Financial Post | 16 January 2020
A clause in the US–China trade deal presents a big opportunity for the oilsands
by Colin McClelland
The initial U.S.-China trade deal signed Wednesday boosts the investment case for Canadian oilsands companies as American producers face political and production headwinds, Toronto-based investment bank Eight Capital Corp. said in a new report.
China’s pledge under the new deal to buy US$52.4 billion of additional U.S. energy products over two years compared with US$9.7 billion in 2017 as it increases its use of heavy oil provides “green shoots” for Canadian oilsands, Eight Capital said in an email accompanying the report.
China agreed to buy “petroleum oils and oils obtained from bituminous minerals, crude” in the next two years, according to an official document.
Eight Capital thinks the clause presents an opportunity for Canada. Citing the trade deal’s wording, the bank said “it is possible to believe that Canadian oilsands/heavy oil that travels through the U.S. via a U.S. subsidiary, refinery, or marketer is considered a U.S. raw material that falls under this definition.”
“China is becoming an even greater consumer of heavy oil and therefore this is especially a positive for Canadian heavy oil/oilsands that can get access to the U.S. Gulf Coast where it could be exported,” the investment bank said.
Canadian production of heavy oil is also bolstered by efforts to add export pipelines, Middle East tensions and the “non-event” of new marine fuel regulations, equity research managing director Phil Skolnick and associate Jeff Ebbern wrote.
However, Canadian oil faces strong headwinds. The price of benchmark West Canadian Select crude trades at US$20 or more a barrel discount to the lighter West Texas Intermediate oil because it needs more refining.
Canada also lacks pipeline export capacity and the country has just one main market, the U.S. Canadian producers are striving to reduce this differential by building new pipelines, potentially to the West coast for a shorter route to Asia, and by promoting the attractiveness to investors of oilsands reserves that typically last longer than those of U.S. shale operations.
“We believe differentials can start to narrow towards pipeline economics possibly in the first half of 2020,” Eight Capital said in the report. “Especially as the Keystone Mainline recovers to 100 per cent of capacity post the late 2019 leak. Plus, there is potential for further improvement with the recent start-up of TMX construction and the latest news on the U.S. side of Line 3, whereby an updated environmental review released by a state agency recently found no serious threat to Lake Superior if crude oil ever leaked from the line.”
Earlier this week, TC Energy said in a court filing that it will start construction work at its Alberta-to-Nebraska leg of the Keystone XL pipeline as early as February.
The Eight Capital authors note that while heavy oil production in California would seem to benefit from the U.S.-China agreement, refinery demand in the state takes most of its supply. Also, a state moratorium on new steam-injected oil drilling may prompt investors in local producers, such as California Resources Corp. and Berry Petroleum Corp., to switch to Canadian companies, at least in part because of the Alberta Conservative government’s strong support of the industry.
Eight Capital’s top stock picks and buy ratings are on Canadian Natural Resources Ltd., Cenovus Energy Inc. and MEG Energy Corp. It also said it likes buy-rated Athabasca Oil Corp. and Baytex Energy Corp. The bank maintains a neutral rating on Encana Corp., Imperial Oil Ltd. and Suncor Energy Ltd., and a sell evaluation on Husky Energy Inc.
A decline in the supply of quality U.S. shale oil wells is combining with a push by investors to boost the free cash flow of drillers instead of growth to potentially reduce the U.S. supply and increase prices, the bank said. Further supporting Canadian oil prices are the tensions surrounding Iran, Iraq and the wider Middle East involving Saudi Arabia that will likely see U.S. sanctions maintained on Iran or even levied on Iraq, the analysts wrote.
Other factors include increased demand by the start up of new petrochemical plants in Asia driven by rising standards of living in emerging markets, measures by members of the Organization of the Petroleum Exporting Countries to cut output and Mexico’s pressure on state-owned Pemex to reduce spending, Eight Capital said.
New rules enacted this year by the International Maritime Organization to slash sulphur emissions from shipping by 80 per cent will have less than a US$5 a barrel impact on heavy oil prices, the analysts said.
Most investors concerned about ESG — environmental, social and corporate governance issues —won’t be deterred by the oilsands companies because financial returns rank higher than environmental issues to them and they value owning stock as a means to push companies to address climate change, the bank said.
“With ‘E’ playing a dominant role in the ESG discussion, and the negative publicity the oilsands has continued to receive, the reality is that the oilsands in particular has made significant strides in reducing emissions intensities/environmental impacts, and has game changing technologies for commercial application that can foster the next step of improvement,” Eight Capital said. “Ultimately, portfolio managers are paid to generate returns, and a sustainable outperformance of the energy sector will be difficult to ignore.”
Last week, Cenovus Energy Inc. said it’s setting a goal of reaching net-zero emissions from its operations by 2050, in an effort to appeal to environmentally conscious investors. Canadian Natural Resources Ltd. and MEG Energy Corp. have also set long-term, targets of achieving net-zero emissions from their operations.