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An overview of Canada’s energy and mining sectors

Natural resources – energy, minerals and metals – are fundamental to the strength of Canada’s economy and important to the income stability of its citizens. In 2009 natural resources generated $133 billion, or 13% of Canada’s GDP, and directly employed close to 759,000 workers. In times of economic boom our trade is robust, as rising commodities prices promote increases in output capacity and opportunities for technological advancement; however, the recent economic downturn has weakened demand for some of these resources. I will provide a brief overview of Canada’s mining and energy sectors, as well as elaborate on current and forthcoming market conditions. It is to serve as background information on future stock pitches and on industry updates of companies primarily listed on the TSX.

According to Natural Resources Canada, in 2009 minerals and metals made up for 2.7% of Canadian GDP. Canadian companies make up for about 40% of worldwide mineral exploration, and we are home to three of the top five largest gold extraction companies in the world, including Barrick Gold, the largest of all. It is also important to note that, with the exception of some mid-large-cap firms like Barrick Gold, Canadian firms extract the majority of their resources from Canadian soils; iron and steel are Canada’s largest commodity exports, followed by gold, aluminum and copper. International resource interests are still dominated by the United States, which imports over 50% of Canada’s mineral commodities and plays an even larger role in the Canadian energy sector.

Three commodities (crude oil, non-crude oil, and natural gas) constitute roughly 90% of the trade in Canada’s energy products – slightly more for imports and a little less for exports. Crude oil is the largest of the three categories, making up 55% of energy exports and almost 59% of energy imports. In 2010 crude exports soared to $51.9 billion, an increase of $9.1 billion, or 21.3% over 2009 levels. The largest integrated oil and gas companies listed on the TSX with significant Canadian operations are Suncor Energy Inc. (TSX:SU); Imperial Oil Ltd. (TSX:IMO); Cenovus Energy Inc. (TSX:CVE); and Husky Energy Inc. (TSX:HSE).

The United States was the principal destination for Canadian exports of fuels, oils, and other energy products in 2010, accounting for some 92.6% ($87.7billion) of total Canadian exports. In terms of dollar value, these numbers are expected to grow as countries are increasingly seeking easier access to oil. Canadian oil reserves are a prime candidate to meet these needs as they are not government-run, nor state-controlled.

North American companies have for decades dominated Alberta’s oil sands. However, recently Chinese firms have been rushing to invest in Canadian oil sands projects. As we move forward with China at the helm, the BRIC nations (Brazil, Russia, India and China) will hold heavy sway over Canadian natural resource exports. With a current urban population of roughly 630 million, expected to grow to over 900 million by 2020, China will look to expand its own interests in our natural resources. A nation that once consumed 5% of the world’s base metals in the 1980s now uses over 30%. Traditionally, coal has accounted for 80% of total energy shipment to China; however, the past 18 months we have seen China increase dramatically its interest in the sands, to the tune of $15 billion. Chinese interests are attracted to one of the world’s lowest-risk oil investments so as to quench the exploding energy demands of Asian markets. Chinese firms have recently purchased shares in companies with existing projects; for example, Sinopec spent $4.56 billion last year to acquire a 9% stake in Syncrude Canada, Ltd, the world’s biggest oil sands producer.

According to the Alberta Minister of Energy, “That influx of capital can help companies ramp up production and expand operations at existing projects…Plants that are currently 25,000 barrels a day, they want to expand to 100,000 barrels a day, and they don’t have the capital to do that.” These companies are desperately seeking new capital injections, and China is a ready investor.

Even with slower economic growth and a potential for another recession, oil consumption is expected to grow and prices, according to the US Energy Information Administration, are expected to remain in the mid-US$90s per barrel into 2012. While we are certainly facing economic problems today – Euro debt, US joblessness – they are not of the same magnitude as in 2008. If this view is correct, the energy sector is an attractive investment.

The entire Canadian equity market has been hit hard this year. The S&P/TSX index, an index of the largest stocks on the Toronto Stock Exchange by Market Capitalization, has tumbled 13.27% since January 4th, 2011. But energy firms have been hit harder: the iShares TSX Capped Energy ETF (XEG/TSX) is down 18% this year to date and 27% since March, bringing its price, at just over $16, down to October 2008 levels. Individual Firms have been even worse-off. Suncor Energy Inc. (SU/TSX) and Canadian Natural Resources Ltd. (CNQ/TSX) are down roughly 25%, and Talisman Energy Inc. (TLM/TSX) a jarring 41%. On a valuation basis, these stocks, and by extension, XEG, are cheap. Forward price/TSX-earnings ratios are in the 8-to-9-times range for all of them, excepting Cenovus at 13.6 times. The same ratios were around 8 times in the autumn 2008. They all have debt-to-equity ratios below 50%, a good thing in case of recession.

In fact, Suncor has stated that it would buy back up to $500 million worth of its own shares, roughly 1.1% of its outstanding issuance, by next September. Such confidence should be seen as a great opportunity for investors with the grit and resolve to buy stock during these times of economic volatility.

As concerns deepen that many governments are running out of tools to avert another global recession, commodities fell on September 23rd to a 9-month low, led by routs in metals. On September 21st, copper had its largest slide since 1983. According to Christin Tuxen, a senior analyst at Danske Bank A/S in Copenhagen, “We are seeing commodity prices correcting, so they are more compatible with the global economy…. When we have fears over the economic cycle as we have now and a higher probability of contraction, it hits industrial metals and commodities.” For certain, Canadian exports are directly correlated to macro developments, and companies will continue to respond sharply to unstable market conditions.

photo credit Alex Abboud