Canadian Association of Petroleum Producers’ conferences can be particularly useful in getting a quick update on company operations, but whether attending this year’s event or not, energy investors should be looking for clues from the industry on how they are dealing with the uncertainties that have pushed stock valuations down to levels not far off the 2008 financial crisis lows.
This includes: (1) A rapidly growing oil production profile in the U.S. that is suppressing Canadian oil prices; (2) The availability of foreign capital to support further development of Canada’s vast resources, especially given the latest actions by the federal government; (3) The oversupplied natural gas market keeping prices low; and (4) T he sustainability of the expanding dividend model from larger intermediate producers down to the juniors.
On the first point, the International Energy Agency’s (IEA) World Energy Outlook caused quite a stir when it was released in mid-November. In particular, the organization believes the U.S. will overtake Saudi Arabia and Russia to become the world’s largest oil producer as early as 2017. This will be a dramatic shift given the U.S. currently imports 20% of its total energy needs, 30% of which comes from Canada.
The IEA also believes the U.S. will be a net exporter of crude oil by 2030. This is not good news for Canadian producers, because the more U.S. production that comes on stream, the less refining and pipeline capacity there will be available for Canadian oil.
This bottleneck is already starting to happen, with Canadian crude oil being backed out by the rapidly growing light oil production in North Dakota.
Therefore, until new pipeline projects by TransCanada Corp. and Enbridge Inc. are built, Canadian crude oil prices will trade at a discount to West Texas, which, in turn, is trading at a discount to Brent.
That said, we remember that there were some rather bold calls being made in the early 2000s that global oil production had peaked and higher oil prices were to be the norm. Therefore, it is always useful to look at the other side of the trade. In this case, we are very curious as to what some of the larger Canadian oil producers are doing to mitigate the risk of falling Canadian oil prices.
The second theme could potentially be the availability of foreign capital from state-owned enterprises (SOEs) and whether they will continue to allocate investment dollars to Canada.
The timing on this is relatively short as investors eagerly await the federal government’s decision to approve the CNOOC-Nexen Inc. and Petronas-Progress Energy Resources Corp. deals. (At press time, Ottawa had yet to make public its decision on the two large foreign takeovers.)
A number of Canadian companies require third-party capital to develop their resource plays. The absence of this kind of investment may mean a lot of marginal or higher-cost plays will be cut, so keep a close eye on how the companies will be presenting the timing of the development of their project(s).
The third theme we anticipate will be on the oversupplied natural gas market. North American producers have been stubbornly resistant to curtail natural gas output despite weak pricing. Production levels are still 0.9 bcf/d higher than last year, according to recent Bentek figures.
However, one of the hottest summers on record and recent nuclear outages have increased demand for the commodity, sufficiently reducing a large potential overhang on the market.
In regards to Canadian producers, we would look to see how they are positioning themselves in this environment. For example, we’ve found that patient capital, such as private-equity players, are taking a long-term bullish view on the commodity and positioning themselves accordingly.
This contrarian view is based on the expected build-out of export capacity to markets where gas prices are currently three times higher than in North America.
Finally, we would look to see if there will be more companies converting into an income-and-growth model by instituting a dividend. We think this could end up being a win-win scenario for the sector, because junior producers may have the option of either growing into dividend companies and raising capital as part of that plan, or selling out to an existing dividend-paying junior producer.
Of course, the jury is still out on whether the income model will work for smaller producers.
For the energy investor wanting to stay apprised of these themes but unable to attend the conference, look for commentary from sell-side analysts in attendance. In addition, most companies will be uploading a copy of their corporate presentation on their websites.
Source: Financial Post