Canadian investors know that the Toronto Stock Exchange is an energy-heavy exchange, with S&P/TSX Composite Index being 25% weighted toward the energy sector. With much of Canada’s economic growth coming from the oil sands, it is difficult, and perhaps unwise, to avoid energy stocks completely. Unfortunately, energy stocks are extremely exposed to commodity price risk, and with oil prices dropping 25% since the summer, investors may be wondering how to minimize risk while staying exposed to this sector. Cenovus Energy Inc. (TSX: CVE)(NYSE: CVE) and Pembina Pipeline Corporation (TSX: PPL)(NYSE: PBA) offer a solution. Why Cenovus Energy is a smart…
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Canadian investors know that the Toronto Stock Exchange is an energy-heavy exchange, with S&P/TSX Composite Index being 25% weighted toward the energy sector.
With much of Canada’s economic growth coming from the oil sands, it is difficult, and perhaps unwise, to avoid energy stocks completely. Unfortunately, energy stocks are extremely exposed to commodity price risk, and with oil prices dropping 25% since the summer, investors may be wondering how to minimize risk while staying exposed to this sector.
Why Cenovus Energy is a smart play in a weak price environment
Low oil prices equal lower margins for oil producers. Goldman Sachs estimates the global average supply cost breakeven point for an oil project is US$70/bbl. That is to say, most oil projects would need oil prices of at least $70 bbl to remain profitable.
Some new Canadian projects have breakeven points higher than this. It makes sense then, that companies with low production costs, especially companies with breakeven points significantly below the current U $82 price for West Texas Intermediate, are most prepare to thrive in a low price environment.
Cenovus Energy has among the lowest global supply costs, with a breakeven point between US$35-$65/bbl. This means in the current price environment, Cenovus will be solidly profitable.
These low costs are likely to stay as well. Cenovus is weighted towards oil sands rather than conventional oil, and contrary to popular belief, oil sands projects are more economic than the conventional tight oil plays in the U.S. according to a recent BMO report. This is due to the fact that oil sands projects have very low decline rates compared to U.S. tight oil plays, and after a high initial capital expenditure, can produce and expand for decades at low cost.
In addition, Cenovus is continually improving its steam-to-oil ratio (SOR), which will further drive down costs, and is already the lowest in the industry. For steam-assisted gravity drainage (SAGD) projects, which include all of Cenovus’ oil sands operations, the SOR is a measure of how much steam is required to produce a barrel of oil. Low SOR means lower capital costs and lower operating costs, which equates to higher margins.
Cenovus’ Narrows Lake project is also expected to be the industry’s first demonstration of solvent aided process (SAP) technology, which is a modification to standard SAGD technology that uses a solvent together with steam. This is expected to reduce SOR by 30%, and increase oil recovery from the reservoir by 15%, further cutting costs.
Why Pembina Pipeline is a smart play in a weak price environment
Pipelines get most of their revenue independent of commodity prices, through fee-based contracts. Fee-based contracts involve the pipeline being paid per unit of production transported, and since pipelines get paid based on volume, oil prices do not strongly affect profits.
Pembina Pipeline is especially well suited to benefit going forward. Currently, Pembina transports over 50% of western Canadian conventional oil, and 30% of NGL volumes.
Unlike its peers, Pembina has the advantage of having 100% of its projects being fee-for-service. This means Pembina has no commodity price risk at all. In addition, its major projects are backed by long-term contracts, most of them 25+ years, including volume commitments.
In this, Pembina offers investors a way to participate in the massive volume growth coming out of Western Canada, without exposure to price risk.
Although oil prices are uncertain, oil production growth is expected to increase dramatically, and Pembina is prepared to capitalize on this growth as its customers demand greater access to refineries and export pipelines. With a $7.8 billion project backlog, Pembina is expected to grow its capacity from the current 628 mbpd to ~1508 mbpd over the next several years.
For investors wary about oil prices, Pembina provides exposure to growth without commodity risk and Cenovus provides exposure to oil production through a low-cost, low-risk producer.
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Fool contributor Adam Mancini has no position in any stocks mentioned.