Canadian oil stocks lag oil price increases

Something has to give

World oil prices are up sharply since the summer. The ~US$20 a barrel run-up in oil prices points to higher cash flows for Canadian oil producers, most of whom have paid down debt considerably over the past two years.

Western Canada Select (WCS), the standard grade of heavy oil in Canada, is trading at US$80 in Cushing and about US$70 in Canada (a differential of about US$10 a barrel). At today’s exchange rate, the Canadian dollar price of heavy oil is CAD$94 a barrel, up from about US$55 a barrel or CAD$74 a barrel only a few months ago in March of this year. For some producers, a CAD$20 bump in WCS prices is big money. MEG Energy (MEG.TO) produces 100,000 barrels a day more or less, and the price jump is worth $2 million a day in revenue or over CAD$700 million a year at annual rate. Knock off royalties and apply a four times EV/EBITDA multiple and MEG’s 285 million shares should have risen by CAD$8 a share more or less, but the stock today trades at CAD$26 versus CAD$24 back in March.

That phenomenon is true across the WCSB producers - Canadian oil stocks have not followed oil prices in lock-step. History tells us that over time they will.

Here are a couple of Canadian producers that appear deeply undervalued if the current firm price environment persists for the next couple of years:

Bonterra Energy (BNE.TO) at about CAD$8.00 a share has a market capitalization of CAD$280 million, about $150 million of debt, and at today’s oil prices (largely Canadian light oil for Bonterra, which is priced north of CAD$100 today) Bonterra valued at four times EBITDA should be priced somewhere around CAD$16.00 a share, about double the currnt market price.

Rubellite Energy (RBY.TO) at about CAD$2.00 a share has a market capitalization of about $120 million and with production now over 3,200 Barrels a day of heavy oil and netbacks of around CAD$50 a barrel, should be turning in over CAD$55 million of annual cash flow and at a four times EBITDA multiple trade in the CAD$3.50 range, about 75% higher than current market.

There are of course many others. Tamarack Valley (TVE.TO), Baytex (BTE.TO), Crescent Point (CPG.TO), Headwater (HWX.TO) and Canadian Natural Resources (CNQ.TO) are all beneficiaries of the higher prices and are solid choices in an improving commodity price environment.

If the much-anticipated recession continues to be postponed by robust consumer demand and world oil prices remain relatively firm, the oils should enjoy a good winter. If the global recession everyone fears does begin, all bets are off.

I am not a fan of the current crop of economic experts and their “I wish” projections. Most of them have succesfuly predicted five of the last two recessions.

Full disclosure, I have large positions in Bonterra (50,000 shares) and Rubellite (65,000 shares) and a small position in Baytex (5,000 shares) and currently own none of the other names mentioned.