Athabasca Oil Corp. is back in the doghouse after a promising rally earlier this year came to an abrupt end amid weaker oil prices and renewed confusion over the future of pipeline expansions. But there’s something here for investors with a bit of patience and a strong risk appetite.
The Calgary-based oil producer has offered one of the more volatile ways to gain exposure to the Canadian energy sector, given its focus on oil production and high sensitivity to oil prices.
When things go right with energy fundamentals – a rising oil price is a good start – Athabasca’s share price should rally higher than the vast majority of its bigger, more diversified and well-financed peers.
According to the company’s own estimates, every US$5 improvement in the price of oil (per barrel of West Texas Intermediate, or WTI, a U.S. benchmark) should add $80-million to Athabasca’s funds flow, or cash flow from its operating activities.
To put that into perspective, management believes it is on track to report a funds flow of $165-million in 2018, according to the company’s most recent quarterly statement in August. So, a US$5 gain in oil prices should, theoretically, boost the company’s funds flow by about 50 per cent.
Things did go right for Athabasca earlier this year, not long after I wrote a bullish column about the stock (I got lucky with the timing). The share price rallied about 70 per cent from the end of March until the third week of May, rising to a high of $1.98.
But just as the stock is sensitive to improving energy fundamentals, it gets killed when those fundamentals deteriorate. The share price has retreated 30 per cent since May, worse than most peers, and the reasons aren’t hard to spot.
For one, forecasts for global oil demand from the likes of the U.S. Energy Information Administration and the Organization of the Petroleum Exporting Countries have been trimmed amid wobbling emerging market economies.
For another, Canadian oil producers are suffering from pipeline constraints that have been hammering the price of Canadian oil. Yes, WTI is a great benchmark for U.S. oil, but domestic producers are tied to Western Canadian Select WCS, a Canadian benchmark that tends to trade at a discount to WTI.
That discount, or spread, was about US$25 a barrel earlier this year. It narrowed to just US$15 between April and July, lifting Athabasca’s share price and most of the Canadian energy sector.
But the spread has since widened again, and the recent federal court decision that quashed the Trans Mountain pipeline expansion has no doubt contributed to this widening. On Friday, WCS traded at a discount of US$36 a barrel to WTI.
Is there hope here? You bet.
First, global fundamentals are set to improve. The Financial Times last week outlined a number of factors that could drive oil prices higher.
These factors include: Iranian oil exports are expected to decline after U.S. sanctions take effect in November; U.S. shale production is expected to grow at a slower pace in 2019 amid the sector’s own pipeline capacity constraints; the U.S. hurricane season is feeding anxieties about pipelines and coastal pumping stations; and hedge funds are starting to bet on a rising price of oil, after taking bearish positions previously.
The spread between WCS and WTI oil prices will have to narrow for investors to gain much enthusiasm for Canadian energy stocks, though. And given the political and judicial complications in Canada right now, it’s no wonder that investors are shying away.
But if a narrower spread between WCS and WTI will send Athabasca shares rallying, then a wide spread should be a buying opportunity in anticipation of better days ahead. It’s a risky bet, for sure, but the upside is substantial.
David Berman