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Are Short-Sellers Right About Canadian Natural Resources (TSX:CNQ)?

The Motley Fool logo The Motley Fool 4/22/2019 Matt Smith
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Despite oil surging to its highest price for 2019 to see West Texas Intermediate (WTI) trading at over US$65 a barrel at writing, there is still considerable negative sentiment surrounding Canadian energy stocks. One that is attracting considerable negative attention is the largest oil sands operator, Canadian Natural Resources (TSX:CNQ)(NYSE:CNQ) which is the fifth most shorted stock on the TSX.

In fact, the oil sands giant is attracting more negative attention than many of the big banks, which have also been targeted by U.S. short-sellers. The reasons for this are simple: there is considerable risk and uncertainty attached to the oil sands, along with recent political developments and Canadian Natural’s considerable amount of long-term debt, leave it particularly vulnerable.

Rising possibility of weaker oil

There are fears of another oil price collapse emerging later this year when OPEC and Russia consider whether to extend the current production cuts, as Trump’s moves to eliminate sanction waivers coupled with deteriorating oil output in Libya and Venezuela effectively remove the cartel’s rationale for having those cuts in place.

In addition, once Edmonton winds down its mandatory production cuts, the price Western Canadian Select (WCS) could plunge once again as production and local inventories grow.

The prospect of weaker crude is particularly bad news for Canadian Natural because bitumen and other forms of heavy crude produced from oil sands make up a fifth of its production. Another significant proportion of Canadian Natural’s oil output is synthetic crude. This is essentially bitumen that has been upgraded, a costly and complex process resulting in production outages caused by operational issues.

Furthermore, Canadian Natural has considerable exposure to natural gas that makes up around a quarter of its total hydrocarbon output. Despite favourable fundamentals including rapidly growing consumption, natural gas has been caught in a sustained slump for some time now.

After spiking significantly toward the end of 2018, the fuel has fallen sharply to be trading at around its lowest price since mid-2016 at writing.

The impact this is having on Canadian Natural’s earnings is being exacerbated by the wide price differential between the Canadian AECO natural gas price and the North American Henry Hub benchmark. That differential has widened noticeably in recent weeks to see AECO price of $0.89 per million British thermal units (MMBtu) at roughly one third of the Henry Hub price.

When these factors are considered in conjunction with Canadian Natural’s high estimated break even costs of over US$40 a barrel, it is easy to understand why it is such a popular target among short-sellers.

Investors should also note that the company is carrying a massive debt burden of over $19 billion, which is a worrying 25 times its 2018 EBITDA. Such a burdensome amount of debt reduces Canadian Natural’s financial flexibility, making it extremely vulnerable to another downturn in crude.

As mentioned earlier, there is every likelihood that oil could weaken substantially during the second-half of 2019 as emerging supply constraints are eliminated by OPEC and Russia opening the spigots further.

What does it mean for investors?

While I am not a tremendous fan of shorting stocks, particularly one with a dividend yielding 3.6% that must be paid, it’s easy to understand why Canadian Natural is being targeted. There are a range of indicators showing that oil prices could plunge once again, placing considerable financial pressure on the company and its market value.

This is being exacerbated by the push to cleaner sources of energy and the increasing unpopularity of Canada’s oil sands as a source of crude. For these reasons, investors seeking exposure to the energy patch would do better to look elsewhere.

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Fool contributor Matt Smith has no position in any of the stocks mentioned.

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