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PRINT EDITION
For energy investors, a silver lining to the discount on Canadian oil
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By DAVID BERMAN
  
  

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Wednesday, October 17, 2018 – Page B1

The Canadian energy sector has a problem: Western Canadian Select (WCS) heavy crude is selling at a steep discount to U.S. oil, and Canadian energy stocks are suffering. But there may be buying opportunities in the Canadian oil patch for anyone willing to bet that this wide discount will soon narrow. Based on patterns over the past decade, now may be an especially good time to buy.

West Texas intermediate (WTI) crude often dominates our attention when we consider energy stocks because it generally reflects the oil market worldwide. But even though the price of WTI has risen to a range between US$65 and US$75 a barrel for much of this year amid strong U.S. economic growth, Canada's WCS crude has slumped to about US$26 a barrel, or near a two-year low.

The spread between the two crude oil benchmarks reached a high of US$50 a barrel last week, surprising just about everyone. That is the widest spread going back at least a decade, according to Bloomberg.

On Tuesday, the spread was only slightly narrower, at US$47 a barrel.

To put that into perspective, the two crude oil benchmarks traded within US$15 of each other as recently as May, which was close to the long-term average.

No wonder the Canadian energy sector is frustrating many investors. The sector is down 38 per cent from its 2014 high, essentially unchanged over the past decade. Recent investors who thought they were buying bargains can't be happy either: So far in 2018, the energy sector is down nearly 7 per cent.

But here's where the opportunity comes in: A wide spread between WTI and WCS doesn't last long. And when it narrows, Canadian energy stocks tend to rally.

Brian Belski, chief investment strategist at BMO Nesbitt Burns, found that most prolonged discounts are followed by "Vshaped" recoveries as the spread between WTI and WCS narrows.

"Since 2008, WCS spreads have rebounded by 50 per cent on average within two months of a trough," Mr. Belski said in a note.

The impact on the Canadian energy sector can be sharp as well. Energy stocks rebound about 5 per cent, on average, within three months of the spread improving.

The oil and gas exploration and production sub-sector tends to perform even better, rising by an average of nearly 7 per cent within three months.

With the spread between WCS and WTI at its widest on record, Mr. Belski added, "investors should be looking to increase positions at these levels."

The big question is whether we have already seen the widest spreads.

No one knows, of course, but it's a reasonable bet that the worst is nearly over.

Analysts believe that the deteriorating price of Canadian oil is not a mystery: It follows tight capacity within export pipelines at a time when demand for Canadian oil at a number of U.S. Midwest refineries has been temporarily hampered by maintenance issues.

But solutions are at hand. U.S. refineries should be back in action soon, raising demand.

Enbridge Inc. is expected to complete its Line 3 replacement line to the United States in late 2019, easing bottlenecks.

Longer term, TransCanada Corp. expects to start construction on its Keystone XL pipeline next year, and the federal government is still pushing to restart the Trans Mountain expansion project.

In the meantime, Canadian railways expect to increase their shipments of oil by 50 per cent by the end of this year.

"This is big; it wasn't that long ago when there was no oil-by-rail (2011) and now it's as if rail companies built a pipeline while Canadians were sleeping," Derek Holt, head of capital markets economics at Bank of Nova Scotia, said in a note.

He expects the spread between WCS and WTI will be cut in half over the next year. So do Greg Pardy and Robert Kwan, energy analysts at RBC Dominion Securities, who noted that Cenovus Energy Inc., MEG Energy Corp. and Athabasca Oil Corp.

stand to benefit the most as spreads narrow.


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