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Canadian energy markets: promise amid uncertainty

Canadian energy markets: promise amid uncertainty

The Canadian energy market is a mess of tangled up government regulations, conflicting news reports and contradictory policy objectives. That mess, however, is a thriving and profitable marketplace for those who know how to navigate the energy landscape. This report provides an overview of the five largest and most significant energy sub-sectors in the Canadian economy.

Oil

Over the last year, perspectives on Canada's petroleum markets have shifted from uncontrolled exuberance to decidedly cautious but positive.

There are two big pieces of good news for Canadian petroleum. Production is rising and will continue to rise -- perhaps rapidly -- for the foreseeable future. First, the Bakken Formation now appears to hold much larger reserves than previously anticipated, and advances in fracking technology make a larger portion of those recoverable than was imaginable five years ago. Second, continued development of the tar sands deposits promises radical expansion of that market, too. Overall, Canadian oil production is expected to more than double by 2030.

At first, all that extra production looked like a a black gold rush. Investors sobered up, however, as they watched global oil prices tank over the last year. In late 2014, the price of oil plunged below $50 per barrel for the first time since 2004. All that extra production from Canada, the United States and Russia functionally flooded the market just as demand growth started cooling off in China.

The current prices are artificially low, according to most experts. Many analysts expect oil to climb back over $70 a barrel by the end of 2015. Provided the price stabilizes, Canadian producers will be able to count on a healthy profit. If prices were to plummet again, however, some of the smaller producers could face serious cash flow problems. Future production growth would also decline if prices stay low.

Another factor counseling caution in the Canadian petroleum market are environmental objections. The tar sands projects remain controversial because the process of extracting and refining tar sand oil is much more polluting than conventional drilling. The industry has largely overcome domestic protests to tar sand extraction, but the environmental lobby successfully persuaded President Obama to veto construction of the Keystone XL pipeline. The pipeline isn't essential for Canadian petroleum's growth, but it's a worry sign. If the environmental movement gains more steam, it might pose a real challenge to profits.

Finally, Canadian oil will also have to compete with growing production from the United States. Most of the Bakken Formation is in North Dakota and available to U.S. petroleum countries. The U.S. has also expanded offshore drilling and, if the next president is a Republican, will likely increase drilling in Alaska, too. Since Middle Eastern production looks to be on the rise as well, it's possible demand will fall well short of supply and drive prices down further.

Overall, however, a few ugly splotches on the canvass shouldn't overwhelm the oil industry's rosy picture. Canada's natural oil wealth is larger than ever, and extraction efforts already in progress all but assure profitability.

Natural Gas

Oil and natural gas follow an almost parallel trajectory in Canada due to their similar extraction methods. With proven reserves in excess of 58 trillion cubic feet and a well-developed industry, it's no surprise that Canada is the world's fourth-largest producer. New technologies and ambitious investments by energy firms promise to increase that production over the next few years.

However, the same risk factors associated with Canada's oil industry apply to the natural gas industry. Gas prices didn't fall quite as precipitously in late 2014 as oil prices, but the markets definitely took a bearish turn. Production isn't only increasing in Canada--almost every other major player on the gas market is gearing up to open the floodgates.

Rising production and lower prices isn't necessarily a disaster for Canadian natural gas, but it does mean that producers will earn a lower margin per unit of gas extracted and sold.

Coal

Of the big three fossil fuel markets, coal looks to be the least exciting growth opportunity in Canada for 2015. The industry is definitely stable, capable or producing more than 60 million tons of coal a year and remaining profitable, but its growth prospects look sluggish.

With reserves clocking in at over 10 billion tons, Canada controls right around 4 percent of the world's remaining coal. Despite the immensity of its reserves, Canadian coal is strikingly underdeveloped. Only 19 coal mines operate within the country, with almost half of that in British Columbia. Part of the problem is that much of that reserve coal is located in remote regions of the country, but other issues are more significant.

