7 Canadian Energy Investments For The Income Investor

by: Michael J. Ray

Early on, income seekers recognized the great potential of Canadian energy investments, formerly known as Canadian Royalty Trusts. Even the Halloween Massacre of 2006 was not enough to hold back these investments for long.

For those not familiar, the Halloween Massacre of 2006 was a decision by the Canadian government to tax all income trusts domiciled in Canada in a similar manner as corporations. The decision caused dramatic declines in stock prices, but in the end most stocks bounced back and still remain highly attractive investments to this day.

These companies, since they are holders of oil and natural gas assets, should have ever increasing demand as world population and energy needs do not seem to be letting up. Also, their location in Canada has some very competitive advantages, namely Canada's economy.

The country has a history of balanced budgets and low debt which is always a plus, especially in this type of environment. And unlike the U.S., Canada is still creating jobs and showing that they can increase wages while doing it. That being the case, the average Canadian citizen will be much better off in their own debt structure. Even the housing markets operate on a conservative level and the government and banks have fairly tight lending standards on home loans. Canada provides stability needed for any income investor. Here are some of the top Canadian energy companies that any income investor should consider.

One of the most popular energy sector choices is Enerplus (NYSE:ERF). This company engages in the acquisition, exploitation and operation of crude oil and natural gas assets in both the United States and Canada. Energy production is almost an even break of 53% natural gas, 47% crude oil and natural gas liquids. With a yield of 8.6% and dividends being distributed on a monthly basis, what is not to like about this company?

According to the latest company presentation it seems that the real story surrounding this company is its growth potential. The company has stated that its goal is total production growth of 10 – 15% over the next two years. As natural gas prices are still lagging, ERF will concentrate on the oil production side of the business with production set to increases by over 20% through 2012. Of course to pull this off there will be a need for capital expenditures. The original capital expenditure plan for 2011 was worth over C$650 million, but now has been revised to C$770 million. ERF has at its disposal a $1 billion unutilized credit facility that it plans to support development in 2011/2012.

As good as this all sounds though, ERF has had its challenges this current year. Severe weather delayed the execution of drilling programs and held production rates back for the year. The company has stated that the 2011 exit production guidance should be 81,000 – 84,000 BOE/day which will put production rates back on track by the end of the year. Also, as natural gas prices show no real signs of life just yet, the company does not hedge its production. The company does hedge its oil productions as shown in the July 27, 2011 chart provided by the company below. Click to enlarge:

All in all, ERF seems to be what most income investors might be looking for, a proven track record, solid financials, and a growth story. Click to enlarge:

Another well known Canadian entity is Penn West (PWE). PWE engages in acquiring, exploring, developing, exploiting, and holding interests in petroleum and natural gas properties. Since the market selloffs in August of 2011, PWE’s share price has suffered. In late February 2011 the shares traded for roughly $28 a share, only be literally be chopped in half by late September. No matter how one looks at it, a drop in price like that is a nightmare for any income investor. But at these lower levels PWE might just be an interesting buy. The company currently has a 6.4% yield that pays quarterly. Let’s look at some of the positive aspects of this company.

It has access to 6.2 million acres which is plenty of room to grow. The company is also applying new drilling technologies which will be a highly effective way to get to oil that otherwise might not be unattainable. It is this new drilling technology (horizontal drilling) that could be the key for PWE. Of PWE’s total reserves, only 5% is related to the horizontal drilling which represents wells that have been drilled. So basically the idea is that PWE’s reserves are understated by quite a bit. As new wells are drilled over time, the reserve life should be revised.

Another reason PWE might make a great addition to one’s portfolio is that Penn West owns 15% of the approximate 80 billion barrels that is said to be in place in the Western Canadian Sedimentary Basin (WCSB). That is quite a bit of reserves, but if one were to go to their company reports, one will find they report 661 million BOE of proved and probable reserves. To tap into these unbooked reserves, Penn West in 2011 is estimated to expend C$1.4-C$1.5 billion in capital expenditures for 2011. The company should also have access to a borrowing limit of $2.25 billion if need be.

The negative aspects for the company are related to extreme flooding, weather, and forest fires which all contributed to delays in production and the bottom line. The company has stated that fourth quarter production levels will hopefully return to normal and thereby relieving some of the investors concerns.Click to enlarge:

Next is the very popular and resilient company Provident Energy (PVX). Provident Energy Ltd. engages in the natural gas liquids (NGLs) infrastructure and marketing business in Canada and the United States. The company is involved in the extraction, processing, storage, transportation, and marketing of NGLs, as well as offers these services to third party customers. It also provides fractionation, storage, NGL terminalling, loading, and offloading services. When looking at the stock price for the company, income investors can feel a bit more reassured as the company still trades for roughly what it did before the late summer selloff. The same cannot be said for many other Canadian energy income investments. The company pays a monthly distribution which is currently yielding 5.8%.

