By Richard Macedo
Uncertainty fuelled by unrest in the Middle East, the European debt crisis and persistent worries about the U.S. economy took the stock market on a wild roller-coaster ride in 2011, and many of the same external factors are in play again entering the early part of 2012.
The uncertainty has had a particular impact on smaller producers, notedGeoffrey Vanderburg, managing director with Bryan Mills Iradesso (BRIR), who said that investors have been beating up the juniors.
"Small oil and gas companies have always been relatively high-risk, high-reward propositions but there were fewer rewards and higher risks in 2011," he said. "Down markets don't like risk.
"What's interesting about the third quarter of 2011, however, is that the average junior managed to pull out all the stops to increase production both overall and on a per-share basis."
He added that companies weren't issuing shares at depressed prices and were finding ways to continue to grow.
"Unfortunately, even production growth wasn't good enough to turn share prices around in the third quarter of 2011, with the average junior declining 24 per cent," said Vanderburg. "There are some great juniors on the market but it will take a wave of optimism to bring shareholders back."
"[If you] look at the sector throughout the first half of the year, it was a significant out-performance by the service stocks, the pumpers and the drillers, namely," added Chris Theal, president and chief executive officer of Kootenay Capital Management Corp."You had a very strong operating environment, oil was healthy through $100 and they massively out-performed the producers.
"The backdrop there was the activity levels and you were seeing margins going up for the service companies."
When the calendar flipped to July, "everything very much became a macro, headline-oriented market," Theal said.
"You went through the U.S. debt default, the initial round on Greece and then the successive failed attempts by the Euro leaders to resolve issues over there," he noted. "It was just very headline-dominated."
Entering 2012, Theal said the Euro Zone is still a concern.
"That structural component that they need to achieve on fiscal accountability has to be put in place," he added. "I think the U.S. avoids recession, I think China has a soft landing and I actually think you're going to start seeing a differentiation in equity markets geographically. [That means] North America kind of detaches from a weaker performance in Europe."
Randy Ollenberger, an analyst with BMO Capital Markets, said that in 2011, companies with attractive yields (former trusts) and those pursuing new oil and liquids plays such as the Duvernay did relatively well.
The biggest external factors affecting energy stocks last year were economic uncertainty and the European debt crisis. The same factors are in play again this year, Ollenberger said, adding that the potential disruption in Iranian supplies or blockage of the Strait of Hormuz could significantly impact oil prices.
"[Prices] could increase significantly from current levels if Iranian production is taken off the market or the Strait of Hormuz is blocked," he said.
Peters & Co. Limited noted that energy markets in general were affected by global economic concerns and volatile commodity prices, particularly in the second half of the year. A report by Peters showed thatImperial Oil Limited was the best performer in the integrated oils category of the PE 125, posting an annual return of 13 per cent, whileSuncor Energy Inc. was bottom of the group at negative 22 per cent.
As for Canadian large producers, Crescent Point Energy Corp.topped the list at eight per cent, while Talisman Energy Inc.was the worst performer at a negative 40 per cent. In the intermediate category,Trilogy Energy Corp. was king of the group with a return of 209 per cent while Petrobank Energy and Resources Ltd. was at the bottom with a negative 58 per cent.
Cequence Energy Ltd. finished the year on top in the junior producers category with an annual return of 51 per cent. At the other end,Perpetual Energy Inc. recorded a negative 65 per cent to finish at the bottom. Open Range Energy Corp. was the top performer among small producers with an annual return of 581 per cent (returns for Open Range include the value of Poseidon Concepts Corp. based on the closing share price), while Compton Petroleum Corp. was the worst with a negative 95 per cent.
Among oilfield services, Black Diamond Group Limited topped the list at 77 per cent and Calmena Energy Services Inc. was at the bottom of the group with a negative 69 per cent. The infrastructure index listed AltaGas Ltd. as the top performer with a return of 53 per cent while Enbridge Income Fund was bottom with a return of 17 per cent.
The PE 125 is a value weighted index of 125 Canadian-based energy stocks. It divides the stocks into seven sub indicies based on size or classification of business. Entity returns are adjusted to include dividends/distributions paid during the year.
In terms of the service sector, Scott Treadwell, vice-president, equity research, oil and gas services withTD Securities, said that pumpers did well in the first half of last year but they were affected by oversupply concerns through the second half.
"They ended up down about 10 per cent on the year," he said.
Drillers fared better, up between five and 15 per cent.
"My outlook for 2012 is for things to be slightly better from an activity point of view year-over-year but not a lot," said Treadwell. "Margins should continue to improve as growth spending slows down for service names. Pumpers should do better in 2012 as visibility improves on industry conditions and new plays [like the Duvernay] and Horn River work ramps up."
Meanwhile, BMIR compiled third quarter 2011 results into its latest iQ Report, which showed that the median enterprise value of Western Canada's junior oil and gas companies slid in the third quarter. Enterprise value is calculated by adding a company's market capitalization to its net debt. Companies with high valuations are often better positioned to access capital or use equity to complete accretive deals.
For the juniors, the median enterprise value in the third quarter of 2011 was $59,912 per bbl of oil equivalent compared with a median enterprise value of $74,834 per boe in the second quarter of 2011 and $59,692 in the third quarter of 2010. Figures in the latest quarter ranged from $19,229 to $244,464 per boe.
The median enterprise value for the intermediates stayed consistent in the third quarter of 2011 at $74,958 compared with $72,751 in the second quarter of 2011 and $70,968 per boe in the third quarter of 2010. Enterprise values in the latest quarter ranged from $14,338 to $184,073.
BMIR said that the stock market malaise faced by Canada's oil and gas companies was not a function of their operational performance in the third quarter.
"In fact, both the juniors and intermediates managed the rare feat of increasing their production per share during the quarter," the report stated.
From the second quarter to the third quarter of 2011, the intermediates showed a median increase of five per cent in overall production and four per cent in production per share. The juniors performed almost as well, with the median overall production level increasing 4.2 per cent while production per share increased 1.9 per cent.
By comparison, from the first quarter to the second quarter of 2011, the intermediates showed a median decline of 2.9 per cent in production per share. The juniors fared even worse, with the median production per share dropping 5.3 per cent from the first quarter to second quarter of 2011.
Given the low natural gas prices, Western Canada's junior oil and gas companies have been making slow but steady progress on the path to decreasing their dependence on natural gas since the second quarter of 2010, the report noted. Despite this trend, the average junior and intermediate exploration and production company is still producing more natural gas than oil.
The median junior had a natural gas weighting of 55.5 per cent in the third quarter of 2011 compared with an almost identical 55.6 per cent in the second quarter. Meanwhile, the median intermediate natural gas weighting was 65 per cent in the third quarter compared with 67.9 per cent in the previous quarter.