Oil and Gas: Supply up; Demand Growth down │ But for how long?

The supply of oil and gas has risen. The demand growth for oil and gas has decreased. Both factors have sent down the price of oil. West Texas Intermediate—North America’s benchmark—now trades at its lowest level in two years. This creates extra risks for energy producers.

The U.S. is using newer technology to produce a lot more energy. This technology lets producers tap previously-unavailable energy. And old oilfields have in many cases become economic again. As a result, the U.S. is importing far less oil than before.

At the same time, the growth in the demand for oil has been weak. One reason is slow growth in Europe. The euro area’s economy is now expected to grow by just 0.9 per cent in 2014. Europe is China’s largest market. As a result, the world’s second-largest economy is also growing much less quickly. While the U.S. economy is growing swiftly, its economy relies less upon oil than in past decades.

Demand growth tracks the global economy

Lower commodity prices could hurt the results of oil and gas producers. Particularly those that need high prices to make their projects viable. The cost of building these projects also remains high, with skilled labor in short supply. But the critical question is: How long will commodity prices languish?

Railroads are transporting much more oil to markets—reducing prices. In the long run, the industry needs pipelines to carry oil at a lower cost. But strong opposition to pipelines in the U.S. and B.C. is likely to delay their development.

In the short- to medium-terms, some fuel consumers will switch to cheaper natural gas if they can. In the long run, the construction of plants to liquefy natural gas for export will eventually alleviate or eliminate the glut of this commodity.

Europe would likely embrace imports of liquefied natural gas from North America. This would cut their dependence on supplies from Russia—supplies which are prone to interruption in price disputes between Russia and former Russian-dominated countries such as the Ukraine.

A second factor supporting the price of oil is that it’s usually found in unstable countries with little or no rule of law and violence or corruption: Iraq, Iran, Nigeria, Russia and so on. Canada’s stability, by contrast, makes domestic producers reliable suppliers. Foreign companies also do business in Canada.

Environmental concern is leading to the development of alternate energy that could compete with oil and gas. Hybrid cars, for instance, use less energy. And people keep finding ways to save energy.

But Canadian oil and gas producers should do well in the long run. The world will need their production for many years to come. Just remember that lower commodity prices would hurt their financial results.

If you’re finding it difficult to decide how to structure your portfolio to include oil and gas stocks, here are a few suggestions:

■ Diversify globally. Choose first from among the U.S. and international producers such as Royal Dutch Shell, for exposure to global opportunities.

■ Buy a Canadian integrated company. Husky Energy is now the best buy of our Canadian integrated oils, though Imperial Oil and Suncor Energy also are buys.

■ Diversify among oil producers and natural gas providers. Choose one that focuses on oil, such as senior producer Cenovus Energy. About 70 per of its production is oil. Also buy one that focuses on natural gas, such as Birchcliff Energy. About 83 per cent of its production comes from natural gas, the balance from oil and natural gas liquids.

 

The Investment Reporter, MPL Communications Inc.
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