Why Canadian Oil Stocks Should Fare Well for Investors

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THE MACRO DILEMMA – PART 2
By Cory Mitchell, CMT

Part 1 suggested the macro force of “peak oil” which will constrain global oil supplies, will push the price of oil higher.  Yet if peak oil occurs, it implies peak debt and GDP.

Without GDP growth, a stagnant economy implies downward pressure on the price of oil.

In part 2 I look at which factor is more dominant in moving the price of oil, which country looks favourable in such an environment and where I believe the most opportunities lay in terms of oil stocks.

Canadian oil stocks are one of the best places for investors.

Canadian oil stocks benefit from rising oil prices, and the global supply constraints of “peak oil” should push oil prices higher.

In spite of the potential for peak oil production, which would stunt global growth, there will be strong demand for oil for the next couple decades.

This is good for Canada as its oil production is increasing, while global oil production has already levelled off.  Canada has relative strength in oil compared to the rest of the world, and this means opportunities for investors in the Canadian oil sector.

Global oil production levelled off in 2005, as OPEC levelled off.  Non-OPEC production had actually flat lined at least a few years before this.   While OPEC claims to have spare capacity there is little evidence in the way of their actions to support this.  Even as the price of oil screamed higher in 2007 OPEC production barely budged.

European production has been declining since 2001, Mexican production since 2004.  No more giant fields are being discovered. Couple this with rising demand in China, India and emerging markets and a long-run strain on production is inevitable.  Add to this that most countries around the globe are consuming more of their own production.  This basically means that exporting countries or regions are exporting less as their own demand for oil rises.  Figure 3 shows OPEC as well as non-OPEC production flat lining.

Figure 3. Oil Production and the Price of Oil


 

Source: http://www.theoildrum.com/node/8268.  Figures based on EIA data.

The levelling off and eventual decline in global oil production should outweigh opposing factors in pushing the price of oil higher.  Even in economic contraction oil consumptions drops very little.  This means demand keeps up while production wanes.  The long-term impact is steadily higher oil prices in the years to come.

While global oil production is sagging (good for pushing oil prices higher), Canadian oil production has been rising and is expected to continue to rise, or in the worst case level off, according to the National Energy Board of Canada as shown in Figure 4.

Figure 4. Canadian Oil Production Forecast

Source: National Energy Board of Canada

How Does This Help Canada?

Since Canada is largely reliant on oil production (and price) as a contributor to GDP, in the event that other countries see a decline in GDP, Canada is likely to be at least partially protected from such a decline.  Rising oil prices also help produce relatively strong returns in Canadian oil stocks. There are several reasons Canada is insulated and should see strong oil stock performance:

  1. Canada has a lower debt level than many other countries.  This means there is room for growth.  Canada has money, debt availability and resources to invest in projects which are profitable – one of these is the Canadian oil sector.  Countries such as the US on the other hand are facing a peak debt scenario (as discussed in part 1) and are unlikely to be able to generate sustainable growth for some time.  Canada is much farther away from peak debt, indicating a decade or more before the Canadian economy plateaus.  The Canadian economy will not plateau until Canadian oil production declines, which is not forecast to happen any time soon.
  2. Global peak oil production will dampen economic growth and eventually lead to a global economic decline.  Canada is insulated from this; as Canadian oil production increases and sells at a higher price, Canadian GDP is likely to rise while many countries face economic declines.  An increase in Canadian oil production means Canadian companies sell more oil, which is good for GDP and stock returns.  That attracts investors. A global decline in oil production indicates a supply constraint, which means Canadian companies sell more oil at a higher price (higher margins).  It comes down to simple math—if Canadian companies can produce more oil and sell it at a higher price, Canadian oil stocks are likely to outperform in good and even poor global economic conditions.  Again, this shows relative strength, which is where investors want to be.
  3. Rising Canadian oil production draws investors not only from Canada but also from outside.  The transparent and developed oil market attracts liquidity from around the globe. Canada is also a friendly place for new start ups, which means more opportunities arise as companies push to tap more and more of the Canadian oil reserves – currently third largest in the world according to the CIA.

