(Public) Make Canadian Energy Great Again
Editor’s Note: To celebrate the resignation of Justin Trudeau, we have created a T-shirt that says, “Make Canadian Energy Great Again.” It’s been 9 years too long and finally, we can say good bye to that dreadful leader.
Let’s make Canadian Energy Great Again!
By: Jon Costello
Justin Trudeau’s resignation as Canadian Prime Minister earlier today marks a new era for the Canadian energy sector. This is the most bullish event for Canadian oil and gas stocks in more than a decade.
We’ve long favored Canadian E&Ps over their U.S. peers. However, we’ve found that many investors refuse to invest in Canadian oil and gas due to the adversarial relationship that has existed between the government and industry. We’ve lost count of how many times we heard a prospective investor question why they would invest in a country with a government that was trying to kill its own energy industry.
The change in leadership will usher in an improved Canadian oil and gas industry over the coming years. The changes range from the immediate to the longer-term. Virtually all are positive for investors in Canadian energy stocks.
Big Changes Lie Ahead
Major change in the makeup of the Canadian government will not be likely until federal elections are held on or before October 20, when Conservative party leader Pierre Poilievre is expected to win. Nevertheless, the outlook for the Canadian energy sector and investor attitudes toward it will change immediately.
In the near term, Trudeau’s resignation makes it less likely that President Trump will impose tariffs on Canadian energy products. With left-leaning politicians like Trudeau rapidly losing support, the new prime minister will be keen on maintaining whatever popularity they can muster. They’re more likely to grant Trump his wishes regarding the border and drug trafficking than enter into a trade war with the U.S. that damages Canada’s already weak economy.
Longer-term, the changes will be more profound.
Since Trudeau was first elected prime minister in November 2015, his administration has sought to rein in Canadian oil and gas activity under the banner of reducing emissions as set forth in the United Nations Paris Agreement, which Trudeau signed in December 2015.
During Trudeau's entire tenure as prime minister, his administration increased regulations on oil and gas production, extracted tens of billions in taxes, and broadened federal regulatory power—all in the name of emissions reduction.
As these initiatives are rolled back over the coming years, the oil and gas operating environment will improve dramatically. Long-term projects will be planned and funded. Oil and gas E&Ps will see their operating, capital, and G&A costs decline and their return on capital increase. A multitude of risks faced by all E&Ps—from operational to legal to political—will recede.
In the end, these changes will create a more supportive environment for oil and gas investment. International capital will flow back to the sector, and equity valuations will increase.
Stifling Regulations
Since 2015, Canadian oil and gas investors have faced a continuous barrage of regulations and taxes imposed by Ottawa. Among those that have kept investors away from the energy sector are the following.
The Canadian government imposed a national carbon tax to reduce oil and gas sector emissions by 40% by 2030 from 2005 levels, consistent with the Paris Agreement. The tax was passed in 2018 through the Greenhouse Gas Pollution Pricing Act. The Act established a tax of $20 per ton of carbon emitted by the oil and gas industry. The tax increased by $10 per year until it reached $50 per ton in 2022. The legislation initially capped the tax at the 2022 level. However, in 2022, the government increased the annual per-ton increase by $15. It is scheduled to reach $170 per ton in 2030.
Canada is the only major oil producer that requires its industry to pay a carbon tax. This disadvantages the Canadian industry compared to competitors in countries that lack carbon taxes. Investors are understandably concerned that the tax will continue to increase if Canada fails to achieve its emissions targets, as many believe it will.
In July 2023, Clean Fuel Regulations came into effect that set stringent requirements for fuel producers and importers to reduce the carbon intensity of the fuels they produce and use to specified thresholds. Fuel suppliers that fail to meet the threshold are required to buy compliance credits.
The Canadian Impact Assessment Act granted broad powers to the federal government over assessing regulatory compliance.
Lest any oil and gas industry participant be so bold as to oppose these or other punitive measures publicly, the Competition Act threatened companies with fines of up to $15 million for making unsubstantiated climate claims. It went so far as to permit private litigants to sue purported perpetrators. The Act put the burden on oil and gas companies to prove that their representations were based on “adequate and proper substantiation,” which, of course, is subjective. It effectively muzzled industry critics of the government’s green agenda.
