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Canadian Midstream Dominates U.S. Rivals

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Canada is better.

That’s the conclusion that investors and we American energy infrastructure analysts in Centennial, Colorado, have made about the investment risks and merits of the Canadian midstream market and its largest companies.

Though not without longer-term decarbonization challenges, Canada’s energy infrastructure titans – Enbridge, TC Energy, and Pembina – offer less execution risk, less market risk, and better dividend security than their American cousins as Canadian oil and gas production remains robust. These unique attributes in Canada have translated into superior downside protection for public investors in 2020. In the trailing year, Canadian midstream stocks have outperformed U.S. midstream stocks by ~25%.

Exhibit 1: One-Year Canadian vs. U.S. Midstream Stock Performance, East Daley Research Estimates

Canada’s midstream titans already have material investments in the U.S. and Mexico, and Canadian financial prowess positions these companies to roll up struggling U.S. operators.

These advantages haven’t arisen by accident. Foremost, the Canadian midstream sector has been more disciplined pursuing growth and has not suffered from the capital glut and hypercompetitive capital spending that characterizes the U.S. market. More risk-averse financial contracts with hydrocarbon shippers also provide revenue insulation. Further, the unique profile of Canadian energy production adds to stability. After initial capital outlay, oil sands production on average stays flat versus the 60 – 70% first-year declines of unconventional tight resource production. These factors combine to create more stable volumes in aggregate with less short-term commodity price elasticity of production.

Exhibit 2: Canadian vs. U.S. Large Cap Treadmill Incline Intensity, source: East Daley Capital research estimates

As shown in East Daley’s Treadmill Incline Intensity analysis, our proprietary measure of cash flow replacement risk, large Canadian firms have 2.5x less cash flow execution and replacement risk through 2023 than their large-cap US counterparts.

Debates about the economic contribution, or environmental damage, of the Canadian oil sands and related infrastructure needs have dominated Canadian headlines, but our forecasts, and forecasts by the Canadian Energy Regulator, expect resilient Canadian production even as global prices swoon from the pandemic shock, electric vehicles penetrate the automotive market, and renewable energy trends sharply higher.

Exhibit 3: East Daley Canadian Crude Oil Production Forecast, Source: East Daley Capital research estimates

Exhibit 4: East Daley Canadian Natural Gas Production Forecast, Source: East Daley Capital research estimates

In 2018, Canadian oil and gas represented 6.5% of the country’s gross domestic product and should remain a material contributor to Canadian economic activity in the years ahead. Crude oil egress megaprojects, including Enbridge’s Line 3 replacement, Trans Mountain, and the less probable Keystone XL project from TC Energy, all will assure export avenues for Canada’s producers, eliminating bottlenecks that previously threatened the economics of Canadian production. If Canadian oil and gas production wanes, it is unlikely to come from either export capacity constraints or resource limitations. Rather, we expect global oil prices, above-ground policy and political forces to shape hydrocarbon exploitation from hereon.

Exhibit 5: East Daley Canadian Western Canadian Crude Oil Supply/​Demand Stack, source: East Daley Capital research estimates

With a still-robust outlook for Canadian oil and gas production, opportunities abound for making Canada’s energy supply chain cleaner, more productive, and more efficient. We expect increasingly stringent environmental demands on both sides of the border to require innovations and improvements in remote monitoring, inspection, and integrity. Marginal increases in plant processing efficiency will determine already competitive dynamics as weak commodity prices squash revenue for producers. Emissions monitoring and controls ultimately will join the capture and sequestration of carbon dioxide to steer oil and gas production into lower emissions intensity.

The speed and severity of carbon restrictions likely will change as often as the political winds. But to remain a valuable economic contributor, Canada’s oil and gas producers and transporters will need to make material gains in emissions and efficiency, offering opportunities for investors in technology and process innovation. The more answers the industry can offer from technology and materials science, the better it will navigate decarbonization challenges ahead. We expect Canadian entrepreneurs and technologists to lead this innovation and profit from addressing these challenges in their backyard.

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East Daley Capital