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O&G Activity – Canada

Sorry for spamming you, I discovered an error in this post after I published it.

I’ve previously put some thoughts O&G activity internationally and in the USA, today I put some things together for Canada.

For those unaware, Canada has the 3rd largest oil reserves in the world (mostly) via the oilsands. There is also multiple LNG projects being commissioned and built in BC to send our natural gas to more expensive markets globally. These are highly complex, multi year, multi billion dollar projects.

British Columbia, Alberta, and Saskatchewan make up the vast majority of activity, so I will focus on activity in Western Canada. Below is the rig count for Canada, it shows how much of the overall activity is based in AB.

With so much business activity based on cyclical demand for hydrocarbons, Alberta is known as a boom/bust economy. As an Albertan, I understand how important the oil and gas industry is to our local economy. Local businesses compete with the higher wages present during the boom times, but also benefit from the increase in household income. When activity is strong, I notice an increase in our infamous rig rockets around the streets. For those who don’t know what a rig rocket is have a look below for a good example.

As a Canadian, I realize that our country’s largest export is crude and refined petroleum products. Depending on the year and how you add up the various products, they make up 15-20% of our exports. Regardless of your political leanings or views on the impact on the environment, a sharp decrease in price or activity (or both) will be harmful for Canada’s budget (at least in the short to medium term).

https://oec.world/en/profile/country/can#yearly-exports

Though WTIC is a decent indicator for global prices, for Canadians (and particularly us out west), we like to focus on Western Canadian Select (WCS) and a more localized Natural Gas price (say Alberta Nat Gas). WCS is a lower quality oil and it’s further away from major markets than WTIC and trades at a discount to WTIC. It’s also tends to be more constrained by pipeline capacity than other benchmark oils.

WCS wasn’t established until 2004, so that is as far back as we can look.

You can see from the chart there were 2 big drops in the chart at the end of 2018 and during the initial days of the pandemic.

The WTIC and WCS spread makes headlines sporadically when it’s at the extremes. The highest spread was in late 2018 when the difference was over $50. The spread has been as low as $5-7 but usually doesn’t last long. $15-25 is a more typical difference between the two.

Production costs

It’s hard to determine the exact marginal cost for a barrel of oil. It’s obviously project specific as well it’s tied to the available pipe or rail to transport it to a refinery. This may be an over simplification, but I think of Canadian oil as “more expensive” than many other sources. Having said that, it (at least historically) tended to be more “business friendly” out west. So these types of qualitative data points need to be considered if you are a large oil producer. Maybe it’s more expensive to produce in Canada, but there may be more stability.

I grabbed this chart from a 2017 IMF Working Paper. I also attached the paper below.

History

The history of oil production in Canada is colorful. Here are just some of the more memorable recent events I can recall related to activity in Alberta:

  • “Bitumen Bubble” and subsequent impact on Alberta’s budget in 2013.
  • WCS spread reaching $50/barrel in 2018.
  • WCS trading under $10 (and lower on a daily basis) in 2018 and 2020.
  • WCS trading over $100 in 2008 when we were “running out of oil”.
  • The rig count in Canada peaking over 600 during the cold season (2004-2008) and (2011-2013).
  • Production limits mandated by the NDP government in response to the increased spread between WTI and WCS due to mainly to limited pipeline capacity.
  • Keystone pipeline (important for taking AB crude to refineries in the US) commissioned in 2010.
  • Keystone pipeline rejected by Obama administration in 2015.
  • Keystone pipeline production resumption with UCP gov taking an equity interest in 2020.
  • Biden revoking the permit for the Keystone pipeline in 2021.
  • Many others being commissioned, started, stopped, re-started, etc.

For some additional context Alberta is typically a Conservative province (except our recent NDP stint) with our national leadership tends to swing more Liberal. I’m not going to into detail, but the oilsands and hydrocarbon production are always topical. There is a very wide dispersion of public opinion regarding the oil and gas industry, more specifically the oilsands and production of oil. It has been labeled “dirty oil” by many.

Investing Implications

If you managed to make it here, you are likely saying to yourself “ok already… get to the investing stuff, I’m here for the rocket ship emojis not some history lesson on Canada”. This is all just background for anyone interested in investing in O&G companies, albeit it can be boring.

Given the price of oil, the rig count is too low compared to previous cycles. Similar to other parts of the world, large producers have been reluctant to deploy significant amounts of capital to replace the declining reserves. It should be noted that many large producers in Canada have 30+ year reserves, so they may not have a large sense of urgency.

