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Seeing opportunity in the Canadian energy sector

0 Comments|June 5, 2013

What follows are some thoughts from Sprott portfolio manager Eric Nuttall on why Canadian oil stocks

Eric Nuttall joined Sprott Asset Management LP in February 2003. He is a portfolio manager for the Sprott Energy Fund, the Sprott 2012 Flow-through LP and the Sprott 2013 Flow-through LP. A widely recognized expert on the energy sector, he walked me through his strategic views right now.

“I think there is opportunity in the energy sector today -- for patient and longer-term money --, in Canadian, mid-cap, non-yield oil stocks,” he starts.

“Given oil’s close correlation to global GDP, poor worldwide performance has instilled the rising fear among investors that the price of oil could be set to fall.”

Along with poor global economic growth, new production from both tight oil and oil shale -- largely from major fields in the U.S. – casts the specter of U.S. oil independence, which is believed to reduce the importance of Canadian oil producers. “Some believe the U.S. would stop purchasing Canadian oil within 7 to 8 years from now,” says Eric.

Another reason why these companies are out of favor, Eric explains, is a high preference for yield. “Particularly among funds, a lot of money has been leaving resource and sector funds and heading into balanced funds, which are perceived as less risky. That money trickles into yield stocks as opposed to growth stocks.”

Finally, oil transportation infrastructure is perceived as inefficient says Eric, which depresses prices even further.

“Do not let these factors scare you away from the sector now,” says Eric, “this is a powerful opportunity to make money.” Here’s his take:

“I can point to a fix for all four of the issues facing Canadian oil companies – though not specifically to timing. We have opportunities trading at proved, developed, producing reserve value. In these companies, you’re purchasing all of the remaining proved and probable reserves, land, and un-booked resource for free – which is both incredible and frustrating.”

The picture could change as early as the next few months, Eric believes: “This year or next, I see two points of progress that will make people more bullish. Firstly, by the end of 2013, Canada is estimated to have the capacity to transport 250,000 barrels of oil per day through rail cars – a large, short-term, fix to the infrastructure bottleneck. Meanwhile, the Keystone XL project is widely expected to be approved – possibly as early as August, although it could take through 2014. These should immediately improve sentiment towards Canadian oil companies.”

On the issue of surging U.S. oil production: “People are making a mistake by extrapolating the production increases in the U.S. to the next 7 years. We have a two-year trend of production increases in the U.S. of roughly 800,000 barrels per day. I don’t expect that trend to last, as would be necessary for the U.S. to no longer buy Canadian oil within the next 7 to 8 years.”

A major industry player says the current growth rate will slow: “EOG Resources Inc. (NYSE: EOG, Stock Forum), one of the leading companies in shale and tight oil and one of the first to recognize the oversupply problem facing the U.S., has suggested that 2012 is likely to have been the peak year in absolute growth. EOG predicts growth will slow in the coming years. We expect growth of about 600,000 barrels per day for 2013, and around 200,000 to 300,000 barrels per day for the following years.

“As U.S. production increases, although at a much slower rate starting in 2013, Canadian industry and politicians will likely push harder to export Canadian oil to overseas markets. We’ve already seen several large project proposals to send Canadian oil to the East and West coasts, where it can be shipped overseas. I expect to see more dialogue in 2013 and 2014 over exporting oil out of New Brunswick and Quebec.”

These ‘fixes’ could reverse negative sentiment towards Canadian, mid-cap, non-yield oil companies, Eric argues: “What if the concerns about take-away capacity are overblown? What if concerns about the rate of oil growth in the U.S. are overstated? You’re left with the fact that you can buy stocks at proved, producing reserve value with strong balance sheets, and strong management teams that are able to grow production. What happens if market appetite suddenly returns?

“I believe there are ample opportunities to make 100%, within two quarters to two years, with very low risk” says Eric. “High return, with low risk: depending on the individual, this type of deeply out-of-favor sector could be well-worth looking into for your portfolio.”

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