Trans Mountain pipeline is the latest boon to oil and gas stocks, but investors aren’t sold

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Thanks to a shiny new pipeline, Canadian crude is now flowing freely out of the oil patch. For some reason, so is investor money.

Investment funds focusing on oil and gas have seen heavy outflows in recent months, suggesting the sector remains shrouded in negative sentiment. Which is curious, considering all of the good news spilling out of the energy sector these days.

The completion of the Trans Mountain pipeline expansion (TMX) is the latest game changer. For the first time in many years, there is spare pipeline capacity out of the Alberta oil sands.

The sector has also transformed itself financially in recent years. Frenzied drilling is out, cost cutting and debt reduction are in. Now flush with cash, oil and gas producers have become unlikely dividend darlings, aggressively funnelling their profits back to shareholders.

Energy is also the class of the TSX with a three-year rise of nearly 140 per cent – more than three times the gain of any other sector. It remains the stock market’s top performer this year so far.

After years of delays and cost overruns, the $34-billion Trans Mountain pipeline expansion project finally opens

A profile like that would normally see the investing hordes swarming, not to mention dividend investors in a country where such payouts are unusually revered.

“It’s so wildly attractive relative to anything else you could possibly invest in,” said Eric Nuttall, who manages the Ninepoint Energy Fund, the country’s largest energy-focused mutual fund.

Evidently, lots of investors don’t see the appeal. They have pulled a net of $259-million out of energy exchange-traded funds so far this year, which is on track to surpass last year’s outflow of $505-million, according to data from National Bank Financial.

Safe to say that oil and gas is still suffering from reputational issues. The industry has given investors ample reason to retreat over the last decade.

For years, growth was prioritized over profitability to the detriment of shareholders. That backfired when the U.S. shale boom sparked a global glut of oil, crushing crude prices in the process. The global divestment movement then gained traction, and singled out the oil sands for its carbon emissions.

Meanwhile, an inadequate pipeline network saw producers struggle to get their product to market, forcing them to resort to making shipments by rail. In 2018, a barrel of Western Canadian Select sunk to as low as US$13.46 a barrel. Foreign investors withdrew from Canadian energy in those years, and they’ve been slow to return ever since.

“We’ve had to endure the worst bear market in the history of the sector,” Mr. Nuttall said. Only recently, he added, has there been “a very slow awakening of people to the opportunity.”

The new pipeline has certainly caught some attention. It triples the crude that can flow from Alberta to the West Coast, which translates to better pricing of Canadian crude in global markets. The discount on Western Canadian Select against its U.S. equivalent has recently shrunk to the US$13 range. Back in 2018, that differential soared to roughly US$50.

Institutional investors saw well in advance the opportunity that the completion of TMX presented, said David Sherlock, chief investment officer at SAGE Connected Investing in Calgary.

“I think the smart money saw this was a big deal and got in early. Now they’re probably rebalancing,” he said.

Big investors taking profits on Canadian energy’s monster run could help justify the recent investor withdrawal. But it doesn’t fully explain why retail investors haven’t been lured in by the big gains in oil and gas stocks, especially once the generous shareholder payouts that are there for the taking are factored in.

The energy sector is expected to contribute about 27 per cent of the total TSX dividend pool this year, despite accounting for just 19 per cent of the index by size, according to data from Scotiabank.

Some proportion of the investor base will have no interest in being financially aligned with the oil sands. While the green investing frenzy has died down, it undoubtedly made a lasting impact with investors big and small.

Though some of the industry’s big players have committed to cutting net emissions to zero by 2050, critics call it little more than a greenwashing exercise. Oil sands emission actually rose in 2022. And production has spiked in the lead up to the completion of TMX.

For those investors who are not restricted – ethically or otherwise – from taking a stake in the oil patch, many may feel like they’re too late to the party.

That’s only partially true, Mr. Nuttall said: “The sector has gone from radically undervalued to still mispriced.”