It has been a very challenging time for investors in the energy space, but we discover their resiliency impressive, considering they have endured a decade of little to no returns.
Big oil warns world to brace for any different, but equally daunting, price shock to come
Oil companies say there will be a price to pay – a significantly higher price – for all the cost cutting being done today to cope with the collapse within the crude market. Read on
Investors haven\’t made anything over the past decade using the S&P TSX Capped Energy Index gaining a paltry 0.3 percent annually while the Canadian dollar-adjusted West Texas Intermediate oil prices are up only 0.7 percent per year. This compares to the S&P TSX Index that has gained approximately seven percent per year within the same period.
Even though it remained fairly flat over the past 10 years, the power index has experienced tremendous volatility with an average standard deviation of 30 percent, more than double the TSX\’s 14 per cent.
It is doubtful that many investors rode the entire period, instead we believe they pulled the ripcord during a few of the periods of excess volatility. It\’s a whole lot worse for those who purchased at its recent peak in mid-2014.
Which is why we find it rather amazing that investors plowed a whopping $5.5 billion into the Canadian exploration and production sector through bought-deal equity financings within the first quarter, as well as an additional $1.4 billion raised so far this quarter.
Oil ride to continueEra of Canada\’s oilsands megaproject fades as producers shift to bite-sized venturesWorld is on the point of the longest oil glut in at least 30 years with no end in sight
Looking ahead, we wish we shared exactly the same level of enthusiasm for the sector.
With relation to its oil prices, we believe there could more downside than upside on the horizon especially in this environment of the prolonged global supply-demand imbalance.
On the positive side, global oil demand has been improving and is up 1.2 per cent from last May. However, it isn\’t really enough as global supply has exceeded demand for the past five quarters and may soon begin to see the longest glut since 1985, according to financial news provider Bloomberg.
Not helping matters is OPEC production growth because the group aims to protect its share of the market against North American producers which have yet to curtail output regardless of the oil price being halved previously year. Over the past four weeks the low 48 oil production has averaged 229,000 barrels each day higher than the prior four weeks.
With regard to Canadian oil producers, many companies have implied commodity prices at or near the forward curve and some a little bit higher such as Suncor Energy Inc. and Canadian Natural Resources Ltd.
We find this to become a useful exercise at times as a large divergence or disconnect in either case can be suggestive of a sector bottom like in mid-2012 or the peaks of early 2011 and mid-2014.
But today\’s signals suggest more uncertainty and are creating a very challenging environment to make an investment decision in.
The bad news is that this may mean we\’ve not yet seen the final capitulation usually needed prior to the start of a brand new bull cycle.? This is because high CAD-denominated forward prices, low interest rates and the large capital flow in to the sector are selling an artificial sense of hope for marginal producers.
That said, you may still find opportunities within the sector, but one has to work extra difficult to mitigate the risks of uncertainty.
We continue to stay away from Alberta oil and gas producers while there is still way too much jurisdictional uncertainty. They might under perform like they did over the past royalty review and as a result have a more expensive of capital.
Instead, we glance to own those well-funded, non-Alberta producers such as Crescent Point Energy Corp. that want to gain share of the market in this challenged environment.
Finally, the choice market can be a great tool to add value in an uncertain energy sector. Recommendations put writing on names we love to to be an excellent way to add tax-efficient income to the portfolios along with covered calls.
For example, put option writers, or sellers, sell put options with the hope that they expire worthless to enable them to pocket the premiums. In a scenario in which the option is exercised, the put writer will have to buy the stocks they like but in a lower and more attractive access point.
Synthetic strategies also help create asymmetrical payoff profiles on companies and commodities we favour, creating scenarios that mitigate part of the downside without giving away the upside.
Martin Pelletier, CFA, is a portfolio manager at Calgary-based TriVest Wealth Counsel Ltd.