In a monumental shift for the energy markets, China recently became a bigger oil importer than America. The U.S. is switching to more fuel efficient cars and driving less, while China's per capita GDP continues to grow and spur more demand for oil. The world's oil consumption is shifting, and smart investors are helping bring oil to Asia.
Follow the refiners
Canada's oil producers are facing a smaller U.S. market, and the next logical place to turn is Asia. The problem is that oil sands producers are separated from B.C.'s ports by the Rocky Mountains. A number of new pipelines are on the drawing boards, but the permitting process takes a number of years. For the immediate future railroads will provide the critical link between the Canadian interior and the coast.
West Coast refiner Tesoro (NYSE:ANDV) has positive news for investors. The Port of Vancouver recently approved Tesoro's rail offloading oil terminal with an initial capacity of 120 thousand barrel per day (mbpd). It will allow cheaper land-locked crudes be used as feedstock for Tesoro's refineries. The facility is not expected to be completed until 2014, but it is a positive catalyst for the company. While the facility calls for the transport of Bakken crude from North Dakota, there is no reason why Canadian crudes could not be transported as well.
Various Canadian and Bakken crudes can be priced $10 to $30 below WTI, giving Tesoro a cost advantage. In 2012 Tesoro's competitors in Washington used 19% foreign crude, 55% Alaska Northern Slope crude, and 26% Canadian crude. In 2013 Tesoro expects to use 40% to 50% discounted Bakken crude, just 10% to 20% Alaska Northern Slope crude and 30% to 40% discounted Canadian crude. When the new Vancouver terminal is complete it will give the company even more flexibility in sourcing discounted oil.
The falling WTI-Brent spread has hurt the company. Wall Street expects its 2013 earnings per share (EPS) to fall down to $3.43, but by 2014 its EPS should bounce back to $5.76 thanks in part to strong feedstock flexibility.
The Canadian rail plays
Canadian National Railway (NYSE:CNI) and Canadian Pacific Railway (NYSE:CP) are two profitable companies ready to piggyback on the changing oil market. CN Rail has major lines heading from Edmonton down to the ports of Vancouver and Prince Rupert. Edmonton is a major terminal for the Canadian oil sands, and CN Rail is well positioned to take Alberta's gold to Asia and the West Coast. CN Rail recently started preliminary discussions to ship oil from Edmonton to Prince Rupert with a potential capacity of 550 mbpd.
CP Rail has a slightly different network. It passes through Edmonton, and then eventually heads down to Vancouver. While both companies enjoy fat profits from an industry with huge barriers to entry, CN's access to Vancouver and Prince Rupert makes the company quite attractive.
Oil already plays a big part of both firms. Based on recent data for Q3 2013, 20% of CN Rail's freight revenue came from its petroleum and chemicals segment. CP Rail does not have a specific petroleum segment; instead it puts crude oil within the general industrial and consumer products segment. In Q3 2013 this segment provided 25.7% of CP Rail's freight revenue.
CN Rail has a profit margin of 24.9%, a return on investment (ROI) of 14.7% and trades at a price-to-earnings ratio around 19. CP Rail is a similar company, but it has a profit margin of 13.3%, a ROI of 7.5%, and trades at a P/E ratio around 33. CN Rail makes more money on its investments, earns more profit from its revenue, and yet it trades at a lower valuation. It has a network that goes from Edmonton to the ports of Vancouver and Prince Rupert, while CP Rail's network only goes to Vancouver. In summary, CN Rail is a more attractive investment.
The upstream perspective
Suncor Energy (NYSE:SU) is a Canadian oil sands producer ready to benefit from more transportation capacity to Asia. The company is shareholder-friendly with a $2 billion share buyback program announced in Q2 2013. To receive high international prices for its oil the company refines or upgrades a significant portion of its production. Even with its network of upgraders and refineries, greater transportation infrastructure to Asia would help boost its earnings.
Suncor is also trying to bring up its margins by improving its production process. Through its SAGD LITE technology it hopes to decrease its steam usage by 10%. Its profit margin of 7.1% and ROI of 5.6% have room for improvement, and midstream upgrades will help the company pump out more profits.
There are many ways to invest in growing Chinese oil consumption. You can buy an experienced producer like Suncor and enjoy its dividend while more midstream infrastructure is being built. You can invest in a railroad like CN Rail for greater diversity. Within U.S. borders the refiner Tesoro is another good option with more feedstock flexibility coming online. At the end of the day the oil industry offers many investments beyond the quintessential Texan rig operator.