The stocks of Canadian heavy oil producers have just taken a shellacking over the last six months. Much of the downdraft has coincided fairly well with the results of the American presidential election in early November, sending Donald Trump back to the White House. Trump has promised to levy a 25% tariff on Canadian imports if that country doesn’t improve its border security measures. The smart money recognizes this as being mostly bluster on his part, but it has put the Canadian government into a full-stop panic-as it was intended to do.
Since the election a non-stop parade of Canadian officials-Justin Trudeau and a couple of his key ministers have made the 1,200 mile trek southward from Ottawa to Mar a Lago to dine with the incoming American president and meet with his advisors. In the intervening time Canada has announced a new series of regulations meant to address President-Elect Trump’s concerns.
There is no indication from the Trump camp as yet if these measures will be sufficient to allay the northern border concerns, but I think the likelihood of tariffs being applied to Canadian oil imports is fairly remote. Canada is our largest supplier of the heavy crude that is mixed with lighter shale oil in our Gulf Coast refineries. In fact as documented by the EIA-WPSR it is our largest source of imported oil, period. There would be significant knock-on effects to tariffs on oil, but it might not be what you expect.”
The initial reaction is that consumers will see the price increases and that will lead to inflation. That can happen, but it’s an over-simplified application of this economic tool. For reference we had higher prices circa mid 2010’s $80-90 per bbl, and inflation in the 1-2% level, so there is no direct link between the two. I am firmly in the camp that the inflation we experienced a couple of years ago is much more closely aligned with the increase in money supply from the Covid era and the related logistics and supply chain kinks that had more money chasing fewer goods. The structurally higher price regime we now live with is just waiting on a recession to restart price competition at the retail level. Your guess is as good as mine as to when this will happen.
This is not to say that consumers wouldn’t see higher gasoline and other energy related prices. Let me explain. Producer psychology in commodities is to seek the highest price they can get for their product. Tariffs set a floor price for a good in practice. Domestic producers rightly figure, if the market clearing price for oil is 25% higher than the NYMEX…hey they want that price too and it becomes the market price. This has the effect of restricting imports and increasing domestic production-and profitability. Don’t believe me? Here is a scholarly take on what I’ve just described.
“When a tariff or other price-increasing policy is put in place, the effect is to increase prices and limit the volume of imports. In the figure below, price increases from the non-tariff P* to P’. Because the price has increased, more domestic companies are willing to produce the good, so Qd moves right. This also shifts Qw left. The overall effect is a reduction in imports, increased domestic production, and higher consumer prices.”
Accordingly, I do not expect that tariffs will go into effect on Canada for this reason coupled with the fact that the country seem to be making a ‘good-faith’ effect to come into compliance with Trump’s demands.
If all of what we have discussed to this point is true, then the sell-off in the Canadian Oil Sands miners is not justified based on a fear of tariffs. Here is a recommendation that investors might want to consider to take advantage of this temporary dislocation in prices of one company in particular.
Suncor Energy
Suncor Energy, (NYSE:SU) had rallied into the middle $40’s on the strength of low multiples, growing production and an aggressive cost reduction program that has knocked $10.00 of cost in the last year. Demand in Canada has also received a 600K BOPD boost from the start-up of the Transmountain Express-TMX, pipeline west into British Columbia for export. This has also had the effect of narrowing the WCS discount to WTI. All music to stock analyst’s ears.
SU has recently reached a net debt target of $8 bn CAD, triggering enhanced shareholder capital returns. Aided by a recently reduced capex plan for 2025, this return of capital could become increasingly attractive to investors seeking future income. The stock is currently trading in the middle $30’s USD, and pays a recently raised dividend of $1.58 USD annually. Also in Q-3, 2024 the company repurchased 42 mm of its common shares or 3.2% of its outstanding float in an NCIB authorization that ends in February, 2025.
Key risks to the investment thesis for SU are primarily fuel related. SU uses natural gas to fire boilers to produce steam for injection into the heavy oil reservoirs from which its low (teens) API gravity oil is produced.
SU’s base plant mine is likely to see end of life-ARO, costs from inventory depletion in about 10-years, but this may be alleviated by the Firebag development, which has already seen record production in its first five months of operation.
Finally, if tariffs were to be placed on Canadian oil imports SU’s revenues could suffer as refiners turn to other sources for heavy blending crude.
Commodity analyst firm Goldman Sachs is bullish on the oil sector for 2025, which was noted in a recent Yahoo Finance piece. Suncor was picked as their number two idea in the upstream sector, noting that it had a 58% upside to current prices in the next year.
All in all, I think SU rates as a top idea going into 2025 and the current price represents an excellent entry point for capital growth and well-funded capital returns.
By David Messler for Oilprice.com
