Boasting vast endowments of oil and gas resources, the Canadian energy sector boom dates back two decades when superior technologies, high crude prices and a global supply shortage encouraged companies to exploit the potential of the country’s natural assets. However, the oil industry downturn coupled with U.S. shale revolution has hit the country hard, quashing years of expansionary phase and a job creation wave within Canada’s energy industry, especially its oil sands region.
Scars of the Slump
Oil sands, contributing to more than 66% of the total Canadian energy output, drove the annual economic growth of Alberta at 5.5% rate between 2010 and 2014. However, high-production costs associated with the oil sands and the crude’s fall into bear market territory wreaked havoc on the profit margins of most companies. Finding development of resources too expensive, the likes of Marathon Oil Corporation MRO, Royal Dutch Shell plc RDS.A, Equinor ASA, ConocoPhillips et al exited Canadian oil sand deposits. These companies then preferred to explore the U.S. shale plays and invest in short cycle projects, much opposed to deploying money across capital-intensive operations in Canada.
With the crude downturn, oil sands development was severely affected inducing axing of around $30 billion projects and more than 50,000 jobs. Oil sands capital spending declined for three consecutive years ending 2017.
Canadian Oil Sands Still on Slippery Slope
Canada’s oil sands, popularly referred to as bitumen sands, are extremely heavy crude oils, which can’t be recovered at a commercial rate through a well. The process of extracting crude from oil sand reserves is extremely costly and a complicated one, involving strip mining and underground heating. Moreover, obtaining crude from oil sands is also quite carbon-intensive, causing more than 15% higher emissions compared with the conventional methods of production. Leading operators in the region include Canadian explorers, namely Suncor Energy Inc SU, Imperial Oil Limited IMO, Cenovus Energy Inc CVE and Canadian Natural Resources Limited CNQ among a few others. All these companies carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
While the production from oil sands might grow on the back of completed projects and investments made prior to crude crash, Canadian producers are not willing to make fresh investments in the region even though the oil prices have been recovering.
Reportedly, the crude pricing strength is not likely to lead to a proportionate increase in the capital investments in the oil industry of Canada with capex in 2018 to remain almost unchanged with the prior-year levels of around $43 billion. Instead of investing in risky and costly oil sands projects, the companies are now looking forward to pump resources into two of the popular shale plays of the company — Duvernay in central Alberta and Montney in east central British Columbia.
Duvernay and Montney in the Spotlight
Canadian shale plays Montney and Duvernay require much slimmer upfront investment, and also result into faster top-tier returns compared with offshore and oil sands projects. Known for lighter oil, which is cheaper to produce and easier to refine, Montney and Duvernay give a tough competition to the prolific U.S. shale plays. Notably, the two fields together hold resources of around 500 trillion cubic feet of natural gas, 20 billion barrels of natural gas liquids and 4.5 billion barrels of oil.
Canada’s shale output, accounting for 8% of the country’s total oil production, currently stands at around 335,000 barrels per day (bpd) and per the estimates of energy consultants Wood Mackenzie, the output is anticipated to be raised to 420,000 bpd in the next 10 years.
Deals Heating up the Canadian Shale Plays
Cashing in on the gradual uptick in oil prices along with attractive economics and prospects of Duvernay and Montney plays, Canadian producers as well as various global oil companies are betting big on the country’s vast shale reserves.
Leading Canadian explorers Seven Generations Energy Limited, Cenovus Energy and Encana Corporation ECA along with smaller players such as Raging River Exploration Inc, Vesta Energy among others are already tapping into these lucrative regions.
However of late, major global oil players like Chevron Corporation, Shell and ConocoPhillips have also started putting money on the promising zones. Notably, Chevron green lighted its first Canadian shale development last November, targeting to develop 55,000 acres in the Duvernay. Shell also intends to spend huge sums of money on the Duvernay shale this year. ConocoPhillips expanded its Montney foothold this year, acquiring 35,000 net acres for $120 million.
