“What’s left of Canadian oil?” – March 29, 2020:
27-Mar-2020: TSX Oil Producers
| Name | Root Ticker | MktCap 31-Jan-2020 ($M) | MktCap 27-Mar-2020 ($M) | Loss |
|---|---|---|---|---|
| Suncor Energy Inc. | SU | 61,973 | 25,172 | 59.4% |
| Canadian Natural Resources Limited | CNQ | 44,182 | 15,811 | 64.2% |
| Imperial Oil Limited | IMO | 23,343 | 9,816 | 57.9% |
| Cenovus Energy Inc. | CVE | 14,155 | 2,887 | 79.6% |
| Husky Energy Inc. | HSE | 9,230 | 3,226 | 65.0% |
| Tourmaline Oil Corp. | TOU | 3,617 | 2,116 | 41.5% |
| Vermilion Energy Inc. | VET | 2,985 | 587 | 80.3% |
| ARC Resources Ltd. | ARX | 2,486 | 1,335 | 46.3% |
| Crescent Point Energy Corp. | CPG | 2,308 | 481 | 79.2% |
| Seven Generations Energy Ltd. | VII | 2,222 | 488 | 78.0% |
| MEG Energy Corp. | MEG | 2,024 | 365 | 82.0% |
| Whitecap Resources Inc. | WCP | 1,974 | 387 | 80.4% |
On January 31, 2020 there were 12 companies trading at a market cap of above $1 billion in the space (I removed the non-Canadian ones trading on the TSX). At the end of March 2022, there are about 28 of them.
CNQ is now the top dog with nearly a $100 billion market cap.
CVE bought HSE and is now sitting at around $50 billion.
How things have turned.
The even more interesting factoid is that when looking at CNQ’s quarterly earnings report, they have gone painfully out of their way to avoid telling people how much money they will be making.
The entire complex is trading as if the commodity environment is a ‘transient’ event. As a result, we are seeing very low free cash multiples to enterprise value.
This creates two avenues to earning a return.
One is that you sit on your rear end and wait for these firms to buy back their stock and/or give out dividends and you will earn a return the old-fashioned way – by buying and holding.
The other way is through speculation that the fossil fuel price environment is here to stay for a lot longer than most expect – you will then be a happy recipient of a multiple expansion.
Unlike a technology company stock that promises to pay out a decade from now after making copious amounts of expenditures, most (if not all) of the fossil fuel producers are generating cash today.
What is even more interesting is putting your mindset into the perspective of a pension fund manager.
You have a mandate to earn a return of, say, 7% for your clients. I’m ignoring the fact that CPI has skyrocketed this year (which would inevitably push up this number for the cost of living allowances that are typically given out with defined benefit plans, including the CPP).
On a day like today, both the overall equity market AND the long-term bond market have dropped. Normally there is an inverse correlation between the two assets. This correlation appears to be breaking.
If your pension plan is forbidden from investing in fossil fuels for whatever reasons, the pension managers have to achieve their returns in the rest of the market that does not include fossil fuels.
This is an exaggeration, but it is the financial equivalent of trying to earn a 7% net return on the residential condominium market in Toronto (or Vancouver, take your pick).
Formerly you were able to do it with leverage (e.g. take a 4% gross return and turn it into 7% by borrowing a bunch of money at 2%), but today, you can’t do this in a rising rate environment. Rising interest rates increase the cost of carrying debt, and hence why you are seeing liquidations.
Likewise in the equity and bond markets, the leverage trade appears to be unwinding. Central banks have given fair warning rates are increasing. Unlike in 2017 when rates rose again and inflation was very low, today’s environment has inflation figures that have not been seen since the early 80s.
“The entire complex is trading as if the commodity environment is a ‘transient’ event.”
Well, depending on the time scale in question, these high prices are a transient event. Certainly, the past months have been very good to the sector, allowing much needed healing of balance sheets and the acceleration of the return of FCF to investors. What of the future though?
The narrative “everybody knows” is that low prices killed investment in production and ESG forces are preventing reinvestment at the scale required to bring prices down as demand returns post-COVID. Putin’s insane war clearly helped Western producers too.
I’ll suggest here that demand destruction today is deeper and longer lasting than anything the world has seen, particularly but not only in Europe. Yes O&G will be used for decades yet but the future of much lower demand is being pulled closer by high prices and global efforts to decarbonize.
If Putin’s special operation fails, for example, and Russian reparations are required in Ukraine, O&G prices will plummet making any share buy backs today look like a terrible waste of capital. Canadian O&G producers are wise to return cash to shareholders – if it is in the form of regular and special dividends.
The time to buy O&G stocks was many months ago. For those that did, now is the time to enjoy to spoils. It will end sometime, maybe soon maybe not. When it does, the entire complex will get killed, again. I’m long gone with the exception of some midstream investments.
I have no doubt there will be a decarbonization effort, but I will only start to believe it actually taking place when I see nuclear reactors actually built and operating (conventional or small modular, doesn’t matter).
The other scenario that kills demand is an economic collapse that takes down the world to a degree where it will impact a few million barrels a day of demand (e.g. from 2019 to 2020 world oil consumption fell from 98 million barrels/day to 88 million, due to Covid shutdowns). Whether this presumptive collapse occurs due to high energy prices or not is another matter (I am sure it will be a partial reason).
The Russian situation is indeed a wildcard.
However, on the demand side, right now there is an obvious insatiable and increasing demand for fossil fuels, especially coming from Asia (India, China, Vietnam, Indonesia, Korea, Japan, etc. you name it). We might be cutting back in North America, but definitely not overseas.
“We might be cutting back in North America, but definitely not overseas.”
I think you’re underestimating this Sacha. For example, China’s 14th five year plan (2021-2026) has a goal of “half of the vehicles in China be electric or fuel-cell powered, and half hybrid by 2035.”
Half of new car sales in Norway were plug in electric last year and Germany was hitting more than 1/3 earlier this year – which, supply chain allowing, will be shooting up big time.
On the grid side, nuclear, battery storage (including especially, bidirectional charging for EVs) and other investments are definitely required for a step change. I agree there.
Good luck to producing those battery vehicles. You’ll have to strip mine half the planet to get the raw resource to construct them in the quantities they’re talking about.
I think it is a big myth that Norway’s move to electric vehicles has impacted their fossil fuel consumption. Data, for example: https://ycharts.com/indicators/norway_gas_and_diesel_oil_demand
Again, when countries get serious about nuclear, it will open up many more options for electrification than present. Just as a trivial example, if General Fusion was successful and produced energy “too cheap to meter”, it would open up very interesting engineering options to mining lithium out of ocean water, and desalinization plants all over the place, etc, etc. A lot more becomes viable if your electricity was effectively free, the mind goes wild. And just think of the infinite crypto you can mine!!