I have lost faith in a meaningful recovery in the western Canadian oil and gas sector. I have sold my Macro Enterprises and Essential Energy Services and with the money from these sales, have placed my bets on the current market rally losing steam by the end of the year.
Over the past few weeks I have thrown in the towel on my investments in Canada’s oil and gas sector. I sold off my holdings in both Essential Energy Services and Macro Enterprises. While both of these companies, and quite a few more besides, are trading at a mere fraction of their former prices, I have become increasingly skeptical that we will see a meaningful recovery in this sector.
The fracking revolution is re-writing the energy landscape and it is looking like Canada could be one of the losers in the new world order. It is difficult for Canadian oil and gas to compete with cheap and abundant US shale. The oilsands look particularly expensive when compared to light, sweet US crude. Our shale deposits are more competitive, but we have no way of getting these reserves to market. Our pipelines are full and there seems to be no political will to build more.
Macro Enterprises was my play on Canada’s desperate need for more take-away pipeline capacity. The future was looking bright for awhile there, with three big pipeline construction contracts in the bag but one by one these are falling by the wayside, prey to environmental and indigenous concerns. Recent news that the big Coastal Gaslink pipeline was being delayed by native protests and that the owner of this project was shopping its stake around, hoping for an easy exit, was the straw that broke the camel’s back for me. I sold off the last of my Macro Enterprises last week.
Essential Energy Services was jettisoned as well, despite it having fallen dramatically in price and trading at a fraction of tangible book value. That book value is made up of very expensive drilling rigs, many of which are sitting idle. My big worry is that they will remain that way and eventually be sold for scrap at pennies on the dollar.
Longer term, there is a theory that is gaining traction that we are close to peak oil demand. Transportation accounts for 70% of worldwide demand for oil. If we are on the cusp of an electric vehicle revolution this does not bode well for future oil demand. The global oil market is very finely balanced. Relatively minor changes, on the order of a percent or two, in global supply or demand seem to be enough to drive the price of oil up or down dramatically. If the world switches en masse to electric vehicles, which use far fewer hydrocarbons (even considering the need for electricity generation) than internal combustion engines do, this could result in a massive shift in worldwide oil demand and a massive reset in oil prices. Only the lowest cost oil producers may survive. And Canada isn’t one of those.
It is often said that the time to be buying is when there is blood in the streets. I whole-heartedly endorse this sentiment and take glee in buying up companies that have been left lying bruised and battered on the ground. However, this strategy relies on the ability of the companies in question to get back up on their feet. Sometimes a company or an industry is down for the count and simply won’t recover. I wonder if that is perhaps the case with the Canadian oil and gas sector. If it does recover, it may only be a pale shadow of what it once was. Am I foolishly exiting Canada’s oil patch in the darkest hours before the dawn? We will see.
I have not given up on the oil sector entirely. I am keeping my holdings in Questor Technology and PHX Energy Services. Both of these companies are predominantly exposed to the US shale oil sector which at the moment is looking far more vibrant, although some of the same long-term concerns loom on the horizon there too.
But shorter term, the outlook appears reasonably bright. Questor Technology was selected by Acumen Capital as one of its “2019 Top Ideas”. A few weeks ago, they announced a big order to supply their combustion incineration technology to three production facilities in Mexico, a new and exciting market for them. PHX Energy Services spent heavily in 2018 to expand its leading-edge drilling technology offerings and anticipates that these investments will really start to bear fruit in 2019’s first quarter.
So I continue to keep a toe in the water as regards my oil and gas investments but am choosing to place my bets south of the border, not north of it.
Betting Against The Market Rally
Meanwhile, I chose to use the majority of the cash I raised from these sales to bet against the current blistering market rally. I added to my S&P 500 put options, betting that the market will ultimately trade lower by the end of the year.
I continue to see signs that the party is almost over. In recent weeks, the unemployment rate has begun to climb, jobless claims are moving higher, large companies are reporting weakening sales, especially in their overseas operations and earnings growth estimates for the first quarter have turned negative. The federal reserve appears to be loosening again after a period of tightening and yield spreads are steepening after a period of flattening. These are all typically signs of an imminent recession. I remain hopeful that we will see renewed market weakness as the year progresses.
Hopeful because I want to see lower prices. I recently completed a survey of several hundred of the cheapest US stocks I could find. After looking long and hard at the top candidates I just couldn’t bring myself to pull the trigger on any one of them. While stock prices are a tad cheaper than they were 6 months ago, they are still higher than what I am generally willing to pay.
I am patiently awaiting better bargains ahead.
Full Disclosure: I own shares in Questor Technology and PHX Energy Services. I do not own shares in Essential Energy Services or Macro Enterprises.