Oil prices and Canadian oil stocks have gone in vastly different directions since mid-December. The West Texas Intermediate crude commodity benchmark price has dropped 3.2 per cent since December 15 while the broader energy sector has climbed 23.4 per cent. Have equity buyers in the energy sector gone insane?
This week's chart shows the value of a hypothetical $10,000 investment in each of WTI crude (converted to Canadian dollars), the broad S&P/TSX energy index and the 39-member S&P/TSX oil and gas exploration and production index.
From the end of 2012, Canadian energy stocks tracked the commodity price reasonably closely. The first exception, May to October 2013, was caused by a sharp rise in the U.S. dollar in the wake of the taper tantrum (the Fed's first warning that they were going to cut back on quantitative easing). The WTI price was actually stable around $90 (U.S.) for the period.
The second divergence between equities and the commodity price started on December 15 when Repsol SA announced a takeout of Talisman Energy Inc. for a 68 per cent premium to the stock price at the time. Canadian energy equities have been climbing since, while the oil price continues to fall.
Energy Stocks vs the Oil Price: Value of $10,000 Invested
SOURCE: Scott Barlow/Bloomberg
At this point, equities are well ahead of the commodity price. Those optimistic about the prospects for the sector will claim that "the market is looking forward" to a time when the commodity price will be higher. But if so, this is a new phenomenon. Previously, energy stocks and the oil price moved roughly in tandem. Equity prices didn't look ahead before, so it's hard to argue that stock prices have suddenly become a leading indicator.
There is, no doubt, a significant degree of speculation in TSX energy stocks at the moment. Investors are gambling that the current low oil price will be temporary despite a series of warnings from Wall Street that a commodity price recovery is a long way off.
Citigroup global energy strategist Anthony Yuen predicted that the WTI price would fall to $20 (U.S.) per barrel in a recent media appearance. On Thursday, Bloomberg quoted Goldman Sachs analyst Sven Jari Stehn predicting that "the decline in oil has been driven by an oversupplied global oil market [and] the new equilibrium price of oil will likely be much lower than over the past decade."
But if energy investors are working without a net somewhat, a deeper look at the performance attribution (not shown in the chart) of the S&P/TSX energy index shows they have not gone completely out of their minds. Three of the largest positive contributors to index performance since mid-December are pipeline companies Enbridge Inc., TransCanada Corp. and Inter Pipeline Ltd. – they are far less sensitive to lower oil prices than producers. Along with gas-heavy names like Encana Corp., these non-oil companies are the main reason the energy index has so drastically outperformed the narrower S&P/TSX oil and gas exploration and production index.
The point remains, however, that oil producer stocks remain well ahead of where the commodity price suggests they should be, in defiance of a number of credible expert opinions. This does not mean the gamble won't pay off in the end, but investors should be aware of the risks they're taking by buying oil producers in the current environment, and allocate their investment assets accordingly.
Follow Scott Barlow on Twitter @SBarlow_ROB.