Shifting Fundamentals of North America's Energy Sector

By Arthur Pinkasovitch - February 22, 2012 | Tickers: CNQ, ENB, ECA, TLM, TRP | 0 Comments

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Canada’s oil industry has come under intense scrutiny from climate control experts. As the European Union goes to vote on trade restrictions concerning Canada’s oil sands exports, claiming that the energy source emits too much greenhouse gases, research published in Nature has indicated that Alberta’s oil sands are not nearly as dangerous as previously believed and significantly cleaner than some alternatives. Recent negative sentiment over environmental concerns has hindered the expansion efforts of TransCanada (NYSE: TRP) and Enbridge (NYSE: ENB) as they have thus far failed to get the green light on their respective Keystone XL and Northern Gateway pipelines. The University of Victoria finds that in order to produce the economically feasible 170 billion barrels of crude hidden in the oil sands, the century long process will only impact global temperatures by as little as 0.02 degrees Celsius. Although it is practically impossible, producing the total 1.8 trillion barrels of oil-sands crude would add 1/3 of a degree Celsius to global warming. These findings could potentially influence the European clean energy directive to be more lenient when voting on Canadian energy restrictions.

Although the research offers a potential bright light to Alberta’s (and Saskatchewan’s) future energy ambitions, producers are fighting another foe – natural gas prices. EnCana (NYSE: ECA) recently announced that it will be slashing North American gas production by 20% due to slumping resource prices which are diminishing the company’s marginal rate of return. With Canada’s largest natural gas producer expected to cut output by 600 million cubic feet a day, a drop of almost 20%, CEO Randy Eresman was quoted saying “It is abundantly clear that a continued reduction of drilling activity will be required to restore market balance...For the industry as a whole, near-term natural gas prices are at levels below what it costs to add most new production.” Likewise, Calgary based Talisman (NYSE: TLM) also announced that depressed natural gas prices have forced the company to slash spending in the Marcellus shale. Capital spending cuts of $600 million, a 50% drop are being made as the company plans to cut the number of operational rigs from 11 to 3 in the region.  An oversupply of North American natural gas has made many large scale projects to reach an economically unprofitable state.

Oil prices, which have remained resilient so far, are also presenting an unfavorable environment for production and exploration companies. Tight oil production in the United States is constraining pipeline and refining capacity, depressing prices below those realized outside of North America. While growing demand from emerging markets and continued tension with Iran have been adding upward pressure on both, WTI and North Sea Brent, the substantial $17 divergence between the two benchmarks is making Canadian and U.S. based operations much less profitable. Strong production in the Bakken, Eagle Ford and Utica is pushing oil fundamentals in the same direction as those reflected in the natural gas market. The discrepancy between West Texas Instrument and Brent would even be greater if it wasn’t for Canadian Natural Resources’ (NYSE: CNQ) shutdown of the Horizon oil sands upgrader. CNQ is Canada’s largest independent oil producer which must now fix a fractionator unit in its upgrading plant, thus taking 110,000 daily barrels off the market.

At over $105 per barrel it’s hard to make the argument that oil is cheap; $2.60 per MMBtu for gas, on the other hand, is a different story. The main problem with low prices is that foreign competitors can gain access to Canadian (and U.S.) resources for a fraction of the costs compared to 5 years ago. As North American companies trade at discount prices and try to divest their poor performing assets, international players with a long term perspective will easily gain our valuable resources. For example, EnCana recently sold 40% of its Cutback Ridge property to Mitsubishi Corp; Devon Energy struck a partnership with Sinopec and Sinopec will be soon purchase Canada’s Daylight Energy. Although low energy prices are hurting the long term fundamentals of Canada’s resource business, the recent publication addressing the “dirtiness” of the oil sands does shed some light on the sector.

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