Warning signs that oil prices are range bound for many years

The future price of crude oil is very important to the Canadian economy and to investors in the Toronto stock market (TSX). The Canadian oil patch represents a 25% weighting in the overall index. Over the past few months, we have seen a massive sell-off of oil sands assets by foreigners.

In March, Royal Dutch Shell and Marathon Oil sold stakes in the Alberta oil sands project to Canadian Natural Resources for $12.7 billion. Marathon sold its 20% stake in the project for $2.5 billion. Later in March, Conoco Phillips sold their partnership in the oil sands to Cenovus Energy for $17.7 billion.

Reuters reported last week that BP is considering the sale of its stakes in three Canadian oil sands projects.

“BP’s 50 per cent stake in the Sunrise project near Fort McMurray in Alberta, where Husky Energy Inc owns the rest and is the operator, is the most valuable of the three assets. It also owns a 50 percent stake in Pike, operated by Devon Energy Corp, which is still awaiting a final investment decision, and is majority-owner of the Terre de Grace oil sands pilot project.”

Also in the news is Chevron was exploring the sale of its 20% stake in Canada’s Athabasca oil sands project which could fetch $2.5 billion.

“Faced with a lower oil price environment and challenging economics, which include high cost operations and carbon taxes, global players are increasingly put off by the oil sands.”

Extracting oil from the vast majority of Canada’s oil sands is a very labor and capital intensive process. It requires much higher crude oil prices to justify the more expensive extraction method. Global players exiting their oil sands positions could be a warning sign that the price of oil getting above the $60 level is overly optimistic.

The upcoming IPO of Saudi Arabia’s state own oil company (Saudi Aramco) is another warning sign that the price of oil could be range bound. The company’s oil assets are valued around 2 trillion dollars. It begs the question; why would Saudi Arabia sell part of its state own oil assets to investors?

The simple answer is the Saudi’s need more revenue to pay for their government spending programs. I believe that this is another warning sign that the price of oil will stay lower for much longer. OPEC’s current production cuts are aimed at stabilizing the oil market so that the Saudi Aramco IPO will be successful in raising much need cash for Saudi Arabia.

The key question for the future of the oil market is for how long can a surge in U.S. shale supplies make up for the slow pace of growth elsewhere in the oil sector. The 5 year chart below illustrates the returns on owning two different oil ETFs. You would have lost money owning the Canadian oil ETF (XEG) and you would have broken even on the Spider ETF (XLE). 

In my humble opinion, long term buy and hold investors should avoid oil stocks. I have been bearish on Canadian oil companies for a long time because our oil and gas is land lock. Our only customer is the United States and they have already put a 20% tariff on softwood lumber. There are growing tensions around renegotiating NAFTA which could lead to a tariff on Canadian oil. Oil stocks are still trade-able but you need to be very nibble.

 

Do you agree or disagree? All comments are welcomed.

 

Disclaimer: This post is for discussion purposes only, do your own research before you invest.

 

 

Will Trump disappoint Wall Street & America?

cartoonthumb-copy

There is no doubt that the Republican Party was totally surprised and unprepared by the November election results. Trump’s management style is going to drive his management team, the media, most of the American people and the world nuts. A new reality show has come to Washington, “The Billionaire Apprentice”, who will be the first to get fired?

I think that there is going to be more than the usual amount of personnel turnover in the first six months. The media will be writing about how Trump can’t keep people and about all the chaos in the White House. The world has never seen an American president with this type of management style. It is going to make most of us uncomfortable.

The stock market has high expectations regarding less regulations, infrastructure spending, a new tax policy and the replacement of Affordable Care Act. Failure to deliver something that at least comes close to meeting those expectations is going to have a significant negative impact on the markets and the economy. Some market watchers believe that a correction will show up in the next 60 days if there are cracks in Trump’s agenda.

