It has been tough to find value in energy this year. Oil shale still represents the best investment opportunity in the U.S., but most U.S. exploration-and-production (E&P) companies have already had a massive run. 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 U.S. and Canadian companies I follow couldn't be more different. U.S. firms pursue unconventional oil from horizontal hydraulic fracturing, and Canadian firms generate growth from oil-sands development, mostly in the Athabasca. But, in the end, value in the E&P space is related to price -- and Canadian share prices have been steady as U.S. companies have soared. So the oil-sands space, as burdened as it is, is looking better all the time.
Of course, it is the Keystone pipeline controversy that has helped keep down the share prices of Suncor (SU), Canadian Natural Resources (CNQ) and Cenovus (CVE). Even if the further development of oil shale isn't much dependent upon Keystone, and even though 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 those for a fracked well in West Texas, the costs to keep it running are far lower. Furthermore, 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: It now uses less water, and is able to recycle more of it. As the environmental disadvantages of oil-sands recovery continue to lessen, and as the costs continue to drop, these Canadian companies are going to be more and more competitive with U.S. E&Ps for refinery contracts.
Then there are the local oil markets and their influence. Benchmarked to West Texas Intermediate (WTI), Permian oil (Midland) has been running at a progressively deeper discount, amounting to more than $8 last week. In contrast, Canadian sour grades, Western Canadian Select (WCS) has been running at less and less of a discount to WTI, coming from as deep a discount of $30 a barrel in the fourth quarter 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 than ever before to Midwest and Eastern Canadian and U.S. refineries. 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 for its innovation in SAGD processes. None of the three companies I mention will blow you away with their dividends, as they all deliver yield of between 2% and 3.5%, but they won't leave you in the lurch waiting for share appreciation either.
In a very tough market, they might be the best opportunity left out there in the energy space.