Our forecast for the energy sector

We expect lower prices for crude oil by next year, which could hurt struggling Canadian producers even more, says Morningstar equity analyst Joe Gemino.

Joe Gemino 11 September, 2017 | 5:00PM Christian Charest
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Christian Charest: For Morningstar, I'm Christian Charest. The energy sector was the main driver of Canadian equity markets' outstanding performance in 2016. But so far in 2017, the exact opposite has been happening. So, what's the prospect for this sector? I'm here with Joe Gemino, he is an equity analyst here with Morningstar, to talk about the prospects for these stocks.

Now, Joe, when we talk about energy in a Canadian context, we are really talking about the price of oil. So, what are your prospects for that commodity?

Joe Gemino: Well, right now, crude fundamentals look healthier now than they have been in years. And this is due largely to OPEC's voluntary production cuts. By giving up about 1.8 million barrels a day of production OPEC has essentially engineered a supply shortage which aims to align global inventories with their historical average. Unfortunately, this cartel may pay a steep price for any near-term benefit. We think that OPEC is underestimating U.S. shale producers' ability to rapidly increase production in a US$50 to US$55 oil price environment. Once the cuts end in March, full OPEC production coupled with increasing U.S. supply will likely outstrip any demand growth and could tip oil markets back into oversupply in 2018. Therefore, we actually forecast lower oil prices next year at US$45 a barrel WTI. Our midcycle oil price forecast is US$55 a barrel, which is a price we think will keep a lid on any further U.S. shale growth.

Charest: Now, we know that Canadian oil sands producers have a hard time being profitable with oil prices being in those ranges. How are they doing in that kind of environment?

Gemino: Well, we still see oil sands as the best opportunity for production growth within Canada, but they have long been characterized by high capital requirements and high production costs. Using some of the current extraction techniques, we are seeing the average SAGD project require oil prices to be about US$60 a barrel to justify expansion while the average mining project requires about US$65 a barrel. And because of this we see them being struggling to compete globally with other supply sources such as U.S. shale.

Charest: Now, it's not all bad news for Canadian producers. There are some new technological innovations that are helping lower the breakeven thresholds. Can you tell us about that?

Gemino: Right. So, fortunately, for these producers we think solvent-assisted technology is on its way. And essentially, what this will do is, this will improve project economics by lowering production costs and increasing netbacks to producers. By the end of the decade we think breakevens on the best project can fall to about US$45 a barrel WTI. However, the commercial implementation of solvent-assisted technology is not expected for at least a few more years. So, expansion projects are not expected to drive meaningful value stock prices in the short term. Nonetheless, we still see some attractive investment opportunities in the oil sands.

Charest: Thank you very much, Joe.

And in a subsequent video we will be talking about some of Joe's picks in the Canadian energy sector. So, please stay tuned. For Morningstar, I'm Christian Charest. Thank you for watching.

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About Author

Joe Gemino

Joe Gemino  Joe Gemino, CPA, is an equity analyst for Morningstar covering Canadian oil and Gas companies.

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