that will not enable future demand and so we are confident there will be a recovery at some point,” Jackie Forrest, vice- president energy research at Calgary- based private equity firm ARC Financial Corp. said in an interview. “But in the short term it is looking challenging even into next year.”
OPEC scrapped its production ceiling earlier this month, giving its members carte blanche to produce at record output levels, as it maintains its policy of driving down prices to squeeze out high- cost producers.
With Iran expected to bring more supply into the market once it shakes off sanctions early next year, and U.S. lawmakers scrapping a 40- year oil export ban, the world will likely remain oversupplied for some time.
If the situation persists, the Canadian oil and gas sector will become smaller, and produce less conventional crude oil and natural gas, said Martin King, analyst at investment dealer FirstEnergy Capital Corp. “When you take those type of stress test on prices it will impact the sector on a wide scale.”
The S&P/TSX Capped Energy Index has fallen 28.5 per cent year-to-date, compared with the 26-per-cent decline in the Dow Jones Global Oil Shares Index. But the Canadian energy sector’s decline is even more pronounced if the loonie’s depreciation against the American dollar is taken into account.
Laura Lau, senior portfolio manager at Toronto- based Brompton Corp. says investors, especially from the U.S., are concerned about Canada’s cur- rency and changes to the oil and gas royalty regime expected in Alberta next year.
There is a structural change under way, too, as U.S. investors now have the option to stockpick enterprising American oil and gas companies.
“In the past if they wanted to have oil exposure, the Americans would come to Canada,” Lau said in an interview. “But they don’t have to do that now.”
Lau’s US$ 106- million Dividend Growth Split Corp. fund is stocking up on American names — a move it never contemplated in the past. But from the depths of despair is the hope that investors may look more favourably on the battered Canadian oil and gas stocks next year.
“Canadian energy stocks are trading at a discount, definitely compared to the Americans,” Lau said.
While it’s tough to foresee the entire Canadian oil and gas complex rebounding if commodity prices recover, the major players will live to fight another day, says Taylor, who believes the Americans would return to the Canadian market.
“When you take a look at our Canadian assets on a global basis, they are attractively priced,” Taylor said. “Not only can you buy these stocks cheaper on a valuation and historical basis, but if you are using U. S. dollars to buy Canadian assets, they are now on sale.”
RBC Capital Markets says Canadian Natural Resources Ltd. and Cenovus Energy Inc. are its “favourite” picks for 2016.
“Managing balance sheet leverage and capital spending will be the name of the game in 2016, but select integrated and senior producers offer mediumterm growth visibility and warrant a closer look,” Greg Pardy, analyst at RBC Capital Markets, wrote in a note to clients.
Taylor says stocks such as Paramount Resources Ltd. and MEG Energy Corp. are being beaten up as the market is not recognizing their midstream assets that offer considerable value.
Saskatchewan-focused WhiteCap Resources Inc. and Crescent Point Energy Corp. may also get some investor love until Alberta’s royalty regime uncertainty subsides.
However, natural gas players will once again remain under pressure. AEC O natural gas prices are trading at $ 2.28 per million cubic feet, and producers have been operating in a low- price environment for years, with few upside catalysts on the horizon.
“Natural gas has always been about the weather, and the weather has been very warm this year,” says Lau, who has a five per cent exposure to gas stocks in her fund. “I just see natural gas very rangebound.”
National Bank Financial recommends playing defence in the volatile crude price environment.
“In the face of weakening oil prices, financial flexibility appears to be king,” wrote National Bank analyst Brian Milne in a note to clients, suggesting that Suncor Energy Inc., PrairieSky Royalty Ltd., Vermillion Energy Inc., and Raging River Exploration Inc. and Advantage Oil and Gas Ltd. were among its favoured “defensive picks.”
The defensive strategy may be prudent as there is more pain to come, with more job losses, company closures and off-loading of distressed assets in 2016.
“Companies will be stressed ( at these prices),” says King. “There is more shakeout coming.”