Crude Observations

Buying Low

So here I was this week hoping for something to come along and inspire me for blog writing. Some seminal event that I could latch onto and use as inspiration for a mid-August barn-burner. I gotta say though, this type of hope appears to be increasingly misplaced as we, as a world and an energy economy, seem to be permanently stuck on a hamster wheel of inanity and self-loathing.


Don’t believe me? Consider these news topics and opinion pieces from the prior week.


  • Trump reinstates aluminum tariffs on Canada.


  • Dakota Access Pipeline back on again.


  • Canadian oil – it’s time is over


  • Alberta’s squandered wealth – why Norway does it better, version 4.12.138 (d)


  • KXL – going to be cancelled AND construction continues, week 633 since it was first proposed.


  • Peak oil – it’s just around the corner and it may already be here, so watch out all you Neanderthal fossil fuel junkies


Add in the ongoing chaos of a pandemic that isn’t going away any time soon and it is easy to see how it’s all so exhausting. Cover the same territory over and over again, argue the same arguments, often with the same people. I think I may need a break. But even taking a break is just a repeat of what I did last year, so maybe I won’t take a break. I don’t know.


Last year at this time, I was taking a break in Las Vegas (I know, summer right?) and I managed the inconceivable – I made a 600% return on an “investment” and it didn’t involve buying stock in an overhyped, over-valued, maniacally run EV manufacturer to get there. Nope, I just used everyday, run of the mill slot technology and got out when I was tempted to double down.


I took a downtrodden, disrespected $20 and turned it into $144.50. Not bad for someone who hates gambling.


Speaking of stock, gambling and over-valued companies, another thing that has been in the news lately and is puzzling me to no end is the ongoing disconnect between tech companies, the stock market, the economy, the energy sector and, what’s that thing called, reality.


It is amazing to me that the stock market has gone so bananas since the big sell off early in 2020 and equally obvious that the market is trading off cheap Fed money as opposed to the reality on the ground of what a 32% decline in GDP actually means. On the other hand, we’ve been waiting on this day of reckoning for a long time and it hasn’t materialized yet.


But enough doom and gloom, we’ve got one more hamster wheel thing to talk about, and that’s the undervalued state of Canada’s energy companies.


Look, I get it, not a sexy sector right now and with everyone pilling on and bailing out, why in the world am I even bringing up this sad-ass, non ESG group of also-rans?


Well because like any energy sector participant, I am a big sucker and do have a few names in my portfolio that are active in the Canadian energy sector. Or put another way, since my day-job is 100% leveraged to a volatile and downtrodden energy world just isn’t risky enough, I also have to have my passive investments in there as well.


And let’s just say, they haven’t been the darlings of my portfolio by a long shot.


It’s hard for a Canadian energy company to catch a break. The sector is under siege, the federal government is indifferent, the media has dug your grave, the pandemic has cratered demand, the capital markets are closed.


But a funny thing happened on the way to mutually assured joint bankruptcy in the second quarter. A lot of Canadian energy companies made a surprising amount of money and cash flow. What’s that you say? That’s right. Unlike their brethren to the south who have been flaming out in record numbers in 2020 and have lost a cumulatively staggering $300 billion plus in Free Cash Flow since 2014, Canadian energy companies tend to be very Canadian. Relatively boring, risk averse, conservatively managed and able to eke out cash flow at both the best and worst of times.


Will the market ever notice this historic disconnect and value play or will they continue to chase cheap money fuelled diminishing gains on overvalued macro plays? That remains to be seen, but it’s probably worth taking a look at why they should consider it.


So here goes nothing.


