December 11th, 2014
by Ari Charney, Investing Daily
It's been yet another brutal week for U.S. investors in Canadian energy stocks.
First, state-owned Malaysian energy giant Petronas chose to defer its final investment decision on whether to proceed with its estimated USD32 billion Pacific NorthWest liquefied natural gas (LNG) project in British Columbia.
As we wrote last week, the prickly province finally got into gear to accommodate Petronas' year-end deadline, but its efforts appear to have been too little, too late-a perfect (and painful) reminder of the extent to which politicians take wealth creation for granted.
While Pacific NorthWest is just one of as many as 18 proposed Canadian LNG export projects, it was considered the frontrunner in the race for first export. Prior to this announcement, the project's timeline showed that export operations would commence in 2019, at the earliest.
Should Petronas decide that it simply doesn't make sense to proceed at this juncture, then that could push the timeline for the overall industry back, while resulting in export volumes lower than the 2 billion cubic feet per day that analysts had projected by 2020.
With the U.S. absorbing the vast majority of Canada's energy exports, it's absolutely critical for the country to diversify its export markets, especially now that the U.S. shale boom has created a glut of production. And LNG exports will hopefully still be a big part of that.
Although it's possible Petronas will still decide to pursue the project after all, the ultra-long-term contracts that underpin global LNG trade mean that the already narrow window of opportunity is rapidly closing.
In the past, the company's tough talk seemed like a negotiating tactic. That could still be the case, though, at this point, it sounds like it's all about making the numbers work.
And one of the factors that likely drove British Columbia to offer greater concessions than it had previously could also be the project's undoing: the bear market in crude oil.
Because there's no global benchmark for LNG, trade in the supercooled commodity is linked to crude prices, so oil's recent swoon has undermined the economics of the project.
Now Petronas is looking for ways to pare costs on the pipeline and the LNG export facility to make the overall project economically viable.
In a statement issued by the company, Petronas CEO Shamsul Abbas said:
"Petronas hopes that all outstanding factors can be resolved as soon as possible to enable the Final Investment Decision to be made within the identified LNG supply and demand window. This is vital in light of the current intense market environment and for Pacific NorthWest LNG not to lose out on long-term contracts to competitive U.S. LNG projects."
Although it certainly sounds like the company is still weighing its options, Eric Nuttall, who oversees USD106 million at Toronto-based Sprott Asset Management LP, told Bloomberg that he believes this is the "nail in the coffin for the project" because competing projects in other geographies, such as the U.S., are less costly and will also get to market much sooner.
That's because Canadian operators must build their LNG export facilities and the attendant pipeline infrastructure from the ground up, while competitors in the U.S. will mostly be converting existing import facilities into export facilities.
For now, Petronas will continue to work toward securing regulatory approval from the federal government, while also investing in natural gas development in the province.
Saudi Arabia's Second Salvo
The other news this week was cause for more fearful downward volatility in energy sector stocks, particularly oil and gas producers.
Last week, Saudi Arabia prevailed on its fellow OPEC members, who are already feeling significant pain from crude oil's selloff, to maintain crude production volumes at current levels.
This week, the kingdom made it even clearer that it's digging in for a price war to defend market share amid lower prices, while possibly stealing market share from higher-cost producers in unconventional plays, such as those that operate in Canada's oil sands and the U.S. shale formations.
State-owned oil company Saudi Aramco announced it had lowered its official selling prices for Asia-bound oil for January delivery by between USD1.50 per barrel to USD1.90 per barrel, while also cutting prices for its oil in the U.S. by betweenUSD0.10 per barrel to USD0.90 per barrel.
Previously, an unnamed OPEC official told The Wall Street Journal that there would be "panic" among members if global crude benchmarks hit USD70 per barrel.
But now the generic contract for January delivery of global benchmark Brent crude trades near USD68.95, according to Bloomberg, down 40% from the high in June, and officially below the panic threshold.
Clearly, the other OPEC members decided to take all their lumps at once, rather than cut production and possibly lose market share, as has happened to the organization in the past.
Meanwhile, the North American benchmark West Texas Intermediate (WTI) trades near USD65.68, down 38.8% from its trailing-year high in late June.
There are varying estimates for breakeven prices among oil producers that operate in Canada's oil sands. But one of the more commonly cited ranges seems to be USD60 per barrel to USD65 per barrel.
The thing to remember is that the price of the commodity won't be the only thing that corrects. The costs of skilled labor, services, machinery and equipment all rose in tandem with oil prices and will have to undergo their own downward adjustments, which could help lower costs at the producer level.
Additionally, most energy producers hedge their production to help make their earnings more predictable. That should mitigate some of the pain in the near term. We'll have additional detail on the hedging strategies among individual Portfolio names in the forthcoming issue of Canadian Edge.
While crude oil tries to find a floor in the near term, it may be some comfort to know that analysts see prices climbing back toward the mid-80s next year. According to Bloomberg, WTI is forecast to average USD86.32 per barrel next year. Of course, it's difficult to know how much stock to place in such projections, though presumably analysts are taking all kinds of variables into account with their models.
It may be tempting to throw in the towel, but we've endured such downward volatility in commodity prices before. That's why it's important to take a long-term perspective, even though recent news on this front has been positively gut-wrenching.