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The Belt Gets Tighter for Canada’s Energy Sector

By Ari Charney on April 7, 2016

Canada’s oil and gas producers are getting lean and mean. But they’ll have to get even leaner and meaner.

The good news is that the energy sector is only one part of Canada’s investment story, and just one of several key contributors to the country’s overall economy.

During boom times, for instance, the resource space accounted for just 16% of Canada’s economic output and 6% of total employment.

But that doesn’t mean the energy sector isn’t of vital importance. After all, such data may understate how the industry’s fortunes ripple throughout the economy.

Certainly, the crash in crude oil prices weighed on last year’s economic growth, which more than halved from the prior year.

However, the contraction in the energy sector was just one factor in the economy’s deceleration, paring gross domestic product (GDP) by about 0.3 percentage points, or a little less than a quarter of the year-over-year decline in the overall growth rate.

There are two areas where the energy sector does have an outsize role in Canada’s economy: business investment and exports.

When oil traded in the triple digits, energy-sector spending accounted for about one-third of Canada’s business investment.

Needless to say, those days are over, at least until the cycle turns. And with oil prices still trading well below breakeven for unconventional producers, oil and gas companies remain in aggressive cost-cutting mode.

That’s prompted the Canadian Association of Petroleum Producers (CAPP) to sound the alarm. The lobbying group forecasts that the sector’s capital spending will drop to C$31 billion this year, down nearly 62% from 2014.

CAPP says that’s the largest two-year decline on record since the entity and its predecessors began tracking such data in 1947.

Part of that staggering statistic is simply a function of the sort of bloat that occurs during a bubble. Industry observers expect those excesses to be undone during the next six months, especially when it comes to head count.

Encana, for example, plans to cut another 20% from its workforce this year, which would bring the firm’s total layoffs since the beginning of 2015 to 50%.

An even starker statistic is the steep drop in the energy sector’s cash flow, which is forecast to hit C$17.5 billion this year, or less than a quarter of what was generated in 2014. With a number like that, it’s clear why management teams are doing everything possible to keep the lights on (and continue servicing their firms’ mountains of debt).

Meanwhile, energy products have lost their former ranking as Canada’s top export by value. The category now places a distant third behind motor vehicles and consumer goods.

As an aside, the good news here is that there’s evidence of the much-anticipated rotation in the country’s economy: Exports of automobiles and consumer goods are up 45.7% and 16.4%, respectively, over the past year, compared to a 36.6% decline for energy products.

That’s likely due to a lower exchange rate, which gives different sectors an opportunity to assume leadership as others falter.

Although it’s possible we’ve already witnessed the bottom in oil prices, the glut is projected to persist a while longer.

The latest data from the U.S. Energy Information Administration show that the global oil market is forecast to remain oversupplied through the end of 2017, though the margin is projected to narrow significantly during the second half of next year.

Keep on tightening, gentlemen.

Our Super-Secret Stock Pick

In May, we’re holding our annual Wealth Summit–this year in Las Vegas. It’s a great way for us to meet you, our subscribers, one-on-one, and there are still spaces open if you’re interested.

Also this year, we’ll be making a special recommendation to those who attend the Summit, and to those who are part of our Wealth Society, whose members receive all the Investing Daily newsletters and other premium services.

It’s a fun exercise for us because there are no rules. We don’t have to pick a Canadian stock. In fact, our pick doesn’t even need to be a stock: It could be an alternative investment that isn’t traded on a public market.

Our publisher says we can’t reveal the pick in Canadian Edge, or even to him before the Summit. But in the weeks ahead, we’ll let you in on some of the research we’re doing to identify this exclusive pick.

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