Five bright spots in energy
To call the Canadian energy sector challenged would be quite the understatement: Many companies have sold off to 2009 recessionary levels, even though crude oil prices are setting new 52-week highs.
That said, we’ve identified some bright spots during our regular quarterly due diligence that could represent opportunities for investors.
Investors paying for income Investor demand for income has shifted available capital toward those companies that pay a healthy dividend. The same applies to the Canadian energy sector, which has spawned a number of higheryielding companies in order to tap into this capital base.
There is also a cost-of-capital advantage as many of the dividendpaying energy companies have outperformed those focused solely on delivering growth.
Improving cost structures We’ve come across a number of comments by senior management about the noticeable improvements in drilling, completion and overall operating costs, enabling stronger profitability. Some companies also stated they now have much better access to 24- hour drilling crews, allowing quicker development turnaround times.
Some of the smaller oil sands companies are also really struggling to find capital to fund their projects. However, we view this as a positive for the larger senior oil sands players that are developing expansions on their existing projects.
Increased hedging Many of the oil producers have also stated they plan to take advantage of the current oil price environment by increasing their hedging program. This isn’t surprising given that Western Canada Select heavy blend crude is trading at only a US$15-a-barrel discount to West Texas Intermediate, compared with a US$40 discount back at the beginning of the year.
Hedging programs have already risen to 35% to 40% of 2013 expected volumes from 20% to 25% in January.
Strong upcoming quarter predicted
for oil producers Given the rebound in pricing, we’ve heard there are going to be some very strong second quarters by some of the oil producers, which could result in some upside when they report in the coming weeks.
The only risk is that it has been a somewhat wet quarter and that has impacted some drilling programs and production targets.
Very attractive valuations There is tremendous value in the Canadian energy sector, especially among oil-focused producers. For example, WTI oil prices are up approximately 17% this year compared to a 3.5% rise by S&P/TSX capped energy index. National Bank Financial research, as at July 4, 2013, shows the senior oil producers are reflecting a 30% discount to current oil prices, while the intermediates carry a 20% discount.
We believe this disconnect cannot continue and will eventually mean revert, just like what happened between the Brent and WTI spread.