The rig count is seasonal as it’s strongest in the winter when the ground is frozen and the rigs can get out into the bush where there aren’t roads.

The ESG movement and transition to EV has taken center stage for many firms (especially those who look to gather more assets). My opinion is that we will be tied to hydrocarbons longer than we think and this last cycle(s) coupled with covid has left us underinvested relative to our demand picture.

Here is the 5 year performance of iShares U.S. Oil & Gas Exploration & Production ETF (IEO) vs iShares US Oil Equipment & Services ETF (IEZ). IEO is a little over break even and IEZ is way under water.
Here is the 1 yr chart.

This of course can be misleading. Who knows if I picked the appropriate times to compare these. You could go back longer and come to a different conclusion, so be warned. In reality we should be looking at valuations on an absolute and relative basis along with the share price and fund flows.

Having said that, I believe that there may be an opportunity to invest in companies tied to O&G market activity (not production alone) that will produce (in aggregate) reasonable returns relative to risk.

For my portfolio, I look at investing in O&G companies as a top down bet. I don’t know all the nuances of each cycle, so I take a basket approach. I try to be diversified geographically and by product/service. This does leave me with more companies to follow and can stretch my bandwidth at times. I currently own McCoy Global ($MCB.to) and Pulse Seismic ($PSD.to) that are directly tied to oil and gas activity. As well, I have a position in Macro Enterprises ($MCR.to) that benefits from overall investment in oil and gas infrastructure.

I’ll go over how I benchmark this trade/investment in a future post.

Anyone else follow the rig count or have anything to add?

Thanks,

Dean

*long $PSD.to, $MCB.to, $MCR.to

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November 2021 Update – $CSW/B.to, $OSS.v, $REPH, $ISDR, $ISV.to, $STC.to, $VLN.to, $VMD.to & $VMD, $SYZ.to, $MCB.to, $FRii.to, $FXC.to, $PZA.to, $MCR.v, $KUT.v

TIKR

I use TIKR to quickly look through ideas and check comparable companies. Would recommend. Referral code below.

https://app.tikr.com/register?ref=smob7c

Thoughts on Market Activity

The market has reacted to the news of another variant that seems to spread quicker than Delta. Governments around the world have reacted quickly by imposing some requirements for traveling to the affected zones (at least those currently affected). It will be interesting to see how effective the current vaccines are against this variant and if the mandatory vaccination movement gains more or less traction. Of course, I have no idea and haven’t changed by portfolio.

My portfolio has underperformed the market this year. It is hard to determine how much has been poor decisions vs. some returns being pulled forward in 2020.

I have been on the lookout for tax loss selling opportunities.

