Tag: CNQ

Canadian Energy Update

Here is a quick post on the state of Canadian energy production companies – especially as the federal government continues to destroy the industry. As of September 30, 2020 there are 12 companies listed on the TSX that are over a billion dollars in market capitalization. There are 24 between $100 million and $1 billion, and some of these names are in very bad shape indeed. Also out of these 36 companies, some are TSX listed but have the majority of their operations outside of Canada.

For this post, I will focus on those above $1 billion. Companies that are under this threshold are still invest-able but one has to pay careful attention to whether they will survive or not in the hostile regulatory environment.

If your central thesis is that fossil fuels are going to decline and die in a relatively short time-frame (e.g. 20 years) then you probably won’t want to invest in any of these. Demand destruction will impair pricing and the ability to produce supply will not accrue excess gains to any names.

However, this is not going to be the case from a simple perspective of energy physics (laws of thermodynamics if anybody is interested in studying). Renewable sources do not scale to the magnitudes necessary. It also costs massive amount of up-front investment to implement renewable energy sources. It is relatively easy to ramp up energy usage from 0% to 5%, but above this, it becomes very obvious what the deficiencies are of renewable power sources (California discovered this in the summer). Putting a long story short, the more renewable (intermittent) sources you have on a grid, the better will be for on-demand generation sources – this means either you go with natural gas (fossil fuel!) or hydroelectric (we’re mostly tapped out in North America). Batteries make sense in smaller scale operations but not in state-province level grids. Or you can rely on imports, which just like liquidity during a stock market crash, is generally very expensive or not even there when you need it the most.

With respect to transport fuels, we will classify this as passenger, freight and aviation. For passenger vehicles, we all see Teslas and the like on the road, but the infrastructure required to refine and produce the battery materials to replace a substantial portion of the automobile fleet is still a long ways away. For freight, battery-powered transport automobiles are an illusion due to the requirements of existing freight haulers (you need to be able to transport 80,000 pounds of goods at a long distance and also cannot afford to spend 12 hours at a charging station to refuel).

My opinion will change if nuclear becomes a viable option again for power generation (from a political and cost perspective, not a technical perspective).

Some pithy notes (these are the C$1B+ market cap companies):
SU, CNQ – Clearly will survive and represent playing a very long game. Personally like these much more than the big majors (e.g. XOM, CHV, COP, BP, etc.).
IMO – Majority foreign (US) held (XOM), wonder if they will make an exit
CVE – The best pure-play SAGD oil sands player (maybe to be contaminated by HSE acquisition)
TOU – Spun off another sub, largest of the Canadian NG players, FCF positive
HSE – Soon to be bought by CVE – will be interesting to see how CVE makes more efficient
OVV – Mostly American now, with big major style culture and cost structure (i.e. $$$)
ARX – Second NG/NGL play, FCF positive
PXT – Substantively all Colombia operations, that said their financial profile is quite good relative to price
PSK – Royalty Corp (royalties are not my thing – just buy the futures, although pay attention to price, if they get cheap enough, royalties are typically a better buy)
CNU – Chinese held, illiquid security
VII – Liquids-heavy gasser, FCF positive (barely), a bit debt-heavy

Natural gas prices getting slaughtered

The “discovery” of economical shale gas mining has done an extraordinary job of depressing natural gas prices since the price shock of 2008:

It is noted that the spread between crude oil and natural gas prices have reached an all-time divergence, but this is likely to be temporary – it will just be a matter of time before the laws of supply and demand force effective conversion between the two commodities. For example, it makes it more economical to use a higher natural gas input to achieve an output of crude given the price spread. Activities such as tar sands mining are very intense on natural gas (to generate steam) and as a result, the market should equalize over time.

One of the worst ways of playing natural gas is by purchasing a Natural Gas ETF (UNG), as it does not actually hold the physical commodity – traders will eat away at the fund when it has to rollover its futures contracts. Even purchasing calling options or the futures directly still exposes you individually to rollover risk. You could buy long-dated futures, but there is very little liquidity in the marketplace and you pay a significant premium, as the market is anticipating future price increases.

The only real way for people to play natural gas on a long-term basis are to purchase producers with considerable reserves. Which producers to pick is a matter of risk tolerance and market pricing. Typically if an investor wishes to be fancy, they would ideally pick a producer that has a marginal cost structure such that the cost to produce natural gas is that of the present market price; such a company will be losing significant amounts of money and will be trading at depressed valuations. Assuming this is the case and assuming the market has significantly marked down the equity in such a money-losing company, it is a very speculative way of playing for a natural gas price increase.

This principle also works with any other commodity on the planet – including crude oil and gold companies. Again, it depends on doing your homework with respect to valuations and knowing what value you are receiving when you put in the order for shares.

A more conservative strategy and one that relies on other market participants to have done their homework to receive a fair price is to purchase shares in EnCana or Canadian Natural Resources, which are the top two natural gas producers in Canada. After the split-up of EnCana and Cenovus, EnCana is a much more “pure play” on natural gas than Canadian Natural Resources. With either company you will not see your money double over the course of a year or two, but it will certainly be there at the end of the day and also provides a bit of comfort with respect to inflation-proofing a portfolio. Despite all of the media and political attention paid to carbon emissions, it is a given that natural gas and crude oil continue to be consumed in massive quantities for the foreseeable future. The only promise is that, over the long run, it will get more expensive.