As a wealth manager in Calgary, David Sherlock helps shield oil and gas professionals from the oil and gas industry.
His clients mostly made their livelihoods in the Alberta energy sector and subsequently invested much of their own wealth back into oil and gas companies. But the losses they have suffered through the industry’s enduring downturn have provided a powerful incentive to purge their portfolios of oil sands exposure.
“They’re capitulating, saying I’ve got 50 cents on the dollar left, let’s get it back to work. They’ve given us their core wealth to manage, away from this space,” said Mr. Sherlock, chief investment officer at SAGE Connected Investing, which has been out of Canadian oil and gas producer stocks for nearly four years.
"There are just too many unknowables. We can make money easier elsewhere,” he said.
The Canadian energy sector has been a great place to lose money for many years now. Exploration and production companies (E&Ps) in the S&P/TSX Composite Index are collectively trading 70-per-cent below their 2014 peak, the year an acute excess global supply of oil first crushed global crude prices. Going even further back to the days of US$145-per-barrel oil in 2008, that same group of Canadian producers is down by 80 per cent. And energy has been the worst performing sector of the Canadian stock market in four of the past six calendar years.
After all that, a resurgence in the Canadian energy sector is still nowhere in sight, leading more and more investors both here and abroad to the conclusion that the oil patch, in its current state, is uninvestable – there is just too much uncertainty involved to justify betting on the sector’s recovery.
For a sector that was once the largest on the Toronto Stock Exchange and a magnet for energy investors around the world, it’s been a long fall from the top, fuelled by forces both external and local.
The explosion of U.S. shale production has transformed the global oil market, generated a persistent oversupply, and put crude oil on sale indefinitely. Meanwhile, the environmental movement has increasingly targeted the Alberta oil sands over its carbon footprint. And the lack of pipeline capacity has required mandatory production restrictions just to keep Alberta crude prices from collapsing. The latest setback for the industry is the Chinese coronavirus epidemic, which threatens to wipe out growth in energy demand and bring about another oil glut.
Going into this year, there was renewed hope in energy circles. The decline of oil investment around the world that started with the 2014 energy sector crash seemed, finally, to be bringing the market back into balance. In the three months up to early January, West Texas Intermediate rose from around US$52 to US$63 a barrel – the highest price in more than eight months. The S&P/TSX Composite Energy Sector Index rose by 12 per cent over the same period.
But then key parts of the great Chinese industrial machine ground to a halt in an effort to contain the coronavirus outbreak, which has infected more than 64,000 people worldwide and killed more than 1,300.
China is the world’s second-largest consumer of oil, and prior to the outbreak, was expected to account for 40 per cent of the growth in global oil consumption in 2020.
Energy analysts have scrambled to revise market forecasts to keep up with the epidemic’s rising toll. For the month of February, China’s idled factories and travel restrictions could trim up to 4 per cent from global oil demand, or four million barrels of oil each day, according to energy research firm S&P Global Platts. A bear-case scenario could see daily demand for the full year decline by one million barrels, which would effectively erase forecast consumption growth for 2020.
While resurgent stock markets suggest investors overall are confident a global pandemic will be averted, crude prices remain 18 per cent off their January peak, and Canadian E&Ps are down by 13 per cent over the same period. “The oil market has been subject to many supply shocks over recent years, but an acute demand shock has not been felt since the 2008 financial crisis,” RBC Dominion Securities analyst Michael Tran said in a recent note. The risk of another glut looms large over the oil market.
So far, the Organization of Petroleum Exporting Countries has failed to stabilize the market. The cartel is considering a production cut of 600,000 barrels a day in response to the coronavirus, but Russia is reportedly reluctant to agree. For decades, Saudi Arabia, backed by the other OPEC members, served as the global oil market’s swing producer, opening or closing the spigots in response to supply-demand imbalances, to try to keep prices steady. That role has been undermined in recent years by the U.S. shale boom.
Russia’s 2016 alliance with OPEC united the world’s two largest producers in an effort to curb a stubborn overabundance of oil, largely fuelled by runaway growth in U.S. fracking. The United States has since become the world’s top producer, its ocean of shale oil consistently dragging down world prices.
U.S. frackers are far from immune to the pressures of the well-supplied market they helped create. Since 2014, the U.S. energy sector has cut jobs and slashed capital expenditures to adapt to a low-price era, just as the Canadian sector has. But even with the cutbacks, there was ample growth baked into U.S. drilling and production plans. Between 2014 and 2019, the global daily output of liquid fuels, excluding things such as biofuels, rose by six million barrels. The U.S. accounted for 87 per cent of that growth, Scotia Capital analyst Paul Cheng wrote in a recent report.
More recently, the U.S. shale revolution has faced a harsher reckoning, as investors lost patience with incessant growth over profitability. Drilling activity in American shale fields has plunged. And yet, total production in the biggest shale plays there will likely continue to rise until roughly 2027, Mr. Cheng said.
After the peak, however, the U.S. shale oil sector could shrink just as quickly as it grew. Within a decade, the supply of oil globally should top out, Mr. Cheng said. On the consumption side, oil bulls doubt forecasts that global demand for oil and gas will moderate in the coming years, particularly considering the global population is expected to rise by two billion people by 2050, according to United Nations projections. “We need power and fuel and petrochemicals and we need it to be affordable and we’re going to need it for two billion more people,” said Jennifer Stevenson, a portfolio manager at Dynamic Funds.
But the energy market itself doesn’t see an era for higher prices anywhere on the horizon. While the spot price of oil is highly volatile, with a barrel of WTI trading as low as around US$26 and as high as US$76 within the past four years, futures contracts looking five years ahead have consistently priced WTI at about US$50. “Simply put, the market no longer believes producers will ever regain their long-lost pricing power,” Mr. Cheng said.
The macro backdrop for oil is just too heavily skewed to the downside, said Andrew Pink, a portfolio manager at LDIC Inc. “Ultimately, there’s just too much oil in the world. And anything that threatens the balance between supply and demand really hurts the oil price.” That’s reason enough to avoid investing in oil and gas stocks, even before considering the problems specific to the Canadian energy sector, Mr. Pink said.
On that front, there has been some recent progress on Canadian pipeline projects. In December, Enbridge Inc. completed the replacement of the Canadian stretch of its Line 3 pipeline, and construction on the Trans Mountain expansion project got underway. But pipelines remain a bitterly divisive issue in Canada. Currently, protests over the Coastal GasLink project have brought much of the country’s passenger and freight railway network to a standstill.
“I don't think investors will give any credit until there's oil flowing through a pipeline,” Mr. Pink said. “The timelines on these projects have just become extremely unpredictable.”
That uncertainty has sparked an exodus from the oil sands of foreign investment capital, fund flows and jobs. “Our younger engineers and geophysicists have moved to Oklahoma or Texas,” Mr. Sherlock said. “Our tools and equipment have actually been moved across the border.”
The producers that remain are stuck in a holding pattern with little choice but to commit free cash flow to dividends and share buybacks, so long as takeaway capacity is limited and curtailment is in force. “We’re sitting in this same range going forward for the foreseeable future,” Suncor CEO Mark Little said in a conference call with analysts last week. “When the [oil] price went down in 2014, I don’t think people realized that we literally were going to go [down] year over year over year.”
That realization is a bitter one for Mr. Sherlock’s clients once they move their money out of Canadian oil producers. “It’s painful for them to watch us be right on their behalf,” Mr. Sherlock said.