2022 continues to establish itself as one of the most influential years of my generation. Unlike my parents’ generation, I have lived a life with minimal fear of a global war. That feeling of security changed on February 4th when Russia sent its army into Ukraine. The implications of that invasion reverberated throughout the world and has touched us all. One of the most obvious impacts has been the acceleration of the energy crisis(1) that our industry has been highlighting for several years.
Over the summer, I have read a number of books on this topic in an attempt to grasp the consequences of the shifting energy sands in relation to climate change issues. The four most recent books I have read on these topics were:
1. The New Map: Energy, Climate and the Clash of Nations by Daniel Yergin
2. How the World Really Works: The Science Behind How We Got Here and Where We're Going by Vaclav Smil
3. Apocalypse Never: Why Environmental Alarmism Hurts Us All by Michael Shellenberger
4. How to Avoid a Climate Disaster by Bill Gates.
I would recommend any or all these books to get a better understanding of the challenges ahead. There are no simple solutions to the complex issues being raised, but the one fundamental reality is that the world uses a tremendous amount of hydrocarbons, and that is not going to change overnight. 83% of the world’s energy comes from fossil fuels – a decrease of only 3% from 20 years ago. Even Elon Musk has stated that “At this time, we actually need more oil and gas, not less.”(2) 
The ongoing debate on how we decarbonize the global energy sources will continue through our lifetimes. The one constant need will be to continue to provide the developing nations with energy and electricity. Sadly, the International Energy Agency has advised us that the number of people without access to electricity is set to rise in 2022, the first time this has happened in decades.(3) The IEA estimates that currently, 770 Million people today of our eight Billion global population live without access to electricity, mostly in Africa and Asia.(4)
The Russian invasion specifically highlighted the energy crisis in Europe, which had already manifested itself before the attack on Ukraine. The invasion specifically focused attention on the implications it would have on Europe, and specifically, on Germany and other EU nations that had a high dependence on Russian natural gas for winter heating. The sabotage of both the Nord Stream 1 and 2 Pipelines further exacerbated this issue.(5) The good news is that US LNG shipments have played a large role in allowing European natural gas storage to be 95% full compared to the prior 10-year seasonal average of 89%(6) and that has helped to temper the massive natural gas price increases Europe experienced this summer(7).
The bad news, though, is that even with full natural storage going into the winter, Europe is still in danger of running short of energy this winter and into 2023. (8)(9) The fact that Europe has been such an aggressive buyer of LNG does not bode well for emerging markets seeking LNG.(10)
With all of the focus on Europe this summer, less attention has been paid to the North American gas storage situation. We are now entering the withdrawal winter season for natural gas, and as you can see in the TD charts below, the North American market is quite “tight” with storage levels in Canada and the US 11% and 4% below their respective five-year averages.
These storage levels are a good indication of just how strong North American natural gas demand has been this summer. The NOAA declared that June-August was the third hottest summer in the US(11) and US electricity generation from natural gas hit a record in mid-July(12). If there had not been the Freeport LNG fire in June, an additional two Bcf per day of gas would have shown up on the demand side of the equation instead of supply. With Freeport expected to come back online this winter(13), at the same time as expansion at Sabine Pass, an additional 3 Bcf/d of exports will be added to US LNG exports, taking the total up to 14 Bcf/d, which will be the highest level ever for the World’s largest exporter of LNG. Although natural gas supply has been strong this year in both Canada and the United States, the North American storage deficiencies are a good indication that natural gas demand has grown even faster than the supply growth.
This market tightness has not been ignored by the commodity trading markets. This week we had the first cold weather forecasts in North America and the response from spot and forward strip natural gas pricing was immediate and material. Given the storage situation in North America, natural gas prices look to continue to be dynamic and volatile this winter. In fact, there is now speculation that the Northeast US may see a similar energy crisis to that which as Europe is currently enduring.(14)
What is exciting for the North American natural gas markets is that even more demand is on the horizon with another six Bcf/d of LNG exports expected to come online in 2025, just as 23% of all the coal fired fleet of power generation is coming off the US grid.
This US LNG growth in 2025 will coincide with Mexico’s planned LNG facilities coming online(15) and Canada’s scheduled LNG export debut out of the LNG Canada facility in Kitimat, British Columbia. This $40 Billion project is now 70% complete(16) but is not the only LNG facility being planned in Canada. In fact, we could have close to six Bcf/d of LNG exports at the end of this decade if all the proposed facilities listed below come online. Keep in mind that Canada only produces 17.5 Bcf/d of natural gas so these export projects could consist of over 1/3 of our current production. In addition, these projects do not include other LNG export facilities being contemplated on both the East and West coasts of Canada.(17)(18)
To bring some of these longer-term macro views back to Western Canada today, Alberta continues to set record demand numbers for natural gas this month, with winter still ahead of us and Western Canada natural gas storage already on the low end of historical levels.
With the ongoing maintenance and expansion work on the Nova gas system in Western Canada this past summer, we experienced some low AECO daily natural gas prices in Alberta. We knew that this work would impact prices, so we did three things: we put in place hedges to protect approximately 30% of our natural gas production; we utilized our own pipeline system to redirect gas to higher priced markets; and we sold a significant amount of our production forward on monthly 7A prices instead of leaving them exposed to the 5A daily spot price volatility. The pipeline system maintenance and expansion work appears be complete for 2022. The AECO natural gas price this morning was at $5.30 Mcf, with the forward winter price at $5.48 Mcf.
Included in this email is a link to my Q3 2022 Letter to Shareholders. In it, I highlight Pine Cliff’s past quarter’s adjusted funds flow, which was the second-best quarter in our history. We have now increased our dividend for the second time since we started paying a dividend in June of this year. At today’s closing stock price of $1.62 per share, our dividend yield equates to 8% and places it as one of the highest in the Canadian markets. At some point, I believe more of the generalist investors will eventually return to the energy sector looking to enhance their stock portfolio performance. It will be tough for generalist investors to continue to ignore the comparative outperformance the energy sector has delivered to investors in the first three quarters of 2022.
Interestingly, as investors return to Canadian energy space, they will not find as many investment options as there were just 10 years ago.
I think the generalist investors will focus on free cash flow when they return to our energy sector to differentiate their investment options as that is a metric that investors can compare across industries. With the lowest production decline of all oil and gas public companies at 6%, Pine Cliff screens very well on free cash flow comparisons. And as indicated in the Desjardin Capital charts below, PNE also looks attractive with our lower cash flow multiple compared to others in our sector.
And finally, if investors are looking for stocks that have performed well over the past three year and one year periods, PNE screens well there too as shown in the Stifel FirstEnergy charts below.
I hope you found some of this information useful. As always, please do not hesitate to share any pieces of information you may come across regarding natural gas supply and demand, and of course, feel free to call me directly if you would like to discuss Pine Cliff or the natural gas markets. I hope to see or talk to you again soon.
Regards,
Phil