Husky Energy Offers To Buy MEG Energy - Jolts Canadian Heavy Oil Names Higher

by: HFIR


There were 3 bullish news items over the weekend for Canadian energy.

Husky offers to buy MEG at C$11 a share.

LNG exports will be finally coming to Canada following Shell and its four partners approval over the weekend.

NAFTA negotiations finished with the new trilateral agreement titled USMCA.

We believe Canadian heavy oil names remain undervalued.

Welcome to the jolt edition of Oil Markets Daily!

Over the weekend, Canadian energy stocks received 3 positive news items:

But the big news for our portfolio was the news that Husky offered to buyout MEG at C$11 a share. MEG was the 4th largest position in our portfolio, so the ~37% pop today was a nice one for the portfolio.

More importantly, the news that Husky is buying MEG sent the entire Canadian heavy oil sector on a tear. Cenovus (CVE) is now up ~13% since announcing the crude-by-rail deal with Canadian National (CNR).

It wasn't long ago that we published our piece on September 13th titled "Peak Pessimism - Investors Have Given Up On Canadian Energy Stocks, Why Now Is The Time To Load Up."

If you had bought Canadian heavy oil names, your return would have varied from 5% to 54% depending on which names you bought. We wrote repeatedly that Canadian heavy oil names present a bargain to their intrinsic value in light of the widening WCS-WTI differentials. The market has already embedded the wider than normal discount into the valuation, so the moment crude-by-rail capacity increases and the WCS differentials narrow, the Canadian heavy oil names will massively outperform.

We believe investors remain too pessimistic on Canadian energy names. The news that Husky wants to buy MEG is only a wake-up call. The premium that Husky offered is too low compared to where WTI is today and where WCS-WTI differentials are headed (~$18/bbl). In our view, Husky is going to need to raise its bid if it wants to takeout MEG. A more appropriate price tag will be around C$15 to C$18 per share.

In addition, with November WCS contracts now trading, we should start to get a better sense on how much demand is out there. The big reason WCS differentials are currently very wide at the moment is because of PADD 2 refinery maintenance. But as the maintenance ends by mid-November, the refineries will have to start buying about a month in advance. This should start to push the spread lower and with crude-by-rail capacity increasing to ~300k b/d by the end of the year, we think spreads have the potential to narrow into the high teens and low 20s. This would present another reason for why investors should buy Canadian heavy oil producers today.

Overall, the news flow over the weekend were very bullish, but the Canadian energy sector remains undervalued, and we are especially kin on Canadian heavy oil producers.

We are long Gear Energy (OTCPK:GENGF) (GXE.TO), MEG Energy (MEG.TO) (OTCPK:MEGEF), Cenovus (CVE) (CVE.TO), Athabasca Oil (OTCPK:ATHOF) (ATH.TO), and Baytex (BTE) (BTE.TO).

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Disclosure: I am/we are long GXE.TO, MEG.TO, CVE.TO, ATH.TO, BTE.TO.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.