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Energy Rebounds

May 05, 2014 | About:
Gordon Pape

Gordon Pape

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What a difference a year makes. Twelve months ago, the energy sector was in woeful straits. Oil producers were being forced to sell at deep discounts to the benchmark Texas West Intermediate crude price. Natural gas prices were in the dumpster. Oil sands production risked being locked in by a lack of pipeline capacity. Fracking had created a completely unexpected natural gas production boom in the U.S. Access to the Asian markets was being blocked by opposition to Enbridge's proposed Northern Gateway pipeline. In short, the whole sector, which is so critical to Canada's economy, was in a mess.

Fast forward to now. Although many of the problems remain unresolved, there's a new sense of optimism in the oil patch and profits are on the rise. The drop in the Canadian dollar has been a big contributor to the bottom line since oil and gas sales are in U.S. currency. But there's more to the story. The price differential for Western Canada Select crude has narrowed significantly. The bitter winter, which was a nightmare for many people, was a boon for natural gas producers, pushing prices up by more than 70%. Although the Keystone XL pipeline remains stalled in the morass of U.S. politics, oil producers have found other ways to move product to market including a big increase in rail shipments.

Industry giant Suncor Energy (SU) (SU), which reported first-quarter results last week, said that over 95% of its upstream production in the quarter received global-based pricing. That means the price was comparable to that for North Sea Brent crude, which is the touchstone of the international industry.

That translated into what CEO Steve Williams called "the best financial quarter on record". The company reported operating earnings of almost $1.8 billion ($1.22 per share), compared to about $1.4 billion in the same period last year. Net earnings were almost $1.5 billion ($1.01 per share), up from $1.1 billion a year ago. Cash flow from operations came in at $2.9 billion ($1.96 per share) while free cash flow was $3.2 billion for the 12 months to March 31. Several financial analysts raised their estimates for the stock following the release of the results.

What is especially interesting is that the improved financial results were achieved despite a decline in the daily average production to 545,300 barrels of oil equivalent per day (boe/d) in the quarter compared to 596,100 boe/d in the first quarter of 2013. Suncor said the production decline was due to the sale of its conventional natural gas business and the shut-in of its production in Libya.

However, oil sands production was up, coming in at 389,300 barrels per day (bbls/d) compared to 357,800 in the previous year. Production costs rose to $35.60 per barrel from $34.80 last year due to higher natural gas prices. (Oil sands production uses a large amount of natural gas).

Market access is the key to Suncor's rebound and will be critical to all other Canadian producers as well. Commented Mr. Williams: "The successful implementation of our long-term market access strategy positions us well for the future. We secured new pipeline capacity to the U.S. Gulf Coast and increased our ability to transport inland priced crude by rail to the Montreal refinery. The anticipated reversal of Enbridge's Line 9, combined with increased rail access is expected to further improve profitability of the Montreal refinery by increasing the company's flexibility to transport 100% inland crudes to the refinery."

Suncor wasn't the only company to report improved results. Earlier, Cenovus Energy (CVE) (CVE), another major oil sands producer, announced first-quarter earnings of $247 million ($0.33 a share), up 40% from $171 million ($0.23 a share) the previous year.

Cenovus's oil sands production averaged 120,444 bbls/d net in the first quarter, up 20% from a year earlier, primarily driven by the strong performance at the company's Christina Lake oil sands project. Production at Christina Lake increased 48% from 2013.

Like Suncor and other producers, Cenovus has been exploring new ways of accessing North American and world markets. Among the latest developments, the company said it is now delivering approximately 7,100 bbls/d of oil for transportation by rail to destinations in the U.S. and on Canada's East Coast. As well, Cenovus has committed 75,000 bbls/d to Enbridge's Flanagan South system and expects to start moving an initial 50,000 bbls/d in the second half of 2014.

The company has also committed to move 200,000 bbls/d on the proposed Energy East pipeline, has additional shipping capacity of 175,000 bbls/d on proposed pipelines to the West Coast, and plans to move 75,000 bbls/d on TransCanada's Keystone XL system - if and when it is ever built.

Keystone remains the big x-factor in the access equation. Industry leaders were deeply disappointed by the announcement by the U.S. government that the decision on the cross-border pipeline has been postponed yet again. Suncor's Mr. Williams, in particular, was highly critical of the set-back, saying: "It's crazy for Canada's future to be dependent on one customer and we have not been particularly impressed with the way the Americans have been handling this in the last few years."

But despite (or perhaps because of) the Keystone frustration, it's becoming increasingly clear that Canada's energy producers are finding new, cost-effective ways of getting their output to market. That's showing up on the bottom line and the share price of the companies. Suncor's shares hit a multi-year high of $43.22 (US$39.33) on Friday and are up about 14% year to date.
Cenovus is up more than 15% since touching a 52-week low in mid-February, finishing the week at C$32.58, US$29.67.

As a whole, the S&P/TSX Capped Energy Index is ahead 16.7% year to date, making it the second-best performing sector on the exchange (gold is number one).

That is probably only the beginning. The energy sector is hot once again and it looks like there are more profits to be made in the months to come, both for the companies and for investors.

Both Suncor and Cenovus are Buys.

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Gordon Pape
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