Various companies are also considering opting for merger strategies to widen their geographic footprint and bolster future growth prospects. In April 2018, Vermillion Energy Inc. inked an all-stock deal with Canadian rival Spartan Energy Corporation for C$1.4 billion. Just a week ago, Baytex Energy Corporation secured a $2.3 billion deal to acquire Raging River for broadening its scope of operations in Duvernay Shale.
Late last year, Canadian Natural Resources completed a major expansion of its Horizon oil sands mine, increasing the production capacity by 80,000 barrels per day. Exxon Mobil Corporation operated Hebron project — offshore oil field in Canada — came online last December and is likely to yield about 150,000 barrels of oil per day at its peak. Earlier this year, Suncor Energy completed its significant Fort Hills project, anticipated to boost the company’s output by 20%.
Per the International Energy Agency (IEA), Canadian oil output is estimated to average more than 5.11 million barrels of oil per day (bbl/d) in the current year, higher than the 4.8 million bbl/d averaged in 2017. Production growth from three major projects including Fort Hills, Hebron and Horizon oil sands mine, which became functional of late, is likely to provide the boost.
Pipeline Problems Galore
However, pipeline construction in Canada has failed to keep pace with the rising domestic oil, forcing producers to sell their products at a discounted rate. Reportedly, infrastructural bottlenecks are likely to lead to lost revenues of C$15.8 billion in 2018.
With the cancellation of major projects like Northern Gateway and Energy East along with uncertainties relating to existing ones, things have gone from bad to worse for investors in the Canadian oil energy space. Though several major pipeline projects have received the nod from country wide review agencies, Canadian industry observers felt that it’s not going to be a smooth ride amid environmental and political turmoil.
TransCanada Corporation’s $8-billion Keystone XL pipeline has been facing regulatory obstacles and opposition from landowners, environmentalists and Native American tribes. The company is yet to make a final investment decision on the project. Enbridge Inc.’s Canada-United States connecting Line 3 replacement project confronted criticism from the Ojibwe communities. The fate of the project is expected to be decided in a couple of days. However, Line 3 will not commence operations before 2019. Further, it will be little surprise if the date is further postponed amid public outcry due to environmental concerns.
Kinder Morgan, Inc.’s C$7.4 billion Trans Mountain pipeline expansion project, aimed at transporting Canadian tar sands oil to the Asian markets, has been tackling severe opposition from the green crusaders. In fact, federal government has agreed to buy the company’s project, nationalizing the pipeline. This might defer the in-service date of the pipeline to at least 2021.
The pipeline shortage is also increasing dependence on railway and trucks for transportation of crude, a highly costlier and an environmentally unsafe option for the industry.
The industry needs streamlined regulatory system, tax reforms and inflated capital investments. Notably, capital investment in Canada’s energy sector is witnessing decline of late, with the spending reduced by 47% between 2014 and 2017. This, in turn, is minimizing jobs, impacting the overall economy. Lack of sound regulatory and environmental framework is eroding the country’s investment climate.
While overall Canadian oil production likely to increase to 5.6 million bpd by 2035, lack of takeaway capacity — a major challenge haunting the industry — is not expected to wane anytime soon. The country, targeting production growth of around 30% by 2030, requires more pipelines to be built to supply additional capacity of around 1.3 million barrels a day by the time.
Canada also needs to bring in new pipeline projects to connect supply with the tidewater. This is precisely because the U.S. market is the chief importer of Canadian oil and as the former is itself revving up its production, the U.S.demand for Canadian oil is likely to decline. Therefore, Canadian producers must access the new emerging oversees market to enhance its competitive edge.
However, as already discussed, there is immense uncertainty surrounding a pipeline project even after being shown a green signal. Major pipelines like Keystone XL and Trans Mountain are not predicted to come online before the start of the next decade, which puts the Canadian oil industry into much ambiguity at least in the near term, if not in the long run.
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