Industry Spotlight: Energy and Utilities

Pranavan Ganeshalingam, YIC Member & Arbitrage Contributor, www.yorkinvestmentclub.com

Energy is the backbone of modern industrial society, enabling us not only to light our homes and drive our kids to school, but to power factories and heat offices, creating jobs and wealth.  Until recently, most Canadians took it for granted that there would always be an ample, affordable supply.

In reality, energy can be extremely volatile.  For example, a string of hurricanes that extensively damaged American oil production facilities in the Gulf of Mexico in the late summer of 2005 showed how volatile the market can be: gasoline prices spiked across the continent, hitting as high as $1.39 per litre in the wake of hurricane Katrina.  That storm knocked out much of the United States’ drilling capacity in the Gulf of Mexico and left southern refineries unable to turn crude oil into gasoline and home heating fuel for extended periods.  Facts and fears left some gas stations in Canada and the U.S. critically short of fuel, a reminder that the long line-ups for fuel from the 1970s could return.  Add to that an ever-increasing demand for oil from the world’s two most populous nations—India and China—and you have a recipe for volatility.

If you ask ten oil industry experts how much oil is left in the world, you might get ten different answers.  Nobody knows for sure.  What they do know is that as the world’s supply of oil is depleting, there is only one way for prices to go: up.

However, market turbulence is not just limited to oil.  Increasingly, natural gas and electricity prices are under pressure.  Most new homes in Canada rely on natural gas for heat, and in electricity-hungry Ontario, the province is relying more on natural gas to produce power as it slowly relieves its dependence on coal-fired generators.

As a result, Canada is slowly becoming a net importer of natural gas.  This was evident during the summer of 2005, which was one of the hottest on record in much of the country.  The high demand for electricity placed the electricity grid under pressure in Ontario, which forced the province to buy power from the United States at a rate much higher than what it was capable of charging.

In addition, rising prices have persuaded governments, businesses and consumers to take a renewed interest in other energy sources, such as nuclear power, solar energy, wind power, biomass and harnessing the energy of tides.  Technological advances in all those fields are beginning to make these options less costly and more reliable, although obstacles still remain.

Despite relatively bearish natural gas fundamentals, North American natural gas prices continued their recovery and are hovering around $5/GJ.  Natural gas continues to trade at a significant discount relative to crude oil.  In a prepared statement accompanying the National Energy Board’s (NEB) Winter Outlook, the NEB noted that owing to robust inventories of natural gas going into the heating season, Canadians should expect to see wholesale prices between $4-$5.50/MMBtu.

Factors putting upward pressure on natural gas prices are the declining supply as well as the improving economic outlook.  Pushing back down on prices will be the record natural gas storage inventory, as well as the potential for more liquefied natural gas (LNG) imports coming into North America if the prices move higher.

In response to low prices this year, producers reduced drilling activity and shut in some gas production.  Canadian production is down, as are exports to the US.  However, the impact on North American production will likely be dampened owing to rapid growth from the US unconventional supply.

Industry Relevance in Canada

  • Canada’s proven oil reserves are second only to Saudi Arabia’s.  At the end of 2006, Canada’s remaining established reserves amounted to 179 billion barrels, of which more than 95 per cent are in the form of crude bitumen in oil sands.
  • Crude oil production has been increasing fairly steadily during the last two decades.  While conventional resources continued to account for more than half of crude oil production, most of the production growth in recent years has come from oil sands.
  • Canada is a net exporter of crude oil.  Domestic oil is exported from the western provinces while the eastern provinces import international oil.  In 2006, exports reached $38 billion and imports amounted to $23 billion.
  • Canada has an extensive network of pipelines carrying crude oil to domestic refineries.  The three main refining centers in Canada are in Edmonton (Alberta), Sarnia (Ontario) and Montreal (Quebec).
  • Oil is the most important energy source used in Canada, ahead of natural gas and electricity.  Over two-thirds of the refined petroleum products sold in Canada are used for transportation: gasoline, low-sulphur diesel and aviation fuel.
  • After a period of low and relatively stable prices during the 1990s, crude oil prices have risen in recent years in international markets.  This has resulted in increased revenues for Canadian producers and higher prices for Canadian consumers.
  • In coming years, the Canadian oil sector will be dominated by the pace of oil sands development.  New pipeline and refining capacity will also be required to accommodate supply and market requirements.

Company in the Spotlight

It’s not the one and only, but Hydro One is by far the largest power supplier in Ontario, Canada.  Through its subsidiaries, this crown corporation transmits and distributes electricity to 1.3 million residential and commercial customers (including municipal utilities) in Ontario.  Its primary utility subsidiaries are Hydro One Networks (transmission and distribution) and Hydro One Brampton Networks (electricity distributor to urban areas).  Hydro One Telecom markets the group’s fibre-optic capacity (broadband) to businesses, and Hydro One Remote Communities supplies energy to 20 remote areas in Ontario.

Competitive Landscape for Hydro One Inc.

Demand depends heavily on the health of the US economy, including corporate profits and local government budgets.  The profitability of individual companies depends on accurate project bids and efficient operations.  Large companies have advantages in their ability to engage in multiple projects simultaneously and in many types of construction.  Small companies can compete effectively by specializing, working in a limited geography, or serving as subcontractors on larger projects.  Average annual revenue per industry worker is $290,000.

Article first published in the YIC Newsletter.

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