How to Find the Best of the Best

After determining Canada has relative strength globally in oil, making it one of the best places to invest, investors should look at which oil stocks are showing relative strength – a phenomenon discussed in a prior OGIB article, Oil Stocks & Relative Strength: What to Look For.  This can be summed up as buying strong stocks which are holding up very well in a weak market, and move aggressively higher in strong markets.

This doesn’t mean plunging headlong into every Canadian stock.  Potential global supply constraints will continue to create volatility, which means buying companies that hold up well in tough economic situations is essential.

Canadian Energy Services (CEU.TO) is an example of this and was highlighted in my relative strength article.(Disclaimer: Cory Mitchell does not own shares or have any affiliation with this company; Keith Schaefer does own shares.)

While the stock has had a wide range (on a percentage basis), the stock held above January and February levels even as the overall TSX plunged below its January and February levels – in other words CEU held up well in a tough economic environment.

Since early October, oil and the stock market have crept higher, while CEU has exploded to near all time highs – the TSX Composite remains negative for the year, while oil is close to break-even.  Figure 7 shows CEU.TO (blue) compared to the TSX Composite (red).

Figure 7. Canadian Energy Services (blue) vs. TSX Composite Index (red), Year to Date

Source: Free Stock Charts

The chart shows that even during tough times for the economy, there are excellent opportunities.  As stock markets and economies decline, looking within the Canadian energy space for stocks which form a base and hold at or above support levels will provide the best opportunities.  These same stocks that show strength in overall market weakness usually exhibit outperformance type strength when the overall market is flat or moving higher.

Conclusion

The Canadian oil sector is looking good.  I expect Canadian stocks to do well relative to many other bench marks.  As long as Canadian production increases, Canada should also remain insulated from economic declines which other countries may face due to “peak oil” and “peak debt.”  The main reasons are:

  • Canada increasing oil production while the rest of the world declines means more demand for Canadian oil, pushing Canadian oil stocks and GDP higher.  That show Canada’s oil market has relative strength to the rest of the world.
  • Declining global oil production pushes the price of oil higher, which means Canadian companies producing oil can sell at a higher price, increasing margins (good for stocks).
  • Debt levels in Canada are low relative to many other countries.  Unlike debt constrained nations which face limited growth prospects, Canada is not likely to face a long-term decline in the economy until its oil production begins to decline, which is not currently forecast.
  • The Canadian market attracts liquidity from around the globe.  The market is transparent and the potential for relative outperformance and the strong Canadian dollar are likely to continue to attract investors.

Patience is still required when making trades, but Canada stacks up well whether the global economy does well or poorly.  If anything, the clash of these giant macro forces will create amazing opportunities in the sector, due to the volatility that is created.

– Cory Mitchell, CMT

Cequence Energy Reports Lower Cash Flow and On Track Production in 3Q11

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1940bkg
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Calgary-based junior exploration and production company Cequence Energy Ltd. (CQE:TSX) reported cash flow per share (CFPS) of C$0.07 for 3Q11 and production of 9,745 barrels of oil equivalent per day.

While production was in line with the estimates of Canadian brokerage Canaccord Genuity, CFPS was below both the estimates of the Canaccord (C$0.09) and a consensus prediction of C$0.07. The shortfall caused the Canadian brokerage to lower its rating to HOLD from BUY and reduce its target price to C$4.25 from C$5.40.

The exploration and production company lowered its production estimate for the year to 9,050 barrels of oil equivalent per day from 9,400 barrels of oil equivalent per day. This downgrade was primarily blamed on challenges to production. Cequence is suffering from unplanned downtime in its plants. The company's 1-10 Wilrich well has hit an open fracture and is currently experiencing a IP30 rate of 1.0 million cubic feet per day.

Cequence is experiencing a production shut in of 500 barrels of oil equivalent per day to make up for pad drilling.

In contrast to the negative metrics released regarding cash flow and production, Cequence has announced positive news surrounding its infrastructure projects. The company announced that it built a seven kilometer 8-inch gathering line, along with an early agreement with Alliance Pipeline and Aux Sable to build a 120 Mmcf/d metering station at Simonette. Phase II of Cequence's Simonette facility is expected to be completed soon.

