Oil and gas extraction contributed 7.6% towards Canada’s gross domestic product in 2022. This significant exposure to oil and gas helped the TSX outperform Nasdaq last year. Is this energy rally over after the oil price fall to $71.74, or is more upside in the cards for energy stocks? June is an interesting month for both the United States and Canada.
Key happenings in June 2023 that could affect Canadian energy stocks
Firstly, the Organization of the Petroleum Exporting Countries (OPEC) announced the second oil production cut in four months. Saudi Arabia plans to reduce oil output from 10 million barrels per day (bpd) in May to 9 million bpd in July, its biggest reduction in years. The oil cartel is cutting production to push oil prices above US$80/barrel.
Secondly, the U.S. government will probably suspend its debt ceiling for two years, averting an immediate crisis of a government default and preserving the dollar. The dollar’s stability is important for energy stocks as oil trades in U.S. dollars in the global markets. The instability of the U.S. dollar could significantly reduce Canadian energy stocks as Canada exports over 99% of its oil to America. If the U.S. averts the debt crisis, it could boost Canadian energy stocks.
Lastly, the Bank of Canada will decide on the interest rate on June 7 as April inflation increased to 4.4% after falling to 4.3% in March. A rate hike could put downward pressure on energy stocks as businesses and people would refrain from spending.
More scenarios point to a steep upside in Canadian energy stocks later in June. At present, energy stocks are on sale as OPEC reduced output in May and tensions around the U.S. government defaulting alleviated. Now is the right time to buy three Canadian energy stocks and lock in a higher dividend yield before the above events push these stocks upwards.
Canadian oil stocks
You can buy two Canadian energy stocks in the current cyclical dip before the winter season rally begins.
Suncor Energy (TSX:SU) produces oil at an average cost of $30-$43/barrel. If the oil price rises, it can sell crude oil at a higher price and enjoy windfall gains. The company has been enjoying windfall gains for the last two years and passed it to shareholders by increasing quarterly dividends by 148% from $0.21 in 2021 to $0.52 in 2023.
Canadian Natural Resources (TSX:CNQ) has some of the largest natural gas reserves in Canada. Its significant exposure to natural gas reserves gives the company cash flow stability when the oil price falls. It has helped the company grow its dividend in 22 of the last 23 years.
Suncor stock is down 11% and Canadian Natural Resources 5.2% in two months. Now is a good time to lock in a 5.3% and 4.78% dividend yield, respectively. You can buy these stocks now and sell them when oil and gas price increase in the winter season. Or you can hold them as they have the potential to pay dividends in a recession and even grow them in most years.
Canadian pipeline stocks
Other than oil stocks, Canadian pipeline stocks are trading near their 52-week lows. These stocks are a buy at every dip because of their robust business model that allows them to pay incremental dividends even in a crisis.
Enbridge (TSX:ENB) has long-term supply contracts that bring assured cash flows for 98% of its service cost. It has hedged its loans against rising interest rates by maintaining less than 5% of its debt at a floating rate of interest. Moreover, North America’s largest pipeline network does not take loans from U.S. regional banks, protecting it from the U.S. banking crisis.
Enbridge collects cash from tolls and deducts maintenance costs, debt servicing costs, and taxes to arrive at distributable cash flow (DCF). And even with this DCF, it pays only 60-70% in dividends. Enbridge increases its DCF by adding more pipelines, expanding existing ones, and through share repurchases (from the remaining DCF). Depending on the 2023 DCF, Enbridge will determine the 2024 dividend payout.
Enbridge’s cash flows are predictable as they start flowing when the pipeline comes online, which helps it pay regular dividends.
Buying these energy stocks at the dip can help you earn better long-term returns.