Look abroad for strong energy plays

Stock performance has been mediocre for energy firms with strictly Canadian operations, leading investors to look abroad. Three energy experts tell us what’s hot.

The landscape

Energy investing should be purely opportunity driven, says Norman MacDonald, portfolio manager for Trimark Investments. “I’m underweight Canada because I see better opportunities elsewhere. The most important factors are the company’s profile and the energy opportunity; location is less critical.”

He notes oil and gas are the key energy plays, and suggests coal is on its last legs. “It’s a dirty molecule and will be phased out over time. Natural gas’s strong outlook will help push coal off the stage.”

U.S. stocks such as Cabot Oil & Gas, ConocoPhillips and Noble Energy have outperformed their Canadian counterparts the past few years, notes David Popowich, a research analyst at Macquarie Securities Group.

But he adds many Canadian-listed stocks with international operations are “fairly cheap because they’re riskier than companies with operations only in Canada,” making them good buys when the fundamentals are strong. Canada-only firms deliver slow and steady production and reserve growth, and typically pay yield, says Popowich.

When evaluating foreign energy plays, he looks for these four risks:

• Security: There could be violence or political unrest.
• Political: The host government could change fiscal or regulatory terms, or nationalize the industry.
• Geological: Disclosure in some countries isn’t as complete as in Canada, so foreign geological information can be weak.
• Infrastructure: Underdeveloped infrastructure forces companies to build it themselves. Land owners may resist infrastructure projects near their property.

Where to invest

Pennsylvania, U.S.

The Marcellus Shale is a geological formation known for its stores of natural gas. It also has ethane, propane and natural-gas condensate, so companies operating in the area are more resilient, says MacDonald. “When natural gas prices collapsed, [those companies] did better than most pure gas plays: they were generating a $4 revenue line when gas prices were below $3 because the associated liquids were picking up the slack from low gas prices,” he explains. Two companies to watch: Ultra Petroleum and Range Resources.

Must-Have stocks

• Calgary’s Talisman Energy. “We’re its largest shareholder. It’s worth between $17 and $19, but it’s still at about $12,” says Maarten Bloemen, portfolio manager with Templeton Global Equity Group.
• Paris-based Total. “Its dividend yield is more than 6%, which it could still pay if oil were at $80 a barrel. Its production growth estimate, near 3%, is at the top end of integrated oil and gas companies,” he explains.
• Royal Dutch Shell and BP. “They’ve cleaned up their balance sheets to less than 20% debt-to-equity, and they’re trading at a discount in part because of Europe’s financial situation.”

North Dakota, U.S.

Whiting Petroleum produces oil in the Bakken resource play in this state. It’s private land that companies lease. “Conventional techniques couldn’t extract the oil, but with innovations like horizontal drilling it’s now accessible,” MacDonald explains. Whiting is severely undervalued. “Compared to Crescent Point—a Canadian company with a similar asset base—its price is about 24% lower [as of July 2013].”

Mexico

It has an entrenched national oil company, so foreigners can’t invest in the commodity directly. But they can invest in service providers.

Argentina

“Last year the government expropriated oil assets from Repsol, but more recently Chevron announced a joint venture with Repsol to develop the country’s shale oil,” says Popowich. “Chevron is taking over the assets Repsol lost, and has committed to drilling 100 wells, with plans for 1,000 more. This shows Argentina recognizes the need for western expertise.”

And Argentina is now permitting energy revenues to leave its borders. “Previously, oil proceeds had to be reinvested within the country, so the new policy is an incentive for foreign firms,” Popowich explains.

Columbia

The government has supported foreign involvement in its oil industry, and Popowich expects this to continue. “The working class has benefited from the resource boom; any party that takes power will be pro-business.”

He notes Columbia “has an entrepreneurial atmosphere, with many small-cap oil companies taking off. And because the fields there are fairly small,” consolidation isn’t likely. The stocks Popowich covers trade at premiums, but “investors like the management teams and geology, so they don’t mind.” A point of caution: FARC rebels frequently target oil infrastructure. An attack shut down Gran Tierra Energy’s main pipeline for six months last year.

