Bargain Hunting in the Canadian Energy Market

By , Money Morning •

By Jennifer Yousfi
Managing Editor

With oil down more than 20% from its record high, Canadian energy stocks have been beaten down to more affordable levels. But as concerns over demand and refining margins grow, it can be hard to determine which Canadian energy stocks are still viable profit plays.

Strong oil exports helped to boost Canada’s trade surplus in June. The trade surplus increased to $5.4 billion (C$5.8 billion) from $4.8 billion (C$5.2 billion) in May, the national statistics office announced earlier this week. But a large part of that increase was due to higher prices, not higher volumes. Oil reached a record of $147 per barrel on July 11. Since then, oil has dropped to below $115 a barrel.

The drop in oil prices coupled with a curb in demand from consumers who are fed up with high prices at the pump have put pressure on all of the oil majors, causing share prices to fall. But Canadian oil companies have one huge advantage over both their southern rivals in the United States and European competitors.

Many Canadian oil company holdings are in stable geopolitical regions, free from threats of state seizure or terrorist attacks. Government seizing of assets in Venezuela and Russia and the volatile political unrest in areas such as the Nigerian Delta have plagued oil majors such as Exxon Mobil Corp. (XOM) and Royal Dutch Shell PLC (RDS.A, RDS.B). But Canadian oil companies that mainly operate in North America and Northern Europe are free from such hassles.

Also, companies that operate in less-developed nations are often subject to production-sharing agreements with the local governments, which can quickly eat into the oil majors’ bottom line.

Barron’s reported that Oppenheimer analyst Fadel Gheit wrote in a recent research note that “high oil prices are not good for Exxon's business as they increase government take in royalties and taxes, strengthen national oil companies, limit access to resources, but, above all, depress the share price.”

But without the burden of similar agreements, Canadian oil companies are set to profit from any future spike in oil prices.

On the flip side, compared to other countries, many Canadian oil reserves are in tar sands or shale oil, which are harder and more costly to refine. At a certain price point, these deposits become less viable as they can cost upwards of $30 per barrel to refine into a finished product.

This would be cause for concern if oil were set to continue its recent decline. But the current pullback in oil prices is likely to be short-term and improved technology is making such reserves more affordable to extract and refine.

Over the long-term, oil will be on the rise again due to shrinking global reserves and increased demand from emerging markets. Money Morning Investment Director Keith Fitz-Gerald has a $225 per barrel price target for oil due to a variety of factors including the fact that members of the Organization of the Petroleum Exporting Countries (OPEC) have been misrepresenting their reserve capabilities for years.

Two Canadian Energy Profit Plays

With the appropriate investment time horizon, this could be the perfect time to scoop up some Canadian energy stocks at affordable prices.

Here are two to consider:

Talisman Energy Inc. (TLM) is a well-positioned Calgary-based oil and gas company with 95% of its production in the relatively stable areas of North America, the North Sea and Southeast Asia. Talisman shares are well off their 52-week high of $25.71, closing yesterday (Wednesday) at $17.34. However, the lower share price has brought this Canadian energy stock’s Price/Earnings (P/E) ratio down to a more affordable level of 10.13, with a yield of 1.09%.

Talisman is a bit of a speculative play, with so many of its assets concentrated on so-called “unconventional programs.” But late last month, Talisman boosted its 2008 capital-spending budget to $5.5 billion due to a “very promising start” to its North American unconventional natural gas programs.

“Its new push to develop unconventional natural gas and oil may be tricky, but we are optimistic Talisman is taking the right steps to unlock significant value from these assets,” Morningstar analyst Kish Patel said in a recent research report.

Petro-Canada (PCZ) is another Calgary-based oil and gas firm that has become rather affordable due to recent price pressures. But Tom Guinness, co-manager of Guinness Atkinson Global Energy (GAGEX), feels this is one oil company that will profit even if oil drops down to $100 per barrel in the short-term. Petro-Canada is trading at a P/E ratio of 5.98, with a yield of 1.69%. Shares closed at $44.39 yesterday and have traded between $40.56 and $62.78 over the past 12 months.

Petro-Canada is fully integrated with both production and refining capabilities, making it Canada’s second-largest refiner. And while the firm has had some refining problems of late, a $2 billion overhaul of its Edmonton-based plant – which will be capable of processing 135,000 barrels a day from its Alberta oil sands holdings – will soon be completed.

The drop in oil prices might hurt Petro-Canada on the production side, but should only help on the refining side as lower gas prices spur consumer demand and lead to more fill-ups at the pump.

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