Canadian energy stocks are in trouble again, as sharp declines on Thursday outpaced a meltdown by the broader market. But be wary of buying this dip: The share prices of large energy producers had been reflecting an optimistic scenario for oil prices in recent weeks – and this scenario is withering.
The S&P/TSX energy sector slumped 9.8 per cent, dealing a serious blow to what had been a promising rebound since March.
The price of West Texas Intermediate crude, a U.S. benchmark, fell 8.2 per cent to US$36.34 a barrel, marking its worst one-day decline since April 27. The joys of a reopening global economy are giving way to a far more sober look at the prospects for economic activity.
A couple of skeptical weigh-ins on Wednesday didn’t help.
The Organization for Economic Co-operation and Development (OECD) said that it expects the global economy will contract by 6 per cent this year, and that’s if the world can prevent a second wave of novel coronavirus infections. If prevention fails (and there have been worrisome upticks in various U.S. states), the OECD estimates that the economy will shrink by a more severe 7.6 per cent – no doubt limiting energy demand.
The U.S. Federal Reserve was similarly cautious in its monetary policy report. The Fed said in its statement: “The ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”
The problem for energy stocks is that the rebound in the price of crude oil left the stocks vulnerable to a setback.
Less than six weeks ago, the price of WTI languished at just US$18 a barrel as demand for energy vanished. A May futures contract that was close to expiring traded as low as negative US$38 a barrel on April 20, meaning that traders paid to have oil taken off their hands.
On Monday, though, WTI surpassed US$40 a barrel, boosting energy stocks to such remarkable heights – Husky Energy Inc. was up nearly 150 per cent from its lows in March, while Canadian Natural Resources Ltd. was up 165 per cent – that analysts re-examined the underlying assumptions for the price of crude oil in large Canadian oil producers.
According to Jamie Kubik, an analyst at CIBC World Markets, share prices assumed the price of WTI would rise to US$50 a barrel in 2021, which is close to the price of oil before the North American lockdown. That led to some valuation concerns.
“Although the commodity has gained support in recent weeks, we do think it may be a little optimistic to fully price US$50 a barrel into oil stocks at this time,” Mr. Kubik said in a note earlier this week, before the selloff.
Jason Bouvier, an analyst at Bank of Nova Scotia, pointed to another hurdle in a note on Thursday: Even with the price of WTI in the mid-US$30s, Canadian energy producers will likely reverse prior production cuts throughout the summer, leading to more oil output at a time when energy demand is unclear.
But Mr. Bouvier recommends a way to embrace the uncertainty ahead: Invest in Suncor Energy Inc. Though the company recently slashed its quarterly dividend by 55 per cent, it has a strong balance sheet that can withstand setbacks. And as an integrated energy company with a substantial refining business, Suncor should perform relatively well even if oil prices falter.
Just don’t expect a smooth ride. On Thursday, Suncor shares slumped 8.4 per cent.
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