Oil & Gas companies hit hard but are likely oversold

by Adam Pankratz

One of the key battles in Tolkien’s Lord of the Rings is the battle for Minas Tirith. Before the battle, Sauron casts a dark shadow over much of Gondor to aid his advancing armies and dispirit the defenders of Minas Tirith.

A similar shadow and lugubrious mood hangs over Canada’s resource industries these days. The shadow cast by blockades, delayed pipelines and seeming government inaction and disinterest for oil and gas, as well as mining, makes it tough to see light in these dark times. To make matters worse, the COVID-19 virus threatens world resource demand. But is all lost? Or, are we simply in the low of a cycle which will run its course?

Teck Resources’ withdrawal of its Frontier oil sands project in Alberta was taken by many as the nail in the oil sands coffin. It is indeed concerning. To read between the lines of the letter Teck CEO Don Lindsay wrote is to understand that political risk is now a significant enough problem in Canada to cancel resource development projects. That political risk is now consideration for companies investing in Canada should give us all pause.

Political stability and predictability of a regulatory process has always been a competitive advantage for Canada. We have allowed the process to be hijacked in such a way as to classify our nation as politically risky for investment. That the problems do not end with Frontier and Warren Buffet pulling his $4 billion investment out of the Énergie Saguenay Project in Québec due to “the political context” confirms this.

The current Canadian chill won’t melt overnight. Worse, the COVID-19 virus has already slowed global growth and will keep fossil fuel prices lower than expected for several months and maybe longer. It’s impossible to know the exact impact of Covid-19 but estimates predict a worst case COVID-19 spread could see a catastrophic 2009-like market slump, while a more controlled spread would see a 1% decrease in global GDP; far from good news, but not financial Armageddon on its own.

Almost forgotten now, the Russia-Saudi Arabia price war has seen oil production increase and further contributed to prices tumbling. Indeed, West Texas Intermediate was trading below zero on April 20 (-$37.63) on the May futures market – the first time in history.

Together with COVID-19 the impact to Canadian oil producers has been dramatic. On March 13, a number of them announced plans slashing capital expenditure and cutting dividends.

Today, oil producers are hurt and bleeding, but will they die? It seems unlikely for robust producers. Resources are too important to the Canadian economy for even the most ardently environmental government to ignore them. Producers with strong balance sheets which can withstand a short-term shock are probably oversold at the moment.

In the meantime, total gloom need not be the permanent order of the day in Canada’s energy sector. Despite the recent blockades and protests, public support for the Coastal GasLink pipeline has actually increased. These two projects would have a massive positive impact on the ability of Canadian producers to match their products to markets and maximize returns and profits for investors. Premiers Horgan and Prime Minister Trudeau have remained steadfastly behind these two pipeline projects and for that they deserve credit. A ray of hope in the form of Suncor’s application to expand its Base Mine near Fort McMurray should be taken as such.

On the demand side, recent actions from governments around the word, and particularly the US Federal Reserve, hint at a willingness to do anything it takes to keep the economy running. This augurs well for strong, long term, stable producers.

The recent combination of COVID-19 and the OPEC oil production surge have combined to be a panic double punch which has seen Canadian oil producers likely become oversold short-term. This has been partially mitigated by OPEC and other producers recently reducing production by 9.7 million barrels per day.

Savvy investors who are choosy can find some incredible deals in the market but shouldn’t be fooled by dividends that look too good to be true: they probably are. Recent dividend and capital expenditure cuts are a warning to heed. Majors and mid-majors are at all-time lows, some looking almost like penny stocks.

Large questions hang over drillers and juniors who live off bull markets and positive sentiment for their exploration activities. They will be the last the recover.

There is no hurry. Watching from the sidelines and sitting on cash is certainly not a bad idea and a long-term view with the ability to sit on an investment is an absolute must. Buy quality producers with robust balance sheets; they will come back, others won’t.

Current oil and gas equity prices could be the perfect buying opportunity if chosen wisely. Just as Minas Tirith thought all was lost until the Ghost Army appeared to wipe out the forces of Mordor, so too could a sudden global pick up and pipeline construction drag oil energy equities out of their current trough.