Being Canadian, I am not an expert on American politics. In my humble opinion, a civil war maybe brewing between Trump and the Republican Party on the implementation of a new tax policy and infrastructure spending. Repealing and replacing the ACA isn’t going to be easy without some bipartisan cooperation. Some republicans maybe hesitant to support some of Trump’s agenda in fear of losing their seat in upcoming congressional elections in Nov. 2018! Trump’s team could be stuck in the Washington swamp!

If you have any doubts that protectionism is at the top of Trump’s agenda, you clearly need to watch Trump’s inauguration speech. President Trump’s first few days in office was to pull out of the Trans-Pacific Partnership and signed an executive order to renegotiate NAFTA.

canada-trump

My buy American and hire American playbook

Avoiding:

  • Auto industry (including part suppliers)
  • Canadian lumber producers
  • Health care and biotech
  • Oil & gas (watching U.S. fracking companies)
  • Retail & Restaurants
  • U.S. industrials that depend on infrastructure spending

Investments that could be Trump Free

  • U.S. banks (including some regional banks)
  • Tech stocks (including semi-conductors, cloud plays)
  • Some U.S. domestic stocks
  • Gold & silver stocks
  • Cash (in case of a correction)

What do you think? Has President Trump over promised and will he under deliver?

 

Carbon tax: a sign that oil prices will stay lower for longer

The federal government of Canada plans to impose a national carbon tax on any province that refuses to establish one on their own. They argue that putting a price on carbon will give people and companies an incentive to look for lower emission options to save money.

In reality, Canada is the second largest country in the world, just ahead of the United States and behind Russia However, our population is one-tenth the size of our largest trading partner, the United States and one-quarter the size of Russia. I estimate that 75% of Canadians live in rural areas where driving is a necessity and switching to electric heating or electric cars is way too expensive.

At the Golden Globe Awards, Meryl Streep called Canadian actors nice. I would like to add that we, as a nation, are dumb when it comes to energy. Refineries in Eastern Canada are spending billions to purchase about 700,000 barrels a day of foreign oil to meet customer needs while 3 million barrels of Western Canadian oil is sold to the United States at a discount due to lack of pipeline capacity between producing fields in Western Canada and refineries in the East.

Our governments rely on tax revenues from the oil and gas industry which are down with the price of oil. In truth, this carbon tax has nothing to do with lowering emissions but just another tax grab. This is a clear sign that the government believes a rebound in the price of oil is many years away.

The Canadian economy is fragile and the last thing it needs is yet another tax. The potential costs for the average Canadian family by 2022 is up to $2,569 per year. The carbon tax will also increase the price of food and clothing. It will mean lost jobs and make Canadian businesses less competitive.

Lack of pipelines makes me bearish on the Canadian oil patch

  1. It will take years to build the Keystone XL pipeline even if approved by Trump. Plus there will be a massive backlash, both on the ground and in the courts that could tie this project up for many more years.
  2. Prime Minister Justin Trudeau gave the green light to Kinder Morgan’s Trans Mountain pipeline expansion but I expect protestors will also delay this project.
  3. The Line 3 Replacement Program was also approved and is the largest project in Enbridge’s history. The anticipated in-service date for this project is 2019, pending U.S. regulatory approvals.

Additional reasons to be bearish on Canadian oil stocks

  1. Most Canadian oil companies are still losing money
  2. The profitable ones have very high price to earnings ratios (CNQ – EPS for 2017 is $1.04 or 39 times earnings and SU is 27 times earnings for 2017)
  3. Shipping oil by rail is way more expensive than by pipeline
  4. The biggest risk to the Canadian oil patch is Trump! He could put a 20% border tax on imported oil.

Foreign oil stocks that I own for yield

I bought some Royal Dutch Shell (RDS.A) for it’s 6.8% yield in my wife’s retirement account. The dividend is exempt from U.S. withholding tax because it is in a retirement account. Converting the U.S. dividend to Canadian dollars gives me a current yield of 6.8% times 1.32 or 8.98% which is much higher than owning bonds. Plus I can sell covered call options that could boost my returns by 5% or to protect against a fall in oil prices.

