In one of the great contrarian investments of our time, billionaires such as Murray Edwards and Li Ka-Shing are pouring money into Alberta’s oil sands.
While foreign energy companies were selling their oil-sands holdings and investors were purging domestic energy stocks from their portfolios, Mr. Edwards’s Canadian Natural Resources Ltd. (CNRL) and Li family-controlled Husky Energy Inc. have increased their stakes in the region. As part of a massive shift in ownership that has seen more than $37-billion of oil-sands assets change hands, CNRL dropped $16.5-billion to acquire properties from Devon Energy Corp. and Shell Canada Ltd., while Husky spent US$435-million on a heavy oil refinery last summer. Both companies are expected to keep investing.
Why the show of faith from Mr. Edwards and the Li clan? As Dustin Hoffman’s character was told in the film The Graduate, in one word, plastics.
Research from the International Energy Agency (IEA) and other non-partisan groups shows that “petrochemicals are the fastest growing source of oil consumption, and we believe this is not well known among the investment community,” said energy analyst Phil Skolnick at Canadian investment bank Eight Capital in a recent report.
When it comes to demand for what Alberta produces, the IEA’s studies show countries such as China and India will look to petrochemicals produced from heavy oil as a source of everything from fertilizer to packaging, digital devices, car parts and clothing. Globally, at least 12 major oil refineries will come on stream in the next six years, according to Mr. Skolnick’s research, with the capacity to process 4.5 million barrels of oil each day, including 2.4 million barrels of heavy oil, an Alberta specialty.
This new demand will come at a time when traditional energy suppliers such as Venezuela and Iran face significant headwinds to production. Venezuela’s economy is collapsing, and Iran faces geopolitical headwinds from its adversaries, including the United States. Mr. Skolnick said: "There is a major fundamental shift happening, whereby the refining industry is moving away from maximizing production of transportation fuels to maximizing production of higher margin petrochemicals.”
Soaring demand for plastics is moving refineries into the center of the climate change debate, with the industry moving to deal with the issues that come with increasing consumption of heavy oil and other fossil fuels. Last October, the IEA tabled what it called an “ambitious but achievable pathway to reduce the environmental impacts of petrochemicals,” a series of measures that would cut air pollutants from chemicals production by 90 per cent over the next three decades, reduce greenhouse-gas emissions by 60 per cent and halve ocean-bound plastic waste. In releasing the report, IEA Executive Director Fatih Birol said: “Petrochemicals are one of the key blind spots in the global energy debate, especially given the influence they will exert on future energy trends."
It’s currently fashionable to hate CNRL, Husky, Cenovus Energy Inc. and the other Canadian players that now control Alberta’s oil sands. These companies sell every barrel of oil they produce at a significant discount to the price that rival producers receive for lighter grades of oil. There has been a long and difficult battle over plans to build new North American pipelines. And increasing awareness of climate change is shifting consumer sentiment away from gasoline-fuelled cars and single-use plastics, trends seen as curtailing future demand for oil.
Against this backdrop, it’s understandable that most investors, retail and institutional, are underweight energy stocks. Their recent experience has been unpleasant. An exchange-traded fund that tracks the S&P/TSX capped energy index, which has a lot of exposure to oil sands companies, has lost more than half of its value in five years.
The contrarian thesis, quietly embraced by Mr. Edwards and the Hong Kong-based Li family, is that over the long term, global demand for heavy oil will increase, supply will tighten and many of the problems facing Canada’s producers can be solved. Mr. Skolnick expects an increasing amount of Alberta oil to be transported by rail, which will help shrink the difference between the price paid to Alberta producers and those in other regions.
The bullish case for the Alberta oil sands grows stronger if federal government moves ahead with the long-delayed expansion of the Trans Mountain pipeline. The best-case scenario is the controversial project will be finished by 2022. Coming close to that schedule means Trans Mountain could be moving oil to Asian customers just as China becomes the world leader in refinery capacity, an event that’s expected in 2024, when the country finishes a complex on its northeastern coast that rivals anything on the Gulf of Mexico.
Eight Capital, a Toronto-based firm led by chief executive David Morrison, thinks that development will benefit investors who load up on oil sands stocks such as Cenovus, CNRL, and MEG Energy Corp., which turned down a takeover offer from Husky in January.
Mr. Skolnick said: “Given the expected impact and sustainability of petrochemical-related oil demand, we believe this is a theme that could garner the interest of generalist investors.” In other words, people will wake up to trends that a pair of billionaires realized years ago.
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