Time to Look North of the Border

2014 has been a tough year to find value in energy.  With oil shale still representing the best investment opportunity in the United States but with the massive run that most US E+P's have already had, it's been tough to find value in the space.  That's why I'm starting to think that the remaining value in E+P might lie north of the border, in Canadian oil companies.  

The model for production and the risks between the US and Canadian companies I follow couldn't be more different, with US firms pursuing unconventional oil from horizontal hydraulic fracturing and Canadian firms generating growth from oil sands development, mostly in the Athabasca.  But in the end, value in the E+P space is related to price -- and with Canadian share prices staying steady while US companies soar, oil sands, as burdened as it is, is looking better all the time.

Of course, it is the Keystone pipeline controversy that helps keep the price of shares of Suncor (SU), Canadian Natural Resources (CNQ) and Cenovus (CNE) down.  Even if the further development of oil shale isn't much dependent upon Keystone, and other pipelines for transport are available, the overhang of Keystone as the symbol of oil sands remains.  A Keystone approval would be the ultimate signal for getting into these names.

But there are other, more fundamental reasons to own Canadian E+P.  While the costs of initiation of an oil sands "well" are greater than for a fracked well in West Texas, the costs to keep it running are far lower.  And, the life of an oil sands well is generally much longer too.   In terms of technology, there is nothing quite as advanced as the new shale stimulation techniques being used in fracked wells in West Texas.  But oil sands recovery hasn't stood still either -- it is no longer just ugly strip mining of bitumen in wide open pits.  Steam Assisted Gravity Drainage, called SAGD, is an old technology that melts the bitumen underground with hot steam and then separates it from the water that comes back up.  But SAGD has moved forward too, using less water and able to recycle more of it.  As the environmental disadvantages of oil sands recovery continue to lessen and the costs continue to drop, these Canadian companies are going to be more and more competitive with US E+P's for refinery contracts.  

And then there are the local oil markets and their influence.  Benchmarked to West Texas Intermediate (WTI), Permian oil (Midland) has been running at a deeper and deeper discount, amounting to more than an $8 discount last week.  In contrast, Canadian sour grades (WCS) has been running at less and less of a discount to WTI, coming from as deep a discount of $30 a barrel in 4Q of 2013 to less than $15 last week.  This is an enormous turnaround in local crude pricing that makes Canadian sources for crude a whole lot more compelling to Midwest and Eastern Canadian and US refineries than ever before.  And I believe that these differentials are more likely to last for a lot longer than most others think.  

Of the three benchmark companies I slightly prefer Cenovus (CVE) for their innovation in SAGD processes.  None of the three companies I mention will blow you away with their dividends, delivering between 2% - 3.5 %, but they won't leave you in the lurch waiting for share appreciation either.

And in a very tough market, they might be the best opportunity left out there in the energy space.