What I’m Reading

  • What The Dog Saw: And Other Adventures by Malcolm Gladwell

Posts this month

  • None

Developments on Companies Mentioned

  • Corby Spirit and Wine Limited – $CSW/A.to & $CSW/B.to
    • Reported fiscal Q1 2022
      • Revenue down 4-5% vs last year
        • Covid is making yoy comparisons hard
      • Cash balance down from the upfront fee to represent Pernod Ricard brands in Canada
    • Shares seem to have an equal upside vs downside at the moment and I’m going to stop updating CSW.
    • I do think the company represents a decent bet in an income portfolio.
  • OneSoft Solutions – $OSS.v
    • Reported Q3 2021
      • Rev growth was better than I expected
      • I was expecting slightly less cash burn by this stage although they are getting closer to break even and seem to have enough cash to get there
      • They are continuing to add customers (up to approx. 20)
      • Outlook seemed positive
      • Still expensive price to sales so will need high growth to justify committing capital to this company
  • Recro Pharma – $REPH
    • Reported Q3 2021
      • Was weaker than expected
      • I’m watching from the sidelines but won’t follow as closely as prior
      • I am going to stop updating REPH here
  • Issuer Direct – $ISDR
    • Reported Q3 2021
      • In line with my expectations
      • I’m hoping they can outgrow any significant margin pressure from here on in
  • Information Services Corp – $ISV.to
    • Reported Q3 2021
      • Quarter was pretty good
        • They benefited from Sask real estate
          • Likely wont’ see the same growth in 2022
        • Subsidies ending in Q4 2021 could bring some opportunity for Paragon
  • Sangoma Technologies Corp – $STC.v
    • 7 for 1 share consolidation announced
    • Reported fiscal Q1 2022
      • Slightly stronger than expected and guidance was maintained
    • IPO in the US
      • Issuing 5.5 mil shares
    • Then pulled the share issuance – ???
  • Velan – $VLN.to
    • Formalized the appointment of Bruno Carbonaro as CEO as they announced previously
  • Viemed – $VMD.to
    • Reported Q3 2021
      • Seemed like a decent quarter
      • Rev came in at the top end of guidance
      • Guiding to a bit lower growth in Q4 from the core biz relative to Q3
      • Margins slowly coming back
      • Looking to get back to traditional growth rates in 2022
      • Lots of uncertainty
  • Sylogist – $SYZ.to
    • Announced 5.9mil in contracted revenue
      • Good to see some wins
  • McCoy Global – $MCB.to
    • Reported Q3 2021
      • Was better than I was expecting
      • Backlog is up and outlook is positive from here
  • Freshii – $FRII.to
    • Announced a new franchise deal in Texas
      • 20 units over 6 years
    • Reported Q3 2021
      • Was weaker than I expected – particularly gross margin
        • Urban locations still significantly affect by covid
      • Not expecting a significant cash burn from Natura
      • Continued to invest in franchise partners during the quarter
      • Long term see lots of opportunity in Canada
  • FAX Capital – $FXC.to
    • Reported Q3 2021
      • Deployed some capital into Hamilton Thorne during the quarter
      • Accumulating shares in another public Canadian company
      • Purchased 2 mil shares of Avante Logixx
    • I have liquidated my position and will no longer be updating $FXC.to
  • Pizza Pizza Royalty Corp – $PZA.to
    • Nice bounce in activity with some more mobility in Canada
    • Still some stores shut down and yet to reopen so I don’t think we are not at peak earnings
  • Macro Enterprises – $MCR.v
    • Reported Q3 2021
      • Results were in line with my expectations
        • Revenue was 110 mil vs 94 mil last year
      • Expects revenue to exceed 385 mil for 2021
      • Trading about 2.5 EV/EBITDA and likely less than 2x EV/EBITDA if they maintain 350+ in rev
  • RediShred Capital – $KUT.v
    • Reported Q3 2021
      • Results were better than my expectations
      • EBITDA grew 53% from acquisitions and organic growth
      • Trading at 10x EV/FCF given my run rate estimate with stable paper prices

Long – $OSS.v, $ISDR, $$STC.to, $VLN.to, $VMD.to & $VMD, $MCB.to, $FRii.to, $MCR.v, $KUT.v

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September 2021 Update – $OSS.v, $ISV.to, $STC.v, $FTG.to, $VMD.to, $URB/A.to, $MCR.v

TIKR

I use TIKR to quickly look through ideas and check comparable companies. Would recommend. Referral code below. They recently did an update that has added some more features.

https://app.tikr.com/register?ref=smob7c

Thoughts on Market Activity

Nothing worth noting.

What I’m Reading

  • I have been spending most of my free time this month focused on the build out of my garage gym. Shoot me a message if you ever want to chat lifting.

Posts this month

Developments on Companies Mentioned

  • OneSoft Solutions – $OSS.v
    • Notice of the CEO selling some shares
      • He still has about 8.8% of the outstanding
      • This is something to monitor if it continues
  • Information Services Corp – $ISV.to
    • Upped dividend from $0.80 to $0.92
    • Now yielding over 3%
  • Sangoma Technologies Corp – $STC.v
    • Held Special AGM and passed motion to consolidate shares in plans to uplist to US exchange
    • Released Fiscal 2021 results and held conference call
      • Results were slightly ahead of previous guidance
      • Issued new guidance for fiscal 2022
        • Higher than expected EBITDA margin
        • Slightly higher than I expected for organic growth
      • Continuing to pursue uplisting
      • I would have thought the stock would have responded better to this news
      • I’m going to listen to the call again to see if there is anything I missed
  • Firan Technology – $FTG.to
  • Viemed – $VMD.to
    • has been hitting new 52 wk lows consistently
  • Urbana Corp – $URB/A.to
    • Renewal of NCIB announced
      • Any purchases at this large of a discount to NAV should be highly accretive
    • NAV continues to march higher
  • Macro Enterprises – $MCR.v
    • Announced Subcontract for Trans Mountain Expansion Project
      • Revenue to reach 350 mil in 2021 with some additional investment in PPE
      • I thought the stock would have popped even more given how much visibility they have into next years revenue

Have a good one.

Dean

Long $OSS.v, $STC.v, $VMD.to, $URB/A.to, $MCR.to

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