More regulations were set to arrive. In December 2023, Canada proposed a federal cap-and-trade system for the oil and gas sector to bring its emissions to “net zero” by 2050 as stipulated by the Paris Agreement. This cap would curtail significant volumes of Canadian oil and gas production. The uncertainty created by the cap’s mandates beyond 2030 remained a source of policy instability that deterred firms from sanctioning multi-billion-dollar oil and gas investments.
Other industry-stifling measures included the government not allowing transition periods for industry participants to implement onerous regulations, making upfront compliance essentially impossible.
The Trudeau government would fund green charities, like the Canadian Institute for Climate Choice and others, and then use the data they produce to justify more stringent regulations on the oil and gas industry. The government would also fund domestic media to incentivize hyper-critical coverage of industry while squelching the voices of government critics.
The Outlook Brightens
New leadership will improve the Canadian energy landscape in many ways. Polls and betting markets show Pierre Poilievre as a shoo-in for the October national election. In a recent interview with Jordan Peterson, Poilievre outlined his energy priorities. As prime minister, he intends to eliminate carbon taxes, build more refineries, clear the hurdles to additional LNG export facilities, and add hydroelectric power.
Under Poilievre, Alberta—which has its own pro-energy government and vast natural gas reserves—will become a haven for data centers. Many will go off-grid, adding to regional Canadian natural gas demand and improving the prospects for the more westerly natural gas-producing regions in the WCSB.
Importantly for Canadian oil and gas investors, E&P financial returns will improve. Canadian energy producers already possess equity return profiles on par with U.S. shale producers, but Canadian E&P returns have been on the upswing relative to their U.S. peers. The narrowing WTI-WCS differential attributable to the Trans Mountain Expansion has boosted oil producers’ top line while costs have increased less. We expect the supportive operating environment that will emerge over the next few years to foster lower operating and capital costs. These will increase the return on capital earned by E&Ps even further.
Over the next few years, we expect the returns on capital generated by Canadian E&Ps to increase while the returns generated by independent U.S. E&Ps will decrease. Higher returns on capital translate to higher equity multiples, and we expect Canadian E&Ps to garner multiples in line with today’s U.S. E&Ps, as shown in the chart below.
Source: National Bank Financial, Dec. 20, 2024. Highlighted sections circled in red added by author.
Furthermore, Canadian E&Ps will increasingly be seen as having superior prospects versus their U.S. peers. U.S. E&Ps are seeing their production grow gassier at a rapid clip. At the same time, they’re facing the exhaustion of their most economic drilling locations. Canadian oil producers, by contrast, can hold their crude oil production steady and grow while retaining a multi-decade inventory of premium drilling locations. This will increase captial flows to Canadian names.
A multiple re-rate would result in a 25% bump in Canadian E&P stock prices, first, as investors begin to appreciate the consequences of the new regulatory regime and second, as they see evidence that sustainably higher returns are being achieved. Canada will become the obvious destination for U.S. and global equity capital seeking long-term exposure to oil prices.
While this may not sound particularly appetizing for today's investors, with most preoccupied with the latest tech craze, we expect the situation to grow more meaningful in the years ahead. Higher oil prices will be necessary as global oil demand continues to rise while non-OPEC+ conventional and unconventional sources become increasingly challenged to satisfy demand. Canadian E&Ps will fare particularly well in such an environment.
Conclusion
Investors should position for these changes now, before they’re more widely appreciated by the investing public. Investors in U.S. E&Ps should transition over to Canadian names.
We look forward to circling back in a year to see how the oil and gas operating environment has changed and how E&Ps have performed. If we’re right, high-quality Canadian E&Ps will have handily outperformed their U.S. peers from today’s levels. Given the changes on the horizon, investors should buy now and hold tight.
Analyst's Disclosure: Jon Costello has a beneficial long position in the shares of The HFIR Energy Income Portfolio either through stock ownership, options, or other derivatives.