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.