Energy stocks boom unimpeded
T he Canadian oil and gas sector has gone from a four-year drought, with limited capital and little interest in local producers, to a flood of deals and stocks that are setting new 52-week highs.
Times sure have changed and rather quickly, as oil and gas clearly have some momentum thanks to a broader market rotation into commodities and commodity-related securities from other sectors such as consumer discretionary.
This change isn’t that unusual, as energy is typically the last to rally in the later stages of a bull market. But it certainly doesn’t hurt that there are ongoing geopolitical events, such as what has recently been unfolding in Iraq this past week, that pose a serious risk to oil prices.
Investors’ interest in energy began with the development of U.S. unconventional resource plays. Canada was supposed to have been left behind due to a lack of pipeline capacity, but the value gap widened to such a point where investors couldn’t ignore it any longer and they are now piling into the sector, sending many stocks rocketing much higher this year.
This has resulted in Canadian oil and gas producers outperforming their underlying commodity exposure and many are now trading at a premium to the forward market as reflected in their underlying NAVs. Put another way, investors are betting the forward markets for oil and gas prices will move higher from where they are currently trading.
For example, West Texas Intermediate oil prices have risen 11% in the past 12 months, while stocks such as Canadian Natural Resources Ltd. and Suncor Energy Inc. are up 56% and 41%, respectively.
NYMEX natural gas prices have done better, rallying 29% in the past 12 months, but they are also dwarfed by the 40% gain by Encana Corp. and 44% gain by Tourmaline Oil Corp.
Equity gains are even higher when looking at the Canadian juniors, with some stocks tripling or even quadrupling over the past year.
As a result, times are great in Calgary once again, with a high level of confidence about the future outlook among industry participants and those providing the financing capital. All told, it should be one heck of a Stampede party this year.
That said, we’ve been around for quite a few cycles and have learned that it pays to be humble during such periods rather than being humbled after the fact. The sector can turn down just as quickly as it has turned up, so it’s important to take a step back and not get caught up in the euphoria.
At least, it’s something to keep in mind when reading sell-side research reports touting massive potential resource values to backstop-stretched valuations or about companies reporting overly aggressive operational updates such as new wells with high initial production rate profiles.
There is nothing wrong with locking in some of the impressive gains the sector has recently provided, or at least protecting the downside with some risk-managed strategies such as the option markets.
This way, one can still participate in the sector’s strong momentum while feeling secure during times of excess volatility, which it is known for but often quickly forgotten.