Headwinds and tailwinds. Why Canadian Oil and Gas stocks deserve a serious second look


1 – Pipelines and Egress


Yes, I know.  It’s getting pretty boring isn’t it? But it’s one of the most important factors affecting the energy industry and Canadian energy company stock prices. Without new pipelines and the ability access new markets, Canadian energy stocks will always be perceived as a dollar short. Why? Because we have told the market that so they bid accordingly. While the COVID-related cutbacks in production mean there is room on Canadian pipelines, it was less than a year ago that Crude by Rail was at record levels. The egress problem is getting solved, the pandemic has bought us time and once full capacity is restored in the Canadian market, Line 3 should be a thing, the TransMountain expansion will be at 50% completion or better and Keystone XL will be whatever it is. And when the market figures out that the egress problem is solved, part of the Canadian discount will disappear. In the meantime, Canadian producers will continue to incrementally increase production, stealthily make money, strategically invest and do all the things we expect them to do. Tailwind


2 – Commodity Prices


While this isn’t going to be news to anyone, oil and gas stocks tend to move up and down with the prices of the commodity they produce. This of course is the way it should be. If oil is higher priced, then it stands to reason that a company that produces said oil should be worth more. Makes sense, right? Not anymore. Currently the performance of Canadian energy stocks is disconnected from the prices of the underlying commodities. It is never a good sign when stock movements get disconnected from their underlying revenue generating line of business. Oil prices collapsed in early 2020 and while they have since recovered, the market lacks confidence in sustainability due to OPEC+++, COVID demand destruction. While some US companies have seen decent recoveries on price appreciation, Canadian companies have so far not been invited to the dance. Crosswind


3 – Stable, long term production


Canada has the capacity to produce some 4.5 mm boepd of oil. While this capacity has been reduced by some 30% due to government imposed curtailment and voluntary reductions due to COVD related demand declines we have the ability to bring most of that production back on stream fairly easily. And unlike the Light Tight Oil market in the United States we aren’t dealing with literally tens of thousands of wells with super steep decline profiles to accomplish this. More than 80% of Canada’s crude production comes from oil sands projects – both mining and in situ which are extraordinarily long-lived assets with very low decline rates. These projects are also already paid for which means rather than worrying about concept to production breakeven, the biggest worry is breaking even on an operating basis, and our costs are generally pretty low. Put another way, put a floor under prices and these projects are more of an annuity than a flyer. Tailwind


4 – Bad Public Relations


I think I wrote a whole blog about this some time ago, but we do a really lousy job of self-promotion. Aside from all the market and business issues, there are very few uninterested parties extolling the virtues of the Canadian energy sector. Instead we have a whole ecosystem of aggression and doom and gloom that serves to push investment in different directions. Who is going to invest money in a sector that needs to be defended by a “War Room” that talks about a giant cabal of US oil companies and charitable foundations lined up to protest us out of existence? The reality is far different. Canadian companies make money, have conservative balance sheets and offer high quality in demand product to a voracious consumer. Plus we have a pretty enviable regulatory system. But we aren’t getting the message out to the right people in the right way. This is why companies write down their investments in the sector and ESG focused financial institutions find reasons to not invest or to not insure our oil sands and related infrastructure. I’m not singling out the government here – if industry did a better job, do you think Jason Kenney would feel the need to try and do their job for them? As a whole, the industry needs to do a much better job figuring out its audience and its message. When producing companies are leaving your advocacy association, it’s time to take a second look. Headwind


5 –Climate Change and Peak Demand Fears


It is unavoidable that climate change factors play a part in the publicly traded energy sector. In a world where fossil fuels are seen as a pariah and renewables ascendant, it is easy to see where replacement fears, stranded assets and inevitable peak demand are catalysts for investment decisions. Canada is squarely in the crosshairs on this and the more air the misguided belief that fossil fuels are on their way out in the very near future gets, the more the prices of publicly traded companies find themselves held down. This is misguided on several levels but I would point out the following – the likelihood of fossil fuel demand being substantively reduced in the next generation is pretty much nil, peak demand assumes no growth in Africa and the Indian subcontinent and a perfect storm of renewable energy implementations. The next point I would make is that energy companies are run by very smart people. There is no chance that these management teams won’t be able to adapt to changing circumstances given and reinvent their companies for a gradually changing world. Headwind


