As Canadian energy stocks are finally seeing a bit of a push, and demand for Canadian commodities looks set to rise, juniors are confident that economics will ensure that Canadian oil-the cheapest in the world-will find its way to more markets, with or without Washington’s approval of Keystone XL. In the meantime, some sweet spots in the Western Canada Sedimentary Basin, like the Montney shale formation-are showing promise as gas turns into oil for the bigger players, while the juniors are hoping to piggyback on this new success.
Interview by James Stafford.
James Stafford: For the first time in months, Canadian ETFs are seeing an increase in flows-especially for financial and energy stocks. What is pushing this?
Colin Soares: I think there were a few factors. International money started flowing back into Canadian energy as global oil prices jumped 15%, on the back of Libya production falling down. WTI followed suit and all of a sudden the Canadian oil price was over $100 a barrel. Cash flow and profitability soared in Q3 2013.
Canadian management teams have got so used to deep oil price discounts, we focus only on developing top assets-ones that payout in a year on $75 oil. That’s certainly true for the juniors-and there are hundreds of them in Canada. We have become a lot more disciplined in the last year as investors switched from growth at all costs to sustainable growth; growing within cash flow.
Then I think you just combine all that with the fact that the valuations on Canadian oils were so cheap-from juniors like us right through to seniors like Suncor. Warren Buffett bought a big chunk of Suncor this year and I think that helped money flows into our sector as well.
James Stafford: Can we expect stronger demand for Canadian commodities?
Colin Soares: Absolutely. The Americans are not allowed to export their crude, and Canada is. We now have the cheapest oil in the world, and simple economics says it will find a way to a market. The light oil might go to the west coast via a new pipeline, or it might travel across Canada to the eastern Maritime provinces, but it will find a way-for both heavy and light oil.
The US will always want our heavy oil, as their refining complex is mostly heavy oil. And our heavy oil trades at a discount to both Mexican and Venezuelan heavy oil.
James Stafford: What does this mean for Canadian juniors?
Colin Soares: It means we can budget on at least $70 oil, which is what we’re doing.
James Stafford: Canadian heavy crude is sold at a large discount to US and world crude, but analysts are now predicting the end of these big price “differentials” as they’re called, for Canadian heavy oil. Do you see an end to this volatility, and what factors will contribute to closing this gap?
Colin Soares: No, volatility will absolutely stay. Just having one refinery go down creates a big differential for a few days. And of course, pricing is seasonal as refinery maintenance happens in spring and fall, and oil prices are lower then, and the differentials are bigger then. You just get used to that and budget an overall price. Strong projects, with good economics will make money regardless of fluctuations in the oil price.
At High North we have been using a $70/barrel oil price to calculate our numbers and we are confident that we still have one of the fastest payouts of any wells in North America.
James Stafford: How do you see this playing out by the end of the year and into the first quarter of 2014?
Colin Soares: Differentials will stay larger than normal-though what’s normal anymore?-through Q1 2014 until more pipeline capacity gets into place around North America. There is 800,000 barrels a day of refining capacity coming online in just the next two weeks! That is more competition and will raise North American oil prices.
And pipelines are racing to keep up to production increases and doing a good job. TransCanada’s Keystone South project will be starting in just a few weeks taking oil from Cushing down to Houston.
James Stafford: How much depends on Washington’s approval of the northern leg, the Keystone XL pipeline?
Colin Soares: Fundamentally, not as much as before-because of huge increases in crude being transported by rail-but from a market point of view I think it’s still a big deal– I think market valuations would increase with Keystone approval.
But even with the approval of the Keystone XL, we are still a long way off until the pipeline is built and price differentials narrow to be really tight. Once again, good projects with strong economics will make money regardless of the fluctuations in the oil price.
James Stafford: Will Canada continue to increasingly rely on rail transport for oil products despite the Quebec train disaster?
Colin Soares: Yes, and in the US as well. Right now Canada is transporting about 200,000 bopd of oil by rail, and experts are thinking that will more than double in two years. Until new pipelines are approved and built, oil products will rely more on rail.
James Stafford: As we head into a New Year, what will be the key drivers for the Canadian oil and gas industry?
Colin Soares: I think the market will be more focused on balance sheet and financials, not just straight growth, or growth at any price. It’s a lot more about sustainability now. With a lower oil price, you will have to show you can grow inside cash flow, or very close to cash flow. Plays where the wells payout their costs really quickly-like around a year–will get a premium. And that’s the type of asset we have.
James Stafford: Canada’s National Energy Board just said the Montney Formation in the
Western Canadian Sedimentary Basin is one of the largest gas deposits in the world-some 450 trillion cubic feet of gas, 14.5 billion barrels of liquids and 1.1 billion barrels of oil. What does that mean for the Canadian energy industry?
Colin Soares: For gas, it means we have decades of supply-and low cost supply. All those liquids like propane and condensate pay for the gas wells-so the gas has almost no cost to it. The liquids make the gas very economic.
And so when everybody starts drilling these big gas wells, they’ve been finding oil as well. And you’re seeing a lot more exploration now targeting light oil to the North. The oil is shallower, and so it’s cheaper to get it out of the ground-it’s actually a perfect play for a junior like High North.
James Stafford: How much can we expect to be spent on developing the Montney oil play for this year and next?
Colin Soares: There are several companies working in north-western Alberta who are having success developing the Montney oil play. Long Run Exploration recently announced a $110-million expenditure to develop its Montney oil project-they’re right beside us developing a big fairway. RMP Energy recently raised $50 million through GMP Securities, bringing their capital budget to $168 million for their Montney project.
James Stafford: What’s the sweet spot in the Montney formation for oil?
Colin Soares: That’s too early to say yet. I would love to say we are in the sweet spot, being as Long Run is just to the north and east of us and RMP is just to the south and west, but the reality is that RMP right now looks like it has an initial sweet spot at Ante Creek.
But there is still a learning curve involved with drilling successful wells. The key for the juniors is to piggyback off the knowledge of larger players like Long Run and RMP.
James Stafford : Colin, thanks for taking the time to join us today.