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Alberta Production Cuts Boost Oil & Gas Canadian E&P Industry

Nilanjan Choudhury

The Zacks Oil and Gas - Canadian E&P industry consists of Canada-based companies focused on exploration and production (E&P) of oil and natural gas. These firms are engaged in finding hydrocarbon reservoirs, drilling oil and gas wells, and producing and selling these materials to be refined later into products such as gasoline.

Let’s take a look at the industry’s three major themes:

 

  • While oil production is surging in Canada, the country's exploration and production 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. As it is, Canadian heavy crude is inferior to the higher-quality oil extracted from shale formations in the United States and is also more expensive to transport and refine.

 

  • The deep discounts, which expanded to a staggering $50 per barrel in the early part of fourth quarter, led the former Alberta government (of Premier Rachel Notley) to issue a mandate on Dec 2, 2018 to remove 325,000 barrels of oil production per day from the market beginning in 2019. While the unprecedented output cuts – relaxed in subsequent months – have brought down the price gap to a large extent (less than $20 now), the production curtailment has forced a number of Canadian energy producers to trim their capital expenditure budgets for 2019 as they can’t boost output growth. Meanwhile, the government intervention and lack of spending opportunities have left the large Canadian energy companies flush with funds that they intend to utilize for dividend hikes, share buybacks and debt reduction.  

 

  • The positive final investment decision for Royal Dutch Shell’s (RDS.A) LNG Canada project is seen as a significant turning point for the country’s energy industry. The initiative, located in Kitimat, British Columbia, is estimated to cost C$40 billion and marks the nation’s largest infrastructure project ever. While the production of gas is soaring in Canada, lack of pipeline construction and export facilities are forcing producers to sell their products at a discounted rate (just like oil). The LNG Canada project will likely provide a fresh lease of life to Canada’s gas industry. The additional export facility will certainly help mitigate the oversupplied gas market of Canada, which has debilitated the commodity’s price in the country since the past few years.

 

Zacks Industry Rank Indicates Rosy Outlook

The Zacks Oil and Gas - Canadian E&P is a 10-stock group within the broader Zacks Oil - Energy sector. The industry currently carries a Zacks Industry Rank #43, which places it in the top 17% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates bullish near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Before we present a few stocks that you may want to consider, let’s take a look at the industry’s recent stock-market performance and valuation picture.

Industry Lags Sector & S&P 500

The Zacks Oil and Gas - Canadian E&P has lagged the broader Zacks Oil - Energy Sector as well as the Zacks S&P 500 composite over the past year.

The industry has declined 41.2% over this period compared to the S&P 500’s gain of 4.2% and broader sector’s decrease of 19%.

One-Year Price Performance

 

Industry’s Current Valuation 

Since oil and gas companies are debt-laden, it makes sense to value them based on the EV/EBITDA (Enterprise Value/ Earnings before Interest Tax Depreciation and Amortization) ratio. This is because the valuation metric takes into account not just equity but also the level of debt. For capital-intensive companies, EV/EBITDA is a better valuation metric because it is not influenced by changing capital structures and ignores the effect of noncash expenses.

On the basis of the trailing 12-month EV/EBITDA ratio, the industry is currently trading at 4.32X, significantly lower than the S&P 500’s 10.9X. It is also below the sector’s trailing-12-month EV/EBITDA of 4.84X.

Over the past five years, the industry has traded as high as 18.83X, as low as 3.34X, with a median of 7.39X, as the chart below shows.

Trailing 12-Month Enterprise Value-to EBITDA (EV/EBITDA) Ratio

 

Bottom Line

Agreed, Canadian crude prices are most likely to trade at a discount to WTI because of quality and pipeline issues. However, as part of a strategic shift, Canadian oil companies are now looking to pump resources into two of the popular shale plays of the country — Duvernay in central Alberta and Montney — instead of investing in risky and costly oil sands projects.

The continued project ramp-ups along with efficient strides adopted by the companies during the slump are now encouraging producers to rev up development. As a result, most Canadian upstream players reported significant production growth in 2018, exceeding their output targets through a combination of a high level of operational execution, lower completion cycle times and impressive cost reductions.

Meanwhile, the official go-ahead for the much-awaited Kitimat mega LNG export facility is expected to be a game changer for the Canadian energy sector. The project will help ease the nation's gas oversupply while tapping into the growing demand for the commodity in Asia. Due to Canada’s proximity with the Asian markets along with robust natural gas production in British Columbia and Alberta, the nation is a much-preferred destination for the LNG export facilities. The startup of the Kitimat project is likely to unleash a new LNG wave in Canada.

Finally, the government-mandated production curtailments have come to the rescue of the distressed Canadian oil while priming the companies for shareholder friendly moves with the excess cash at their disposal.   

We are presenting four stocks with a Zacks Rank #2 (Buy) that are well positioned to grow.

You can see the complete list of today’s Zacks #1 Rank stocks here.

Enerplus Corporation (ERF): This upstream operator focuses on oil and natural gas exploration and production in Western Canada and the U.S. Enerplus has an expected sales growth of 24.6% 2019 and has surpassed estimates in the last two quarters.

Price and Consensus: ERF

 

 

Obsidian Energy Ltd. (OBE): This oil and gas explorer is focused on assets scattered across Alberta. Obsidian Energy has an expected earnings growth of 57.1% for 2019.

Price and Consensus: OBE

 

 

Encana Corporation (ECA): This energy finder focuses on three key growth areas namely Permian, Montney and Anadarko). Encana has seen the Zacks Consensus Estimate for 2019 increase 13.4% to 76 cents over 30 days.

Price and Consensus: ECA

 

 

Crescent Point Energy Corp. (CPG): This oil and gas explorer’s operations are primarily concentrated in southwest and southeast Saskatchewan and Utah. Crescent Point Energy has an expected earnings growth of 9.1% for 2019. Over 30 days, the company has seen the Zacks Consensus Estimate for 2019 increase 140%.

Price and Consensus: CPG

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Royal Dutch Shell PLC (RDS.A) : Free Stock Analysis Report
 
Obsidian Energy (OBE) : Free Stock Analysis Report
 
Enerplus Corporation (ERF) : Free Stock Analysis Report
 
Encana Corporation (ECA) : Free Stock Analysis Report
 
Crescent Point Energy Corporation (CPG) : Free Stock Analysis Report
 
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