I also own Alerian MLP ETF (AMPL) which is a energy partners ETF with a 8% U.S. dollar yield. It has a 10.5% yield in Canadian dollars but does has a high management fee of 0.85%, still better than owning bonds. There are higher yielding limited partnerships but they carry more risk than owning an ETF.

U.S. Shale producers are on my watch list

The majority of these producers are still losing money. At the top of my watch list is Marathon oil (MRO) which is currently trading at $17. 45 but has a book value of $27.40. Their losses have been decreasing and the earnings estimates for a fourth quarter is for a loss of 15 cents a share. I am waiting for Marathon to release their results on Feb 15 to confirm that they are lessening their losses and that their revenue is increasing before I invest.

What oil stocks do you own and why?

Disclaimer: Please do your own research or consult with a qualified financial advisor.

 

 

 

 

Another suckers rally in oil stocks?

opec

Over the past year there has been a lot of talk regarding the possibility of OPEC either freezing or cutting production. The Organization of the Petroleum Exporting Countries (OPEC) on Wednesday agreed to its first oil production limits in eight years, triggering an oil rally. The new norm for crude prices could be between $50 and $60 going forward.

OPEC has said it is seeking to secure 600,000 barrels per day of cuts from non-OPEC producers, and that Russia has committed to temporarily cut production by about 300,000 barrels per day in the first half of 2017. Russia and other non-OPEC producers are set to meet with OPEC on Dec. 9.

The key to all of this is whether these cuts will be implemented. Plus market watchers are also questioning whether the oil group will cheat. The sharp oil-price rally may well be short-lived, as oil production has been turning the corner in the U.S., with the rig count up 50 percent from lows in May.

Extracting oil from the Permian Basin, which spans west Texas and southeast New Mexico, is less expensive than it is in many major fields.

“Basically, $50 is good for Permian Basin stocks,” said Paul Sankey, senior oil and gas analyst at Wolfe Research. Pioneer Natural Resources and EOG Resources expanded their presence in the region in the last few months, and Sankey said the two companies would also benefit from $50 oil.”

In Conoco Phillips’ third-quarter conference call, management said the company was adding three rigs to its operations in the North Dakota Bakken oil fields for a total of four rigs in the region.

“The Trump Wild Card”

Cutting corporate income taxes will make U.S. shale producers more profitable and they could have extra cash to produce more oil. Less banking regulations could also allow more bank loans to the energy industry. Could Trump impose tariffs on imported oil? He is after all unpredictable!

The oil futures market has quotes for monthly contracts that are being offered at $53.00 for the first quarter of 2017 and $55 for the rest of the year. The trading volumes of contracts changing hands is very low which could be a bullish sign that oil producers believe that higher prices are coming.

Now over the last two years, I have avoided investing in oil stocks and posted many articles regarding the oversupply problem. I am currently doing research on some U.S. shale oil producers. Unfortunately, the fundamentals haven’t changed and most companies are still losing money at current oil prices.

What do you think?

Is this another suckers rally because hedge funds are rushing in to cover their short positions or is this the start of a bull market in the oil patch?

 

 

 

 

 

The Trump Rally: Buy on rumor, Sell on news?

trump-stocks526

Never in a million years did I think that Trump would not only win the election but that the stock market would rally afterwards. It proves once again how difficult it is to time the stock market.

Trump’s promise of a big stimulus package, tax cuts and less regulation has boosted the dollar and triggered a selloff in the bond market. The “Trump trade” has become the reflation trade with investors buying cyclical stocks and selling bonds. Financials have benefited as well as industrials.

The markets have rallied assuming that Donald Trump is pro-growth. However, he was also the same guy who talked about tariffs and tearing up trade deals, things that are anti-growth. The stock market is currently ignoring the negative side of Trump’s campaign promises.

