Energy Investors Waiting for a Nice, Long Cold Snap

We’re not far into the New Year, but Canadian oilmen are sad to report that oil prices are not warming up. In fact, prices are down about $10.00 from their 2006 average of $66.25.

Not much is different in the natural gas department, as this warm winter, one of the warmest on record, means oil and gas inventories are hitting record highs.

For North America, this is a case of déjà vu, since January 2006 wasn’t much different. In contrast, Europe was marked by a vicious freeze last year, which supported natural gas prices. My family lives on the Adriatic Coast, and last year they saw the first snow that they can remember. This year, on the other hand, my friends and cousins went swimming in November and December, and October was almost as warm as August. (Now, why was it that I moved to North America again?)

I would have expected Canada’s oil patch to be squirming under the pressure these days, but there are various degrees of impact. For example, if oil producers were quick on the trigger to get in on low cash cost properties, they could be weathering this lull in energy prices relatively well. One such property was EnCana’s North Sea Buzzard property, which started pumping 60,000 barrels a day only a few days ago at a cash cost of $40.00 per barrel. So, even if prices drop to $50.00 a barrel, we’re still talking about $3.7 billion in cash just from that well.

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If only there were more North Sea Buzzards out there. Of course, this is not the case. To make matters worse, when prices were low during 2003 and 2004, many producers opted to hedge portions of their future production at fixed prices. One such example is Petro- Canada, which locked in some of its North Sea Buzzard production until 2010 at an unbelievably low price of $25.98 per barrel! Of course, hindsight is always 20/20. Let me just say that when Petro- Canada snatched its share of the North Sea Buzzard in 2004, this hedging decision was widely regarded as prudent.

And while oil producers have some wiggle room, the energy trust sector is in dire straits. Disregard for a moment the new trust distribution tax rules. Things are going from bad to worse because of falling oil prices and anemic natural gas prices, which, in turn, pressure trust unit prices into an almost nosedive. The next logical step will be decreasing trust distributions, which is bound to aggravate investors.

Aside from describing water to a drowning man, the point I am trying to make is that the softness in the energy sector indicates consolidation might be in the cards. In all likelihood, it would not just be a game of big fish eating small fish. The era of hauling in obscene profits just because oil prices were at historic highs could be over. Going forward, companies will have to base their valuations on something more substantial to attract new money.

Then again, if we get hit with a nice, long cold snap, or if another war breaks out somewhere strategically important, all of this could change. Now, where’s that crystal ball of mine?