The Canadian energy sector has essentially become the pipeline sector.
Pipelines have assumed an energy leadership role amid the continuing decimation of the oil patch, which is seeing its size and influence over the Canadian stock market shrink by the day.
Pipelines and storage companies now make up nearly two-thirds of the energy component of the S&P/TSX Composite Index – that’s an eight-fold rise in the subsector’s relative size over the past 12 years.
As a result, Canadian index investors are much more heavily invested in transporting oil and gas than in exploring and producing it.
Unfortunately, in the COVID-19 crisis, the entire energy complex has been walloped. While pipeline stocks have held up a bit better, the big names are still down by roughly 30 per cent from their prepandemic peaks.
Current pressures aside – and there are many of them – there is good value in Canadian pipelines, said David Sherlock, chief investment officer at SAGE Connected Investing.
“The yields are high and attractive. They have positive earnings. And they’re delivering a commodity that people will need, no matter what price.”
You can’t say the same about explorers and producers (E&Ps), Mr. Sherlock added.
A little more than a decade ago, when American crude was trading well in excess of US$100 a barrel, Canadian E&Ps accounted for more than a 25-per-cent share of the overall market capitalization of the S&P/TSX Composite Index. Today, that figure sits at just 3 per cent.
The forces behind the sector’s downfall are by now well known. A global supply glut inflamed by the U.S. shale boom put an end to an era of high oil prices. Domestically, a shortage of pipeline capacity left producers with no option but to slash production. Then along came the novel coronavirus, which struck at the heart of global energy demand.
The net effect of all of that is a wave of business failures, an exodus of foreign investor capital out of the oil patch, and an 80-per-cent decline in the S&P/TSX Capped Energy Index since its 2014 peak. The latest sign of strain is Suncor Energy Inc.'s plan to cut up to 15 per cent of its remaining work force, which the company announced on Friday.
For the past six-plus years, any investor betting big on a turnaround in Canadian E&Ps has come to regret it.
Pipelines, on the other hand, behave a little differently. No less tumultuous and politically explosive, of course. On Wednesday, Alberta Premier Jason Kenney blamed the federal approvals process for new delays in the expansion of the Nova Gas Transmission Ltd. pipeline. The $2.4-billion project by TC Energy Corp., which is designed to add capacity to the country’s largest natural-gas pipeline, is now expected to be deferred for about a year.
At certain points of the broader selloff of the energy sector, pipeline stocks have exhibited some level of insulation. Unlike E&Ps, pipelines are not directly exposed to commodity prices, but rather make their money off of volumes, which have remained robust in the pandemic.
“There is continued demand for heavier Canadian oil,” Craig Basinger, chief investment officer at Richardson GMP, wrote in a recent report.
“However, regulatory/political hurdles remain the biggest challenge in any new project approvals. This does increase the value of any pre-existing pipeline but limits growth.”
The market has not been inclined to give credit to the pipelines for that value in the midst of the pandemic. The hit to global growth, and cyclical stocks as a result, has weighed on pipeline names, as has “political overhang,” Mr. Sherlock said.
The selloff in pipelines has pushed dividend yields to extraordinary levels – TC Energy and Enbridge Inc. currently yield roughly 5.8 per cent and 8.4 per cent, respectively.
Meanwhile, the benchmark yield on Government of Canada five-year bonds is currently at about 0.35 per cent.
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