The Keystone XL Pipeline and your investments
By Alek Sawchuk, CFA, CIM 19 February 2021 6 min read
As one of his first actions in office, newly-appointed President Joe Biden formally revoked the permit needed to build the Keystone XL Pipeline (KXL) extending from the Canadian oilsands to Steele City, Nebraska.
Over the last few weeks this has left investors wondering how this decision will affect the Canadian energy sector, oilsands, and what precedent it sets for permit cancelation moving forward. Many Albertans are understandably concerned about how this might impact their portfolios.
Although the ultimate impact of this decision on the Canadian energy sector is yet to be fully realized, proper portfolio construction and diligent diversification can largely alleviate the impact felt from the cancellation.
Portfolio impact, of course, is not the only consideration as there are many dollars invested outside of traditional portfolios and jobs lost in the province given the revocation of the pipeline permit.
Should I be worried?
If your portfolio is Canadian energy-heavy, the decision will likely affect your portfolio. Some companies, like Suncor, announced that they are putting projects on hold because of the uncertainty the cancellation has brought. TC Energy, headquartered in Calgary, is the owner of Keystone XL.
Issues with the pipeline expansion are likely to restrict growth in the sector. Without the expansion, oil sold will continue to garner lower prices. Alberta oil currently fetches $40 per barrel (WCS denominated in USD as of January 2021 month-end), less than the widely followed West Texas Intermediate (WTI) settling at a respective $52 USD. The expansion would have allowed Canada to sell to other markets for much higher prices. Without it, Alberta will see the maintenance of the status quo, rather than any real growth.
Oil prices - WTI vs. WCS
Understanding oil and gas prices
Being an informed investor means understanding which oil benchmark (reference price) the news is actually referring to. There are three main crude oil benchmarks quoted in the markets: WTI (West Texas Intermediate), WCS (Western Canadian Select) and Brent (International).
These three benchmarks differentiate themselves by geography and oil quality (grade) characteristics; with WCS representing the price more directly impacting Canadian oil companies and having the qualities of being “heavier and sour” - which is related to the nature of oilsands and the heavier “sludge-like” extraction and subsequent refinement process involved.
The oil price benchmark distinction is important since WCS prices impact our provincial economy. Historically, oil prices in Canada (WCS) have traded at a material discount to its United States counterpart oil benchmark (WTI). The driving force behind this extends to supply constraints and the inability for Alberta to push out its oil supply and satiate global demand; lower WCS prices were subsequently not driven as much by a lack of demand (which fluctuates over the years), but rather the inability to transport our “hot commodity” which was gushing out of storage tankers.
Taking a look at the chart, we can see the difference between the two oil price benchmarks WCS and WTI. The chart data goes back to mid-2008 and we can see during the historic period the steepest Canadian oil discount was ~$50USD on October 11, 2018. Overall, it is quite evident that WCS has historically traded at a discount to WTI with persistent supply constraints. It should also be noted that WTI prices went negative on 4/20/2020 and settled at -$38 for the first time in history.
The Keystone XL pipeline was a project which seeked to alleviate some of this “bottlenecked” oil as storage capacity hit an all-time high. However, given the steadfast and resilient nature of Albertans - we attempted to utilize other vehicles (such as railway) “crude-by-rail” transportation to move our desirable oil products, and the provincial government attempted to stabilize prices with mandatory curtailment measuress with some evident success.
Why is a diversified investment portfolio important?
Diversifying a portfolio means spreading your investments across different sectors and countries, so as to reduce the risks from any one area. Over time, allocating your investments to different areas of the overall economy helps to smooth out your return and have less volatility in your portfolio. That’s why the pipeline decision will have little impact on appropriately diversified portfolios.
While investing in a single sector can bring large, short-term returns when that particular industry is booming, it can also backfire on you.
If your portfolio is heavily concentrated in one sector, for example technology, your stocks could fall by as much as 50% rather quickly. Unless something catastrophic happens to markets, your diversified portfolio won’t be down 50%. Even then, investors are more likely to experience volatility rather than a permanent capital loss.
What is home bias and how can it harm investment returns?
Home bias is the tendency to invest in the stocks of companies that are in your home country. Much like Albertans investing heavily in oil and gas, investors tend to bias their investments towards company names and geographies they’re familiar with, because they feel they understand them better.
The problem with having a home bias in your investments is that if your country performs poorly, your whole portfolio performs poorly. With home bias there’s nothing else to make up for those losses.
With diverse investments, you can have exposure to global stocks to offset your portfolio when one sector or country underperforms. So far this year, Canada has been fairly flat, with the S&P TSX Composite up almost one percent. In the US, the S&P 500 is up about 14% in Canadian dollar terms, so if you’re investing only in Canada, so far this year you wouldn’t have made nearly as much on your investments as you would’ve if you also had US exposure.
Different sectors within different geographies can also make a difference within your portfolio. For example, the US is very strong for technology, with Apple, Facebook and Google and it also has consumer giants like Walmart and Amazon. Canada doesn’t have local companies that are nearly as competitive as these giants. That’s why it’s important to invest globally.
Do I have too much oil and gas exposure in my portfolio?
If you’re working for an energy company and have invested considerably in their stock, then your portfolio will probably be too heavily concentrated in one sector. It’s similar to an individual working in a bank and owning all bank stocks. Many people invest in the sector they work in, because they’re familiar with it. But when you’re working within it, you can get wrapped up in the emotions of it. In the case of Albertans, your salary, and the value of your home, are also tied to oil prices.
Professional money managers can help investors manage their home bias and prevent them from being overly concentrated within their portfolio. Getting financial advice can also help keep other emotional decisions at bay.
Invest for the long-term to minimize short-term noise
Events, like the pipeline expansion decision, can cause you to be uncertain about the future. There is always going to be volatility, so it’s important to have a diversified portfolio that can smooth out those volatile events.
A diversified portfolio can ride out volatility but listening and reacting to the noise can lead to permanent capital loss. If you feel your investments are too energy-focused or have too much of a home bias, contact ATB Wealth and we will help you construct a portfolio that’s right for you.
At the end of the day we want to refrain from getting caught up in making decisions based on short-term market news largely out of our control. It’s important to maintain a long-term investment approach spread both geographically and across all of the investment sectors, since we can’t guess which will outperform/underperform in a given year.
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