Canadian oil stocks have disappointed this year. BMO Equal Weight Oil & Gas ETF (TSX: ZEO) is flat year to date. Meanwhile, the S&P/ TSX Composite Index is up 3% over the same period. Canada’s energy sector has underperformed the rest of the market and significantly underperformed tech and growth stocks throughout 2023.
Why is the industry lagging behind, and what comes next for the oil and gas giants?
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Headwinds
Economic uncertainty, geopolitics, and a mild winter created the perfect storm for crude oil prices. Industry experts were expecting an energy crisis in Europe, as they faced a shortfall of Russian oil and gas. Meanwhile, crude production was lower because of a decade of underinvestment. The global economy’s recovery from the pandemic was expected to boost demand.
However, these forecasts were missed. Europe quickly pivoted to natural gas from Qatar and North America while winter temperatures were higher than usual. Meanwhile, the global economy slowed considerably, especially in China. Now, economists and investors are worried about a recession.
This is why a barrel of crude oil trades at US$75 right now, while it was above US$100 last year. Canadian energy stocks, like Suncor (TSX: SU) have followed this trajectory. The stock is down 25.9% from June 2022.
What comes next?
In the near term, investors are worried about a recession. If economic growth turns negative, oil demand could drop further. Crude oil has lost value in every previous global recession. However, some believe that the long-term fundamentals are still intact. The global supply of oil and gas is systematically below long-term demand, as the world’s population and economy keep growing.
This is why Warren Buffett has kept his stake in oil producers and boosted his stake in a natural gas company recently. The Oracle of Omaha probably sees value in this industry. The average energy stock across North America trades at a price-to-earnings ratio of 4.8 and offers a dividend yield of 4.6%. Suncor is trading at 6.6 times earnings per share and offers a 5.7% dividend yield.
Simply put, this industry is undervalued, despite the headwinds. Value-oriented investors who are willing to be patient should seek out opportunities in Canada’s energy sector.
Bottom line
Energy experts were expecting a commodity supercycle. Oil supply was low, while demand was expected to soar this year. However, these forecasters have been disappointed.
In the near term, Canada’s energy sector faces tremendous hurdles. The global economy could dip into recession, while the rapid adoption of clean energy and electric vehicles could dampen demand further.
However, energy stocks are cheap. Sometimes unbelievably cheap. Investors looking for a bargain or passive income from high-yield stocks should take a closer look at this beaten-down sector.
Canada’s energy sector could deliver reasonable cash flows for the next few decades.
