Oil and natural gas stocks – staples in Canadian investment portfolios for decades – have become permanent red blotches on quarterly statements for many long-term investors.
The benchmark S&P/TSX Canadian Energy Index has lost 77 per cent of its value since January, 2014. During the same period, the price of West Texas Intermediate crude oil has plunged to about US$40 a barrel from US$100. Going back further to January, 2008, when a barrel of oil topped US$140, the energy index has shed 83 per cent of its value. The current global pandemic is just the latest disaster to hit the Canadian oil patch.
The culprit has been a combination of high production costs in the oil sands, lack of pipeline capacity to get the product to global markets, oversupply from lower-cost U.S. shale producers and dwindling demand as the world turns to more environmentally compatible energy sources.
“When it comes to growth, the Canadian oil companies are disadvantaged, partly because of the pipeline situation, but also the cost structure is higher to build new oil sands facilities than it is to drill a bunch of shale wells,” says Randy Ollenberger, oil and gas equity analyst at BMO Capital Markets in Calgary, who has been covering the Canadian energy sector for 25 years.
“I don’t know that there’s a big rush to make some of these investments if you are Suncor [Energy Inc.] or Canadian Natural Resources Ltd. They might be much better off to continue to harvest capital from their existing asset bases,” he says.
Mr. Ollenberger says he doesn’t think crude oil will top US$100 again any time soon, but expects demand to continue growing for the next decade. Even if prices remain at current levels, he says large producers such as Suncor Energy Inc. (SU-T) and Cenovus Energy Inc. (CVE-T) can continue to pump profits and pay – or eventually increase – dividends.
“The Canadian companies are pretty well positioned. They’ve got cash-flow break-evens in the lows US$30 [a barrel range], meaning the oil prices required for them to hold production flat and cover their dividends,” he says.
Mr. Ollenberg adds that alternative energy has not progressed as quickly as many people think, giving traditional oil patch producers plenty of time to make the transition profitably.
“Despite all the hype around alternative energy and electric cars, that transition is going to take a long, long time,” he says. “As those technologies and alternative energy continue to evolve and costs come down, [these companies] can pivot more slowly toward that.”
Crude oil remains Canada’s largest export, but the role of oil producers on the S&P/TSX Composite Index has diminished to a weighting of about 13 per cent from 24 per cent in 2005. Investment advisors often take similar energy weightings in client portfolios to reflect the broader index.
For Michele Robitaille, managing director, Canadian equity, and portfolio manager at Guardian Capital LP in Toronto, that means reducing energy exposure to only the best companies.
“Because of all the headwinds facing energy, the majority of larger institutional money managers are focused on the large, liquid, well-capitalized players with strong assets and strong balance sheets,” she says. “There’s certainly a place for them in a diversified portfolio.”
Among Ms. Robitaille’s top picks are beaten-down stocks including Suncor and Canadian Natural Resources. She also expects pipeline companies such as Enbridge Inc. (ENB-T) to perform well on the market and keep paying annual dividends in the high single digits.
“Pipeline companies have very strong dividends today and they are very sustainable,” she says.
Ms. Robitaille also advises holding companies that are well positioned for the transition to alternative energy, including electric and gas-power generators such as Fortis Inc. (FTS-T) and Emera Inc. (EMA-T).
“If you are willing to ignore the noise that is going on right now, there will be a rebalancing in the marketplace and it will be focused on energy transition,” she says.
Andrew Pyle, senior wealth advisor and portfolio manager at ScotiaMcLeod in Peterborough, Ont., isn’t waiting for the alternative energy transition to play out. He’s already tilting client portfolios away from fossil fuel generators, even if that means taking short-term losses.
“What we’re seeing now is a trend away from traditional energy. That trend is continuing and intensifying. We’re moving our portfolios away from traditional energy and moving more to clean energy,” he says.
One of his motivating factors is a flurry of dividend cuts in the Canadian energy sector this year, including Suncor. Energy companies are traditionally seen as strong cash generators for income-dependent investors.
“It’s hard to make that argument in the traditional energy space, where we’ve already seen dividends pulled back and could be pulled back even further,” Mr. Pyle says.
He admits that finding alternative energy investments can be difficult for investors who have become familiar with the old Canadian energy names that trade in Canadian dollars, adding that the transition requires a more global view.
“There are only so many clean energy companies in Canada. I think investors are going to have to look beyond Canada to build that exposure so they are diversified as well,” he says.
Investors might also need to sacrifice dividends from clean energy stocks as the burgeoning industry becomes more established. Mr. Pyle expects payouts from alternative energy stocks will eventually come as governments continue to restrict fossil fuel production and provide more support for clean energy.
“The return potentials are probably going to be higher in the alternative energy space especially if we see [those] policies,” he says.
That’s not to say Mr. Pyle is abandoning Canadian energy in his client portfolios. He says some companies, including Suncor and TC Energy Corp. (TRP-T), are evolving over time and expects dividend growth to resume eventually.
“There are companies out there that are making a transition,” he says.