Energy

Despite oil price volatility, a number of investors retain the bullish belief that based on a few important fundamentals, the Canadian energy sector will record significant growth in the medium to long term.

Despite increased oil price volatility, crude demand is continuing to rise. That has led to a positive Canadian energy demand growth forecast as well as a robust energy production outlook moving forward.

The past 18 months have been challenging for the Canadian oil and gas sector as a whole as producers and investors have been forced to tackle a number of challenges, including persistently wide price differentials and substantial decreases in capital spent by producers.

The share prices of oil and gas companies declined substantially last year, with the average market cap for small- and mid-cap companies coming down 19 percent, according to energy-focused law firm Stikeman Elliot. Despite such drops, a large number of investors and analysts retain the bullish belief that the Canadian energy sector could record significant growth in the medium to long term. Here are three key points for those looking to invest in the Canadian oil sector to consider moving forward.

1. Foreign investment

Investors should be aware that strong growth in energy demand and constantly evolving energy supply profiles could drive foreign investment in Canada’s natural resources even though drastic changes have been made to the country’s foreign investment legislation.

Investors watched with interest last year as the federal government approved two separate takeovers of Canadian oil and gas companies: the $15.1-billion acquisition of Nexen by CNOOC (NYSE:CEO,HKEX:0883) and the $6-billion deal that saw Progress Energy Resources transfer ownership to Malaysian energy giant PETRONAS. At the same time, the government used the occasion to announce that it had made changes to foreign investment rules: with the issuance of the revised guidelines for investments by state-owned enterprises, the Canadian government confirmed that moving forward, state-owned enterprises (SOEs) will be permitted to acquire Canadian oil sands businesses only under “exceptional circumstances.”

“To be blunt, Canadians have not spent years reducing the ownership of sectors of the economy by our own governments, only to see them bought and controlled by foreign governments instead,” Reuters quoted Prime Minister Stephen Harper as stating in a rare public address on corporate concerns.

While the new rules do not place any further restrictions on private foreign investment in Canada, investment by foreign SOEs will be altered dramatically moving forward. Investors need to realize that there will likely be a shift in the market as a result of a decline in SOEs looking to acquire Canadian oil assets and an increase in alternate investments, such as joint ventures, which allow SOEs to invest in the country’s natural resources without acquiring full control of businesses.

2. Technological advances and production sources

While the junior market has taken a hit over the past 18 months, impressive progress has been made both technologically and in terms of production. Technological advances have ensured the viability of previously uneconomical shale gas plays, and with the resulting decline in local prices, market analysts are forecasting strong long-term energy demand from Asian markets, especially in terms of natural gas. Many investors hope that this demand will lead to increased investment in Canadian unconventional production sources and will direct more capital toward the development of liquefied natural gas (LNG) facilities to service foreign markets.

While there has been much debate surrounding crude pipelines across North America, there has been a surprising amount of support from government and aboriginal groups regarding the development of LNG facilities in areas such as Prince Rupert and Kitimat, British Columbia. The market is set to benefit from this cash injection in that these facilities will increase Canadian producers’ ability to export to more lucrative markets based out east.

There are currently a number of projects planned, and with the prospect of sizeable LNG exports by 2020, there has been a significant increase in the amount of Canadian and foreign investment aimed at gas-producing regions.

3. Pipelines

The Canadian oil sector faces a major challenge in that it needs to be able to increase both its access to local markets and its distribution of crude and bitumen to global markets. However, until now, both producers and investors have been left frustrated as they struggle to deal with increasing objections to crude distribution channels from various groups. As a result, oil pipeline expansion will likely challenge the long-term growth of the industry.

Protests over the Northern Gateway pipeline project, a proposal to construct twin pipelines running from Alberta to Kitimat, and the Keystone XL pipeline, a pipeline system aimed at transporting tar sands oil from Canada and the Northern United States to refineries in the Gulf of Mexico, have hampered project development and the overall expansion of the oil sector.

Canada lost out on an estimated $25 billion in oil revenues last year due to pipeline and production bottlenecks and is expected to lose $15 billion a year going forward until it deals with its infrastructure deficit, according to a new CIBC report. “It’s increasingly important that Canada move on one or more of the alternative pipelines to get our product headed Asia’s way,” said Avery Shenfeld, CIBC’s chief economist. The report argues that “clarity on the pipeline front” will help attract the capital needed to support oil sands expansion.

The importance of streamlining this process has not been lost on the Canadian government. That was underlined by the passing of the Jobs, Growth and Long-term Prosperity Act, which is aimed at curtailing what it deems to be increased use of the regulatory review processes to delay development. The act includes enhanced powers to ensure that reviews are conducted in a timely manner and gives the governor in counsel the power to issue the certificate of public convenience and necessity, which approves pipeline construction and operation. While analysts agree that there are likely to be short-term challenges, investors expect that new federal and provincial regulatory regimes will result in review processes that are more streamlined, hopefully leading to a more robust and investor-friendly market environment.

 

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.

Related reading: 

Is the Canadian Crude Discount Here to Stay?

Progress Energy Takeover: Only the Beginning?

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