Cequence Energy Ltd. has frequently focused its drilling activities in the Montney formation and the Wilrich formation in the Montney  at Simonette, Alberta. The target share price that Canaccord has provided for the exploration and production company was based a on a six times multiple of 2012 estimated EV/DACF supplemented by C$2.47 in risked upside from Simonette Montney and Wilrich. Cequence's stock closed at C$3.67 on November 16 and hit a 52-week high/low of C$4.70 and C$1.55, respectively.  

Why I Am Overweight Silver Mining Stocks

By
dj
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In the last few days, I took profits in some of my gold stocks, and used the proceeds to increase my holdings of quality silver stocks. This shift in my portfolio puts me heavily overweight silver stocks.

The reason I went overweight silver stocks is simple – the quality silver stocks I own are the stars of my portfolio. As good as the gains have been in my gold stocks, the gains in my silver stocks have been even better.

What’s more, I think it is likely that the unusually strong action in my silver stock portfolio may be an early sign of things to come – specifically, that silver and silver stocks may be on the cusp of a big move up. If silver does move up strongly, the silver stocks are likely to do even better than the metal.

Why do I think this may the case? Because the action in the quality silver stocks I own are providing the kinds of signals that often precede such moves.

Let me explain.

As a trader of precious metals stocks, one of the key signals I am always evaluating is the relative strength of the precious metals shares in comparison to the underlying metals (i.e., gold or silver). Specifically, I look for signs that gold and silver stocks are either outperforming or underperforming the respective underlying metals (gold/silver).

If silver (or gold) is rising strongly day after day, but the silver (or gold) shares are grudgingly inching up or stalling, I have found it is often a pretty reliable sign that a temporary top is close at hand. (In an article I wrote for OGIB readers in August, I noted the striking underperformance of gold stocks at that time in correctly predicting an imminent temporary top in gold that occurred a few weeks later.)

In reverse, if silver (or gold) is inching up slowly, or even a little down or flat over a span of time, but the silver (or gold) mining shares are powering up, it is often a pretty reliable harbinger that silver (or gold) is ready to make a move higher.

Although many silver stocks are well below the highs they made when silver was soaring earlier in the year — what I call the elite silver stocks are telling a different story. The action in these stocks, which tend to be highly sensitive to prices changes in the metal, appear to be sniffing out an imminent rise in silver, possibly to new all-time highs.

With silver still well below the highs it made earlier in the year, a number of elite silver stocks are showing profound strength and are close to recapturing their old highs.

As an example, let’s look in detail at one of the quality silver stocks I own, Fortuna Silver, and the story its recent action may be signaling.

As you can see in the price chart above, with silver well below its all-time highs, Fortuna is close to recapturing its all-time high. A few other elite silver stocks are in similar situations.

Just looking at Fortuna’s price chart alone, one may come to the conclusion that Fortuna Silver may be close to topping out, as it nears it’s resistance zone of previous highs. In the past, when Fortuna revisited its old highs in this area, it experienced steep corrections.

However, I don’t think that is likely going to be the case this time for Fortuna (and by extension the silver stocks in general). Here’s why:

If we take a look at a relative strength ratio chart of Fortuna Silver versus silver the metal (see the chart below), we see a very interesting picture! (Relative strength is determined price of the stock divided by the price of the metal, in this case, Fortuna divided by the price of silver. If the chart line is rising, Fortuna is performing stronger than silver, and vice versa).

Take a look a look at this chart of the relative strength ratio of Fortuna Silver divided by the price of silver:

The chart of relative strength above shows we just may on the cusp of a significant multi-week up-move in Fortuna Silver, and by extension silver and silver stocks.

Trading is always about assessing probabilities. There are never any guarantees.

On balance, I think the probabilities look good for a potential multi-week rally in silver stocks, and I am positioned accordingly.

Good trading!

By Trader Dave

Trader Dave is a full-time investor and trader of precious metals stocks. Trader Dave writes about his insights on gold and silver mining shares on his blog, Epiphanies on Gold and Silver.

