Today, my outlook for the remaining oil and gas sub-sectors—from best to worst. . .
Light Oil Producers
Here's the dilemma with them: improvements in fracking are enabling a lot more production—so much so it's dropping the light oil price. But the technology is also dropping the break-even price of said oil—so I don't think cash flows will drop as much as people think. At first. Let's see just how far the oil price drops.
But the Street doesn't care, the Hot Money is leaving the producers—pricing in cheaper oil.
Look at two big U.S. producers' stocks—EOG-NYSE and PXD-NYSE. They peaked just as refinery stocks bottomed, and they have been moving against each other ever since—which makes perfect sense. But the international U.S. producers like Exxon (XOM-NYSE) are still at or very, very near their highs.
The Street is steadily pricing in a big drop in the light oil price—expected to happen no later than Q1 2015—when all the imported light oil is squeezed out of the Gulf Coast Refinery Complex. That has been the relief valve for U.S. light oil prices, as production surges.
Condensate prices are about $6/barrel below WTI in Canada (or $88/barrel), vs. Canadian light oil being $16 below WTI now (or $78/barrel).
That makes condensate the most valuable/profitable hydrocarbon up in The Great White North. In the U.S. it is mainly produced as a byproduct of oil in the Eagle Ford formation in Texas. In Canada it is produced with natural gas out of the Montney formation on the Alberta BC border.
Condensate is a very light oil—so light it's a gas underground—that has a lot of uses, but the main one in North America is to dilute heavy oil from the oilsands so it will flow in a pipeline.
And with two multi-billion dollar oilsands projects announced in November totaling 200,000 bopd, I expect demand for condensate to stay strong. Alberta produces 125,000 bopd of condensate now but uses 300,000 bopd.
Enbridge announced a $1.4 billion pipeline to import U.S. condensate from the Eagle Ford up here. And production out of the Duvernay and Montney continues to ramp up fast—but from a low base. So I see the condensate producers in Canada actually having the best relative fundamentals in the North American market.
That's not helping the stocks of the junior condensate producers in Canada—even though condensate pays for the well and the associated natural gas has close to a zero cost base—or less—investor interest is leaving this sector despite wells that pay out in just months—even with a very low natural gas price.
Again, there is the paradox of good fundamentals but declining investor interest stalling these stocks.
Canadian Light Oil Producers
Canadian light oil producers will likely have the worst relative oil fundamentals. Canadian oil has dropped from $100-$77/barrel in a hurry.
The Market believed moving oil by rail would radically reduce Canadian oil price discounts this year, but Canadian light oil is tracking the Bakken oil price, or a few dollars below it (about $2.50/bbl below at time of writing). So Canadian oil has the lowest price and the highest transportation costs to refineries.
Personal feedback I've received from oil and gas marketers in Calgary—the guys in charge of selling the physical commodity for the producers—suggest the Canadian "diffs"—the difference between U.S. and Canadian oil prices—will stay for at least another 2-3 months.
I shaved a lot of my positions in Canadian producers on the first Friday in November.
U.S. Natural Gas Stocks
Natural gas production from Pennsylvania's mammoth Marcellus formation continues, and more infrastructure is getting put into place to get the gas to market.
And right behind that is the neighboring and overlapping Utica Shale. And right behind that could be New York allowing fracking and start drilling the Marcellus there. Get the picture?
At least 600 million cubic feet of gas (Mmcf/d) has recently come onto the market from the Marcellus, and 2 billion cubic feet (bcf) is coming online throughout the winter.
October will almost certainly have set a new all-time monthly record for U.S. dry gas production—over 67 bcf/d. (The latest official stats are from August.) So right now I don't see any increase in fundamentals for U.S. gas producers—just continued improvements in fracking that lower the cost of production, and of course—Old Man Winter.
Without him—at his fiercest—the next shoulder season of Spring 2014 could get really ugly again for producers; U.S. gas could be back below $2/Mcf.
Even the best natural gas stocks in the U.S.—like Cabot Oil and Gas (COG-NYSE), which is the big Marcellus player—are dropping now when the onset of heating season says they should be going higher.
Natural gas prices in the U.S. are all about the Marcellus shale formation in Virginia/Pennsylvania/New York.
It's gone from 2 bcf/d in 2009 to 12 bcf/d today. Until Marcellus production flatlines for three months, you don't need to worry about natural gas prices moving up. But every other natural gas basin in the U.S. is declining, so when that does happen, GET LONG GAS.
INTERNATIONAL OIL STOCKS
Probably the biggest paradox of all—North American listed international oil stocks have very low valuations—1-3x cash flow—despite great fundamentals—i.e. Brent pricing; especially expensive, high capital projects like the North Sea.
CANADIAN NATURAL GAS STOCKS
A hedge fund manager friend of mine said, Keith, you can't separate out Canadian natural gas stocks from condensate stocks—they're really the same thing.
And he's right to a very large degree. There really is no such thing as a Canadian natural gas producer anymore—except for Peyto (PEY-TSX) and Tourmaline (TOU-TSX). You're either a condensate producer or oil producer with natural gas as an associated byproduct.
In Canada, the only reason you're drilling for natural gas is because it's really a condensate or an oil well—those are the two commodities that pay for the well.
Canadian producers have the same problems U.S. producers do, only worse—they're being displaced by Marcellus gas. AND ironically, natural gas prices in Canada are being LOWERED right now because of LNG—Liquid Natural Gas.
The Market sees a lot of excess Canadian gas in the coming years as drilling ramps up for LNG exports off Canada's west coast. But until exports actually happen, that glut of gas being drilled is now being priced into the market at a much greater than normal discount to U.S. gas in the futures pricing.
Normally natural gas in Canada trades 50 cents/Mcf below the U.S. in summer and 30 cents below in winter. But now strip pricing is calling for 60 and 80 cent discounts in the coming two years.
There you have it—my favorite subsectors from first to worst.
Oil & Gas Investments Bulletin