What the Saudi attack means for Canadian oil

Canadian energy stocks soar, and the Canadian Crude Index is up 10%, but pipelines are a key obstacle

Ruth Saldanha 16 September, 2019 | 12:48AM

Saudi oil field fire

Over the weekend, drones targeted Saudi Aramco’s oil facilities at Abqaiq and Khurais. The Abqaiq plant has a processing capacity of more than 7 million barrels of oil per day (MMbpd), equivalent to about 70% of Saudi Arabia’s current 9.8 mmbpd of production. The state-owned oil company said it lost 6 MMbpd of oil – which could impact 6% of the world’s oil output.

It is one of the biggest disruptions to oil output ever.

Brent crude prices and WTI crude both gained around 10%, with U.S. President Donald Trump tweeting that the U.S. would release oil, and also that the country is “locked and loaded depending on verification”, indicating that the U.S. is ready to take military action.

In response, global markets fell, and oil prices soared – taking Canadian oil companies along for the ride. Cenovus Energy (CVE) was up nearly 11%, Canadian Natural Resources was up over 8%, while rare, triple-threat Enbridge (ENB) was up 1.6%. The Canadian Crude Index was up over 10%.

In a note on energy stocks, Morningstar analyst Mark Taylor said, "A higher geopolitical risk premium in the crude price could boost the near-term earnings for oil and gas companies in our coverage in accordance with a stronger Brent futures curve, which we use for our near-term estimates. But our mid-cycle $60 per barrel Brent crude price forecast (2022 dollars) for now stands.”

What does this mean for Canada?

“What is happening with the risks in the Middle East have no bearing on the political and regulatory issues that still loom large over Canadian energy space for foreign investors,” said Mike Dragosits, portfolio manager at Harvest Portfolios.

“There are many US buyers of Canadian crude that enjoy the relative spread that they get by buying Canadian oil often at a discount to other global benchmark prices.  There is no question in our view that the lack of alternative markets for Canadian energy products has put the companies at a disadvantage to other jurisdictions,” he said, adding that a tightening of the spread is still an issue with no access to tidewater and a lack of desire to build pipelines in the country to capitalize on our resources.

Morningstar believes that longer-term, the oil market will be less reliant on Middle Eastern supplies as more U.S. shale gas production comes onstream.

“The attack indicates that the U.S. and Canada are safe places to get oil. But for Canada, it also indicates a need to fix our pipelines, so we can get the oil out to the rest of the world!” said Nicolas Piquard, portfolio manager at Horizons ETFs.

Dragosits agrees, saying, “If we had the ability to supply the global market, we would certainly be looked at as a very attractive and a very stable supplier of crude, especially in light of what has just happened.” As it stands, Harvest Portfolios has been positioned primarily outside of Canada for over 4 years in Energy exposure. 

“We do see there are a number of companies that are trading at attractive valuations in Canada and this move in oil may cause some of them to catch some shorter-term fund flows and move their stock prices in the short term from oversold levels,” the firm pointed out, adding that with a large exodus of international energy giants out of Canada over the past 5 years, more catalysts will be required to have long term capital rush back into buying equities of the Canadian producers en-masse. 

Fiera Capital, meanwhile, is bullish on Canadian energy stocks. “While September’s rotation from growth to value shares has inherently been positive for the energy sector and Canadian stocks alike, recent geopolitical developments are likely to fuel outperformance for energy stocks that continue to trade at extremely attractive valuations”, Fiera Capital portfolio manager Candice Bangsund said.

Here's a look at some Canadian energy stocks trading at a discount to our fair value estimates:

Name

Ticker

Industry

Price / Fair Value

Cenovus Energy Inc

CVE

Oil & Gas Integrated

0.73

Husky Energy Inc

HSE

Oil & Gas Integrated

0.71

Enbridge Inc

ENB

Oil & Gas Midstream

0.75

Peyto Exploration & Development Corp

PEY

Oil & Gas E&P

0.81

Canadian Natural Resources Ltd

CNQ

Oil & Gas E&P

0.90

Imperial Oil Ltd

IMO

Oil & Gas Integrated

0.84

Data as of mid-day 16/09/2019

Global geopolitical concerns

However, while this may seem like good news for energy stocks, rising oil prices lead to higher inflation. Global markets recognized this, and several Asian and European markets traded lower on Monday. Moreover, the Saudi attack could potentially destabilize the middle eastern region, leading to further conflict.

“Outside of the energy space, this weekend’s developments have ignited geopolitical anxieties that have clouded risk assets in general and seen a broad-based flight to safety in the marketplace (with the exception of crude prices and commodity-oriented currencies such as the Canadian dollar),” Bangsund said.

Near-term, uncertainty prevails as to the duration of the outage, which will inevitably dictate the direction for crude prices over the coming weeks, but longer-term, Bangsund remains bullish on both crude prices and energy stocks in general. “Crude prices should remain well-supported by healthy global demand prospects and as efforts from OPEC and its allies to curb production ultimately prove successful in stemming the damage from bloated US stockpiles and help the market find a better balance, while the potential for a prolonged supply disruption in large crude markets abroad should create some upside potential to our already-bullish call for crude prices.” 

Piquard agrees. “Long-term energy prices will rise. There was an initial pop in prices because of the shock of the attack, but going ahead, I expect to see prices stay high. There is a lot of uncertainty around the repairs of the pipelines, though Aramco says it will be fixed shortly, repairs could take time,” he said.

Taylor pointed out, however, that globally, there are also strategic reserves estimated at 4.1 billion barrels, including 645 million barrels in the U.S., which can be partly drawn down to meet shortfalls for a considerable time. 

Will the Aramco IPO happen?

The attacks on Aramco’s facilities are sure to delay its much-anticipated IPO.

“This was a significant attack on Aramco’s assets, and will definitely impact investor perception of the safety of the assets going ahead. There is increased uncertainty, not just on the price, but also the timing of the IPO,” Piquard said.

A spike in the oil prices could boost the valuation of the IPO – but the attach has pointed out vulnerabilities of the company’s assets and has highlighted its risks.

Securities Mentioned in Article

Security NamePriceChange (%)Morningstar Rating
Canadian Natural Resources Ltd39.10 CAD0.49
Cenovus Energy Inc12.18 CAD-1.22
Enbridge Inc51.35 CAD0.49
Husky Energy Inc9.49 CAD0.21
Imperial Oil Ltd33.17 CAD-0.66
Peyto Exploration & Development Corp3.31 CAD2.48

About Author

Ruth Saldanha

Ruth Saldanha  Ruth Saldanha is Senior Editor at Morningstar.ca