An overwhelmingly disappointing set of fourth-quarter results has done little to dim Canadians' enthusiasm for energy stocks.
"We are staying with our overweight recommendation for the Canadian Energy sector," Stéphane Marion, chief economist and strategist for National Bank Financial, wrote on March 25. "[E]quity analysts have slashed their earnings expectations for Canada's energy producers to the point where the consensus now expects profits to collapse to their level of 2002. In our view, much bad news has now been priced in."
The consensus 12-month forward earnings per share estimate for Canada's energy sector has collapsed from approximately $200 to about $60 in recent months, according to National Bank, which used figures from Datastream.
While analysts have (finally) taken a suitable hatchet to their earnings expectations, the market has so far refused to do the same.
According to Bloomberg, the S&P/TSX Energy sector is currently trading at 62 times estimated 2015 earnings – a level that suggests that the extent of the looming damage has definitely not been priced in.
Estimates from analysts have been fairly accurate in predicting actual earnings over the past decade. If they're right this time, a calamitous slump in profits is on the way for Canadian energy firms. Investors, presumably cognizant of the fact that the price of what these companies are selling has collapsed, do not appear to have adequately appreciated just how bad the results are expected to be.
In Canadian-dollar terms, the price of West Texas Intermediate crude oil is down 45 per cent year-over-year, while the S&P/TSX Energy sector has declined by 17 per cent over this period, and is trading at a level last seen when the price of oil was just over $100 per barrel (Canadian) halfway through 2014:
SOURCE: Luke Kawa/Bloomberg
The correlation coefficient between energy stocks and the loonie-adjusted oil price of oil is 0.84 since 2002, indicating that they tend to move in the same direction 84 per cent of the time.
Energy investors could take solace in the fact that a similar gap between the index and the price of oil persisted between late 2005 through 2007. However, the scenarios are much different: that period followed a substantial run-up in the price of oil that encouraged investments to expand production and fostered increased returns to shareholders. The modern equivalent has seen this chasm exist despite dividends getting slashed and the outlook for production growth, as well as the profitability of each barrel produced, looking meagre at best.
Monday's GDP report from Statistics Canada shows that oil and gas production is still growing in Canada. Weekly reports from the United States indicate that the situation is similar south of the border. This "we'll make it up in volume!" approach from North American energy companies – the proximate cause of the supply glut – does not augur well for a substantial near-term improvement in the price of oil.