Saturday, September 11, 2010

3 reasons why Canadian oil stocks could move higher in the coming months

1) Mergers and Acquisitions

BHP Billiton's ongoing $39 billion bid for Potash Corp, and Intel's recent $7.86 billion purchase of McAfee show that M&A activity has been increasing in recent weeks. In fact, according to Thomson Reuters, about $200 billion of M&A has been announced in August. From the beginning of 2010 until August 23, $1.5 trillion of M&A has occurred, which is 20.6% higher than last year.

The increase in M&A activity is due to North American companies having accumulated significant levels of cash during the recession from cost-cutting. In addition, extremely low interest rates and easier access to loans also enhances companies' abilities to make acquisitions. Furthermore, cheap valuations make targets seem more attractive. 

Chinese state-owned companies have done many deals in the Canadian energy sector in the past year. Examples include the $4.6 billion acquisition of a 9% stake in Canadian Oil Sands Trust, and a $1.6 billion purchase of a 60% stake in Athabasca Oil Sands properties. Direct investment by Chinese companies is not going to slow down in the final quarter of 2010 and beyond. This will provide a significant boost to select Canadian companies that are involved in M&A activities, and provide a smaller boost to the entire sector.

2) Hurricane Season

It is currently the middle of the hurricane season, with hurricane Earl having collided with the North American east coast days earlier. U.S. government scientists predict a very active 2010 season, with 14 to 20 tropical storms, and 8 to 12 of them becoming hurricanes. In addition, The National Oceanic and Atmospheric Administration expects 4 to 6 “major” hurricanes, which have top winds of more than 110 mph.  

A strong hurricane season could disrupt oil production in the Gulf of Mexico, sending oil prices higher and benefiting the TSX's one-third weighing in the energy sector. According to Jeff Rubin, former chief economist at CIBC, hurricanes also jeopardize 40% of the U.S. refinery capacity. The 2005 hurricane season raised oil prices by 10%, while prices at the pump rose by 50% to $3/gallon. In 2008, hurricane Ike's direct hit on the Houston refining area sent pump prices to $5/gallon. 

3) Military Conflict in the Middle East

Iran's Bushehr nuclear reactor became operational in late August. News articles have been quoting Israeli military officials for years about how much they want to destroy the reactor. Numerous military exercises have already been conducted in which the Israeli Air Force simulate striking the reactor. Israel has also conducted air strikes on nuclear reactors in the past, bombing Iraq's Osirak nuclear reactor in 1981, and Syria's North Korea-built reactor in 2007. 

According to a recent article in The Atlantic, U.S. Secretary of Defence Robert Gates stated in June of this year that it would take Iran 12 months to acquire a nuclear weapon. Israeli officials estimate the timing to be 9 months, which means Iran would acquire a nuclear bomb by March 2011. It is believed that Israeli officials will give UN sanctions a chance to work until December, then begin preparing for an air strike that will occur by March.

An air strike by Israel on the Bushehr reactor, and the subsequent political firestorm in the Middle East would send oil prices and the TSX's energy sector surging. An example is the military conflict between Israel and Lebanon militants in December 2008 and January 2009. For example, Suncor Energy's shares went from a low of C$21.51 on December 24th to a high of C$29.78 in the week of January 6th (a 38% gain in 2 weeks) simply because of the military conflict. Similarly, Canadian Natural Resources saw its shares rise from C$22.45 on December 24th to C$28.60 on January 6th (a 27.4% gain).

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