Boom times in the oil patch look a lot different than they used to.
Not so long ago, US$100-per-barrel crude oil would have been the catalyst for the deployment of vast amounts of capital into an industry-wide frenzy of expansion.
Today, Canada’s oil and gas producers are using their windfall to slash debt and supersize dividend payments.
Investors returning to the energy sector, perhaps for the first time in years, shouldn’t look at oil-and-gas stocks as they once did – as volatile, growth-oriented entities that live and die by the commodity boom-bust cycle.
Instead, the industry mandate has become the utilization of existing assets at the lowest possible cost while siphoning profits to shareholders.
“They’re like manufacturers now,” said Rafi Tahmazian, senior portfolio manager at Canoe Financial. “Their expertise is no longer how to add production, it’s how to produce cheaper.”
Accordingly, it makes sense for operational factors to guide the process of choosing between companies these days.
It was through an operational lens that a U.S. activist investor targeted Suncor Energy Inc. last week.
Citing the need for Suncor to match its competitors in the efficiency of its aging oil-sands assets and in returning money to shareholders, Elliott Investment Management LP called for a board shakeup and a review of management.
“In recent years, the company has seen a decline in the exceptional performance that was formerly its hallmark,” Elliott wrote in a letter to Suncor’s board.
By contrast, Canadian Natural Resources Ltd.’s strong operational track record seems to have translated into industry-leading share price performance. Since the global crude-oil market bottomed out in April, 2020, CNQ’s stock has outpaced Suncor by a pace of nearly 3 to 1.
“Canadian Natural has developed a reputation over a number of years of being a very good operator,” said Les Stelmach, senior vice-president and portfolio manager at Franklin Templeton Canada. “And that’s finally resulted in them receiving more of a premium valuation.”
The other big draw for investors right now is, of course, dividends. The sector has undergone so much cost cutting in recent years that the average oil-weighted producer can be profitable, with West Texas Intermediate as low as US$43 per barrel, according to a recent Scotiabank report.
The current WTI price about of US$102, as a result, amounts to enormous excess cash flow. Scotiabank expects energy sector dividends of $7.5-billion this year, with the five major oil-sands producers accounting for nearly 90 per cent of them.
“Investors are now clamouring for guidance on how that excess capital is going to be distributed,” Mr. Stelmach said.
Cenovus Energy Inc. recently said that it would return half of its excess free cash flow to shareholders when its debt is less than $9-billion; and if its debt drops below $4-billion, shareholders would get it all. That announcement accompanied first-quarter results showing the company’s profit rose sevenfold over the last year.
Meanwhile, Canadian Natural Resources said in March that it would allocate half of its free cash flow to its balance sheet and half toward share repurchases.
Investors can essentially “pick their favourite mechanism” of shareholder payout from the oil-sands players, Mr. Stelmach said.
Investing capital in growth, on the other hand, does not appear to be on the agenda. There are a lot of reasons to be cautious.
First, oil prices are soaring today, but that’s in large part the product of an unpredictable geopolitical backdrop.
Further, there is still limited pipeline capacity to support any major expansion of energy output.
Then there’s the biggest hurdle of them all – that new production in the oil sands runs counter to emissions-reduction targets.
The federal government recently suggested that Suncor’s proposal to expand its oil-sands base mine would not pass an environmental review.
“Even if you’ve got an oil-sands lease, that doesn’t mean you actually are going to be able to develop them,” Mr. Stelmach said.
In other words, Canadian oil and gas has left its growth ambitions behind and is instead reoriented toward shareholder payouts for the foreseeable future.
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Tim Shufelt