Expect better returns from the oilpatch

This year will be much kinder to energy investors than 2011 for oil and gas, according to a panel of sector specialists at the Calgary CFA Society’s 35^th Annual Forecast Dinner, held January 19 at the Telus Convention Centre.

Making up 26% of the market capitalization of the TSX, the oil and gas sector is the country’s largest product-selling industry, pulling in $115 billion in annual revenues, and directly and indirectly employing 500,000 people across Canada.

“It affects every Canadian,” said panel moderator Peter Tertzakian, chief energy economist and managing director at ARC Financial Corp. “The industry is at a crossroads. Where do we sell our oil, where do we sell our gas? Does the U.S. still want our oil and gas, after 70 years of our sending it down there?”

Nigel Gault, chief U.S. economist at IHS Global Insight, who addressed macroeconomic factors in the U.S. and Europe, noted there are a couple of major risks to global growth that could potentially drive oil prices down.

If the Eurozone recession were to worsen and develop into a major European banking crisis, it would quickly turn into a global financial crisis. “You would see commodity prices falling very sharply in that scenario, oil included.”

The other main downside risk he sees would be “if the slowdown in growth that we expect in China is severe enough to dramatically dampen China’s demand for raw materials, particularly oil, since China is the driving force in the Asian economy. If China’s economy slows sharply then that would mean the world would again see lower prices for oil.”

Another downside risk–which would involve a spike in oil prices–would occur if tensions with Iran actually led to a supply disruption or even heightened fear of supply disruption, Gault said.

The real problem in the oil market is a lack of spare capacity, according to Edward Morse, managing director and head of Global Commodities Research at Citigroup Global Markets.

He’s most concerned about what could lie in store for the Chinese economy, as well as politicians mishandling the eurozone crisis. He’s also concerned there could be conflict in the Middle East.

Eric Nuttall, portfolio manager of Sprott Energy Fund thinks that 2012 will be “a very good year for the oilpatch. Oil fundamentals are very strong.”

World oil consumption is at a record high, at over 90 million barrels per day, and demand is growing. “Despite a weak economic backdrop, world oil demand has been far stronger than most would have expected and at the same time, supply growth has been weaker than most had anticipated.”

Supply and demand fundamentals easily support a price of around $100 per barrel of oil, which portends a very strong environment for Canadian oil producers.

Last year saw a huge run-up in the price of oil, from the low $80s to over $100. Yet the share performance of many oil stocks has not kept up with the upward movement in oil.

“For the time being, the most obvious way to make money in the oil sector is to invest in mispriced light oil companies,” said Nuttall. “Most people’s attention was focused on the European banking crisis, and not on the fundamentals of the Canadian energy sector and how cheap many of these companies have become.”

He says the $100 barrel represents a “good” price for producers, and that many companies have been “unbelievably profitable” yet the market has undervalued their securities.

“One can take advantage of misplaced fear in the market today. We are in a risk-averse market where there is a tremendous amount of cash on the sidelines,” he says. “Investors are waiting for some sense of stability and reduction in overall market volatility. If one can stomach a small amount of uncertainty, there are many attractive investment opportunities.”

He admits that a pronounced slowdown in China poses a risk for energy investors, though, as Chinese demand may be the most significant factor in determining the future price for oil.

Another major risk, is that with such a low price for natural gas–which sits at a decade low–many companies’ capital spending ability is greatly reduced.

Overall, Nuttall thinks that investment opportunities for natural gas could still be a month or two away, as he awaits capitulation in natural gas stocks.

“It’s my belief that in the coming months that there will be a divergence in performance of natural gas and natural gas stocks, where natural gas may go lower but natural gas stocks will have bottomed and will offer a very attractive opportunity, if we can be patient and wait for a medium term-rebound in the price of gas.”