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The Biggest Threat to Canadian Natural Resources Limited Stock

By Matthew DiLallo - Apr 4, 2016 at 10:33AM

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Changes in government regulations and taxes could have an enormous impact on future cash flows for the Canadian oil and gas giant.

Image source: Suncor Energy.

Unsurprisingly, oil prices are a huge threat for any oil company. However, given that Canadian Natural Resources (CNQ 0.67%) is on the path to generate upwards of $2.1 billion in free cash flow starting in 2018 even if oil is only in the mid-$40s, it's not quite threatened by low oil prices as many of its peers. Instead, what is an even bigger threat is the potential for new government regulations or taxes that could eat away at the company's ability to make a profit.

Dodging one bullet, while bracing for the next one
Canadian oil producers recently dodged a major bullet on taxes in Alberta after its government unveiled a new energy royalty tax framework that left legacy rates unchanged. That removed fears that costs would rise on already producing wells when the industry is struggling under the weight of weak oil prices. Under this new framework, which would go into effect next year, existing royalty rates would remain in place for the next decade for wells drilled before 2017.

This is good news for the industry, with Suncor (SU 0.77%) noting that keeping the current royalty rates provides certainty that investors need to make long-term decisions. That said, rates on wells drilled beyond this year will likely be higher. How much higher is still anyone's guess because those new rates won't be unveiled for a few months. The primary concern is what these rates will be and their impact on investment decisions for oil companies like Canadian Natural Resources that operate in the province.

Changing climate, changing plans
Along that same vein is the province's increasing carbon levy on large emitters, which will more than double over the next two years. Previously, large carbon emitters had to pay $15 per tonne, but that increased to $20 per tonne this year before rising to $30 a tonne in 2017. Additional increases or fees could be in the cards if the government decides it needs to do more to stem the rise of emissions. That has the potential to increase Canadian Natural Resources' costs in the future if it doesn't get its emissions under control.

One of the issues for companies like Canadian Natural Resources is that oil sands extraction is more carbon intensive than conventional oil and gas production. As such, Canadian Natural Resources and other producers in the region have been working on ways to bring down emissions. Suncor Energy and Imperial Oil (IMO 1.18%), for example, have been piloting solvent-assisted steam-assisted gravity drainage technology to reduce the use of water and natural gas for underground bitumen extraction. According to Imperial Oil, which recently filed an application to build a new oil sands project based on this solvent-based technology, its project will reduce greenhouse gas emissions by 25% when compared to existing projects. Meanwhile, oil sands miners such as Royal Dutch Shell (RDS.A)(RDS.B) are using natural gas-powered trucks, as opposed to those powered by diesels, to reduce their emissions. Clearly, the industry is making progress using new technologies to reduce emissions. However, it is still threatened by the potential for government regulations that could move faster than the industry can adapt.

Image source: Suncor Energy. 

The problem with pipelines
Another big government-related issue is the complete lack of progress on getting key oil sands pipeline projects approved. Four major oil sands pipeline projects, heading in three difference directions, have come under intense opposition causing delays and higher costs. As such, the industry needs the government to work with it to get these projects moving forward so that it can grow. If not, companies like Canadian Natural Resources might have to pay more to get its oil to market via rail or more expensive pipeline routes, which could impact its ability to generate as much cash flow as it otherwise would.

Investor takeaway
While oil prices are a big threat to Canadian Natural Resources' future profits, that takes a bit of a backseat to the risk of potential changes in taxes or regulations. That's partially because Canadian Natural Resources can thrive at lower oil prices, assuming that it's not paying enormously higher taxes or environmental fees as well as having open access to market via an improvement in pipeline takeaway capacity. 

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Stocks Mentioned

Canadian Natural Resources Limited Stock Quote
Canadian Natural Resources Limited
CNQ
$64.79 (0.67%) $0.43
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
RDS.A
Royal Dutch Shell plc Stock Quote
Royal Dutch Shell plc
RDS.B
Suncor Energy Inc. Stock Quote
Suncor Energy Inc.
SU
$39.06 (0.77%) $0.30
Imperial Oil Limited Stock Quote
Imperial Oil Limited
IMO
$53.32 (1.18%) $0.62

*Average returns of all recommendations since inception. Cost basis and return based on previous market day close.

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