Hey there, time traveller! This article was published 20/8/2016 (1806 days ago), so information in it may no longer be current.
It used to be a Canadian investor’s portfolio wasn’t complete without significant exposure to the energy industry. That has changed in the span of two years.
Now many investors are dumping these investments or, at least, considering doing so — particularly those involved in oil, as the price for the commodity hit lows that, before late 2014, were almost unforeseeable.
Yet, one fund manager following the industry says oil is likely reaching its bottom, and astute investors may find bargains in the midst of the carnage.
"We’re finding most of the value right now for the large integrated companies," says Doug Edman, director of investments and a member of the basic materials research team, covering the oil and gas industry, with Brandes Investment Partners.
The Atlanta-based analyst is referring to large oil firms that extract, refine and sell products such as gasoline and diesel. These include giants such as Suncor Energy, Exxon Mobil Corp., BP Plc. and Chevron Corp.
"Over the last couple of years, because oil prices went down, the market fairly indiscriminately hit the stocks of everything in the oil business, whether it was upstream, downstream, integrated, oilfield services or drillers," Edman says.
While upstream firms — those that explore and extract the commodity — have suffered in North America, with many smaller firms going bankrupt, the bigger integrated oil companies with more diverse streams of revenue, such as selling gasoline, have managed to weather the storm.
And when oil rebounds, they’re poised to do well, Edman says.
Of course, when that will occur is a multibillion-dollar question.
Edman says it’s unlikely consistent US$100-plus-a-barrel oil will be seen any time soon — or ever again for that matter. But that doesn’t mean investors should not have exposure to the sector. Profits are still to be found, he says.
The reason: demand is still growing, even faster than its historical pace.
"If you draw a line for the last 40 years, you’ve seen global consumption of oil ramping up about a million barrels a day each year," he says.
That hasn’t changed. "In fact, last year, there was pretty stellar growth at 1.8 million barrels a day."
For this year, the Energy Information Administration in the United States predicts global demand will grow by more than 1.4 million barrels a day.
The growth alone should be reason enough to believe prices will rise with demand — eventually. But the problem, so far, has been North America’s industry — largely involved in unconventional oil production involving horizontal drilling and hydraulic fracturing (fracking) — had been ramping up production as much as possible while prices were above US$100 for a barrel of West Texas Intermediate oil.
"Most oil companies, as well as oilfield services and drillers, were expanding capacity and really trying to grow. And it made sense (up until the fall of 2014)," he says.
Yet, as supply from North American sources grew, the Organization of the Petroleum Exporting Countries, led by Saudi Arabia, opted not to limit production to maintain higher prices. The decision was, and is, largely driven by OPEC members not wanting to lose market share to North American competitors. And because many U.S. and Canadian producers require high prices to be profitable, cheap oil affects them much more negatively than most OPEC producers, which generally have larger conventional reserves that are less costly to produce.
The strategy has worked. North American producers have cut back on spending on new projects while exploration and drilling have largely stopped. Dozens of firms have gone bankrupt, including many junior companies in Canada.
After consecutive years of growth in North America, production is expected to be down this year, Edman says. And it will continue to slow as long as prices remain below US$50 a barrel.
The lack of new production undoubtedly will stymie supply growth, not just because no new oil is being added to the market. Existing production will also decline among unconventional producing assets because of the nature of those deposits.
"On these unconventional wells, what happens is you see peak production occurring on these assets almost right from Day 1, and they have a very steep decline curve," Edman says.
To maintain production in North American, new drilling is required. And that’s not happening — at least at sustainable levels.
Recent reports indicate increases in rig counts, but that’s largely a response to a decrease in production caused by the Fort McMurray, Alta., wildfire, which shut down activity across the areas for weeks.
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Edman sees a brighter future simply because supply is coming down quickly while demand continues to increase. "Based on current oil prices, through the long term, there will not be enough oil produced to meet global demand. So you’re going to need to see higher prices and, along with those, you’re going to see higher returns being generated by these companies."
However, new environmental regulation to fight climate change and advances in green technology will likely limit how high the price of oil will go, he says. In other words, he doesn’t foresee a return to the 2008 peak of US$147-plus per barrel. He says even US$100-barrel oil is unlikely, and if it does go that high, OPEC will likely intervene to defend its market share.
The sweet spot, he says, is likely between US$50 and US$80 a barrel.
While Edman says he cannot predict with certainty when oil will rebound, he does argue it could be sooner than some think because of basic supply-and-demand economics. Supply will continue to contract below US$50 a barrel, while demand will steadily grow and, at some point, demand will surpass supply.
"In other words, we need greater-than-$50-a-barrel oil price, in my opinion, to be able to meet future demand," he says. "I don’t believe we have to wait five years (for that to happen). It will likely happen in the next year or so."
Upstream, downstream — what’s the difference?
In the oil and gas business, companies are generally broken down into two categories: upstream and downstream. Upstream producers are involved in getting the product out of the ground and to the refineries. Downstream producers are firms that refine the oil and sell its products to consumers.
Some also refer to midstream companies that transport and store oil. In addition, drillers and oilfield suppliers are often considered a subset of the industry. Lastly, there are the integrated companies that explore, extract, refine and sell oil-based products.
Well, not quite. Civilization is still largely addicted to this source of energy, so it’s not going away any time soon. But recently, experts have argued the world’s reserves of oil may become stranded assets in a few decades as we transition off fossil fuels to renewables such as wind and solar. In this camp is former Bank of Canada and current Bank of England governor Mark Carney, who, in a talk last year, cautioned bankers much of the world’s oil reserves could be stranded (left in the ground) if nations become serious about averting the worst impact of climate change.