Peru

Popowich is also positive on Columbia’s southern neighbour. “It has an active oil industry and is open to foreign business,” he says. “They elected Ollanta Humala, who since coming to power has been accommodating to business.” Gran Tierra made a big discovery earlier this year, he notes. He also highlights Repsol, Pacific Rubiales and Pluspetrol.

Brazil

There have been production delays offshore as a result of semi-public oil company Petrobras’ logistical problems, says MacDonald.

“Brazil’s problems are reminiscent of Fort McMurray’s. There’s tremendous cost inflation and management teams have been too optimistic about how quickly production would come on stream,” he adds.

Maarten Bloemen, portfolio manager with the Templeton Global Equity Group, notes Petrobras’ failure to meet its production targets caused a drop in its stock price. “This gave us an opportunity—it’s one the cheapest companies you can buy.” He expects production to pick up as equipment delivery delays are resolved.

Nigeria

Several public companies operate there, including Mart Resources, a Canadian-listed firm, and U.K.-listed Eland Resources.

“Overall, perceptions of Nigeria are changing for the better. The fact it’s allowing indigenous companies to partner with western firms has helped. There’s a lot of oil and some firms are willing to tolerate somewhat punitive fiscal terms to gain access,” he says.

But “up to 20% of crude oil production is stolen. Large-scale industrial thieves tap the pipelines and siphon the crude into illegal refineries,” Popowich explains, adding the government has turned a blind eye to the problem, partly because members of the country’s upper class are beneficiaries.

East African Rift Basin

This high-risk area spans Ethiopia, Kenya, Tanzania and Uganda, where active exploration programs are in progress.

“Investors’ rationale is that there are few places in the world where it’s possible to access such large [oil] reserves, so it’s worth tolerating an elevated level of political and security risk,” says Popowich.

Companies to watch: Canadian-listed Africa Oil and U.K.-listed Tullow Oil.

Chad

Several companies, including Canadian-based United Hydrocarbon and U.K.-based Caracal Energy, have successful operations. While Chad borders Sudan, its oil fields are in the southwest, away from violence.

Libya

An OPEC member with proven oil reserves. “It’s been two years since Gaddafi was ousted, but I don’t expect Libya to be a vibrant place to do business,” says Popowich. Italian firm Eni S.p.A. is the big player.

Egypt

Transglobal Energy has operations in Egypt. “It’s one of the best-run companies we cover, but the Egyptian government is almost bankrupt so they’re having a difficult time paying oil producers for crude sales,” Popowich says.

Of the recent military coup, he says, “It’ll take at least a year for the economy to turn around, and payment permit-granting for energy firms will halt because of administrative confusion. The situation will improve, and the risk of nationalization is low, but investors have to be patient.”

Algeria

Stay away, says Popowich. “There was a major terrorist attack on a gas plant last year, and several small-caps have had their assets expropriated.”

Malaysia

The country’s political risk is low and oil and gas reserves are strong, but investing in the national oil company means adhering to its strict terms, says Popowich.

Burma

“The country has been closed to Western companies for the past 30 years, but it’s now in the process of auctioning off exploration opportunities to foreign firms,” says Popowich.

Russia

Political manoeuvring has spoiled a good buy, Gazprom. “It’s the cheapest energy stock in the world,” notes Bloemen. But the government isn’t selling its gas at international prices, so he trimmed his holdings. He’s kept some stock because of its 6.5% dividend yield and the prospect of a Russian- Chinese pipeline.

Iraqi Kurdistan

Canadian and UK energy investors have liked this play for about five years. Genel Energy operates there, and Tony Hayward, former chief executive of BP, is its CEO.

“Genel has come a long way since it brought in the English management team, and Kurdistan’s made giant leaps towards opening up their export markets,” says Popowich. He adds Kurdistan’s government and the Iraqi central government are currently embroiled in a payment dispute.