Canadian Upstream and Integrated Oil & Gas Outlook

As investors begin to navigate the complexities of investing in Canadian upstream oil and gas in 2024, we are releasing our updated commodity assumptions and equity outlook/key themes and investment trends for 2024 and beyond. In summary, we expect continued strong medium- and long-term investment appeal for the Canadian upstream and integrated oil and gas sector, with markets continuing to navigate near term volatility and the impacts of macroeconomic challenges. These near-term challenges generally see our 2024 forecasts for industry profit margins and returns on capital modestly lower than 2023 (with some commodity price drive downward revisions with this update, primarily to gassier producers). As a result, profitability metrics remain above the long-term industry averages, but trail the 2022-2023 timeframe, and in our view, oil and gas stock picking in 2024 has become inherently more difficult as a result. Key 2024 themes:

Near Term Volatility Driven by Pressure for Negative Earnings Estimate Revisions
Throughout H2/23, with some relatively brief blips of upward price pressure on the back of international conflicts and OPEC production cuts, both the oil and gas forward strip pricing have experienced persistent downward pressure, with both now sitting below consensus expectations across the street with the current gas 12-month strip price now sitting 32% below consensus, and oil 12-month strip 9% below. This gap between street expectations and current strip pricing is likely to contribute to a near-term negative earnings revision cycle that increases upstream oil and gas equity volatility, but also creates opportunity for investors with a longer time horizon.

Valuation Gaps Widened Making Oil and Gas Stock Picking Inherently More Difficult
In our 2022 and 2023 outlooks, we highlighted valuation/multiple convergence as a key trend, where the market was pricing limited differentiation between what we perceived to be higher quality and lower quality business models (with inventory quality and depth as a key attribute to differentiate between higher and lower quality business models, in our view). Over the past 12 months, the market has again begun to clearly differentiate between higher and lower quality business models (see full report), driven by an M&A cycle that has instructively placed a premium on inventory in transaction multiples. As a result of the clear differentiation, we now view stock picking within the sector as inherently more challenging, where investors will have to weigh a trade off between lower quality and higher risk business models and assets at cheaper valuations and higher quality lower risk assets at more expensive valuations, and the breadth of alpha is likely to narrow. We favour higher quality business models, at opportunistic valuations and favour names such as (see full report). 

Long Anticipated Structural Improvement to Canadian Upstream Outlook Hopefully Takes Hold in H1/24, But Not Without Road Bumps
Will 2024 be the year that TMX is completed? We will soon find out, with engineering specifications for a recent variance request due in early January. Once completed, TMX has the potential to bring to fruition long anticipated step changes in Canadian oil and gas egress capacity and industry growth potential with the key project set to change the competitive dynamics of Canadian price realizations by adding material market access, with the forward curve currently pricing WCS differentials at US$13.85/bbl in August 2024 (from US$20.05/bbl currently).

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