Energy portfolios must factor in pricing

Investors need to choose energy stocks carefully, says Domenic Monteferrante, first vice president of Canadian Equities at CIBC Asset Management. He co-manages the Renaissance Canadian Dividend Fund.

“The Canadian energy space is complex and affected by a number of factors, including global energy prices, currency trends, government policies and merger and acquisition activity,” notes Monteferrante, who finds recent years have seen increased domestic production in the U.S., as well as upticks in conservation and environmental initiatives.

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Canadian producers have limited pipeline access to the U.S., however, which depresses prices and forces producers to find new ways to expand.

To do so, some companies have turned to rail or water barges to get their oil to U.S. markets, says Monteferrante.

Another tack has been to lessen reliance on these markets. Take Enbridge and TransCanada, which are both proposing to ship oil to eastern refineries.

“We view these changes as causing some degree of uncertainty over the short-term revenue growth outlook for certain companies,” he adds. And as supply-and-demand dynamics shift in North America, careful security selection is especially critical.

On the natural gas front, Monteferrante says “increased supply coming from the Marcellus region in the U.S. [is pushing] Canadian gas producers…to accelerate the development of liquefied natural gas facilities on the west coast to meet Asian demand by the end of this decade.”

Not all proposed energy projects will be built, though, and “there will be winners and losers among the producers,” explains Monteferrante.

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The potash industry is also in a state of flux, he says. “Low-cost Russian potash producer Uralkali recently announced that it would exit the Belarusian Potash Company marketing group and that it would no longer follow a price-over-volume strategy. As a result, global potash prices are expected to come under pressure.”

And weaker prices will likely nix many new mine projects, but some expansions will go ahead because firms have already spent significant amounts on them. “As a result,” says Monteferrante, “existing potash capacity is expected to grow over the next three years at between 2% and 3% annually.”

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That means lower prices, which will make profitability a challenge for high-cost global producers.

“It is uncertain if there will be demand growth due to lower prices,” notes Monteferrante. “While India and Brazil are large importers of potash, they each face currency depreciation issues, which will limit any increase in demand.

“If we’re entering a new industry paradigm where producers opt for more volume over price and seek increased market share, then fertilizer stock prices will remain range-bound at best for the foreseeable future as industry demand slowly catches up to capacity,” he adds.

That development could take at least another two-to-three years to materialize.

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