Let’s hope Notley can tread fine line
Investors have had a bit of time to digest the NDP’s historic win in Alberta and there is still a lot of trepidation out there.
The uncertainty around a new government formed by a party with a history of challenging oil and gas development is only exacerbated by the concern following a large correction in energy prices.
A lot of this uncertainty is around the lack of substance in the NDP’s platform, which fails to disclose important details on policies that could have a very material economic impact on Alberta’s economy and especially the energy sector.
To be fair, it was the existing PC government that called a snap election hoping to take advantage of the other parties’ lack of preparedness, so it is understandable if it takes some time to get any clarity on the NDP government’s policy toward the energy sector.
It is also very encouraging to see premier-designate Rachel Notley proactively send out calming-type messages to those in the energy industry only a few days after her win.
That said, here is what we know and don’t know so far.
There will be a two per cent corporate tax hike, which we believe industry, even the energy sector, can easily handle. However, we do not know the extent of the costs of new environmental policies and potential royalty changes, which could have a material impact on energy investment going forward.
According to National Bank Financial equity research, if the existing royalty incentives were eliminated and flat royalty rates of 30 per cent on oil and 20 per cent on natural gas were implemented, it would raise the break-even price of oil by approximately US$10 to US$60 per barrel and by 55 cents on natural gas to $2.60 per mcf.
For comparison purposes, the prompt-month WTI price of oil is currently US$58.90 per barrel and AECO natural gas is $2.58 per mcf, leaving little room if any for profitability.
On the environment side, we believe that not having a provincial policy may have played a contributing factor in holding up the approval of the Keystone pipeline in addition to all of the protests against Enbridge Inc.’s Gateway pipeline.
Hopeful ly, any new policy will walk a fine line and not be overly complex and costly, but still appease anyone against further oil and gas development, especially the oilsands.
For investors wondering where we go from here, we hope that the energy sec- tor holds up as well as it did during the last royalty review, when it still traded up with commodity prices, but underperformed its U.S. counterparts by approximately 10 to 15 per cent.
That said, so far, so good, as it appears the sector’s recent sell-off may have more to do with the falling price of oil than the NDP winning the election.
For example, the S&P TSX Capped Energy index has pulled back only three per cent since the NDP’s win, a bit more than the 1.5-per-cent drop in the WTI oil price and the oneper-cent drop in the U.S. producer index (both currency adjusted).
Either way, this was clearly not the disastrous outcome some pundits were calling for last week.
The good news for investors is that there is still time to rebalance, hedge and adjust their energy portfolios to protect against some of the up- coming risks from an uncertain NDP government.
Bullish energy investors should consider undertaking a more balanced energy portfolio by including producers with operations in Saskatchewan, B.C. or even the U.S, while hedging positions with too much exposure to Alberta.
It may also be a great time for investors with an overweight energy position to begin thinking about a plan to transition into a more typical well-diversified global portfolio.
In the end, we truly hope that smart commonsense policy will prevail and that orange is indeed the new black. Otherwise, our new government risks sending both the province and energy companies further into the red.