Good time for Canadian energy investments
Stage is setting for Canadian oil prices to recover
This past weekend I was one of the guest speakers at the Global Chinese Financial Forum in Vancouver, hosted by NAI Interactive. I was rather impressed with the attendance, which I was told was in excess of 1,000 Chinese investors, but what caught my eye was the large amount of interest in Canada’s mining sector and the investment merits of this country’s energy sector.
Canadian energy has a core strategic value that is simply not being reflected in the current public markets, making it one of the best investing opportunities I’ve seen in more than a decade.
Given all the negative sentiment surrounding Canadian heavy oil these days, now might be the opportune time to add exposure.
Refinery outages, supply growth and pipeline divisions continue to support record- high pricing differentials, with Western Canadian Select ( WCS) crude oil prices trading at a more than US$40 per barrel discount to its heavy oil peer, Mexico’s Maya blend, despite their similar grade quality.
Many have forgotten that Canada offers access to welldeveloped world-class energy resources. Globally, this country is the third-largest natural gas producer, sixthlargest crude oil producer and fifth-largest energy producer.
This is rather important considering that only 7% of the world’s estimated oil and gas reserves are in countries that allow private international companies free rein, according to consultant PFC Energy.
Canada is also one of the few places in the world where there is a fair royalty and taxation regime, a transparent environmental and drilling regulatory framework and access to a fantastic database of drilling activity and well and seismic data.
In addition, Canada offers leading-edge technologies that are very attractive to countries such as China that hold large undeveloped shale resource potential but are years away from developing them due to a lack of expertise and technology.
Therefore, it shouldn’ t be surprising when such countries undertake smaller corporate acquisitions and joint ventures as a means of expediting the learning curve and exporting Canadian technology and expertise back home. A great example of this is Sinopec’s acquisition two years ago of Daylight Energy Ltd.
However, while foreign takeovers have been priced at 60% to 100% premiums, investors in the public markets continue to push the valuations of many Canadian oil and gas companies down to near their 2009 financial crisis lows.
We think this represents a great opportunity to take the other side of that trade for a couple of reasons.
For one thing , it can be used as a cheap hedge against inflation if investors are worried about the potential fallout from all the money printing by central banks. Canadian oil companies are an inexpensive way of owning oil as many companies are reflecting a 25% to 30% discounted oil price in their current valuations.
Secondly, we think there is near- term upside once investors realize that the negative headline reporting about Canada’s lack of pipeline capacity is overblown. The Seaway pipeline has been reversed to alleviate the glut at West Texas, Keystone is looking likely to be approved, and some of the recent refinery outages will be resolved.
This sets the stage for Canadian oil prices to recover.
That said, Canadian light oil prices are currently faring quite well and not suffering to the same extent that heavier blends such as WCS are. Strangely, for some reason this is not being reflected in the recent share price performance of light oil and heavy oil producers.
Canadian oil companies are an inexpensive way of owning oil
What kind of near-term upside is there? We estimate there could be as much as 25% from current levels should there be a mean-reversion to historical multiples.
We think there is even more upside in natural gas, but it is for the patient longer-term investor.
Private equity and stateowned enterprises have been strategically positioning themselves by acquiring large gas resources in western Canada. They have been motivated by Canadian gas prices that are at $3 per mcf compared to US$10 to US$15 per mcf in Europe and Asia. This gap will narrow fast upon the build-out of North American export capacity over the next five or so years.
Finally, the nice thing about the sector at the moment is that investors can be paid quite handsomely while they wait for a recovery. The oil and gas companies that pay dividends, including even the less risky senior producers such as Encana Corp. and Canadian Oil Sands Ltd., are yielding on average anywhere from 4% to 10%, which are historical highs.