6 – Capex collapse


In the wake of the Saudi-Russia price war, the demand collapse caused by the pandemic and the production rollbacks by OPEC++++ and other producers, capex programs around the world have been slashed, in some cases by 50% or more. In the short term the implications of this are pretty negligible unless you are a contractor who suddenly doesn’t have any work. But in the medium term, as demand recovers and inventories get drawn down and spare capacity gets used up the implications of all these projects being shelved will become apparent. Holding steady at previous consumption levels, the world needs to replace between 5 and 10 mm boepd of production per year. OPEC +++ spare capacity is about 10. So assuming a return to even 90% of demand, space capacity covers a year, two at best. That’s it. But many of these projects that have been shelved are long term developments that can take up to five years to bring online. This will result in higher prices and greater profitability for producers who have ready access to long term production. Like Canada. Tailwind


7 – Permian Permania Bankruptia


Up until early 2020, the United States continued to grow production like their hair was on fire. Never mind whether that is a good or a bad thing (it’s a bad thing BTW) or whether US companies actually have cash flow (they don’t). The key takeaway here is that the growth of production at all costs attitude of the average US producer has contributed to the worst market for energy stocks since the 1980s and has dragged Canada down with it, regardless of whether our production profile is different or whether our companies are actually returning real cash to shareholders. It was a contagion afflicting North American producers as a whole. But now, the bloom is off the rose so to speak. The rig count in the US has collapsed to less than 200 from more than 800 a year ago and there is concern that US production peaked in March of 2020. In a market where capital was once available on demand, bankruptcy and restraint are the orders of the day. The debt wall that faces the US producer sector just doesn’t exist in the same scale in Canada. Our production profile doesn’t depend on a drill bit focused treadmill – our best producers are generating cash from an installed production base that doesn’t need a tsunami of cash to keep afloat. If you were allocating energy capital to your portfolio, explain again why you would pick a Permian producer over say a Suncor or a CNRL? Tailwind


8 – US Election


Hey, there’s an election in the US this year in case you hadn’t heard. It may be a big deal. Aside from COVID and the pandemic politics, each of the candidates has, somewhere in their bag of tricks, a set of policies that will affect the Canadian energy industry. It’s easy to prefer Trump over Biden if you are an industry participant but I actually view each as bullish for Canada in their own way. Trump is obvious. He favours the fossil fuel industry and approved KXL. So if he gets re-elected that’s great for Canadian egress (and maybe the Permian – careful what you wish for) and oilsands producers. But what about Biden? He’s a Democrat. He hates fossil fuels. He will kill KXL (maybe). That’s bad for Canada! Maybe, but who it is really bad for is the US producer. Biden wants to ban fracking on federal lands, he’s going to introduce strict new methane emissions rules and limit flaring. He’s going to shut down more coal-fired electrical generation. This is all bearish – for the US energy sector. Canada? Not so much. Remember, the argument we make all the time to anti-fossil fuel advocates here is that the production will just come from somewhere else so, if it ain’t coming from the United States, why can’t it come from Canada, what with all that pre-installed infrastructure and all. Tailwind


9 – Competition


No, not renewables. I’m talking about producers and producing countries that produce the type of oil we do. I read a lot of commentary that Canada produces a substandard dirty product that no one wants and that there is no export market for our heavy oil and that the United States buys our dregs at pennies on the dollar because they pity us. Never mind that these comments are insulting to our industry, they are also poorly informed. Oil comes in many different ranges of quality, but for now, let’s separate it into light, medium and heavy. Light oil is used primarily for transportation fuel because it requires relatively little refining the lighter it is. Medium grades are used for transportation and other uses, with many products being made. Heavy oil has the most complex molecular structure which means it can be refined into the largest portfolio of products. A significant portion of the Gulf Coast is set up to refine and process heavy oil. This is why KXL is needed and is a favoured pipeline option. But heavy oil refineries are also in Asia and India and Africa. Heavy oil demand is growing. Light tight oil demand is not. Pre-pandemic this was very obvious to anyone in industry and once the dust settles here, it will be the case again. And who produces heavy oil? Saudi Arabia, Iran, Iraq, Mexico and Venezuela. Oh, and Canada. Iran is embargoed. Iraq doesn’t produce in sufficient quantities. Mexican production is falling and Venezuela, with the (on paper) 1st or 2nd largest reserves in the world has collapsed and doesn’t even have a rig working. Saudi imports into the United States have been on the decline into the United States for years. Why is that? Because little old Canada is a critically important and reliable supplier of much needed heavy oil into the US market. This is a good thing, is it not? Tailwind


