Crude Reality

April 13, 2018

This was a pretty good week for Canadian energy stocks—for a change. Even though the TSX delivered a modest pick-up, compared to strength in New York, the energy patch outpaced with more than a 3% gain and closed at the best level since the start of February. We can thank a euphoric oil market for this, but the bigger picture is still the same and that is that Canada’s oil and gas stocks are being held back by lack of pipeline building

Concerns over an escalation regarding Syria may have dampened enthusiasm in global equities this week, but it was enough to send crude oil futures through technical resistance and up above $67/barrel for the first time since late 2014. The break above $61.50 in January was the first test, given this level held in the short-lived bounce back in the first half of 2015.  We then established what we call a ‘double top’ just north of $66.50 (hit on January 25th and March 26th) and that level broke this week.

The ride has been impressive with prices now up more than 50% from the lows set back in June of last year and we are up over 150% from the chasm near $25 that we fell into back in early 2016. There is another special feature of this week’s breakout. We have now retraced half of the correction from levels north of $100 down to that chasm. If you ascribe to Fibonacci analysis, then the next key resistance level will be up around $76.50.  This would definitely have oil producers salivating.

If only Canadian producers could get more of their black gold to markets.  Which brings us back to the lack of real celebration in the TSX energy patch this week. In fact, there has been little reason to pop the champagne corks all year and the 25% rally in the sector from early 2016 is a drop in the bucket compared the performance in crude.




To be clear, it is not just Canada’s oil patch that has been anemic relative the move in oil.  In the case of the S&P, the energy sub-group has lost about 2% since the start of the year, or 1.4% after accounting for dividend reinvestment. The oil and gas exploration segment has actually gained a couple of percentage points.  Here at home, the TSX energy sub-group is down close to 6% so far this year (a loss of about 5% after dividends) and the exploration group is down almost 3%.

One of the key reasons behind the poor performance of Canada’s energy patch is the divergence between oil pricing in Alberta and the rest of the world. As the chart shows, the difference between the Western Canada Select crude price and the benchmark global oil price (WTI) fell to more than a 4-year low of about minus US$30/barrel in January.  It has bounced back this past week to minus US$15, however, previous recoveries have tended to be short-lived.




The difference between the price of oil in Alberta and the rest of the world comes down to essentially two factors—one we have no control over, the other we do. Since oil produced in Canada is of a ‘heavier’ grade, it is less desirable for refining, compared to lighter grades like Brent or WTI.  In other words, there is a higher cost associated with turning the heavier crude we get out of the west into usable products. That creates a natural discount. The other factor is the ability to get the crude to market. In the case of Brent, which relates to oil from the North Sea and the Middle East, it is produced closer to sea ports which makes transporting easier. WTI, which relates to US crude, is less easy to get to global markets, but is inside the largest market in the world.

Alberta oil, on the other hand, is landlocked. We can ship to the US, via rail and the existing pipeline network, but getting it to the rest of the world depends on expanding the pipelines and transporting to the east and west coasts. Last weekend, Kinder Morgan announced that it was halting all non-essential spending on the Trans Mountain oil pipeline. The fact that this continuing failure by Canada to develop pipeline capacity at a time when oil prices are rallying is nothing new. However, this rally will not last forever; while global demand for oil will be met by others, including the US. Underperformance in the TSX energy patch looks like something that will remain a feature for a while.



Upcoming events

Canada:  International C$ securities transactions, manufacturing shipments, Bank of Canada meeting, retail sales, CPI

US:  Empire manufacturing, retail sales, NAHB housing index, housing starts, industrial production, Federal Reserve Beige Book, Philly Fed index


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