For U.S. investors, the Canadian oil patch still looks attractive

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Boy, it's tough out there in oil country.

Each day brings new pain, with crude prices falling through successive floors and stocks across the sector bending to selling pressure as investors fret over companies' ability to make all their payments.

This week, as oil prices fell to six-year lows, some analysts suggested that the downturn had entered its next stage, pulled by the growing glut of oil around the world.

For at least one U.S.-based investor, though, there couldn't be a better time to take a hard look at the energy sector, especially well-run companies that are still managing to make decent money while oil and gas prices sputter.

"Canada's on sale," says Jason Whitley, Houston-based portfolio manager with EnergyX Capital Management. He is no stranger to Calgary; he makes the trip to town monthly.

Even battered and bruised, the Canadian oil patch still looks attractive. For one, today's currency market, which allows Canadian companies to sell their oil and gas for sturdy U.S. dollars, while buying products and services in Canadian currency for about 78 cents (U.S.) gives them a leg up on U.S. producers.

"So when they do that conversion, their netback [money left over after items such as operating costs and royalties] is pretty damned attractive," he said during a break at FirstEnergy Capital Corp.'s energy conference in midtown Manhattan last week.

The weak Canadian dollar also means U.S. investors have plenty of buying power heft for energy shopping.

That's not the whole story, either. He says the economics of some of the name-brand Western Canadian resource plays, notably the Viking light oil deposits of southwestern Saskatchewan and the Montney shale gas region of British Columbia and Alberta, stack up against the top U.S. prospects, the Permian and Eagle Ford shale zones in Texas.

"Even at these low prices, you have payouts in less than 18 months. If you have a payout in 12 to 18 months, you're generally going to have about a 20-per-cent rate of return. That's attractive," Mr. Whitley said. "If you have a longer payout, say beyond 24 months, you generally cannot really make any money for your investors or yourself."

The next opportunity for investors in Canadian energy stocks will be a jump in merger-and-acquisition activity, and the deal flow will be amplified if the Organization of Petroleum Exporting Countries opts at its next meeting on June 5 to keep the oil taps open, he said.

If OPEC bites the bullet, however, and reduces its members' production ceilings, and convinces non-members such as Russia to also cut output, then global crude prices could recover into the $60s or $70s a barrel, rescuing some companies whose finances are hanging by a thread with oil prices under $43.

"If not, the sellers [oil and gas companies] are going to be, 'Oh God, I don't know if I'm going to even make it until the end of the year,'" Mr. Whitley said. That will lower their expectations of what they believe their assets are worth, narrowing the current bid-ask chasm that has tempered activity.

"That's when I think you're going to absolutely see a jump in M&A activity."

Based on that assumption, it would be logical, then, to buy up a stable of producers that have been knocked on their heels by oil's collapse, waiting for them to get scooped up by stronger rivals. But he does not recommend that, as it becomes more like a game of roulette.

Instead, it makes more sense to scope out the energy players known for managers who can keep costs and debt levels down. "There's a spectrum of them," Mr. Whitley said.

In the small-cap arena, he favours Kelt Exploration Ltd., which has operations in the Montney region, and Raging River Exploration Inc., which drills in the Viking. Among larger producers, Whitecap Resources Ltd., Crescent Point Energy Corp. and Peyto Exploration & Development Corp., all of which have shown they can make money at current commodity prices.

Should oil prices remain in the tank, they have the best chances of weathering the storm, and even taking advantage of acquisitions from the weaker members of the herd.

Should markets rebound, though, such players could quickly become less of a cross-border bargain.