Significant value opportunities emerging in Canadian infrastructure sector
Jim Wright, manager of the LF Miton Global Infrastructure Income Fund, explains why an improving environment for Canadian energy stocks has prompted him to increase allocation from 15.2 per cent at the end of March 2018 to 17.4 per cent…
After a period of stagnation, we see significant value opportunities emerging in the Canadian infrastructure sector.
We expect strong growth in oil and gas production over the coming years, based on abundant resources and more effective and efficient extraction. Demand for oil and gas for domestic consumption, from the USA and, increasingly, for overseas export, is likely to continue to grow, creating substantial need for more infrastructure to process, store and transport these commodities.
Concerns over the environmental footprint of Canadian oil production, wider permitting issues on new pipelines and infrastructure, and the funding model for much of the sector, have weighed on the growth of the sector and valuations of energy infrastructure stocks in recent years. During this period well-capitalised companies in the sector have continued to grow their cashflows and dividends, but valuations haven’t reflected this. As negative sentiment is challenged, and fundamentals are repaired, we see the opportunity not just for valuations to catch up with this underlying growth, but to begin to reflect the future opportunities for these companies.
Looking at Canadian “oil sands”, many investors have taken a negative stance given the high energy footprint for extraction in Western Canada. However, the industry has started to push back on this, pointing out that Environmental, Social and Governance (ESG) ratings shouldn’t solely focus on emissions, but also factors such as safety, corruption, social engagement, the rule of law, open and democratic elections, equal rights and respect for indigenous peoples. There’s little argument that compared to other major oil-producing states such as Saudi Arabia, Russia or Iran, Canada would score well on all these factors.
Issues around permitting have negatively influenced new pipelines. The three planned pipeline expansions to move oil from Alberta to the West Coast of Canada (Trans Mountain Express) and to the USA (Keystone XL and Enbridge’s Line 3) have all met significant regulatory hurdles. However, we’ve now begun to see real progress for these pipelines. One of the strongest voices in favour of Canada building more oil and LNG infrastructure, and expediting the permissioning process, has been the current President of OPEC, UAE Energy Minister Suhail Al Mazrouei. He’s highlighted that the world needs access to the incremental Canadian oil supply, and the UAE has invested in Canadian oil production through the Abu Dhabi National Energy Company.
We believe the sector will get a very significant boost from the growth of overseas export terminals for gas and natural gas liquids, providing access to important new markets in Asia from the West Coast of Canada. The Ridley Island propane export terminal constructed by AltaGas is expected to be in service by Q1 2019 and both Royal Dutch Shell and Pembina are working towards final investment decisions on LNG export terminals.
Canadian energy infrastructure stocks have also been impacted by the negative sentiment around Master Limited Partnerships (MLPs), tax-efficient vehicles set up to own pipeline assets in the USA. This had a direct impact on Enbridge and TransCanada which used MLP vehicles to finance some of their US assets. The tax benefits of MLP structures were thrown into doubt by the Federal Energy Regulatory Commission (FERC) in March 2018, but recent clarifications have been more constructive, and in Enbridge’s case the company has offered to acquire all the minority stakes in MLP vehicles where it’s the sponsor, which will clean up the corporate structure and be accretive to the parent company’s cashflow.
In terms of proven oil reserves, Canada ranks number three globally. A combination of this supply, growing demand, a more constructive permitting environment and well-funded companies will lead to significant growth in earnings, cashflows and dividends and present a compelling case for infrastructure investors over the next decade.