10 – The Emotional often overrides the fundamental


This is the last point I will make and this is why it seems Canadian companies can never win. Our fundamentals are good. At US$30 heavy oil and a $0.75 dollar, while suffering through a pandemic with curtailment and voluntary restrictions, Canadian producers still managed to generate cash flow. CNRL made $415 million in adjusted funds flow in Q2. Our rocks are better. Our decline rates are lower. Our balance sheets are stronger. Our capex and spending discipline is higher. Our environmental standards and ESG scores are higher. Our regulatory regime is (for now) stronger. Our management teams are smarter. Our carbon footprint is shrinking. Our egress is happening. All that but “Trudeau”, “no pipelines”, “single customer”, “end of world pandemic”, “peak demand”, “depression”. It’s emotion and it overrides the fundamental. This is the world we are in. Until that changes, Canada’s energy stock prices are in the doghouse. Woof. But it is hard not to think that the winds of change are here and that at this point in time, sentiment is slowly turning back to Canadian names. headwind that may be turning


A bit of a mixed bag but if it was obvious everyone would already be on board right?


So what’s the answer?


Well you can either sit around and wait for the market to let you know or take advantage of this historic undervaluation of so many quality Canadian companies because it can’t last.


If I had a pile of money sitting around and I was allowed to by my broker, then I’m going long Canadian energy. A hard long. Even if only for the ridiculous dividend yields. I’m picking the highest quality companies in oilsands, conventional and gas-weighted production and letting it rip, trusting battle-hardened management teams to deliver.


Of course, the other alternative is shove it all into a slot machine or an EV company or Amazon and hope for the best. Given how stretched the current market feels, Canadian energy may actually be the less risky play and should have the longer legs return wise.


Prices as at July 31, 2020

  • Oil
    • Oil storage was… down!
    • Production was … FLAT?
    • OPEC+++++ is musing about increasing production come August
  • Natural Gas
    • Storage was up, historically very high; consumption flat; production flat; exports flat.
  • WTI Crude: $41.52 ($40.44)
  • Western Canada Select: $29.72 ($30.39)
  • AECO Spot: $1.943 ($1.814)
  • NYMEX Gas: $2.320 ($1.862)
  • US/Canadian Dollar: $0.7526 ($0.7441)



  • As at July 31, 2020, US crude oil supplies were at 518.6 million barrels, a decrease of 7.4 million barrels from the previous week and 79.7 million barrels higher than last year.
    • Production was down for the week at 11.000 million barrels per day, which of course we know is impossible. Production last year at the same time was 12.300 million barrels per day.
    • Imports rose to 6.010 million barrels from 5.146 million barrels per day compared to 7.148 million barrels per day last year.
    • Crude exports from the US fell to 2.819 million barrels per day from 3.211 million barrels per day last week compared to 1.865 million barrels per day a year ago
    • Canadian exports to the US rose to 3.785 million barrels a day from 3.289 million barrels per day last week
    • Refinery inputs increased during the current week to 14.637 million barrels per day
  • As at July 31, 2020, US natural gas in storage was 3,274 billion cubic feet (Bcf), which is 15% above the 5-year average and about 22% higher than last year’s level, following an implied net injection of 33 Bcf during the report week
    • Overall U.S. natural gas consumption fell 6.2% during the report week.
    • Production was down 0.7% for the week. Imports from Canada rose 10.0% from the week before. Exports to Mexico were up 1.1%
    • LNG exports totaled 18 Bcf
  • As of July 31, 2020, the Canadian rig count increased 2 to 47 (AB – 31; BC – 9; SK – 4; MB – 0; Other – 1). Rig count for the same period last year was 137.
  • US Onshore Oil rig count at August 7, 2020 is at 176, down 4 from the week prior.
    • Rig count a year ago was 770
  • Natural gas rigs drilling in the United States is flat at 69
    • Rig count a year ago was 171
  • Offshore rig count was unchanged at 12.
    • Rig count a year ago was 22

Trump Watch: Delay that election! Thigh Land.

Kenney Watch (new!): School’s back!

Trudeau Watch (for balance): Pretty sure I didn’t do anything wrong…



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