Stocks out of step with oil - Financial Post, January 7
Investors steer clear: But strengthening economy should pump up demand
Claudia Cattaneo, with files from Ian McKinnon
For many Canadian oil producers, last year's
remarkable comeback in oil prices looks a lot
like a party where many investors took a
peek but most declined to stay.
While the crude price bonanza thrust the
earnings of some companies to record
levels, oil producers' shares are so out of
favour that average valuations are in the
tank, with multiples stuck around 3.5 times
this year's cash flow per share, compared
with the historical range of five to six times.
"It's a very unusual situation. You have a
complete disconnection between commodity prices and stock
prices and it's getting wider every day," said Gord Currie, a senior
oil and gas analyst with Canaccord Capital Corp.
The price of the commodity more than doubled over the past 12
months, rising from a low in February of about $11 (US) a barrel
for West Texas intermediate, to the $26 (US) range in the past two
months. Crude closed at $24.78 (US) on the New York Mercantile
Exchange yesterday.
Oil surged after an agreement last spring between members of the
Organization of Petroleum Exporting Countries that tightened
production quotas to fix an overhang in supplies. The glut had
depressed prices for 18 months.
The curbs have cut so deeply into world stocks the overhang will be
wiped out early this year, said Judith Dwarkin, vice-president of
global energy at the Canadian Energy Research Institute.
The think-tank is predicting oil prices in the $19.50 to $21.50 (US)
range for 2000, moving up from a 1999 average of about $19
(US).
"Certainly it will be a much more balanced market because the
stock problem that took two years to accumulate and a year to get
rid of, will have been dealt with by the first quarter of the new year,"
said Ms. Dwarkin.
"The volatile times are between now and the end of January, and
then things will settle down."
More good news for oil producers is coming from a strengthening
world economy that should result in stronger oil demand; also,
lower than anticipated non-OPEC supplies will surprise many on the
short side, said Ed Peplinski, a senior analyst at ARC Financial
Corp., an investment management and advisory firm. Non-OPEC
supplies are tightening because of the industry's global consolidation,
he said.
The commodity's strength was initially mirrored in the Toronto
Stock Exchange oil & gas subindex, which rose in step with oil
prices until August, peaking in September at 6908, from a low of
3958 on March 2.
Some savvy investors made decent profits from the rally, said
George Morgan, a senior vice-president at Templeton Management
Ltd.
But the stock recovery topped out on worries about the
sustainability of high oil prices.
Buyers bailed out because of fears that discipline among OPEC
members would crumble and send crude prices tumbling.
The index drooped back to the 5500 to 6000 level, with the market
pricing oil stocks based on oil in the $17 to $18 (US) range, and
natural gas in the $2.50 to $2.80 per thousand cubic feet range, Mr.
Peplinski said.
That means that Canadian oils --whether senior, intermediate or
junior companies -- are trading on average at 3.5 this year's cash
flow per share, or about the valuation that used to be accorded to
junior oil companies, said Mr. Currie.
"That is lower than any of us can ever remember," he said.
The downward pressure on stock prices is coming from several
fronts. For one, there's continuing skepticism that oil prices will
remain at current levels for long.
"The irony," said Mr. Currie, "is that nobody believes that oil prices
are going to stay at $26, and consequently they are not willing to
value stocks on that basis. But people believe that gas prices should
stay at $3, and now they are down to $2.25," per thousand cubic
feet.
The next milestone for oil prices is OPEC's meeting in March,
where members' quotas will be reviewed.
While most anticipate the cartel will extend output cuts for three to
six months, there are concerns that some members, such as
Venezuela, will turn on the taps.
The sector is also suffering from a liquidity crunch, as cash is
siphoned off by other sectors, principally high technology.
The drought is making it difficult for many companies, particularly
juniors, to raise equity.
"The market is focusing on anything but oil," said Mr. Peplinski.
With techs commanding more of the TSE 300 composite index
because of their higher market capitalization, fund managers wanting
to mirror the index are squeezing out everything else, he said.
"So, it's going to take other sectors to fail and we are going to have
to see consistent returns in the oil and gas business," he said.
Investors are becoming more focused on earnings and less willing to
pay for oil firms that pump up their daily production without a
corresponding increase in profits, Templeton's Mr. Morgan said.
The industry is also suffering from the fallout of high-profile stock
crashes in 1998 and 1999 such as Blue Range Resource Corp. and
Remington Energy Inc., where reserves vanished in major estimate
revisions. The lack of trust in the sector is so significant some fund
managers are now refusing to invest in junior Canadian oil stocks,
Mr. Currie said.
"It wouldn't hurt if the industry collectively took steps to reassure
investors," he said, although "investors need to understand that the
oil industry is not slam-dunk easy as it's sometimes made out to be.
It's a mature basin and everybody has to work hard to find
hydrocarbons. Don't expect double-digit growth."
Mr. Morgan said Canadian producers are attractively priced,
especially when stacked against the multiples being paid for Internet
firms and other high-tech stocks.
"I have to think that we'll be looking forward to a good rally again to
what are distressingly cheap stocks," he said. "The gap between the
energy price and where the stocks are trading at now is as high as it
has been in many years."
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