Crude Oil: is set for its seventh consecutive weekly decline in what is the worst losing streak since 2015 due to two factors: fear about the strength of the global economy due to trade wars (thank Trump) and the possibility of emerging market contagion (Turkey) as well as a timing mismatch between the production increase by OPEC and Russia versus the pending Iranian trade sanctions that will lower that country’s oil exports by 0.7 to 1.7 million barrels per day (bbl/d).
Energy investors have had to mentally contend with far too many sources of uncertainty over the past several years: China soft/hard landing, sovereign debt crises in Greece, Spain and Italy, Brexit, Saudi Arabia abandoning its role as the global oil swing producer and the consequent crash to $26 per barrel, the U.S. supply increase in shale oil production by around 3 million bbl/d over the past several years and the worry about ever-improving technology, Canadian lack of takeaway capacity and the drama around pipeline approvals, unfounded paranoia about electric car adoption and commensurate demand destruction, royalty regime changes, etc. In short, the average energy investor is feeling burnt out. This is resulting in a buyer’s strike which when combined with fewer overall market participants (many energy funds have shut down and generalist investors are still favouring pot stocks or Amazon or Apple) and dismal summertime trading volumes losses get exaggerated. This has allowed for some high-quality names to fall by as much as 25 per cent over the past month. At the current oil price, energy stocks today are trading at less than half of their historical multiples and at 15-per-cent-plus free cash flow yields. Companies with over 60 per cent cash flow margins and healthy balance sheets shouldn’t trade at three or four times their annual cash flow regardless of the sector. The solution to this all-time high level of complete and utter apathy is both share buybacks (like Trican is buying back 10 per cent of their stock this year) and corporate takeovers (both hostile like Iron Bridge or Trinidad, and friendly like Energen or Raging River).
Despite being able to make an investment case for nearly every energy sub sector (oil, natural gas, services), where we see the best opportunity today is in heavy oil stocks. Pipeline and rail constraints combined with year-to-date production increases (Fort Hills) has led to the WCS differential blowing out from the high teens to a recent high of $30 per barrel and to stocks exposed to the differential imploding by 15 to 25 per cent over the past month. The market is taking today’s unsustainably high level and extrapolating it out forever in their financial modeling of heavy oil companies even though there are many reasons for the WCS differential to narrow back down to around $20 per barrel over the next year: rail is slowly responding with potential capacity of 500,000 bbl/d by Q3/19, the Sturgeon refinery is ramping up to ultimately consume 80,000 bbl/d, the BP Whiting Refinery turnaround will be complete in October, Enbridge Line 3 may become operational in the second half of 2019 adding 370,000 bbl/d of incremental capacity, and Enbridge is attempting to fix the Mainline nomination process which could allow for more “real” barrels to flow through it. Longer term, Trans Mountain construction should soon begin with an in-service date of 2020/2021, heavy oil exports from Venezuela and Mexico are in decline, and Keystone XL still has a chance of going ahead. When one combines this improved WCS outlook with our view that oil will trade in excess of $80 per barrel ($100 per barrel?) next year, we continue to see over 100 per cent upside in several heavy oil names.
Oil remains in a multi-year bull market and we continue to believe that energy stocks today represent an opportunity of a lifetime. This however is not without some heartache and significant frustration along the way.
Eric Nutall on BNN.ca Market Call Friday Aug 17th @ 1200ET |
