Market Watch Weekly - May 8, 2015
Erik Dekker - May 08, 2015
Well this week was certainly full of surprises; never did we ever think that the New Democratic Party would win a provincial election in Alberta.
Well this week was certainly full of surprises; never did we ever think that the New Democratic Party would win a provincial election in Alberta. It is certainly too early to say what the economic impact of a political shift such as this will mean for a province that has been led by the political right for several decades, but the following are some broader themed notes we received from our friends at Jarislowsky Fraser.
Short-term: Undoubtedly the money flows from marginal buyer (Americans) of Canadian energy stocks will decrease due to uncertainty around the impact of a party that is ostensibly “left wing, socialist” on industry in Alberta. In short, stocks will very likely be weak for a number of months even with a continued recovery in the oil price. Unions and aboriginal communities likely walk a bit taller and gain some modest leverage in ongoing negotiations.
Medium-term: Corporate taxes will likely go up to 12% from 10% (over time) and minimum wage to $15/h (or, on the way to that number over time) in the next budget tabled by the NDP. This is probably not as big a deal as you might first think since most energy companies pay minimal taxes (offsetting drilling and capital investment credits). The larger companies that are taxable will likely see a small, 1-3%, decrease in net income possible (depending on spending plans and other tax credits) with the biggest impact on Suncor, CNQ and Cenovus (roughly in that order).
The dreaded “Royalty Review”: It appears that the NDP will attempt to approach the third rail of Alberta politics and start a royalty review, but, I would suspect changes to be small and very incremental to avoid the “unintended consequences” and subsequent reversal of the disastrous Stelmach-era review. The NDP have said that they will accept status quo if the review recommends as such. I would expect that the royalty issue will play a role in discussions with industry around increasing domestic processing and employment and emissions control. I think it’s also important to note that this is a different context than the 2007 review which was happening when oil was rapidly rising and hadn’t gone through two major corrections, so there is some basis to assume the government could be more practical this time around.
Domestic Job initiatives: I expect to see some talk of incentives for refining in the province; however, the higher minimum wage and pro-union environment will likely make it challenging to extract as much savings on the labor side of things through the downturn, but is unlikely to stop it completely.
Emissions: Perhaps more likely than a change in the royalties is a change in the carbon price. Currently Alberta has a $15/ton carbon levy, which critics suggest has not really shown it to be sufficient to meaningfully decrease emissions growth. The actual impact is not likely to be that material for the companies we own as they are all actively (and successfully) working on increasing the efficiency of their operations, but it could lead to mildly higher costs in the medium term.
Pipelines: Premier-elect Notley made explicit mention of “building bridges” and “market access” when talking about the energy industry in her (exceptionally classy) victory speech. I would suggest that means that fears of a “no new pipelines” is vastly overblown: she is on record as a supporter of Transmountain and Energy East but she has also singled out Northern Gateway as “not going to happen”. Importantly, an NDP government that makes some progress on emissions control could provide a greater social license to operate in Canada and the US resulting in more progress for pipelines than what could have been seen under the PC’s.
Long-term: This puts marginal producers with bad balance sheets in a world of hurt (good, thing we don’t own these) and likely pushes up the cost base of the Alberta industry 0-5%, which pushes up the marginal cost of oil. The net result is likely to be less supply from Alberta but no real material change in demand or the need for Alberta’s oil, relative to our prior view. Without a material new source of oil (and US shale is unlikely to be that source) to fill the gap or a step change in demand this means oil prices are likely to be modestly higher and modestly more volatile.
No reason to sell anything on this news. The near-term is likely to remain volatile (more so on this news) and there remains some short-term risk of a lower oil price if the surprisingly supportive oil demand normalizes, Iran makes a deal, and/or OPEC does something crazy. The front-end of the oil curves have moved up markedly as demand has been better than expected and helped alleviate the strains on storage, but supply has not really come down so the oversupply remains a potential issue in the short-term.
This week I also attended a conference in whistler where I had the opportunity to sit down with Dan Bastasic and Jeff Sujitno from IA Clarington to discuss the significant macro changes that are taking place within the fixed income markets. As those discussions were also quite lengthy, we will save them for next week, but suffice it to say, changes are coming to how we look at and own fixed income for investors who rely on their yield and capital preservation characteristics.
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Have a great weekend.
The Dekker Hewett Group