Oil is enjoying a bull market. Energy stocks need to catch up

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There is a remarkably bullish backdrop developing for Canadian oil producers this year: Rising crude oil prices are now about 70 per cent higher than they were in early 2020, and the International Energy Agency noted on Wednesday that global oil demand this year will exceed levels seen before the pandemic.

But some parts of the energy sector are struggling to keep up with the good news, suggesting Canadian oil producers remain relatively cheap and could be worth a closer look.

Okay, key stocks in the sector are hardly wallowing in pain. Suncor Energy Inc. SU-T is up 52 per cent over the past year, and Canadian Natural Resources Ltd. is up 108 per cent, pushing Canada’s oft-struggling energy sector to the front of the pack in terms of sector performance within the S&P/TSX Composite Index.

These impressive rebounds, though, haven’t left stocks looking particularly stretched. Suncor’s current share price of $35.55, for example, is still below where it was in February, 2020, before widespread lockdowns sent stocks and oil prices plummeting.

Canadian Natural Resources’ current share price of $66.26 is more than 80 per cent above its prepandemic level. However, the stock’s valuation is curiously low, at just 13.5 times trailing earnings – even as oil prices soar.

On Wednesday, the price of West Texas Intermediate crude (WTI), the North American benchmark for oil prices, rose to US$85.80 a barrel, its highest level since October, 2014. That’s up from about US$51 a barrel two years ago before the pandemic.

Even Canadian oil, which usually trades at a substantial discount to U.S. oil, is on a tear: Western Canadian Select, the benchmark for oils and producers, traded at US$73.51 a barrel on Wednesday. That’s well over double its prepandemic price of about US$32 in February, 2020.

Oil prices can be volatile, of course. But some observers are growing increasingly upbeat about conditions.

In its latest monthly report, the IEA estimated global oil demand this year will rise to 99.7 million barrels a day. That’s above prepandemic levels, as the IEA sees the Omicron variant leading to widespread immunity to COVID-19 by the second half of the year.

Some analysts are also growing more bullish on the price of oil. Earlier this week, Raymond James analyst Jeremy McCrea raised his price assumption for WTI for 2022. He is now using an average 2022 price of US$75.43 a barrel in his analysis for energy producers this year, up from US$73.31 a barrel previously – which is enough to raise stock-price targets.

He now expects Suncor’s share price can rise to $46 within the next 12 months, up from a previous target of $43. He raised his target for Canadian Natural Resources to $70 from $63.

The risks? A number of environmentally conscious institutional investors, including Norway’s sovereign wealth fund, are shunning Canadian oil, removing key support for stock prices. As well, the shift toward renewable energy – as the world strives for net-zero carbon dioxide emissions by 2050 – raises questions about whether the oil sands will remain viable in the long term.

These risks may be weighing on valuations. Clearly, though, Canadian oil producers are extremely viable today, as cash generated from higher oil prices underpins rising returns to shareholders.

After cutting its dividend at the start of the pandemic, Suncor raised its quarterly payout to 42 cents a share in October, which gives the stock a yield of 4.7 per cent. In December, Canadian Natural Resources raised its quarterly dividend to 58.75 cents a share, which is 57 per cent higher than its prepandemic payout. The yield is 3.6 per cent.

Credit Suisse analyst Manav Gupta last month estimated large Canadian oil producers can maintain their dividends with WTI at just US$40 a barrel. Given today’s much higher price of oil, he thinks another round of double-digit dividend hikes are likely coming this year.

The energy sector is on a tear. It looks like a rally worth following.

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