First, coal has developed a major PR problem in significant portions of Canada. Ontario and Quebec have both launched significant green energy projects targeted specifically at displacing coal-burning power plants. British Columbia looks poised to reduce its dependence on coal as well.

Second, even before these green energy initiative really took off, coal consumption in Canada was stagnant. In fact, Canadians are burning virtually the same amount of coal now as they were in 2004.

Third, over the next few years coal will need to compete with incredibly cheap oil and gas. While the three aren't fungible, they do trade off with one another to an extent. If oil and gas prices remain depressed, however, electrical companies may opt to expand oil and gas-based electrical production. That would bite directly into coal's profit center.

Finally, Canadian demand for coal may be set to decline as heavy manufacturers continue to transition overseas. Steel production, famously dependent on coal for energy, has declined significantly in Canada over the last decade. If more metal producers go under or move to Asia, it will be hard for Canadian coal to remain competitive.

Canada remains one of the world's biggest coal producers, but most of its potential export partners are also big coal producers. The United States, for example, is unlikely to buy Canadian imports since it has sufficient domestic production. China has always seemed eager to buy despite its own domestic reserves, but it's trying desperately to control its smog population. Export opportunities don't look promising.

Nuclear

Canada's nuclear energy industry received some very good news lately: the Canadian and Indian governments appear ready to sign a deal promising significant cooperation on building and supplying new nuclear plants in India. Cameco, Canada's largest uranium producer, looks to be the biggest beneficiary from the deal. The company will supply virtually all of India's new uranium demand under the provisions of the new agreement.

However, the domestic nuclear industry continues to suffer from two pieces of recent bad news. First, scientists announced in mid-April the discovery of radioactive isotopes from the Fukushima nuclear disaster on the coast of British Colombia. The news underscores the risks of nuclear energy and may make Canadians even more skittish about supporting power stations near them.

Second, significant congressional opposition to Canada's proposed nuclear waste plan is forming in Washington, D.C. The existing plan calls for Canada's spent nuclear fuel to be stored less than a mile from banks of the Great Lakes. Without a viable nuclear waste storage proposal, it will be very difficult for any new nuclear power plants to break ground on Canadian soil. Democratic lawmakers in Washington may try to derail the storage plan and force Canada's nuclear industry to start from scratch.

Solar and Wind Energy

The future of Canadian solar and wind energy looks bright, especially if voters continue to emphasize environmental concerns at the polls. Canada has progressively expanded domestic solar and wind power production every year since 1992, with last year topping 1,000 installed solar MWp for the first time ever. Quebec alone expects to add 2,000 MWp of wind power by the end of 2015. The relative impact of renewable energies remains limited, however, accounting for only 1 percent of total energy production.

Unless political currents shift dramatically, however, the renewable share of the energy market should grow over the next several years. Photovoltaic panels continue to improve in efficiency, as do wind turbines. Major solar farms are planned for Sault Ste. Marie and Kingston, Ontario, and existing wind farms are growing all over the central plains.

There are a few clouds on the renewable energy horizon, however. First, the drop in fossil fuel prices makes it even harder for expensive solar, wind and other renewable technologies to compete. If gas and coal power plants can produce at less than $0.04 per kilowatt-hour, renewable energies will be stuck depending on government subsidies for the foreseeable future.

Second, political support for renewables may not be enough to keep those crucial subsidies in place. Japan and the European Union have previously filed complaints against Canadian green energy incentives in the WTO, arguing the plans violate free rules. Though some of those cases have lost, others have succeeded and forced Canadian provinces to retool their incentive structures. If other trading partners jump on the bandwagon, growth in solar and wind energy will be difficult to sustain.

Conclusion

The Canadian energy market remains a mixed bag, with some sectors looking very promising in the mid-term timeframe and others looking bleak. As always, the flow of political currents will dictate the success or failure of some critical sectors. However, in the big picture, dependence on fossil fuel makes oil and gas the most reliable bets in the energy world.

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