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Energy Stocks Are No Longer Safe Investments

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A Mainstay of the Toronto Stock Exchange
Over the next blogs, we will trace how and why energy stocks were good investments, but how they now pose significant risk to investors. In this first piece we trace a bit of history. In the next we look at oil v natural gas, and then afterwards where these companies are now.

Investors in Canada often include energy stocks as a key part of their portfolio. After all, Canada is a supplier of energy to the world, whether it be oil, natural gas, or coal, or uranium.  (Canada used to even export nuclear technology through Atomic Energy of Canada which was a Canadian owned world class company)

Recently a new breed of energy company has arisen that is in the green energy business. Some of these companies are having great successes and they are will be the subject of a future article. Some real gems are building their holdings from their Canadian base.

The Origins of Many Energy Companies
Canadian companies are continually being created in the energy sector, and a large segment of the junior stock market in Canada (TSX Venture) is comprised of small companies drilling for oil, or natural gas, or exploring for coal or uranium. Some of these companies succeed and a number of the current large energy companies that are listed on the TSX are as a result of these successes. Investors in Canada and elsewhere own the shares of these companies.

What has been a touch disappointing is that most of these companies trade at lower p/e multiples than industrial companies. Still, this is an accepted part of the investing world, and these companies are well received as conservative stocks for investment portfolios. Usually the life cycle of these companies is:

·  ·         to be created as juniors,

·  ·         accomplish degrees of success,

·  ·         then gobble up smaller competitors to enlarge their resource bases, and

·  ·         then be taken over by still larger international corporations in similar fields.

The World Changed When Energy Became Expensive
After the oil embargo shock which was prompted by the war in the Middle East, the price of oil rose from $12 a barrel to $100 a barrel of oil, and then much higher until it then moderated around the $100 level. This dramatic increase in the cost of energy changed the world. Cheap oil in North America fueled the dynamic North American industrial explosion, which itself created the automotive industry growth, the technology industry growth and so much more that created such a high standard of living for North Americans.

This started to change as energy became more expensive, and in due course, the US transformed from a center of manufacturing strength to a center of financial strength. Jobs moved to cheaper areas of the world, as did services. All of this culminated in the financial meltdown of 2008. Cheap energy became expensive energy and this changed the world.

It also changed investing, as when prices increase, the supply/demand equation changes and companies rush in to deal with the new situation. Investors bought the shares of energy companies and rode the train. All of that is about to change and change dramatically.

When Canada Changed the Rules for Energy Trusts, it Lost its Opportunity
As a side topic, it is worth noting again how Canada completely missed the boat on this boom. As the energy boom was growing, Canada created a type of company called an Energy Trust whereby investors were able to invest in “units” of these companies. Then these companies used the money raised to buy gas and oil production, and the profits from this production were then not taxed in the hands of the companies, but instead were taxed in the hands of the investors. The advantage to investors was that the level of income tax normally imposed at the corporate level was eliminated. Profits distributed to investors were not subject to two levels of taxation, but only a single level.

These Energy Trusts enjoyed ever growing popularity and their very success doomed them. The government started worrying about the loss of tax revenue, and changed the rules, resulting in the Energy Trusts going out of business two years ago – eliminated effectively by government decree, all in the name of collecting taxes.

The energy boom for Canada is now coming to an end, and the riches from exporting gas and oil will soon dramatically diminish. Those Energy Trusts, if they had been allowed to continue growing, would by now be world class and world size, able to compete anywhere in the world. Instead none of these companies now exist; their assets have been dissipated and mostly bought by foreign interests.  The irony of course is that the loss of revenue will now become permanent as Canada’s energy exports are diminishing and will continue to diminish.

The opportunity to have a group of world class companies paying taxes in Canada, and Canadians paying tax on the profit of these companies has been permanently lost. Just another example of the utter stupidity of politicians. What politicians don’t realize is that the world changes and changes occur more and more rapidly. Letting free enterprise create wealth for our citizens is a good thing.

Back to the issue at hand. There is a new reality. Energy is becoming cheaper.

Be Aware – Energy Companies Are Now to be Avoided
There is a monumental change occurring around us. If you ignore this change, it will be at your peril.

While worldwide demand for oil continues to increase, the cost of producing this oil also continues to increase both in monetary terms and in greenhouse emission terms. Recognition of the damage to the environment from the production and use of oil is growing, and the environmental lobby is growing in size and power. It is inevitable that oil will lose its allure as the place to invest. Compare this to the production of natural gas, where demand is rapidly rising and costs are rapidly falling to new fracing techniques and ever greater sources of supply. Energy will become cheaper and the migration by users from oil to natural gas will continue.

Companies Producing and Selling Natural Gas
Let’s start with companies that rely on the production of natural gas, including the companies with primarily natural gas production that used to be Energy Trusts. At one time, there was a repeating pattern that advisors relied upon. At certain times if the year, natural gas was lower priced and at other times higher priced. Then there was an accepted relationship that gas was priced at a specific ratio to the price of oil and could be traded based on the current price relationship and temporary distortions in that comparison.  The two energy sources (natural gas and oil) tended to trade in a narrow range to each other. There were also patterns that repeated, whereby the price of natural gas fell at times, only to recover at other times.

Traders used these known occurrences to buy and sell natural gas. It was sort of like this almost guaranteed source of income for the traders. All of this is history now. None of these old trading strategies are now of value, although most haven’t yet realized this.

What we have instead is ”fracing”. Natural gas has become so plentiful and so easily available that the price of natural gas is very low, and will not rise in the foreseeable future. By now, investors should be aware of this sea-change in older investing maxims, but what investors should also consider are some other effects.

Firstly there are enormous fields of natural gas in the south central USA. It used to be too expensive to find and extract this natural gas, but that is no longer the case. Now this gas is discoverable and extractable at reasonable cost. More and more of these fields are becoming known and are coming into production. At this locally produced natural gas grows in volume, imports reduce in volume. All of this is good for the American economy, and bad for companies that own assets producing oil and gas elsewhere.

Next we will discuss troubling events that are unfolding as a result of this change in the availability and price of energy. Including:

·  ·         the declining ability of natural gas companies to maintain their profits, dividends and share value,

·  ·         the reality of the Canadian Oil Sands,

·  ·         the futility of the new pipelines, and

·  ·         the short term thinkers who are promoting natural gas liquefaction.

The views expressed in this blog are opinions only and are not investment advice. Persons investing should seek the advice of a licensed professional to guide them and should not rely on the opinions expressed herein. This blog is not a solicitation for investment and we do not accept unsolicited investment funds.

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