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Report on Business Pressure mounts for oil patch as crude prices fall, pipeline capacity problems rise

The “Kenney bump” in Canadian energy stocks was short-lived.

Slumping crude prices have combined with a host of new fears about the industry’s inability to expand its capacity to move oil. Anticipation that investors would return to the sector en masse following the election of Premier Jason Kenney’s United Conservative Party government in Alberta has not materialized. Now, analysts see little stability for the sector on the horizon.

“You know what it feels like? It feels like Whac-A-Mole,” said Jeremy McCrea, an analyst at Raymond James. “You solve one problem and another thing pops up.”

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Investors are again worried about the many regulatory, political and legal problems that keep buffeting the industry – including the fight in Ottawa over a new federal environmental assessment policy for major projects, and this week, new concerns about Enbridge’s pipeline system in the U.S. Midwest, Mr. McCrea said.

Those events and falling crude prices have heaped renewed pressure on Canadian oil and gas shares.

In April, the victory for the UCP, which ran a staunchly pro-industry campaign, pleased many energy investors and initially helped to push up share prices to six-month highs. It’s been a sharp retreat since then. The S&P/TSX capped energy index rose slightly on Friday, but is down 18 per cent from its recent high on April 23. Among big-name producers, Encana Corp. has fallen 34 per cent in that time, Canadian Natural Resources Ltd. 15 per cent and Suncor Energy Inc. 12 per cent.

West Texas Intermediate, the U.S. benchmark for crude, jumped nearly 3 per cent on Friday to settle at US$54.09 a barrel. But oil is still down 18 per cent from its April high against a backdrop of worry that trade tension between the United States and China will lead to a widespread economic slowdown and crimp demand, just as forecasts for U.S. oil production are on the rise. The Organization of Petroleum Exporting Countries and other major producers are slated to meet in the coming weeks determine whether to extend current output quotas or change them over the next half of the year.

“I think there’s some kicking of tires in stocks, but realistically, there’s no urgency to invest because every new week presents a new news item or challenge or judicial-type decision. It isn’t really motivating anybody to take on risk in the space,” said Robert Fitzmartyn, analyst at GMP FirstEnergy.

Canada’s oil patch has struggled with a combination of insufficient pipeline capacity to export crude and waning investor interest as the industry in other regions – notably the Permian Basin in Texas and Oklahoma – attracted a gusher of capital. At the start of this year, Alberta’s previous New Democratic government responded to transport woes with a contentious move to force production cuts on oil producers to deal with a glut of supply. The curtailments, although reduced, remain in place under Mr. Kenney.

There is some cause for optimism. On June 18, the federal cabinet is expected to approve the much-delayed Trans Mountain pipeline expansion between Alberta and the West Coast, which would triple the oil line’s capacity to 890,000 barrels a day. Even so, court challenges by opponents are all but certain. Even if construction is allowed to begin, the earliest the project would be in service would be 2022.

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Meanwhile, Enbridge Inc. suffered a setback last week in its already-delayed quest to replace a major Canada-U.S. pipeline known as Line 3 when a Minnesota court ruled its environmental assessment was inadequate. In addition, an existing Enbridge conduit, Line 5, faces the threat of being shut down within two years in a disagreement with Michigan’s governor over whether it should be allowed to operate while the company constructs a tunnel under the Straits of Mackinac to house a replacement line.

Natural gas producers, meanwhile, have also been hit with a combination of tight pipeline capacity and low prices.

Because investors expect that output growth will continue to be constrained, oil and gas producers that analyst Mr. McCrea covers are selling in the market for an average of about four times their cash flow per share. That is paltry compared with historical multiples of about seven times, he said.

The share drops only extend a rough run that began, for some companies, before the oil-price downturn in late 2014, said Martin Pelletier, portfolio manager and co-found of TriVest Wealth Counsel. The situation highlights the difficulties in picking stocks in the oil patch, amid the industry-specific and macroeconomic volatility.

“What you got back in last 10 years hasn’t been very rewarding, especially considering the level of risk,” Mr. Pelletier said. “Especially since we’re not seeing any sort of inflation work its way into the economy. In a disinflationary environment you’re not going to see a strong outlook for oil.”

With files from Megan Devlin in Toronto

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