Tourmaline Poised for Rebound as Gas Gap Wanes

Shares of Canadian natural gas producers led by Peyto Exploration & Development Corp. and Tourmaline Oil Corp. are poised to recover as a discount on the fuel triggered by increased pipeline tolls diminishes.

The gap between Canadian natural gas exported from Alberta and U.S. prices has more than doubled to $1.10 per thousand cubic feet after TransCanada Corp. raised rates July 1 for short-term gas shipments on its Canadian Mainline system. Since then, shares of 13 companies with a market value of C$100 million ($97 million) to C$10 billion that get most of their production from natural gas have dropped an average of 6.2 percent, according to data compiled by Bloomberg.

The discount will probably disappear over the next couple of months as producers sign long-term contracts on the new tolling system and market prices adjust, said Alistair Toward, an oil and gas analyst with PI Financial Corp.

“It’s certainly setting itself up for there to be a mini-rally,” Calgary-based Toward said by phone on Aug. 9. “We’ll hit the low and we’ll get an inflection point, but I’m just not sure that we’re at the inflection point yet.”

Canadian energy regulators ordered TransCanada to cut nearly in half its tolls for long-term contracts on the west-to-east Mainline system in order to make gas from Western Canada more competitive with U.S. shale gas exports from Pennsylvania and other states. After the change, the company boosted short-term tolls, which more than doubled for some delivery points.

Shares Drop

Gas shipped from the Alberta AECO hub traded at $1.10 per million British thermal units below the U.S. benchmark Henry Hub price yesterday compared with a June low of 48 cents.

U.S. natural gas for September delivery fell 2.6 cents or 0.8 percent to $3.316 per million British thermal units today on the New York Mercantile Exchange. Alberta AECO natural gas prices rose 4.25 cents or 1.9 percent to $2.2475 per MMBtu yesterday, according to Natural Gas Exchange Inc., a Calgary-based electronic exchange owned by TMX Group Ltd.

Shares of Peyto have lost 11 percent through yesterday from a recent peak on July 9 and Tourmaline dropped 12 percent from its peak for the year on July 8. Peyto rose 0.6 percent to C$28.60 at 9:47 a.m. in Toronto today while Tourmaline gained 0.2 percent to C$39.33.

“The spread blow-out I think is something that industry sees as temporary,” Petyo Chief Executive Officer Darren Gee said in phone interview yesterday from Calgary, where the company is based. “The real effect has been that we do have about half our production that isn’t forward-sold that floats on the AECO price. So as it dropped from $3 to $2, we lost on that component of our production in the short-term.”

Larger Producers

Peyto said Aug. 13 second-quarter profit more than doubled from a year earlier to C$37.8 million, or 25 cents a share, ith production rising 41 percent to 58,145 barrel-of-oil equivalents a day.

Calls to Calgary-based Tourmaline CEO Michael Rose and to Scott Kirker, Tourmaline’s general counsel, on Aug. 14 were not returned. On Aug. 7 Tourmaline reported second-quarter net income surged to C$30 million or 16 cents a share. Production rose 38 percent to 70,178 barrel-of-oil equivalents per day.

Larger Canadian producers, such as Encana Corp., haven’t been as vulnerable because they have larger balance sheets to withstand lower prices, and have also used their stronger financial position to buy hedges to protect against the falling Alberta gas price. Encana has risen 1.7 percent since June 28.

‘Picking Away’

Share declines for companies such as Tourmaline and Peyto may be only temporary, because producers and buyers will soon become acquainted with the new tolling system and sign cheaper, long-term pipeline contracts, said Martin King, an energy strategist at FirstEnergy Capital Corp. in Calgary.

“The market is going to adjust to get around it and you’ll start to see the pressure come off,” King said in an Aug. 9 phone interview. “But that is going to take maybe weeks to months for the market to kind of wrap its head around this.”

A team of analysts led by Matthew Taylor at National Bank Financial Inc. in Calgary advised clients in an Aug. 5 research note to buy mid-sized gas producers including Peyto and Tourmaline if they continue to slide.

“This is not the first time the AECO basis has blown out and it will certainly not be the last,” Taylor wrote. “We believe it presents a good opportunity to capitalize on picking away at some higher-quality names.”

Adding Tourmaline

Greg Dean, a portfolio manager at CI Investments Inc., said he’s already added to his investments in some of the falling gas shares.

“We added to Tourmaline in a pretty significant way on the pull back,” said Dean, who helps manage a C$7.9 billion portfolio for CI Investment’s Cambridge Global Asset Management. “You’ve seen some of the higher-multiple gas stocks sell off anywhere from 10 to 15 percent and some more, even the high quality ones like a Tourmaline or Kelt Exploration Ltd.”

Dean said he’s optimistic about the companies because he expects the wider AECO differential will moderate, and the New York Mercantile Exchange futures forward curve for natural gas shows prices rising by about 12 percent to $3.76 per MMBtu by January.

PI Financial’s Toward said the gas equities may rally on even small changes in the relative price of gas.

“When the pricing fluctuates between $2 and $4, there’s a gas rally, and if investors are not exposed to that, then you’re kind of probably missing the mark,” he said.

No Joy

He’s not enthusiastic about the long-term prospects for the Canadian gas producers, since the growth of production in the U.S. from shale basins has dramatically lowered the price of gas and the economic viability of many fields in Canada, Toward said.

Today’s U.S. benchmark prices at $3.3425 per MMBtu are almost 60 percent lower than they were on the same day five years ago, according to data compiled by Bloomberg. U.S. natural gas production has increased by 20 percent to 2.2 trillion cubic feet a month over the last five years through May, according to the U.S. Energy Information Administration.

“At much below $4, there’s just not a lot of joy in the Western Canadian Sedimentary basin,” Toward said. “It’s not that there aren’t producers that are doing well at that price, but they are doing well at that price on usually a pretty small fraction of their overall production base. So their best properties are surviving at those levels, but the company as a whole is probably not prospering.”

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