Oil And Gas – Canadian E&P Stock Outlook: Signs Of Tailwind

While oil production is surging in Canada, the country’s exploration and production (E&P) sector has remained out of favor, primarily due to the scarcity of pipelines. In short, pipeline construction in Canada has failed to keep pace with rising domestic crude volumes – the heavier sour variety churned out of the oil sands – resulting in infrastructural bottlenecks.

This has forced producers to give away their products in the United States – Canada’s major market – at a discounted rate. In fact, the price gap between Alberta’s Western Canada Select and the New York-traded West Texas Intermediate recently rose to around $30 per barrel – the most in more than five years.

However, the encouraging progress on a number of crucial infrastructure projects and the broadly improving Western Canadian Select prices should benefit heavy oil producers and cause an inflection in the E&P space over time. A reduction in heavy oil coming out of Mexico and Venezuela is also expected to narrow the divergence between the two benchmarks.

Even within Canada, instead of investing in risky and costly oil sands projects, the companies are now looking to pump resources into two of the popular shale plays of the company — Duvernay in central Alberta and Montney in east central British Columbia.

Finally, throughout the downturn, Canadian energy producers, just like their American counterparts, worked tirelessly to cut costs to a bare minimum and look for innovative ways to churn out more oil and gas. And they managed to do just that by improving drilling techniques and extracting favorable terms from the beleaguered service producers. Moreover, driven by operational efficiencies, these entities have been able to reduce unit costs and live within their cash flows – priming them for upward pressure on both revenues and earnings.

Industry Underperforms on Shareholder Returns

Looking at shareholder returns over the past year, it is quite apparent that investors are not too confident about the industry’s prospects. Despite improving commodity prices and the subsequent strength in profit growth, the space still has a lot of uncertainty surrounding Canada’s regulatory/environmental policy framework, limited pipeline infrastructure, and the resulting large discount for crude priced at Alberta’s Western Canada Select compared to the New York-traded West Texas Intermediate oil benchmark. 

The Zacks Oil and Gas – Exploration and Production – Canadian industry, part of the broader Zacks Oil and Energy Sector, has underperformed the S&P 500 and has barely matched its own sector over the past year. While the stocks in this industry have collectively gained 13.3% – almost identical to the Zacks Oil and Energy Sector’s 13.2%, the Zacks S&P 500 Composite rallied 16.8%.