ENERGY STOCKS STILL A RISK.
Being a former oil and gas analyst I like to check in every once in a while on the Canadian energy sector. Lately, the news hasn’t been good.
Maybe it’s because Albertans were in the midst of an election, but the headlines have been dominated by negative talk about pipeline restrictions, production curtailments, lost jobs and the potentially very punitive legislation currently coming out of Ottawa in the form of Bills C-48 and C-69.
These are all important issues that need to be dealt with if we want to compete against the united States, which has gone from being our largest customer into one of our largest competitors.
As both an investor and a Canadian, however, I fear we have yet to fully grasp the implications of the disruption that has occurred in the energy space, where we once enjoyed a protected position within a global oligopoly.
The advent of horizontal multi-stage fracking in shale reservoirs has been a real game changer. Since 2007, u.s. oil production has gone parabolic from just under 5 million barrels per day to approaching 12 million barrels per day. Canadian output has followed a similar path, rising from 2.5 million barrels per day to nearly 4.5 million barrels per day over the same period, though further growth here looks to be capped due to increased regulation and a lack of export infrastructure.
We think this disruptive growth in the global supply of oil is just getting started. As artificial intelligence and cognitive computing are increasingly applied to downhole data analysis, recovery rates will increase further through the optimization
of automated drilling and fracking.
In this new world, size and scale are everything as the lowest cost, most efficient manufacturer will win the day while those who don’t adapt will quickly lose out.
These efficiencies will also have other broader implications as well. Take for example, the number of workers needed to produce one million barrels of oil in the u.s. According to energy analyst Jamie Webster, this has fallen from 32,640 workers in August 2008 to only 12,636 today.
As a result, it’s now a mad dash south of the border between exxon, Shell, BP and Chevron as to who will be the largest u.s. shale producer. On Friday, Chevron took a big step in that direction by announcing a us$33-billion deal to buy shale heavyweight Anadarko Petroleum, the biggest industry merger since royal dutch Shell and BG Group back in 2016. The move makes Chevron the third-largest oil producer in the world just behind exxon and Shell.
Here in Canada, the mass exodus of foreign companies has resulted in consolidation of production among the default local producers with Suncor, Canadian Natural resources and Cenovus now dominating the competitive landscape. This unfortunately could mean less strategic value for Canadian junior and mid-caps as their positioning really isn’t that attractive to these few remaining producers who already have enough of an internal inventory to develop.
This is an important consideration especially if you are thinking of dipping your toes into this segment of the market. With many smaller producers seeing their share prices down 75 per cent to 90 per cent, it’s hard not to have a look under the hood. But be warned — the situation in a way reminds me of those double- or triple-levered commodity etfs that eventually have to do a share consolidation to rejuvenate their shares after a blow-up.
That said, it isn’t all doom and gloom for investors in the Canadian energy sector as market leaders like Suncor have actually done quite well against their global peers. For example, over the past five years while WTI oil is down 36.5 per cent, Suncor is down only 7.7 per cent which is better than the 11.5 per cent drop in Shell and the 16 per cent drop in exxon.
Finally, from an investing perspective, even if one chose the best-performing companies in this highly disruptive environment one would still have been much better off within the broader market. For example, Chevron is up only 1.8 per cent over the past 5 years compared to the S&P 500 that has rallied nearly 60 per cent.
Looking ahead, there will be winners and many more losers as this paradigm shift continues to play out. As an investor, it’s imperative to understand the bigger picture and try to take stock of the risks, opportunity costs and potential benefits before jumping in.
IN THIS NEW WORLD, SIZE AND SCALE ARE EVERYTHING.