Trinidad Drilling Ltd. 3Q11 EBITDA Beats Consensus Expectation

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1940bkg
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Drilling equipment provider Trinidad Drilling Ltd. (TDG:TSX) recently released its 3Q11 results, which indicated that EBITDA for the period was C$69 million, slightly above the consensus estimate of C$67 million. Investment bank Raymond James responded to this information by reiterating its Strong Buy rating and C$11.00 target share price for the company. Trinidad's website indicates that it has drilling operations in most major oil and gas plays in North America.

Raymond James notes that the drilling equipment provider's stock has returned 48 percent since the end of September while the TSX has risen 9 percent. One factor that the investment bank attributes this strong stock performance to is effective management of capital. Although debt rose marginally during the quarter to C$604 million as a result of C$37 million in capital outlays and C$25 million in working capital investment, Trinidad expects to add five rigs in the next quarter, which should generate cash flow higher than the combination of dividend payments and capital expenditures.

Another factor that has been credited with the strong stock performance of Trinidad is rising profitability in its U.S. operations. Margins from the U.S. division have risen 730 basis points to reach 45.5 percent, as certain contracts were renewed at rates that more closely mirror rates in the spot market.

The C$11.00 target share price provided by Raymond James is based on a 6.2 times multiple of estimated EV/EBITDA and a 12.5 times multiple of estimated 2012 earnings. Trinidad Drilling Ltd.'s stock closed at C$8.27 on November 14 and hit a 52-week high/low of C$11.21 and C$4.86, respectively.  

Southern Pacific Resources 1Q12 Results Indicate Production and Cash Flow Below Estimates

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1940bkg
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Junior oil sands exploration firm Southern Pacific Resources Corporation (STP:TSX) recently released 1Q12 results which showed that its production averaged 3,784 barrels per day (bbl/d) and cash flow of C$10.7 million or C$0.03 per share. These metrics were less than the estimates of investment bank Raymond James, which predicted production averaging 3,994 bbl/d and cash flow of C$13.3 million or C$0.04 per share. Raymond James reiterated its Strong Buy rating and $2.00 target price for Southern Pacific in spite of the below-average results.

The investment bank blamed Southern Pacific Resources' production missing estimates to the greater-than-expected impact of nine days of downtime. It is now clear that the production stemming from Senlac Hill is highly volatile as a result of constantly changing wells.

The geographical site, also known as Senlac Ridge, was the ridge where Harold Godwinson placed his army before the Battle of Hastings in England in 1066. The U.K. Department of Energy and Climate estimates that the country has between 734 and 4,287 million barrels of potential additional oil resources.

The junior oil sands exploration firm has averaged 4,064 bbl/d between the beginning of 2011 and November 15. The firm has predicted that its average daily production will remain between 4,000 bbl/d and 5,000 bbl/d "for the foreseeable future." Ever since Southern Pacific Resources acquired Senlac Oil Ltd. in 2009, daily production has been in this range.

Raymond James based its C$2.00 target share price on its risk-adjusted NAV of C$1.99 per share. Southern Pacific Resources Corporation closed at C$1.37 on November 14 and hit a 52-week high/low of C$1.95 and C$0.87, respectively.
 

Delphi Energy Corporation Reports 3Q11 CFPS, Production Below Estimates

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1940bkg
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Calgary-based exploration and production company Delphi Energy Corporation (DEE:TSX) recently reported that its production averaged 8,967 barrels of oil equivalent per day and that its associated cash flow per fully diluted share was C$0.14 in 3Q11. Canadian brokerage Canaccord Genuity provided slightly higher estimates of 9,319 barrels of oil equivalent and cash flow per share of C$0.15. Canaccord responded to this information by reiterating its C$2.25 target share price and maintaining its HOLD recommendation.

Production results came in lower than expectations as a result of natural gas liquids that were below estimates. The below-target results prompted Delphi to reduce its 2011 production guidance to 8,800-9,000 barrels of oil equivalent per day from the previous estimate of 8,800-9,200.

