Getting Fit for “Lean” Oil: Companies Shape Up, With Cheaper as the New Normal

August 11, 2017 Richard Schmidt

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One sector looking a bit skinny on stock markets right now is energy: many companies have been incurring losses since crude oil prices dropped by half in recent years.

Yes, oil prices are low, but I’m okay with that.

Looking back over 30 years, the sustained high oil prices of the early 2010s look very much like the real anomaly. We’ve certainly seen companies able to profit at a lower per-barrel cost in times past. I still believe there’s a sound rationale for maintaining exposure to the sector.

Let’s talk about why the energy sector is still an important staple in many MD portfolios, and how some of the key companies we’ve held have fared well in tough times—a few have even increased in value since oil was priced up in the triple-digits.

 West Texas Intermediate Oil Price (CAD$ per barrel, adjusted for inflation)Crude-Oil-prices_line-graph-E

High oil prices aren’t the norm: We’ve seen “low” prices before. Again and again.  
Source: Bloomberg.

An economy gorged on oil: then, a crash diet

Just a few years ago, Canada’s economy gorged on the success of our oil sands producers, as crude oil prices topped $100 per barrel. When global prices collapsed in 2014, it walloped the industry, prompting majors such as Royal Dutch Shell PLC and ConocoPhillips Co. to sell off their oil sands assets.

Although prices have recovered from their latest low, they have been range-bound between US$40 and US$50 per barrel. We do not expect the price to move much higher for the rest of the year.

Companies adopting a mindset of “lower prices forever”

The head of Europe’s biggest oil company said last month his business is adopting the mindset of low oil prices “forever.” Royal Dutch Shell CEO Ben van Beurden said this during a Bloomberg interview in which he also revealed the new car he’s getting next month is an electric plug-in Mercedes-Benz.

Canadian oil producers are also adjusting to an indefinite new normal of cheap oil, emerging alternatives and climate change shift—and a few have fared better than others.

Outliers in the oil patch: companies get fitter

A look at specific stocks within our energy portfolios reveals a few that stand out for their resilience through these times. “Despite the dramatic decline in oil prices, valuations for some large Canadian producers are actually higher today than they were in 2014, especially for Suncor and Canadian Natural Resources,” says Hovig Moushian, Portfolio Manager with the Mackenzie All Cap Value Team.

The Mackenzie team is the sub-advisor for the Canadian Equity Segregated Portfolio of stocks we buy for clients of MD Private Investment Counsel.

Moushian says these producers trimmed operating costs, became more efficient and bumped up production to reduce the cost of making each barrel. More importantly, both Suncor and Canadian Natural Resources are generating significant free cash flow on higher production compared to 2014, when cash was directed to large capital projects. 

“We believe valuations are reasonably attractive depending on the company and believe the potential for higher oil prices from current levels is far more likely today than when oil prices were over $100,” he says.

Another plus is opportunity to profit at various stages of production. For instance, Suncor owns four refineries and more than 1,500 retail locations under the Petro-Canada banner.

Everything in moderation

Oil remains an important—if evolving—part of the global economy. MD’s allocation to energy is different for each fund in our roster. Canadian funds typically have a higher allocation to energy, as the sector is a big part of our capital markets, representing 20% of the S&P/TSX.

Of course, I’m not suggesting that everyone will be feasting on energy stocks in the near future—just that they can be maintained as part of a healthy mix to keep a portfolio in balance.  

About the Author

Richard Schmidt

RICHARD SCHMIDT, CFA, is a Quantitative Investment Analyst with the Investment Management team at MD Financial Management. He provides research and analysis for all fixed income and equity mandates.

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