The Canadian oil sands - welcome to the jungle.

William Lacey, CFA

We are initiating coverage on Canada's largest energy companies that have significant investments in the oil sands: Canadian Natural Resources, Cenovus Energy Inc., Imperial Oil Ltd., and Suncor Energy Inc. These Canadian large cap producers have dominant thumbprints on the production coming out of the Western Canadian Sedimentary Basin, and are heavily invested in the oil sands. After being battle hardened over the past six years as a result of depressed commodity pricing and reduced access to capital, the energy sector is starting to turn a corner. Although headwinds such as divestment campaigns, carbon taxes, and market access continue to persist, the sector forges ahead and has a plan to succeed. We believe that, despite the negative headline risk, heavy oil production originating out of Canada may be in a privileged position. With the majority of capital-intensive large-scale projects in the rearview mirror, and a significantly reduced cost structure, the companies appear to be poised to reward their shareholders through rightsizing their balance sheets, increasing their dividends, and buying back their shares. These are some of the energy leaders within Canada, all of whom have a plan to succeed, not just today, but also for tomorrow in a carbon constrained world.

Significant Free Cash Flow, and a Focus on Shareholder Returns
It is our belief that the nature of the oil sands assets, wherein the capital has essentially been spent and the decline rates associated with the production are exceptionally low, position investors for an environment of significant free cash flow generation; focus on generating shareholder returns is pushed to the forefront.

Transition Takes Time
There is significant public discourse related to energy transition, and crude oil is a focal point in terms of carbon reduction strategies. The reality is that transition takes time, and many of these companies are at the forefront in terms of investment and innovation as it relates to reducing the carbon footprint. Meanwhile, the economic collapse of Venezuela and the move by Mexico to refine more of its production within the country has created market opportunities for Canadian heavy oil producers.

Addressing the Numerous Headwinds in the Face of the Energy Sector
A ruthless focus on re-setting the cost structure and focusing on efficiencies, generating scale, and ensuring there is a business to run in the years ahead has been front of mind for all management teams. Last year was a true litmus test to see how things have progressed in terms of sustainability as the focus of industry must be on generating returns for shareholders and treating their capital model as though the last dollar they raised is the last dollar they are going to raise. Though many positive steps have been made, and this message seems to be resonating, the reality of the business is that US$40 per barrel is an environment that does not work for many.

Underinvestment and Best-in-Class Cost Structures Will Be Well Positioned to Capitalize on Opportunities in Front of Them
Hydrocarbons are an essential component of the global economy due in large part to the unique nature of energy density and the interwoven nature of the products that society consumes and is dependent upon. That is not to say that the industry cannot do better, and they will. The Canadian regulatory standards are touted as some of the most stringent in the world. Canadian energy producers have been at the forefront in terms of investment in clean tech, innovations related to carbon sequestration, and leaders in terms of methane reduction. We believe that the sector will adapt and adjust to these changing dynamics all the while focusing on attracting investors back by showing how investors can benefit by being part of this sector.