Oil prices may be trading off their June highs, but Canadian energy companies are enjoying a boost relative to their U.S. counterparts. The U.S. dollar’s rapid appreciation in the foreign exchange market has helped Canadian energy producers become even more profitable – after all, they sell oil in U.S. dollars, but almost all their costs are in Canadian dollars.
Let’s take a closer look at these dynamics and why energy investors may want to look north of the U.S. border for the best oil investment opportunities.
Exchange Rate Mayhem
Nearly every asset class has posted miserable returns in 2022, except for the U.S. dollar. With the Federal Reserve hiking interest rates to combat rising inflation, the U.S. dollar index is up nearly 20% over the past 52 weeks. While American consumers have greater purchasing power abroad, the dollar’s valuation has hurt U.S. exports, including energy exports.
The exchange rate between U.S. and Canadian dollars reached 1-to-0.73 in recent weeks, marking the U.S. dollar’s highest valuation since March 2020. Since crude oil trades in U.S. dollars, Canadian energy producers sell oil and gas in U.S. dollars but pay expenses in Canadian dollars, translating to fatter profit margins and robust cash flow.
Even with the recent dip in U.S. oil prices, there is less of a top line impact to Canadian oil producers when they report their revenue in Canadian dollars.
Meanwhile, U.S. producers must pay most of their expenses in U.S. dollars, making them less competitive in the global energy markets. As a result, energy investors could find better opportunities in Canada than in the U.S., particularly with many smaller Canadian independent energy producers already trading at a discount to their peers.
Independent Producer Discount
Many small, independent energy companies trade at a discount to their larger peers. While some of that discount reflects a risk premium, a handful of these smaller energy companies have a track record of generating robust cash flow with high netbacks. As a result, smaller Canadian energy companies could be worth a second look for investors seeking alpha.
For example, Saturn Oil & Gas Inc. (TSX-V: SOIL, OTCQX: OILSF) estimates it will produce between C$216.3 and C$230.9 million in 2023 cash flow – or roughly C$3.63 to C$3.87 per basic share. After making a series of acquisitions, the company has already surpassed 12,000 BOE/d and is on its way toward reaching a targeted average of 13,500 BOE/d next year.
Despite its production growth and high cash flow potential, the stock closed trading at just C$2.87 per share on October 25, 2022, which is less than its anticipated cash flow per share expectations for next year. Some analysts, like Eight Capital’s Christopher True, recognize the discount and assign a Buy rating and C$7.50 per share price target, but the market has yet to catch on to the story.
Eight Capital recently issued a report on September 30, 2022, comparing Canadian energy companies. In the report, Saturn Oil & Gas Inc. had the highest 2023E Free Cash Flow yield at 79%, when using strip pricing, versus the small and midcap average of 25%.
This is a measure of how much free cash flow a company is expected to generate in relation to its market capitalization. A higher yield represents better value, and Saturn Oil & Gas is currently trading as the most inexpensive energy stock of the peer group.
The strong U.S. dollar is providing Canadian energy producers, large and small, a durable operational advantage over their American counterparts. In addition to Canadian energy majors, investors may want to consider smaller cap, sub-$500 million energy producers that may already be undervalued.
Saturn Oil & Gas Inc. (TSX-V: SOIL) is an excellent example of such a business.
In addition, investors with U.S. dollars can buy Canadian publicly traded companies at a relative discount, given the strength of the U.S. dollar. While Saturn Oil & Gas Inc. trades at C$2.87 on the TSX-V in Canada, the stock trades OTCQX at U$2.15. The strong U.S. dollar is certainly a win/win for Canadian public energy producers.
To learn more, visit the company’s website, www.saturnoil.com, or complete the form below to receive the investor presentation.