PVX also has lots of positive events occurring that should be mentioned. For example, Provident adjusted its EBITDA to C$245-C$285 million, where earlier the company had expected C$210-C$250 million. PVX also doubled its capital expenditure outlook for 2012 to C$135 million and for 2013 to C$145 million. If that was not enough, PVX in early October 2011 announced that it has completed the acquisition of a two-thirds interest in Three Star Trucking which is an oilfield hauling company serving Bakken-area crude oil producers. The acquisition establishes a strong crude oil presence and provides opportunities to enhance its NGL and diluents logistics services businesses.

The company’s management is dedicated to growth of the business and the dividends. To mitigate risk, PVX also employs a disciplined hedging program. Typically a higher percentage is hedged in the near months but where appropriate, additional hedges up to 24 months may also be applied. Below is a sample of the company’s hedging strategy. Click to enlarge:

Pengrowth Energy Corporation (NYSE:PGH) is great energy company for any income investor to consider. PGH engages in the acquisition, exploration, development, and production of oil and natural gas reserves in the Western Canadian Sedimentary Basin. Pengrowth explores for crude oil, natural gas, and natural gas liquids in the provinces of Alberta, British Columbia, Saskatchewan, and Nova Scotia. The current production mix is an even split of 50% liquids and 50% natural gas. The production rate calculated in late June 2011 is 70,958 boe per day.

The company has approximately 900,000 acres of undeveloped land and at the end of 2010 it had a total proved plus probable reserves of 318.4 millions of barrels of oil equivalent. The reserve life index on the proved plus probable is 11.1 years. Management seems to have the right attitude as they state that their primary focus is to create value for shareholders. To do this PGH is utilizing new technology to squeeze more resources from existing pools, as well as to achieve economic production. For 2011 the company planned to spend $550 million in capital programs which was a 54% increase when compared to the $358 million in 2010. The vast majority of these expenditures (85%) were going to be focused on the oil and liquid rich natural gas projects as this is where the money is going to be made.

To protect investors, the company does use hedging activities to try and maintain a more stable business operation. In 2011, 29% of the forecast production of natural gas was hedged at an average price of Cdn $5.38 per mmbtu. In turn, the oil and liquids has a hedge of 44% of forecast production at an average price of Cdn$90.97 per bbl. In early August 2011 PGH reported that its second quarter production was challenged due to a number of uncontrollable external events. In northern Alberta, forest fires, power outages and unscheduled pipeline outages led to production being shut-in, while prolonged facility maintenance activities and severe wet weather limited access and transportation. As a result, second quarter production was reduced by approximately 4,000 barrels of oil equivalent (boe) per day and averaged 70,958 boe per day in the quarter. Despite the operational issues experienced during the second quarter, PGH posted stable cash flows in the quarter where operating activities was approximately $152 million as compared to $147 million in the first quarter.

The company’s payout percentage is 47% so they seem to be covering their monthly distributions to shareholders. The current yield is 8.1%. Click to enlarge:

Another fine choice for income investors is the Baytex Energy (NYSE:BTE). BTE, through its subsidiaries, engages in the acquisition, exploration, development, and production of petroleum and natural gas in the Western Canadian Sedimentary Basin and the United States. As of December 31, 2010, it had proved plus probable reserves of approximately 229 million barrels of oil equivalent. BTE organizes its crude oil and natural gas operations into three business units: Canadian Heavy Oil, Canadian Light Oil and Gas and United States. As one can tell by the charts below, the heavy oil component is by far the largest production product and revenue generator. For the quarter ended June 30, 2011, BTE had an average daily production rate of 47,853 boe/d. For the quarter ended June 30, 2011, total oil and gas revenue was $285.9 million, of which 76% was from heavy oil, 17% was from light oil and natural gas liquids and 7% was from natural gas.

Management of BTE has been committed to a sustainable business model based on a conservative payout ratio and a strong balance sheet. Their goal is to strive to provide investors with a meaningful dividend while growing their production base organically. Approximately 84% of the production and 91% of the reserves are derived from crude oil and they have amassed a significant inventory of long-term, low cost crude oil projects. Baytex has an estimated reserve life index of 13.2 years for proved plus probable reserves based on estimated reserves at December 31, 2010 and assuming an average production rate of 47,500 boe/d for 2011. BTE also maintains a complex hedging policy where they try to manage the exposure to a variety of risks including commodity prices, foreign exchange rates and interest rates. For current hedging click here.

If one were to look at BTE on a historical timeframe they would find that from September 2003 through year-end 2010 they have grown their reserve base at a compound annual growth rate of 12%, to a level of 229 million barrels of oil equivalent. In turn the company has replaced 297% of its annual production at a cost of $5.90 per boe which is a very competitive rate. Currently BTE distributes its dividend on a monthly time frame with a yield of 4.8%. Click to enlarge:

For something a bit different than just oil and natural gas producers, let’s turn our attention to one of Canada’s greatest energy transportation companies, Pembina Pipeline Corporation (OTC:PBNPF). Pembina operates in distinct four segments; Conventional Pipelines, Oil Sands & Heavy Oil, Midstream & Marketing, and Gas Services.

