Stock Smarts: Oil Remains A Shaky Investment

Low prices, pipeline problems, electric cars – these are difficult days in the oil patch.

These are tough times in the energy sector. The price of crude remains stubbornly stuck in below US$50 as supply continues to outpace demand.

OPEC’s attempt to push prices higher through production cuts has been thwarted by the increasing efficiency of U.S. shale oil producers. The U.S. Energy Administration projects that U.S. oil production will hit a record high in 2017 to an average of 9.3 million barrels per day. That will continue to weigh heavily on market prices.

Oversupply isn’t the only problem facing our oil companies. Consider these recent events:

A CN Rail train derails in Illinois, spilling 40,000 gallons of crude oil.

The Liberal government in British Columbia resigns, replaced by an NDP-Green coalition.

Volvo announces that after 2019 all its new vehicles will be equipped with electric engines.

These events may seem to be unrelated but together they spell on-going bad news for Canada’s energy sector.

The Illinois derailment did not involve Canadian-produced oil. But it was a reminder of how much the industry has come to rely on rail to transport its product to refineries across the continent. In 2016, CN generated almost $2.2 billion from the movement of 599,000 carloads of petroleum and chemicals.

Canadian oil producers have been forced to rely increasingly on rail in the absence of any new pipeline capacity to tidewater or to the U.S. Gulf Coast refineries. And there is no indication that will change any time soon.

Donald Trump approved the construction of the Keystone XL pipeline shortly after taking office but, despite saying it remains committed to the project, TransCanada Corp. isn’t rushing to get shovels into the ground. The latest statement referring to Keystone was on July 26, when the company began soliciting new customers to fill the line’s 830,000 barrels a day capacity. The fact that TransCanada has to beat the bushes for clients is not a good omen.

Neither was a comment by CEO Russ Girling on May 5 that the company is “in the process of seeking regulatory approval in Nebraska while progressing commercial discussions with our customers”.

The Nebraska hearing is scheduled for August with a final decision expected by the end of November. It is meeting fierce opposition from environmental groups and landowners along the proposed route.

Kinder Morgan’s Trans Mountain pipeline faces a different set of challenges. It would increase the capacity of the existing line between Edmonton and Vancouver, built in 1953, to 890,000 barrels of oil per day from the existing 300,000. The $7.4 billion project has received federal government approval but the NDP-Green coalition in Victoria has vowed to fight it to at every step. A broad range of local governments, indigenous peoples, and environmental groups is joining them.

Investors appear to be unconvinced that the plan will go ahead on schedule, or at all. In May, Kinder Morgan Canada raised $1.75 billion through an initial public offering to help fund the pipeline. The shares were priced at $17 and immediately ran into trouble. On the first day of trading they fell as low as $15.75 before rallying to close at $16.24. They only recently regained the $17 IPO price, trading recently at $17.07.

Glacial process on pipelines isn’t the only worry the oil patch is facing. Volvo’s surprise announcement is another sign that the electric car revolution is closer than we think. Last month also marked the start of production of Tesla’s Model 3, a low-cost electric vehicle designed for the mass market. The goal is to be turning out 20,000 Model 3s a month by December. That’s a drop in the bucket compared to Ford or GM but it’s indicative of how the industry is changing.

While all this is happening, France sand Great Britain announced that they plan to ban sales of internal combustion vehicles by 2040. The war on gas guzzlers is expanding, albeit with a long time horizon.

The impact of the electric car industry on fuel consumption will be huge. A report released last year by the energy consulting firm Wood Mackenzie and reported by Fortune projects that if electric cars gain more than a 35 per cent market share in the U.S. by 2035, gasoline consumption could drop from nine million barrels a day to two million.

Other studies are less pessimistic. The International Energy Agency projects that global gasoline consumption for passenger cars will decline only slightly between now and 2020. But most projections suggest a larger decline in gasoline demand going forward.

If this happens, oil prices will remain under pressure for the foreseeable future. Canada’s oil industry will be especially hard hit, forced to cope with declining demand and transportation problems that could exacerbate the price discounts it already faces.

For investors, this suggests the use of extreme caution when considering oil companies. The S&P/TSX Capped Energy Index is already in bear market territory, down 20 per cent so far this year at the time of writing.

The temptation is to suggest this is a time to buy quality energy companies. But that assumes that we will soon see a recovery in the oil market. Right now, none of the signs suggest that will happen anytime soon.

The problems faced by the industry are both short and long term. Investors need to take that into account when making their decisions.

Gordon Pape is Editor and Publisher of the Internet Wealth Builder and Income Investor newsletters. For more information and details on how to subscribe, go to www.buildingwealth.ca.