Fabrice Taylor, CFA, publishes the President’s Club investment letter. His letter and The Globe and Mail have a distribution agreement. You can get a free copy here.
Funny how we’re happy to sell the Chinese our resources, BlackBerrys and private jets, thrilled to buy cheap stuff from their factories, and overjoyed whenever someone says they will save the world economy with their hoard of U.S. dollars. But just let them try to buy one of our second-tier oil companies and suddenly we’re a little suspicious.
I think all of the hubbub over CNOOC’s bid for Nexen misses the bigger picture about investing in the oil patch, particularly the Western Canadian Sedimentary Basin. It’s not an attractive place to put money unless maybe you’re a state-controlled entity that effectively pays no tax, has almost unlimited access to capital and a 50-year investment horizon.
Just look at the problems. First, there’s soft demand south of the border. Judging from refinery margins, demand for gasoline is average at best. The U.S. economy might be recovering, but not fast enough to spur demand at the pumps. When a tenth of your work force is unemployed, that’s not surprising. And with extra unemployment benefits set to expire for out-of-work Americans, it’s easy to expect that one of the first expenditures to be cut will be gasoline.
This is reflected in the discounted price for West Texas Intermediate, the North American crude benchmark, in comparison to the price for Brent, the European standard. Crude is piling up south of the border and we need to find new markets for our growing output.
New oil pipelines will eventually help move our oil to more attractive markets, but these take years just to win permit approval, let alone build.
Consider what happened to the Keystone pipeline – politics got in the way and, while the line will most likely get built, it’s been delayed and more delays are possible.
Hopes of getting oil from the basin to Asia in the near term can’t be terribly high either with British Columbia grasping for whatever it can get and Alberta digging in its heels. The Gateway pipeline is probably going to take an extra couple of years or more. It’s already facing several years of engineering and construction.
Don’t count on pipelines to save oil prices. Moving crude by train is an option, but that is expensive and eats into profits. You can’t charge more just because your expenses are higher. Oil producers are price takers.
What you can count on is more supply. The drilling rigs are still going hard, but they’ve shifted their attention away from gas to oil. What new discoveries and new technology did to natural gas they will do to oil, although no one wants to talk about that these days. This is the oil patch after all, renowned for burying its head in the sand. But the evidence is already apparent. Once-abundant oil producers like Texas, whose production had been declining for years, are now growing their output.
The average global cost to supply a barrel of oil is about $75 (U.S.) but some of these technologically advanced plays are considerably lower.
So, more supply with potentially falling costs, stagnant local demand and a barrier to tapping into stronger demand and prices. That sounds like the gas market of a few years ago. History could repeat itself.
And while it’s true that North America still imports a lot of oil, it’s dangerous, if not silly, to think it’s foreign suppliers who will lose market share. They are still, despite transport costs, usually lower-cost suppliers.
Oil is becoming more abundant. That’s good news for the economy, but not necessarily for investors.
Natural gas is probably a better bet. But as long as oil prices don’t crater completely, oil-field service stocks might be the best bet.
There’s an old saying about the gold rush: Only the pick-axe makers made any money. In the rush for oil, there may be an analogy.