The Conventional Pipelines segment operates a 7,500 kilometer pipeline network that transports crude oil, condensate, and natural gas liquids in Alberta and British Columbia. The Oil Sands & Heavy Oil segment owns and operates the Syncrude pipeline, the Cheecham Lateral, and the Horizon pipeline, which deliver synthetic crude oil produced from oil sands. The Midstream & Marketing segment offers storage, terminal, and hub services. The Gas Services segment consists of natural gas gathering and processing facilities, including three gas plants and nine compressor stations. This segment also operates approximately 300 kilometers of gathering systems.

One thing to like about Pembina is that the company has tried to diversify their asset base to leverage their profitability in hot sectors. At the same time this diverse portfolio of business segments also helps the company reduce risk when certain market conditions have downturns in the cycles. For example, consider this 2010 graph that shows the sources of the operating margins. Click to enlarge:

In the end, Pembina is still a story of growth as most all of their major business lines are expanding their capacity. For the second quarter, the company announced that it achieved strong financial performance during the second quarter of 2011, realizing earnings of $48 million, compared to $37.7 million during the second quarter of 2010. Revenue, net of product purchases, during the second quarter of 2011 increased to $148.1 million, compared to $124.5 million during the same period in 2010. Year-to-date revenue, net of product purchases, in 2011 was $288.6 million, compared to $250.3 million during the first six months of 2010. Pembina sports a monthly dividend that makes a yield of 6%. Click to enlarge:

Our last Canadian energy pick for the income investor might be a bit more on the risky side of the house. That company is Encana Corporation (NYSE:ECA). To understand ECA one needs to understand a bit of their history.

Back on November 30, 2009, Encana completed a corporate reorganization and split into two independent publicly traded energy companies – Encana Corporation, a natural gas company, and Cenovus Energy (NYSE:CVE), an integrated oil company. Needless to say, CVE got the better end of the deal with the oil exposure while ECA has to operate in a prolonged period of soft natural gas prices.

As a result, ECA's management has really had to step up to ensure the survival of the company in this time of depressed natural gas prices. One example is ECA pursuing cost savings measures through operating efficiencies and supply chain optimization. The company has reduced well drilling times in the last year by 20 percent, as well as established long-term, efficiency based contracts. In addition, ECA reduced the cost of commodities by self-sourcing steel, sand and fuel. These are proactive cost management programs that ECA expects to provide significant and ongoing cost savings.

In an effort to try to address the challenging natural gas prices, ECA continues to manage price risks through its commodity price hedges. For example, as of June 30, 2011, the company had hedged approximately 1.8 Bcf/d, or about 50% of expected July to December 2011 natural gas production, at an average price of $5.75 per Mcf. In addition, Encana has hedged approximately 2.0 Bcf/d of expected 2012 natural gas production at an average NYMEX price of $5.80 per Mcf and 405 MMcf/d of expected 2013 natural gas production at an average price of $5.29 per Mcf.

In an effort to present the effects of this hedging program, consider the following. As a result of commodity price hedging in the second quarter, Encana's before-tax cash flow was $196 million higher than what the company would have generated without its hedging program. Since 2006, Encana's commodity price hedging program has resulted in about $7.7 billion of before-tax cash flow in excess of what would have been generated had the company not implemented a commodity price hedging program.

With all this cost control and risk management, ECA was able to generated cash flow of $1.2 billion in the third quarter before currency losses on exchange rates. The company also grew natural-gas liquids (NYSE:NGL) production and aims to more than triple its NGL production by 2015. The NGL segment will be the best option for future growth for the company and ECA is forging ahead to promote this business with joint ventures and partnerships. For example Encana, along with Apache (NYSE:APA) and EOG Resources (NYSE:EOG) are planning on developing a Liquefied Natural Gas (LNG) export facility and are almost done with the final government approval. In addition to this, Encana is also involved with Pembina where they intend to expand the NGL extraction and processing capacity of one of their plants. Initial review suggests that ECA should triple its NGL production in the area and improve the extraction capacity to eight times the current rate.

Times are challenging at ECA but management seems to have the upper hand so far. Encana’s Board of Directors has consistently declared a quarterly dividend of 20 cents per share paid on a quarterly basis. That makes for a 4% yield while investors wait for natural gas prices to return. Also income investors can look forward to ever increasing profits from LNG production as the company focus its resources in that direction. Click to enlarge:

In conclusion, the above seven companies are some of the great Canadian investments that might make interesting holdings for income investors. Obviously, there are many more great names and companies out there that might fit the bill. Make sure to complete your own in depth research before purchasing any stock. Articles like this one are nice but in no way provide enough information for anyone to base their decisions on.

Disclosure: I am long PWE.

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