Top Canadian Oil and Gas Producers

The following chart is a brief list of the top-10 sized oil and gas companies in Canada, and their year-to-date performance ended September 1, 2010, not including the impact of dividends (which would be significant in the cases of COS and PWT which distribute most of their income through their trust structure):

Name Ticker %-YTD
Suncor Energy Inc. SU -9.35%
Canadian Natural Resources Limited CNQ -7.63%
Imperial Oil Limited IMO -2.73%
Husky Energy Inc. HSE -16.42%
EnCana Corporation ECA -13.19%
Cenovus Energy Inc CVE 11.66%
Talisman Energy Inc. TLM -13.00%
Canadian Oil Sands Trust COS -14.04%
Nexen Inc. NXY -19.27%
Penn West Energy Trust PWT 6.09%

Cenovus is clearly the winner here – investors are quite happy with parking capital into non-conventional Canadian oil.    It is surprising that Suncor has not fared better, probably due to integration concerns with Petro Canada.  Husky Energy and Nexen have been the worst performers.  Husky has had a significant management change and appears to be in petrochemical limbo with no obvious growth.  Nexen has Gulf of Mexico exposure and this can explain its performance.

It should be important to distinguish the difference between oil and gas – gas commodities have been priced significantly less than oil over the past couple of years, so EnCana and other gas-concentrated producers should lag the oil companies at present.

Finally, there are likely many more analysts out there that follow these ten companies that are much more knowledgeable about the individual companies and their exploration properties, so it is unlikely that by mining the relative price data that there can be any value extracted from this very simple analysis.  It does tell you which companies have had lowered and raised expectations since the beginning of the year, however.

Market psychology in the last week before labour day

Everybody is on holiday this week.

Thus, yesterday, when the markets went down, it was because of “traders betting on a double dip recession”. Today, the markets are up, so therefore it is because “they are betting on an economic recovery”.

It’s advisable to just not pay attention to the headlines and instead just pay attention to individual issues that might be wildly taken up or down in low volume conditions.

Uranium One now majority controlled

Uranium One’s shareholders voted convincingly in favour of the takeover of a majority stake in the corporation by a Russian “crown” corporation SC Atomredmetzolo (“ARMZ”) with approximately 91.99% of non-ARMZ shareholders in favour of the transaction.

The salient terms of the agreement is that ARMZ will take a 51% majority stake, and pay the rest of the shareholders $1.06/share in a cash dividend. Shareholders, assuming they haven’t already sold at market value, will be in for the ride and will have to make sure that their interests are in alignment with the majority ownership.

This is almost the reverse case of Magna International, where the Stronach family is being paid a considerable sum by the corporation to relinquish its controlling stake.

Investors should always be very cautious in making sure whenever they invest in companies that have majority or near-controlling ownership stakes that their interests are in alignment with the large shareholders. While a majority stake is not necessarily an exclusion criterion to considering a potential investment, it does raise the bar considerably higher. I tend to have a high aversion to majority or near-majority controlled domestic corporations as they can abuse minority shareholders.

The debenture holders, however, should be looking good – Uranium One has a December 31, 2011 issue that has a 4.25% coupon that is a very probability candidate for maturity at par; between the bid and ask, it is trading at 98.5 cents. Once you factor in capital gains, it is a relatively low risk 5% return on investment. Uranium One has another outstanding debenture issue that matures in March 2015 and this one is muddied by the fact that the conversion privilege (at $4/share) is close to the common stock price – this issue is trading at around 105 cents.

It is not likely that the 1.3 years between now and December 31, 2011 will pose much of a credit risk for the initial debenture issue – the corporation is likely to refinance this debt. However, the 2015 debenture has more embedded risk simply due to the time between now and the March 2015 maturity – you never know how much of the company assets will get stripped out. The worst case scenario is that ARMZ will try to to repatriate the assets (mainly agreements to mine and sell Uranium, mostly from Kazakhstan) of Uranium One into some other corporation controlled by ARMZ. You then don’t have to worry about the bankruptcy of a Canadian corporation once the assets have been stripped out of it, and debenture holders and shareholders alike would be left with nothing. It is unlikely this scenario will happen by 2011, but by 2015 it becomes somewhat more likely.

Suffice to say, I won’t be touching the equity or debt of this corporation.

Canadian Interest Rate Projections – August 31

Looking at Banker’s Acceptance Futures, we have the following rates:

Month / Strike Bid Price Ask Price Settl. Price Net Change Vol.
+ 10 SE 98.915 98.930 98.925 0.000 16053
+ 10 OC 0.000 0.000 98.830 0.000 0
+ 10 NO 0.000 0.000 98.820 0.000 0
+ 10 DE 98.890 98.900 98.900 0.000 27314
+ 11 MR 98.820 98.830 98.830 0.000 25451
+ 11 JN 98.740 98.750 98.750 -0.010 8618
+ 11 SE 98.600 98.620 98.610 0.010 1774
+ 11 DE 98.480 98.520 98.490 0.020 1197
+ 12 MR 98.360 98.440 98.370 0.060 386

It looks like that there will be a higher than 50/50 probability that the Bank of Canada will raise their overnight target rate by 0.25% in their September meeting, but after that, future rates in the 2011 calendar year are projected to go up by 0.25% to 0.5%.

The drop in increase expectations has likely contributed to depreciation of the Canadian currency – currently at 94 cents US to a Canadian dollar, while this was high as 98 cents earlier in August, and at parity back in April.  During the depths of the economic crisis, the Canadian dollar reached 78 cents multiple times throughout the October 2008 to March 2009 period.

Deflation before inflation – What to do in a deflationary environment

The bond market is pricing in an upcoming deflation. Canadian 10-year benchmark yields are at around 2.8%, which is quite close to the all-time low of 2.55% reached during the pits of the economic crisis in early 2009. Although I stated previously that the next economic cycle will be inflationary, it will only be after certain conditions have been achieved – mainly the willingness of companies and consumers to spend money. Until then (which could be years away), we will not see inflation.

If this is true, then cash is likely to be a good performing asset class, if not the best asset class.

Cash is also the least “sexiest” of asset classes. It is boring. Just imagine trying to tell your colleagues that your investment portfolio is packed full of Canadian dollars. It provides a very low return (about 2%), and no possibility of appreciation. It is ironic that it might be a good asset class by virtue of other asset classes having negative returns.

Investors of government bonds will also be profiting in a deflationary environment because the government will be guaranteeing the payment of the principal – longer durations will result in larger capital gains as yields go down.

Corporate debt and other fixed income securities will fare less well simply because in deflationary environments it becomes more difficult for companies to generate cash. Debt-issuing companies will have to repay debt in nominal dollars that will have higher real value – hence, credit risk becomes a more predominant concern of the pricing of the corporate debt. For companies that have good solvency ratios (e.g. debt-to-equity and/or debt-to-free cash flows are very good), then this becomes less of a concern and corporate debt will then appreciate. But junk debt issues or corporations that are inflation-sensitive (i.e. can’t charge as much to your customers) will not be a safe haven in such an environment.

Deflation really messes with economic intuition and if market participants cannot adapt to it, there will be inefficient pricing in the markets to take advantage of if it does materialize. It would be a virtual guarantee that the Canadian real estate market would get hit badly in an economic deflation, as the prospect of paying off higher-valued debt in the future would crush prices and trump even the low interest rates that would be offered to credit-worthy customers.