The exploration and production company announced that its 2011 capital expenditures program will increase by C$10-15 million, which will probably be invested into drilling activities in the Montney shale at Bigstone. The Montney formation covers ground in both Alberta and British Columbia. Delphi recently upgraded its land position to 45 sections and intends to drill two or three long horizontal wells before the end of 2011. Canaccord predicts that the results generated by Delphi's drilling activities in this play will help to foreshadow the future of the company.

The target share price provided for Canaccord Genuity is derived from a 5.5 times multiple of 2012 estimated EV/DACF. Delphi Energy Corporation closed at C$2.26 on November 13 and hit a 52-week high/low of C$2.89 and C$1.30, respectively.  

Crocotta Energy Inc. CFPS and Production “Crush” Estimates in 3Q11

By
1940bkg
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0

Crocotta Energy Inc. (CTA:TSX) recently released 3Q11 results which indicated the oil and gas company generated cash flow per fully-diluted share of C$0.11 and production of 4,002 barrels of oil equivalent per day.

Both of these reported metrics beat the expectations of Canadian brokerage Canaccord Genuity, which had estimated that Crocotta would record cash flow per fully-diluted share of C$0.08 and produce 3,750 barrels of oil equivalent per day. Canaccord subsequently increased its target share price for the oil and gas company to C$5.00 from C$4.00 and maintained its BUY recommendation.

The above-forecast earnings were attributed to significantly reduced operating costs and royalties that were lowered by government incentives. The Canadian brokerage expects that operating costs will fall further as production activity speeds up in the Bluesky, which exists in Western Canadian Sedimentary Basin. Canaccord also predicts that royalties will stay low.

The strong production numbers exceeding 4,000 barrels of oil equivalent per day were attributed to more robust extraction of oil and liquids and Crocotta most recently estimated that its daily production is 5,500 barrels of oil equivalent per day.

Canaccord Genuity based its target share price for Crocotta Energy Inc. on a 5.5 times multiple of 2012 EV/DACF and the addition of C$0.64 of risked Montney upside. The oil and gas company's stock is currently trading at a 4.2 times multiple of the Canadian Brokerage's 2012 estimated EV/DACF and C$39,803 per barrels of oil equivalent. Crocotta Energy Inc. closed at C$3.36 on November 13 and hit a 52-week high/low of C$3.40 and C$1.60, respectively.  

Crown Point Ventures Ltd. Provides Drilling Updates for South American Basins

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1940bkg
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Junior oil and gas company Crown Point Ventures Ltd. (CWV:TSXV) recently announced its plans to drill between 10 and 24 wells in San Jorge Basin in the next 24 months and two to four wells in the Neuquén Basin. Canadian brokerage Canaccord Genuity replied to this operational update by maintaining its C$3.00 target share price and SPECULATIVE BUY rating for the company. Canaccord is planning on sticking to its current estimates until the latest budget is approved.

The junior oil and gas company has confirmed its drilling plans in the San Jorge Basin over the next 24 months. Drilling in this exploration and production area means taking on less risk. Both field electrification and the wells that will be drilled will likely contribute to production for this area. After starting out with three or four wells, Crown Point Ventures will drill another two or three wells on the Canadon Ramirez block. The San Jorge Basin is located in central Patagonia, and is one of the highest hydrocarbon-producing plays in Argentina, according to Mendeley.

Drilling activities in the Neuquén Basin are on hold pending the issue of environmental permit. Fortunately, the permit for the Cerro Los Leones Block is expected to be granted shortly. The company has initial plans to drill between two and four wells. Two of these are high impact conventional exploration wells. The Neuquén Basin is the largest producer of hydrocarbons in Argentina, Quantec Geoscience Ltd. reports.

Canaccord Genuity's C$3.00 target share price for the junior oil and gas company is derived from a net asset value estimate of C$3.06 per fully diluted share, which consists of C$2.18 per share in risk exploration upside potential and C$0.88 per share of proven plus probably reserve value. Crown Point Ventures Ltd. closed at C$1.09 on November 9 and hit a 52-week high/low of C$2.40 and C$0.97, respectively.  

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