Now, I’m not convinced it’s a one-way street. Under the surface, the trend has certainly changed. Whatever you thought about stocks before the election, you have to like them a little more and whatever you thought about bonds, you have to like them a little less.

Could this be the start of the “Great Rotation’” out of bonds into stocks?

Almost $2 trillion has been wiped off the value of global bonds since Trump was elected as the next U.S. president, sparking a reassessment of growth and inflation views.

JP Morgan notes that over the past week, a record inflow into U.S. equity exchange traded funds (ETFs) was accompanied by a record outflow from bond ETFs.

Within equity markets,  a sharp rotation out of so-called “bond proxies”, dividend-paying sectors such as utilities, telecoms and healthcare which were favored by investors for their yield and a move into more cyclical sectors such as banks, industrials and some commodities-related sectors is already underway.

Before you jump on the bandwagon, there’s a flood of economic data in the week ahead

  1. update to third-quarter GDP on Tuesday
  2. OPEC meets on Wednesday and it will decide whether to curb output
  3. Thursday is ISM manufacturing data and November auto sales
  4. jobs report on Friday expected to show 175,000 nonfarm payrolls

Now, the bond market has already priced in expectations that the Fed is on track to raise interest rates Dec. 14 by a quarter point. Next week’s economic data will be evaluated to determine future rate hikes for 2017. If inflation expectations are overhauled than so are perceptions about the rate outlook. Money markets are starting to price in one or more Federal Reserve rate hikes for next year.

Good economic numbers could cause a further selloff in the bond market next week which would be positive for U.S. stock markets. Plus many active fund managers have underperformed their benchmarks, there could be some performance chasing until year end.

Unfortunately, President Elect Trump is unpredictable and somewhat scary. If he shuts the borders because the anti-trade Trump comes out, we’ll have a recession and the market will go down. If that side stays quiet and he manages to convince congress to cuts taxes, it could be up a lot.

My gut tells me that we could be in over bought territory and that we could see some market consolidation. My fear is that Janet Yellen could spark a stock market selloff like she did in December 2015 when she indicated the possibility of 4 rate hikes for 2016 which didn’t materialize.

Are you buying into the Trump rally or are you a seller?

 

 

 

USO ETF is down this year even as crude has surged

uso

Did you predict that oil prices would bounce in 2016? Nice call! Did you attempt to cash in by buying the biggest oil ETF? That’s where you went wrong. Oil prices have risen about 25 percent this year. But the USO ETF, which promises exposure to oil prices, has fallen more than 5 percent.

At the root of the USO’s trouble is the simple fact that oil set to be delivered in different months and trade at different prices. For instance, October oil trades at $44.59, November at $45.16, December at $45.79, January at $46.36, and oil to be delivered in December 2017 at $49.76. This array of prices forms the futures curve, and with each month’s oil trading at higher prices, the market is said to be in “contango.”

The way the USO endeavors to track oil is by continually holding the most relevant futures contract. The one tracking oil set to be delivered in the following month (until the contract is within two weeks of expiration). The problem comes when a contract’s expiration is near and the USO shifts to tracking the following month’s futures. At that point, the fund’s managers must sell its massive holding of the nearer-dated contract and buy about the same amount of the further-dated contract.

Since the further-dated contracts trade at higher prices, holders of the USO are selling low and buying high every single month. Meanwhile, oil producers are selling their oil in the futures market for higher prices giving oil prices a boost while the USO ETF takes a hit.

This explanation of the USO’s poor performance is likely cold comfort to those who have done so badly on a trade they may have thought was a home run. With a current market value of more than $3 billion, it may be a fair bet that many investors in this ETF had no idea that they would be so hurt by the structure of the futures market.

Retail investors who invested in the XLE (ETF) which contains the oil produces, drillers and refiners did quite well. Even the midstream master limited partnerships like Alerian MLP would have been a better choice. It is has a dividend yield of 11 percent.

Full disclosure I own some shares in Alerian in my retirement account.