Any Way out for Canadian Oil?

Canada ranks No. 6 in the world for crude oil production and No. 11 for oil exports, but its citizens worry about future oil-related economic losses. The problem? For all its production, Canada can't get its oil to market at top dollar. Even though U.S. Gulf refiners would love Western Canadian Select heavy oil, the takeaway capacity just isn't there to fully exploit the commodity. This bottleneck affects Canadian energy companies, as well. Here are three examples.

Turning from gas to oil
Encana Corporation (NYSE: ECA  ) , formed in 2009 in conjunction with the spinoff of Cenovus (NYSE: CVE  ) , was supposed to be a natural gas company profiting from growing gas production and exports to the United States. Unfortunately for its investors, the U.S. got in on the natural gas game in a big way and not only shut down imports, but drove down natural gas prices. Encana suffered accordingly.

This past summer brought a new CEO, new board members and a new attitude that "the status quo is not an option." Even better, the company has been expanding into natural gas liquids and oil. As part of its "status quo is not an option" mentality, Encana has sold non-core assets to fund its oil and liquids business. In particular, Encana has what appears to be a world class asset in its Duvernay shale play.

Encana took further actions to improve its profitability. The dividend dropped from C$0.20 to C$0.07, staff declined 20% through layoffs and non-core assets identified for sale. Not to criticize, but export facilities for both natural gas and oil would really help, too. The Asian market in particular sits ready for imports of both commodities, but right now there's limited capacity to move these resources from Canada to the Far East.

Producing oil inefficiently
Penn West Petroleum (NYSE: PWE  ) produces oil primarily from its Cardium and Viking plays in western Canada. The oil is light sweet crude. This sure beats being a natural gas company. Unfortunately, Penn West pays $3 to $5 a barrel more to produce this oil than its competitors. This cost disadvantage exists despite Penn West's expertise in waterflooding, an enhanced oil recovery technique that delivers more oil from a well.

To its credit, the company is working its own turnaround much like Encana. A new CEO has slashed the dividend and the company workforce. In fact, Penn West laid off roughly 30% of its workforce, including three executives. Further, in addition to waterflooding, the company has been developing better drilling techniques to reduce production costs.

Latest earnings announcement showed Penn West improving earnings from the previous quarter, and also reducing debt. The dividend was unchanged at C$0.14 a share. However, the stock crashed and burned, losing over 15% in one day. For Penn West, its focus on light sweet presents two problems. First, of course, is the lack of take-away capacity. Second, the Bakken also produces light sweet crude. In fact, U.S. refiners are practically at capacity for the stuff. Even if Penn West could ship it all, the actual U.S. market for its oil is limited.

Neglecting its assets
As mentioned above, Cenovus was the oil company half of the Encana/Cenovus break-up. Cenovus produces oil from oil sands using steam-assisted gravity-dependent technology. In particular, its Foster Creek play was considered a pioneering effort for this steam technology. The company believes Foster Creek could produce 300,000 barrels of bitumen a day, far more than the roughly 108,000 barrels it produced this past quarter.

During the third quarter, Cenovus finally performed neglected well maintenance on 7% of its wells instead of the usual 3%. In its second quarter earnings report, Cenovus freely admitted that neglected maintenance would hurt earnings in both lost oil production and increased operating expenses. The company's third quarter report bore that out. Production declined 22% from the previous year, and production expenses increased. Operating cash flow also decreased, but the company managed to increase profits by 28%.

If Foster Creek and other oil sands begin producing oil like Cenovus hopes, the pipeline bottleneck could well crimp revenues. Western Canada Select crude oil currently trades at nearly a $42 a barrel discount to West Texas Intermediate as it is. A near tripling of production from Foster Creek (if all goes well) will add further pressure to oil prices. One reason for the big discount remains the lack of pipeline capacity to transport oil to U.S. and Canadian refineries. According to Bloomberg News, many pipelines are overbooked. Additional pipeline capacity won't come online until 2017 at the earliest.

Final Foolish thoughts
Canada exports most of its crude oil to the United States. A great situation for Canadians aside from the fact that Western Canadian Select is the cheapest oil on the planet. US refiners apparently prefer Canadian crude over declining Mexican or Venezuelan crude, particularly at today's prices. Alas, there's no way to get all this oil to U.S. refiners. This transportation bottleneck will likely blunt earnings growth for all three companies presented here until proposed pipelines are completed.

OPEC hates it, Buffett loves it
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!

 


Read/Post Comments (0) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

DocumentId: 2724524, ~/Articles/ArticleHandler.aspx, 7/31/2014 5:08:10 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...

TREND TRACKER: Get Rich When the Web Goes Dark

It's time to say "goodbye" to your Internet! One bleeding-edge technology is about to put the World Wide Web to bed. And if you act right away, it could make you wildly rich. Experts are calling it the single largest business opportunity in the history of capitalism… The Economist is calling it "transformative"... but you'll probably just call it "how I made my millions." Big money is already on the move. Don't be too late to the party – find out the 1 stock to own when the Web goes dark.


Advertisement