In today’s Wall Street Journal, Chip Cummins wrote a smart article revealing the deleterious effects of America’s shale oil (& gas) boom upon our friendly neighbor to the north: Canada.
In a nutshell, the massive increase in production and reserves of the United States’ light, “sweet” crude is revolutionizing and reorganizing the world’s energy markets. Canada, with its massive supply of oil sands (aka Canadian bitumen) is suffering greatly. This is primarily because oil sands are much more expensive to produce than is America’s oil via their hydraulic fracturing process, which makes oil sands a losing play in basic supply-and-demand models.
Secondly, even though America’s Gulf Coast refiners are geared towards Canada’s heavy crude, the costs of transporting it from point A to point B are becoming significant hinderances. One beneficial solution–or huge obstacle, depending on your political persuasion–would be to allow creation of the Transcanada Keystone XL pipeline. This would reduce the cost of transportation of Canada’s product to America’s Gulf Coast refiners, which would amount to an economic “lifeline.” At least, temporarily.
Is all of this really having an effect?
According to Cummins, “Lower Canadian oil prices helped shave 0.4 percentage point off the country’s economic output in the second half of last year. That’s a big chunk for an economy that grew just 1.8% in 2012.”
If the shale revolution drops a large country’s GDP by 0.4% in a six-month period, you can rest-assured that it also affects you as an investor!
What follows are solid, lucrative ways to play (or avoid!) this long-term trend as an investor. These are not necessarily recommendations for investment, but they do represent the way I think about it–and invest–personally.
Major Oil Companies: This category includes the well-known oil “majors” such as ExxonMobil, Chevron, ConocoPhillips, British Petroleum and Royal Dutch Shell. I rate these as Neutral, as they will adapt and do business more-or-less as usual. They all remain solid, long-term investments that should play at least a small part in anyone’s investment portfolio.
Refiners: I think that American refiners will continue to benefit greatly from lower priced oil and natural gas products during the next 5 to 10 (or more) years. They will also, however, incur increased capital expenditures as they transition from processing Canada’s bitumen to America’s lighter crude. These companies include (but certainly are not limited to): Phillips 66 and Dow Chemical Co. Specifically, even though Phillips 66 (NYSE: PSX) is up 71% since it broke off from ConocoPhillips last year, I’d argue it still has room to run. I rate this category as Strong.
Exploration Companies: Smaller American and International exploration companies may be the most volatile and speculative ways to play the newer “fracking” techniques. While some companies will multiply by 1o’s or even 100’s with an incredible find or two, most others will crash and burn. Being a non-speculative investor, I tend to steer clear of these companies. I, therefore, rate this category as Neutral for speculators with money to burn, and Weak for the masses.
Oil and/or Liquified Natural Gas Exporters and Transporters: Since the U.S. has an over-abundant and quickly-growing supply of oil and natural gas, prices for both are bouncing around inflation-adjusted historic lows. However, prices around the rest of the world for these valuable commodities continue to trend higher. With our international quasi-free markets, this should (and will) lead to a correction of the price differences, based on basic supply-and-demand curves. That is, America’s cheap, abundant energy will eventually find its way to those countries without cheap, abundant energy (think Japan, China, Western Europe and India for starters!). “Picks-and-shovels” transportation companies will be at the front line of profits for this guaranteed phenomenon, and include: Cheniere Energy and Teekay LNG Partners. I rate this category as Strong and highly recommend that you look into the previously-mentioned and other, similar companies.
Pipeline and/or Storage Master-Limited Partnerships: Another fantastic “picks-and-shovels” way to play our rapidly increasing supply of American oil and gas is to buy pipeline Master-Limited Partnerships (MLPs) and pipeline/storage infrastructure companies. Kinder Morgan is probably the most famous of these, though its current price is too frothy for a simple, value-oriented guy like me. Better MLPs, in my opinion, include: Enterprise Products Partners, Energy Transfer Partners, and Williams Partners, all of which sport healthy dividends of more than 4.5%. Also, Chicago Bridge & Iron and KBR focus on building energy infrastructure and will continue to trend higher. I rate this category as Strong.
Short Candidates–Canadian Oil Sands Companies: I generally disdain shorting stocks, though I’ll dabble when the fruit is ripe for the picking. As mentioned at the beginning of this article (and throughout Chip Cummins’ piece for the Wall Street Journal) Canada is already feeling the pinch of America’s shale boom. Specifically, Canadian Oil Sands companies’ margins will continue to get squeezed over the next few years, since their product is significantly more expensive to produce. As demand dries up and their net income drops, look for concurrent falls in stock prices. For short candidates, might I suggest Suncor Energy and Canadian Oil Sands as appetizers.
The shale revolution is here to stay and is already having a meaningful impact on economies, companies and investors in America and across the globe. Get knowledgeable in this arena and you will generate real, long-term investment gains. If you remain uninformed or refuse to adapt, you’ll have to sit on the loser’s bench.
At least you’ll have Canadian oil sands companies and their investors for company.
Jeffrey W. Ross, MD is a Motley Fool investment freelancer.