New York: 17:48 || London: 22:48 || Mumbai: 04:18 || Singapore: 06:48

Global Outlook

Outlook For Canadian Oil & Gas In 2014

January 29, 2014, Wednesday, 05:40 GMT | 00:40 EST | 11:10 IST | 13:40 SGT
Contributed by eResearch


Eric Nuttall is a Lead Portfolio Manager with the Sprott Energy Fund. He has been especially interested in the Canadian oil and gas sector, which he believes is undervalued now. He says markets have overemphasized the U.S. oil and gas boom at the expense of Canada’s oil and gas producers. That means there could be room for stocks in this sector to grow, especially if oil producers in the USA fail to keep up their rapid pace of production increases.
 
The big star of the oil industry over the last two years has been the United States. In 2012, oil production reached 6.5 million barrels per day from around 5.7 million in 2011, an increase of around 800,000 barrels per day.1
 
In 2013, production rose another 1.2 million barrels per day, and the U.S. Energy Information Administration expects it to see another 1.3 million barrels per day in 2014.2
 
Eric is not so sure. Can U.S. oil keep up the pace? He says:
 
“A potential outlier that could affect sentiment for U.S. oil stocks is a disappointing growth rate for oil production. Production will probably continue to rise this year and next, but I think we will see a tapering out in the rate of growth.”.
 
“This could catch many by surprise given the overly-simplistic assumptions that people make about the sector. Many expect a straight-line annual increase of around a million barrels per day - a trend that has been in place for only two years.”
 
And if the rate of the increase begins to taper off, so too could the notion of U.S. oil independence within the next decade, which Eric believes is a ‘complete fairytale.’
 
“That is an exciting opportunity to make money if attitudes change,” he says. “The notion that the USA would stop importing oil has dampened sentiment for the Canadian oil and gas producers.”
 
In fact, there is a simple reason that the USA probably cannot keep up the rapid rise of oil production. Increased supply will lower the price, and oil from unconventional sources is expensive to produce.
 
“Some are suggesting the growth in U.S. oil supplies will create downwards price pressure on oil. If it is too severe, the lower oil price should be a self-correcting process, especially at WTI prices below $90 a barrel,” he explains.
 
According to Eric, this means U.S. oil production cannot grow too fast and that the price of oil cannot drop too much.
 
The market is overly-negative on Canadian oil companies, Eric believes. A lack of pipelines has caused fear that oil production will have no way of getting to market. But the industry has managed to get a surprising amount of oil out via train, he says, and he is optimistic that at least one of the two main pipelines proposed in Canada will see the light of day.
 
“The market is not yet realizing the significant impact of rail capacity. Several years ago, the amount of oil shipped by rail was zero but, by the end of 2013, we had the capacity to transport 375,000 barrels of oil per day by rail. We should see the industry continue to build that aggressively, with capacity set to reach 900,000 barrels per day by the end of 2014.3
 
“Effectively, Canada will have built the equivalent of a 1 million barrel per day pipeline in four years, although the transportation cost comes out at around twice that of a pipeline.”
 
Growing Canada’s oil industry will also require new pipelines, Eric believes, to transport it either to the east or west coast, where it can be sold on the international market. The Northern Gateway pipeline, which would send oil to the west coast of Canada, may not materialize because of issues concerning its path through First Nations lands.
 
Eric believes the Energy East pipeline, which would take oil to the east coast, has a good chance of being built. If it gets the ‘go-ahead,’ it could add export capacity for Canadian oil of around 800,000 barrels of oil per day.4
 
Lifting of the U.S. oil export ban, which has been in place for several decades, would also aid Canadian oil producers. Eric is encouraged by increased political dialogue around the subject, but says he is not convinced that the ban will be lifted.
 
On the broader international market, Brent crude production has not increased much despite sustained prices above $100 per barrel. Eric believes this is a bullish sign for WTI and Canadian oil because it probably means international producers are unable to up production despite higher prices. Because production will stay bounded, he believes the price of Brent will be around $110 per barrel for 2014. WTI crude is likely to trade $10 lower and Canadian oil at an additional $10 discount due to transportation constraints.
 
The deterioration of the Canadian dollar - down 5% this year - has a significant positive impact on Canadian oil companies, says Eric.
 
“We are now at the first time in 16 months where the price of oil in Canada - after taking into account the differential - sells for more than it does in the USA.
 
“This has a very powerful effect given that the cost structure in Canada is much less than in the United States. Most Canadian wells owe a royalty of around 5% of their production to their financers, but in the USA they generally owe over 25% of their production. This means the cost of financing is lower for Canadian oil companies, despite the fact that they are about as efficient with the capital.”
 
Slower rates of increase in the USA coupled with more improvements in the Canadian oil supply chain could heat up sentiment towards Canadian oil producers, Eric believes. The economics of these companies also become more attractive because of lower royalties due on production and the weakness of the Canadian currency.
 
“I think that, because of these factors, the under-appreciation of the Canadian oil and gas sector will finally come to an end in 2014,” he concludes.

Stock Market Forum