In recent years, oil sands investments have been about as bad for investor portfolios as they have been for the environment. I’m going to touch on one key driver that I believe will provide the potential for an oil sands rebound in 2020.
In terms of near-term drivers, low interest rates, and in particular lower bond yields (and in the cases of many oil producers in Canada, junk bond yields) are likely to stick around in 2020 is the key driver that could help fuel a rebound in the embattled oil sands sector.
Debt and interest rates
Debt continues to be a story that’s still floating beneath the surface, and some investors have simply steered clear of all oil sands investments for this reason alone.
Oil sands producers that took on far too much debt in the commodities rally pre-2014 (which lasted more than a decade) have had trouble deleveraging amid dropping oil prices and downgrades across the sector.
For companies like Baytex Energy (TSX:BTE)(NYSE:BTE), debt loads continue to be the headline story. Similar to the producers, Baytex has reduced its leverage ratios and done good work to ensure balance sheet stability and solvency, but the overall market has continued to worry about the company’s interest payments as a percentage of cash flow.
The potential for a company like Baytex to refinance its debt at potentially more attractive levels than a year ago make this company interesting from a valuation perspective, as it’s become clear that the market is not pricing oil sands stocks fully. Value appears to have been on the table for long-term investors interested in buying what iconic investor Warren Buffet would call “cigarette butt” companies.
Baytex investors will certainly not be in for a smooth ride, however, as many headwinds that have stymied growth in Western Canadian companies like Baytex are likely to continue in the medium term.
Perhaps the strongest headwind I would caution investors considering a position in Baytex about the current discount producers of Western Canadian Select (WCS) oil receive relative to U.S. producers of West Texas Intermediate (WTI) or global producers of Brent oil, as a result of supply constraints related to pipeline/rail capacity, and overall quality and utility of heavy Canadian oil relative to other global grades.
With recent protests cutting off rail traffic in B.C and Ontario, thereby limiting the ability for oil to travel East or West (at the time of writing), investors could be hamstring by near-term events and potential downside volatility.
That said, Enbridge’s new line 3 expansion, which is set to come online soon, appears to be in solidarity among the federal and provincial governments. When it comes to enforcing new pipeline expansions, this should help offset these concerns and provide a template for future growth in the sector.
For those concerned about default risks in Canada’s oil patch, I would hold off for now; the ability of companies to raise cash at relatively cheap levels or continue to refinance (even in the junk bond market) is good news for all — at least, for now.
Stay Foolish, my friends.