Is it time to dip back into the energy sector?


No sector stays down forever in the stock market. Droughts can be lengthy, but they eventually end. We’re seeing that happen right now in the energy sector. Is it time to take a fresh look at energy stocks?

It was only a few years ago that the oil patch was thriving on prices of more than US$100 a barrel, and Canada was being touted as one of the world’s energy superpowers, based on our massive heavy oil reserves.

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But everything changed in 2014, when world oil prices began to tumble in the face of oversupply and an inability of OPEC to agree on production cuts. By February 2016, the price for West Texas Intermediate (WTI) crude was about US$26 a barrel, and some analysts were predicting it could fall as low as US$20.

The slide in oil prices wasn’t the only problem plaguing the industry. Getting Canadian output to markets was becoming increasingly difficult. One by one, multi-billion-dollar pipeline projects were being killed off. During his final months in office, U.S. President Barack Obama vetoed Keystone XL, despite a positive recommendation from his officials. (President Donald Trump has since given the project the go-ahead, but there is still some question as to whether it will actually be built.)

The Trudeau government effectively derailed Enbridge’s Northern Gateway pipeline, which would have carried bitumen from the oil sands to Kitimat, by banning tanker traffic off the north coast of British Columbia. TransCanada’s $12 billion Energy East pipeline was the next casualty – it was cancelled in late 2017 in the face of opposition from Quebec and mounting regulatory demands.

Two years ago, I wrote an article titled “Will we ever build another pipeline?” in which I said, “A nation whose wealth is closely tied to resources seems to have suddenly decided that economic stagnation is preferable to any project that might — and I stress the word ‘might’ — have a negative effect on the environment”.

If you need any further evidence of that, look at the battle that is raging over Kinder Morgan’s Trans-Mountain pipeline. It’s the last hope of getting Alberta oil to Canadian tidewater, and in order to make that happen Ottawa had to nationalize it.

In the face of all this, is it any wonder that energy stocks are no longer a significant part of most portfolios?

But it’s time to take a fresh look. The supply-demand imbalance is narrowing. Gross mismanagement is cutting into output from Venezuela. There are concerns about supplies from Libya. Donald Trump has pulled the plug on the Iran nuclear deal and reimposed sanctions, thereby threatening that country’s exports of more than two million barrels of crude oil a day.

Canadian oil stocks generally are benefitting from this turmoil. One that I particularly like is Vermilion Energy Inc. (TSX: VET), which is raised its dividend by 7%, to $0.23 a month ($2.76 per year), effective with the May 15 payment. At a price of C$47.41 (June 30), that translates into a very attractive yield of 5.8%.

This was Vermilion’s first dividend increase since 2014, but it’s important to note that it was one of the few former energy income trusts not to reduce its payout after converting to a corporation. The company says that “delivering a consistent and sustainable dividend is a key priority.”

Vermilion is a rarity among mid-size Canadian oil producers in that about half of its production is from foreign assets in countries like France, Ireland, the Netherlands, and Germany. As a result, it is able to sell that part of its output at higher international prices.

First-quarter results weren’t spectacular compared with the fourth quarter of 2016 due to lower production. This was a result of a planned shut-in of a well in the Netherlands, cold weather downtime in Canada and the U.S., and the temporary shut-in of gas at a German site for instrumentation installation.

Despite this, first-quarter revenue jumped to $318.3 million this year from $261.6 million in the first quarter of 2017. Funds from operations (FFO) were $157.5 million ($1.27 per share, fully diluted), up from $143.4 million ($1.19 per share) the year before.

The company is expanding its European operations, drilling its first natural gas well in Hungary, which it expects to bring into production this year. Vermilion plans to drill several more wells in that country over the next few years as well as in Slovakia and Croatia and says it is optimistic about the prospects in the region.

As well, the company recently announced it is acquiring Spartan Energy, an oil producer in southeastern Saskatchewan, for $1.4 billion, including debt. Management says the deal will be “accretive to all pertinent metrics, adding 7% to production per share, 15% to fund flows per share, and 13% to total proved plus probable reserves per share.”

The purchase of Spartan was a key factor in a significant increase in the company’s production guidance for this year. It now projects output of 86,000 to 90,000 barrels of oil per day equivalent, up from an estimate of 75,000 to 77,500 in January.

Given the volatility of the oil industry, this is not a stock for conservative investors, despite the company’s diverse assets, strong dividend history, and positive outlook. But for those willing to assume a little more risk, the yield is very attractive, and the stock held up much better than most other mid-size energy companies during the downturn.

Courtesy Fundata Canada Inc. © 2018.Gordon Pape is one of Canada’s best-known personal finance commentators and investment experts. He is the publisher of The Internet Wealth Builder andThe Income Investor newsletters, available through his website. This article is not intended as personalized advice.


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